**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE** |
|---------------------------------------------------------------------------------|
| **SECURITIES  EXCHANGE ACT OF 1934**                                            |

 

**For the quarterly period ended March 31, 2005**

 

**OR**

 
| **o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE** |
|-----------------------------------------------------------------------------|
| **SECURITIES  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   incorporation or organization) |       | (I.R.S. Employer   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)        |

 

 

Indicate by checkmark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15 (d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 days.     Yes   ý   No   o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes   ý   No   o

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.

 

| **Class**    | ** ** | **Outstanding at May 3,  2005** |
|--------------|------------|--------------------------------------|
|         |       |                                 |
| Common Stock |       | 17,118,587                           |

 

 

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**EDGE PETROLEUM CORPORATION**

 

**Table of Contents**

 

** **
| Part I.  Financial Information |                                                                                                                                          |
|-------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
|                                | Item 1. Financial  Statements:                                                                                                                |   |
|                                | Consolidated Balance Sheets  as of March 31, 2005 and December 31, 2004                                                             |   |
|                                | Consolidated  Statements of Operations for the Three Months in the Periods Ended  March 31, 2005 and March 31, 2004            |   |
|                                | Consolidated  Statements of Other Comprehensive Income for the Three Months in the Periods  Ended March 31, 2005 and March 31, 2004 |   |
|                                | Consolidated  Statements of Cash Flows for the Three Months in the Periods Ended  March 31, 2005 and March 31, 2004            |   |
|                                | Consolidated  Statements of Stockholders’ Equity as of March 31, 2005 and  December 31, 2004                                   |   |
|                                | Notes to  the Consolidated Financial Statements                                                                                               |   |
|                                | Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations                                          |   |
|                                | Item  3. Qualitative and Quantitative Disclosures About Market Risk                                                                           |   |
|                                | Item 4. Controls and  Procedures                                                                                                              |   |
| Part II. Other  Information    |                                                                                                                                          |
|                                | Item 1. Legal Proceedings                                                                                                                     |   |
|                                | Item  2. Unregistered Sale of Equity Securities and Use of Proceeds                                                                           |   |
|                                | Item 3.  Defaults Upon Senior Securities                                                                                                      |   |
|                                | Item  4. Submission of Matters to a Vote of Security Holders                                                                                  |   |
|                                | Item 5. Other Information                                                                                                                     |   |
|                                | Item 6. Exhibits                                                                                                                              |   |
| Signatures                          |                                                                                                                                          |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

**EDGEPETROLEUM CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                            | ** ** | **March 31,  2005** | ** **  | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|-------------|------------------------|------------|
| ** **                                                                                                                                                                                                                            | ** ** | **(Unaudited)**          | ** **  | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                            |       |                     |        |                   |       |
| CURRENT ASSETS:                                                                                                                                                                                                                       |       |                     |        |                   |       |
| Cash and cash  equivalents                                                                                                                                                                                                            |       | $                        | 4,637,128   |                   | $          | 2,267,423 |   |
| Accounts  receivable, trade, net of allowance of $525,248 at March 31, 2005 and  December 31, 2004                                                                                                                          |       | 14,097,880               |        | 13,715,890             |       |
| Accounts  receivable, joint interest owners, net of allowance of $93,000 and $82,000 at  March 31, 2005 and December 31, 2004, respectively                                                                                 |       | 2,233,619                |        | 5,911,073              |       |
| Deferred income  taxes                                                                                                                                                                                                                |       | 2,098,966                |        | 660,223                |       |
| Derivative  financial instruments                                                                                                                                                                                                     |       | —                   |        | 1,824,790              |       |
| Other current  assets                                                                                                                                                                                                                 |       | 2,536,694                |        | 1,445,923              |       |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| Total current  assets                                                                                                                                                                                                                 |       | 25,604,287               |        | 25,825,322             |       |
| PROPERTY AND  EQUIPMENT, Net – full cost method of accounting for oil and natural gas  properties (including unproved costs of $14.2 million and $15.5 million at  March 31, 2005 and December 31, 2004, respectively) |       | 170,059,552              |        | 165,840,345            |       |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| OTHER ASSETS                                                                                                                                                                                                                          |       | 248,745                  |        | 284,280                |       |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| TOTAL ASSETS                                                                                                                                                                                                                          |       | $                        | 195,912,584 |                   | $          | 191,949,947 |   |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                        |       |                     |        |                   |       |
| ** **                                                                                                                                                                                                                            |       |                     |        |                   |       |
| CURRENT  LIABILITIES:                                                                                                                                                                                                                 |       |                     |        |                   |       |
| Accounts  payable, trade                                                                                                                                                                                                              |       | $                        | 2,315,190   |                   | $          | 3,141,235 |   |
| Accrued  liabilities                                                                                                                                                                                                                  |       | 12,368,425               |        | 13,065,487             |       |
| Asset retirement  obligation – current portion                                                                                                                                                                                   |       | 195,762                  |        | 193,647                |       |
| Derivative  financial instruments                                                                                                                                                                                                     |       | 2,600,095                |        | 468,308                |       |
| Total current  liabilities                                                                                                                                                                                                            |       | 17,479,472               |        | 16,868,677             |       |
| ASSET RETIREMENT  OBLIGATION – long-term portion                                                                                                                                                                                 |       | 2,038,411                |        | 1,995,441              |       |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| DEFERRED TAX  LIABILITY                                                                                                                                                                                                               |       | 5,503,824                |        | 2,618,934              |       |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| LONG-TERM DEBT                                                                                                                                                                                                                        |       | 10,000,000               |        | 20,000,000             |       |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| Total  liabilities                                                                                                                                                                                                                    |       | 35,021,707               |        | 41,483,052             |       |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| COMMITMENTS AND  CONTINGENCIES (NOTE 9)                                                                                                                                                                                               |       |                     |        |                   |       |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| STOCKHOLDERS’  EQUITY                                                                                                                                                                                                            |       |                     |        |                   |       |
| Preferred stock,  $0.01 par value; 5,000,000 shares authorized; none issued and outstanding                                                                                                                                           |       | —                   |        | —                 |       |
| Common stock,  $0.01 par value; 25,000,000 shares authorized; 17,114,555 and 16,535,901  shares issued and outstanding at March 31, 2005 and December 31,  2004, respectively                                               |       | 171,145                  |        | 165,359                |       |
| Additional  paid-in capital                                                                                                                                                                                                           |       | 134,649,661              |        | 126,957,059            |       |
| Retained  earnings                                                                                                                                                                                                                    |       | 26,819,337               |        | 22,095,807             |       |
| Accumulated  other comprehensive income (loss)                                                                                                                                                                                        |       | (749,266                 | )           | 1,248,670              |       |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| Total  stockholders’ equity                                                                                                                                                                                                      |       | 160,890,877              |        | 150,466,895            |       |
|                                                                                                                                                                                                                                  |       |                     |        |                   |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                      |       | $                        | 195,912,584 |                   | $          | 191,949,947 |   |

 

See accompanying notes to consolidated financialstatements.

 

3

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**EDGEPETROLEUM CORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

 
| ** **                                                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| OIL AND NATURAL  GAS REVENUE:                                 |       |                                   |       |   |   |
| Oil and natural  gas sales                                    | ** ** | $                                      | 23,928,689 |   | $ | 15,796,491 | ** ** |
| Gain (loss) on  hedging and derivatives                       |       | (984,844                               | )          | 18,166 |   |
| Total revenue                                                 |       | 22,943,845                             |       | 15,814,657 |   |
|                                                          |       |                                   |       |   |   |
| OPERATING  EXPENSES:                                          |       |                                   |       |   |   |
| Oil and natural  gas operating expenses                       |       | 2,242,465                              |       | 1,205,073 |   |
| Severance and ad  valorem taxes                               |       | 1,866,488                              |       | 1,044,714 |   |
| Depletion,  depreciation, amortization and accretion          |       | 8,635,629                              |       | 5,242,416 |   |
| General and  administrative expenses:                         |       |                                   |       |   |   |
| Deferred  compensation – repriced options                |       | 261,904                                |       | 1,111,099 |   |
| Deferred  compensation – restricted stock                |       | 143,599                                |       | 96,500 |   |
| Bad debt expense                                              |       | 11,000                                 |       | — |   |
| Other general  and administrative expenses                    |       | 2,478,725                              |       | 1,900,827 |   |
|                                                          |       |                                   |       |   |   |
| Total operating  expenses                                     |       | 15,639,810                             |       | 10,600,629 |   |
|                                                          |       |                                   |       |   |   |
| OPERATING INCOME                                              |       | 7,304,035                              |       | 5,214,028 |   |
| OTHER INCOME AND  EXPENSE:                                    |       |                                   |       |   |   |
| Interest income                                               |       | 32,346                                 |       | 4,008 |   |
| Interest  expense, net of amounts capitalized                 |       | —                                 |       | (114,278 | ) |
| Amortization of  deferred loan costs                          |       | (35,535                                | )          | (29,636 | ) |
|                                                          |       |                                   |       |   |   |
| INCOME BEFORE  INCOME TAXES                                   |       | 7,300,846                              |       | 5,074,122 |   |
|                                                          |       |                                   |       |   |   |
| INCOME TAX  EXPENSE                                           |       | (2,577,316                             | )          | (1,790,886 | ) |
|                                                          |       |                                   |       |   |   |
| NET INCOME                                                    |       | $                                      | 4,723,530  |   | $ | 3,283,236 |   |
|                                                          |       |                                   |       |   |   |
| BASIC EARNINGS  PER SHARE                                     |       | $                                      | 0.28       |   | $ | 0.26 |   |
|                                                          |       |                                   |       |   |   |
| DILUTED EARNINGS  PER SHARE                                   |       | $                                      | 0.27       |   | $ | 0.25 |   |
|                                                          |       |                                   |       |   |   |
| BASIC WEIGHTED  AVERAGE NUMBER OF COMMON SHARES OUTSTANDING   |       | 17,042,389                             |       | 12,725,951 |   |
|                                                          |       |                                   |       |   |   |
| DILUTED WEIGHTED  AVERAGE NUMBER OF COMMON SHARES OUTSTANDING |       | 17,692,122                             |       | 13,317,839 |   |

 

See accompanyingnotes to consolidated financial statements.

 

4

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**EDGEPETROLEUM CORPORATION**

**CONSOLIDATEDSTATEMENTS OF OTHER COMPREHENSIVE INCOME (Unaudited)**

 
| ** **                                                                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                  | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                                                                        |       |                                  |       |   |   |
| NET INCOME                                                                  |       | $                                     | 4,723,530  |   | $ | 3,283,236 |   |
|                                                                        |       |                                  |       |   |   |
| OTHER  COMPREHENSIVE INCOME (LOSS), net of tax:                             |       |                                  |       |   |   |
|                                                                        |       |                                  |       |   |   |
| Change in fair  value of outstanding hedging and derivative instruments (1) |       | (1,659,966                            | )          | (616,269 | ) |
|                                                                        |       |                                  |       |   |   |
| Reclassification  of hedging and derivative losses (2)                      |       | (337,970                              | )          | 48,657 |   |
|                                                                        |       |                                  |       |   |   |
| Other  comprehensive loss                                                   |       | (1,997,936                            | )          | (567,612 | ) |
|                                                                        |       |                                  |       |   |   |
| COMPREHENSIVE  INCOME                                                       |       | $                                     | 2,725,594  |   | $ | 2,715,624 |   |
|                                                                             |       |                                  |       |   |   |
| (1) net of  income tax benefit                                         |       | $                                     | 893,828    |   | $ | 331,837 |   |
|                                                                        |       |                                  |       |   |   |
| (2) net of  income tax (expense) benefit                               |       | $                                     | 181,984    |   | $ | (32,460 | ) |

 

See accompanyingnotes to the consolidated financial statements**.**

 

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**EDGEPETROLEUM CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)**

 
| ** **                                                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                         | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                     | 4,723,530  |   | $ | 3,283,236 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                  |       |   |   |
| Loss (gain) on  the fair value of derivative                                       |       | 882,830                               |       | (45,466 | ) |
| Deferred income  taxes                                                             |       | 2,577,316                             |       | 1,790,886 |   |
| Depletion,  depreciation, amortization and accretion                               |       | 8,635,629                             |       | 5,242,416 |   |
| Amortization of  deferred loan costs                                               |       | 35,535                                |       | 29,636 |   |
| Deferred  compensation                                                             |       | 405,503                               |       | 1,207,599 |   |
| Bad debt expense                                                                   |       | 11,000                                |       | — |   |
| Changes in  assets and liabilities:                                                |       |                                  |       |   |   |
| Increase in  accounts receivable, trade                                            |       | (381,990                              | )          | (1,017,896 | ) |
| Decrease in  accounts receivable, joint interest owners                            |       | 3,666,454                             |       | 595,645 |   |
| Increase in  other assets                                                          |       | (1,090,771                            | )          | (300,231 | ) |
| Decrease in  accounts payable, trade                                               |       | (826,045                              | )          | (125,196 | ) |
| Increase  (decrease) in accrued liabilities                                        |       | (669,981                              | )          | 1,769,875 |   |
| Increase in  accrued interest payable                                              |       | —                                |       | 45,195 |   |
|                                                                               |       |                                  |       |   |   |
| Net cash  provided by operating activities                                         |       | 17,969,010                            |       | 12,475,699 |   |
|                                                                               |       |                                  |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                         |       |                                  |       |   |   |
| Oil and natural  gas property and equipment additions                              |       | (12,809,751                           | )          | (11,345,294 | ) |
| Proceeds from  the sale of oil and natural gas properties                          |       | —                                |       | 40,000 |   |
|                                                                               |       |                                  |       |   |   |
| Net cash used in  investing activities                                             |       | (12,809,751                           | )          | (11,305,294 | ) |
|                                                                               |       |                                  |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                         |       |                                  |       |   |   |
| Payments of  long-term debt                                                        |       | (10,000,000                           | )          | (1,000,000 | ) |
| Net proceeds  from issuance of common stock                                        |       | 7,210,446                             |       | 1,323,870 |   |
| Deferred loan  costs                                                               |       | —                                |       | (355,629 | ) |
|                                                                               |       |                                  |       |   |   |
| Net cash used in  financing activities                                             |       | (2,789,554                            | )          | (31,759 | ) |
|                                                                               |       |                                  |       |   |   |
| **NET  INCREASE IN CASH AND CASH EQUIVALENTS**                                     |       | 2,369,705                             |       | 1,138,646 |   |
| ** **                                                                         |       |                                  |       |   |   |
| **CASH  AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                |       | 2,267,423                             |       | 1,327,081 |   |
| ** **                                                                         |       |                                  |       |   |   |
| **CASH  AND CASH EQUIVALENTS, END OF PERIOD**                                      |       | $                                     | 4,637,128  |   | $ | 2,465,727 |   |

 

See accompanyingnotes to consolidated financial statements.

 

6

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**EDGEPETROLEUM CORPORATION**

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

 
| ** **                                                           | ** ** | **Common Stock** | ** ** | **Additional  Paid-in Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|----------------------------------------------------------------------|------------|------------------|------------|---------------------------------|------------|------------------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|
| **Shares**                                                           | ** ** | **Amount**       |
| BALANCE,  DECEMBER 31, 2004                                     |       | 16,535,901       |       | $                               | 165,359    |                   | $          | 126,957,059                                          |       | $                                     | 22,095,807 |   | $ | 1,248,670 |   | $ | 150,466,895 |   |
|                                                                 |       |             |       |                            |       |                   |       |                                                 |       |                                  |       |   |   |   |   |   |   |   |
| Issuance of  common stock                                            |       | 578,654          |       | 5,786                           |       | 7,231,741              |       | —                                               |       | —                                |       | 7,237,527 |   |
|                                                                 |       |             |       |                            |       |                   |       |                                                 |       |                                  |       |   |   |
| Deferred compensation  – restricted stock                       |       | —           |       | —                          |       | 143,599                |       | —                                               |       | —                                |       | 143,599 |   |
|                                                                 |       |             |       |                            |       |                   |       |                                                 |       |                                  |       |   |   |
| Deferred  compensation – repriced options                       |       | —           |       | —                          |       | 261,904                |       | —                                               |       | —                                |       | 261,904 |   |
|                                                                 |       |             |       |                            |       |                   |       |                                                 |       |                                  |       |   |   |
| Change in  valuation of hedging instruments                          |       | —           |       | —                          |       | —                 |       | —                                               |       | (1,997,936                            | )          | (1,997,936 | ) |
|                                                                 |       |             |       |                            |       |                   |       |                                                 |       |                                  |       |   |   |
| Tax benefit  associated with exercise of non-qualified stock options |       | —           |       | —                          |       | 55,358                 |       | —                                               |       | —                                |       | 55,358 |   |
|                                                                 |       |             |       |                            |       |                   |       |                                                 |       |                                  |       |   |   |
| Net income                                                           |       | —           |       | —                          |       | —                 |       | 4,723,530                                            |       | —                                |       | 4,723,530 |   |
|                                                                 |       |             |       |                            |       |                   |       |                                                 |       |                                  |       |   |   |
| BALANCE, March 31,  2005                                        |       | 17,114,555       |       | $                               | 171,145    |                   | $          | 134,649,661                                          |       | $                                     | 26,819,337 |   | $ | (749,266 | ) | $ | 160,890,877 |   |
|                                                                      |            |                  |            |                                 |            |                        |            |                                                      |            |                                       |            |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidated financialstatements.

 

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**EDGEPETROLEUM CORPORATION**

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

** **

The financial statementsincluded herein have been prepared by Edge Petroleum Corporation, a Delawarecorporation (“we”, “our”, “us” or the “Company”), without audit pursuant to therules and regulations of the Securities and Exchange Commission (“SEC”),and reflect all adjustments which are, in the opinion of management, necessaryto present a fair statement of the results for the interim periods on a basisconsistent with the annual audited consolidated financial statements.  All such adjustments are of a normalrecurring nature.  The results ofoperations for the interim periods are not necessarily indicative of theresults to be expected for an entire year. Certain information, accounting policies and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States of America havebeen omitted pursuant to such rules and regulations, although we believethat the disclosures are adequate to make the information presented notmisleading. These financial statements should be read in conjunction with ouraudited consolidated financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2004.

 

***Oil and Natural GasProperties*****-**Investments in oil and natural gasproperties are accounted for using the full-cost method of accounting. Theaccounting for our business is subject to special accounting rules thatare unique to the oil and gas industry. There are two allowable methods of accounting for oil and gas businessactivities:  the successful-effortsmethod and the full-cost method.  Thereare several significant differences between these methods. Among thesedifferences is that, under the successful-efforts method, costs such asgeological and geophysical (“G&G”), exploratory dry holes and delay rentalsare expensed as incurred whereas under the full-cost method these types ofcharges are capitalized to their respective full-cost pool.  In the measurement of impairment of oil andgas properties, the successful-efforts method of accounting follows theguidance provided in Statement of Financial Accounting Standards (“SFAS”) No. 144,“*Accounting for the Impairment or Disposalof Long-Lived Assets*,” where the first measurement for impairment isto compare the net book value of the related asset to its undiscounted futurecash flows using commodity prices consistent with management expectations.  The full-cost method follows guidanceprovided in SEC Regulation S-X Rule 4-10, where impairment is determinedby comparing the net book value (full-cost pool) to the future net cash flowsdiscounted at 10 percent using commodity prices in effect at the end of thereporting period.

 

In accordance with the full-cost method of accounting,all costs associated with the exploration, development and acquisition of oiland natural gas properties, including salaries, benefits and other internalcosts directly attributable to these activities are capitalized within a costcenter.  The Company’s oil and naturalgas properties are located within the United States of America and constituteone cost center. The Company also capitalizes a portion of interest expense onborrowed funds.  Employee related costs thatare directly attributable to exploration and development activities are alsocapitalized.  These costs are consideredto be direct costs based on the nature of their function as it relates to theexploration and development activities.

 

Oil and natural gas properties are amortized based ona unit-of-production method using estimates of proved reserve quantities. Oiland NGLs are converted to gas equivalent basis (“Mcfe”) at the rate of onebarrel equals six Mcf. Investments in unproved properties are not amortizeduntil proved reserves associated with the prospects can be determined or untilimpairment occurs.  Oil and natural gasproperties include costs of $14.2 million and $15.5 million at March 31,2005 and December 31, 2004, respectively, related to unproved property,which were excluded from capitalized costs being amortized. Unproved propertiesare evaluated quarterly, and as needed, for impairment on aproperty-by-property basis.  If theresults of an assessment indicate that an unproved property is impaired, theamount of impairment is added to the proved oil and natural gas property coststo be amortized.  In accordance with SECStaff Accounting Bulletin (“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.

 

8

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In addition, the capitalized costs of oil and naturalgas properties are subject to a “ceiling test,” whereby to the extent that suchcapitalized costs subject to amortization in the full-cost pool (net ofaccumulated depletion, depreciation and amortization, asset retirementobligations and related deferred taxes) exceed the present value (using a 10%discount rate) of estimated future net after-tax cash flows from proved oil andnatural gas reserves, such excess costs are charged to expense.  Once incurred, an impairment of oil andnatural gas properties is not reversible at a later date.  In accordance with SAB No.103, “*Update of Codification of Staff Accounting Bulletins*,”derivative instruments qualifying as cash flow hedges are included in thecomputation of limitation on capitalized costs. The period-end price was between the cap and floor established by theCompany’s hedge contracts at March 31, 2005 and thus no impact wasincluded in the calculation.  Impairmentof oil and natural gas properties is assessed on a quarterly basis inconjunction with the Company’s quarterly and annual filings with the SEC.  No impairment related to the ceiling test wasrequired during the three-month periods ended March 31, 2005 or 2004.

 

Sales of proved and unproved properties are accountedfor as adjustments of capitalized costs with no gain or loss recognized, unlesssuch adjustments would significantly alter the relationship between capitalizedcosts and proved reserves.

 

***Inventories–***Inventories consist principally of tubular goods andproduction equipment for wells and facilities. They are stated at the lower ofweighted-average cost or market.

 

***Asset RetirementObligations –***TheCompany records a liability for legal obligations associated with theretirement of tangible long-lived assets in the period in which they areincurred in accordance with SFAS No. 143, “*Accounting for Asset Retirement Obligations.*” The Companyadopted this policy effective January 1, 2003, using a cumulative effectapproach to recognize transition amounts for asset retirement obligations,asset retirement costs and accumulated accretion and depletion. Under thismethod, when liabilities for dismantlement and abandonment costs, excludingsalvage values, are initially recorded, the carrying amount of the related oiland gas properties is increased. Accretion of the liability is recognized eachperiod using the interest method of allocation, and the capitalized cost isdepleted over the useful life of the related asset.

 

At January 1, 2003, the Company recorded thepresent value of its future Asset Retirement Obligations (“ARO”) for oil andnatural gas properties and related equipment. The changes to the ARO during theperiods ended March 31, 2005 and 2004 are as follows:

 
| ** **                                  | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|
| ** **                                  | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ARO, Beginning  of Period                   |       | $                                     | 2,189,088  |   | $ | 1,811,995 |   |
| Liabilities incurred  in the current period |       | 61,649                                |       | 86,311 |   |
| Liabilities  settled in the current period  |       | (49,950                               | )          | (83,647 | ) |
| Accretion  expense                          |       | 33,386                                |       | 26,285 |   |
| Revisions                                   |       | —                                |       | — |   |
| ARO, End of  Period                         |       | $                                     | 2,234,173  |   | $ | 1,840,944 |   |
|                                        |       |                                  |       |   |   |
| Current Portion                             |       | $                                     | 195,762    |   | $ | 391,982 |   |
| Long Term  Portion                          |       | $                                     | 2,038,411  |   | $ | 1,448,962 |   |

 

During the three monthsended March 31, 2005, ARO liabilities incurred include nine new wellobligations and liabilities settled include eight wells that were plugged.

 

***Stock-BasedCompensation***- The Company accounts for stockcompensation plans under the intrinsic value method of Accounting PrinciplesBoard (“APB”) Opinion No. 25, “*Accountingfor Stock Issued to Employees*.” No compensation expense is recognized for stock options that had an exerciseprice equal to or greater than the market value of the underlying common stockon the date of grant.  As allowed by SFASNo. 123, “*Accounting for Stock-BasedCompensation*,” the Company has continued to apply APB Opinion No. 25for purposes of determining net income. In December 2002, the FASB issued SFAS No. 148, “*Accounting for Stock-*

 

9

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*Based Compensation – Transition andDisclosure – an amendment of FASB Statement No. 123”* toprovide alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  Additionally, the statement amends thedisclosure requirements of SFAS No. 123 to require prominent disclosuresin both annual and interim financial statements about the method of accountingfor stock-based compensation and the effect of the method used on reportedresults.

 

Had compensation expensefor stock-based compensation been determined based on the fair value at thedate of grant, the Company’s net income and earnings per share would have beenas follows:

 
| ** **                                                                                                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Net income as  reported                                                                                                              |       | $                                     | 4,723,530  |   | $ | 3,283,236 |   |
| Add:                                                                                                                                 |       |                                  |       |   |   |
| Stock based  employee compensation expense included in reported net income, net of related  income tax                               |       | 263,577                               |       | 718,942 |   |
| Deduct:                                                                                                                              |       |                                  |       |   |   |
| Total stock  based employee compensation expense determined under fair value based method  for all awards, net of related income tax |       | (124,745                              | )          | (55,201 | ) |
| Pro forma net  income                                                                                                                |       | $                                     | 4,862,362  |   | $ | 3,946,977 |   |
|                                                                                                                                 |       |                                  |       |   |   |
| Earnings Per  Share:                                                                                                                 |       |                                  |       |   |   |
| Basic – as  reported                                                                                                            |       | $                                     | 0.28       |   | $ | 0.26 |   |
| Basic – pro  forma                                                                                                              |       | $                                     | 0.29       |   | $ | 0.31 |   |
|                                                                                                                                 |       |                                  |       |   |   |
| Diluted – as  reported                                                                                                          |       | $                                     | 0.27       |   | $ | 0.25 |   |
| Diluted – pro  forma                                                                                                            |       | $                                     | 0.27       |   | $ | 0.30 |   |

 

The Company is alsosubject to reporting requirements of FASB Interpretation No. (“FIN”) 44, “*Accounting for Certain**Transactions involvingStock Compensation”* that requires a non-cash charge to deferredcompensation expense if the market price of the Company’s common stock at theend of a reporting period is greater than the exercise price of certain stockoptions.  After the first such adjustmentis made, each subsequent period is adjusted upward or downward to the extentthat the market price exceeds the exercise price of the options.  The charge is related to non-qualified stockoptions granted to employees and directors in prior years and re-priced in May 1999,as well as certain options newly issued in conjunction with the repricing. Apre-tax charge of $0.3 million and $1.1 million was required for the threemonths ended March 31, 2005 and 2004, respectively.

 

***AccountingPronouncements***–In December 2004, the FASB issued SFAS No. 123(R), “*Share-Based Payment.*” This statementrequires companies to measure the cost of employee services in exchange for anaward of equity instruments based on a grant-date fair value of the award (withlimited exceptions), and that cost must generally be recognized over thevesting period. SFAS No. 123(R) amends the original SFAS No. 123 and95 that had allowed companies to choose between expensing stock options orshowing pro forma disclosure only. This statement eliminates the ability toaccount for share-based compensation transactions using APB Opinion No. 25.We currently account for our stock-based compensation plans under theprinciples prescribed by APB Opinion No. 25. Accordingly, no stock optioncompensation cost is reflected in net income, as all options granted under theplan had an exercise price equal to the market value of the underlying commonstock on the date of grant. The adoption of SFAS No. 123(R) will impactour results of operations, but will have no impact on our overall financialposition. In March 2005, the SEC issued SAB No. 107. Among otherthings, SAB No. 107 provides interpretive guidance related to theinteraction between SFAS No. 123(R) and certain SEC rules andregulations, as well as provides the SEC staff’s views regarding the valuationof share-based payment arrangements for public companies. SFAS No. 123(R)was to become effective as of the beginning of the first interim or annualreporting period that begins after June 15, 2005, but on April 14,2005, the SEC issued press release 2005-57, which amends the compliance date ofSFAS No. 123(R)for fiscal years beginning after June 15, 2005. Weanticipate adopting the provisions of SFAS No. 123(R) in the firstquarter of 2006 using the modified prospective method for transition.

 

10

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Under this methodwe will recognize compensation expense for all stock-based awards granted ormodified on or after July 1, 2005, as well as any previously grantedawards that are not fully vested as of July 1, 2005. Compensation expensewill be measured based on the fair value of the awards previously calculated indeveloping the pro forma disclosures in accordance with the provisions ofSFAS No. 123 (see Stock-Based Compensation above). The Companyexpects the impact to be immaterial due to the fact that the Company has notissued options since April 2004 and there will only be a minimal amount ofunvested options as of our adoption date. SFAS No. 123(R) also requiresthe benefits of tax deductions in excess of recognized compensation cost bereflected as a financing cash flow, rather than as an operating cash flow ascurrently required.

 

In March 2005, the FASB issued FASBInterpretation No. 47, *Accounting forConditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143*(“FIN 47”).  FIN 47 clarifies that the term, “conditional asset retirementobligation” as used in SFAS No. 143, *Accountingfor Asset Retirement Obligations*, refers to a legal obligation toperform an asset retirement activity in which the timing and/or method ofsettlement are conditional upon a future event that may or may not be withinthe control of the entity.  Even though uncertainty about the timingand/or method of settlement exists and may be conditional upon a future event,the obligation to perform the asset retirement activity is unconditional. Accordingly, an entity is required to recognize a liability for the fair valueof a conditional asset retirement obligation if the fair value of the liabilitycan be reasonably estimated.  Uncertainty about the timing and/or methodof settlement of a conditional asset retirement obligation should be factoredinto the measurement of the liability when sufficient information exists. The fair value of a liability for the conditional asset retirement obligationshould be recognized when incurred generally upon acquisition, construction, ordevelopment or through the normal operation of the asset.  SFAS No. 143acknowledges that in some cases, sufficient information may not be available toreasonably estimate the fair value of an asset retirement obligation.  FIN47 also clarifies when an entity would have sufficient information toreasonably estimate the fair value of an asset retirement obligation.  FIN47 is effective no later than the end of reporting periods ending after December 15,2005.  Retrospective application for interim financial information ispermitted but is not required.  Early adoption of FIN 47 isencouraged.  The Company is currently evaluating what impact FIN 47 willhave on its financial statements, but at this time, it does not believe thatthe adoption of FIN 47 will have a material effect on the Company’s financialposition, results of operations or cash flows.

 

***Reclassifications***- Certainreclassifications of prior period statements have been made to conform tocurrent reporting practices.

 

**2.   LONG TERM DEBT**

 

Effective December 31,2003, the Company entered into a new amended and restated credit facility (the “CreditFacility”) which permits borrowings up to the lesser of (i) the borrowingbase or (ii) $100 million. Borrowings under the Credit Facility bear interest at a rate equal toprime plus 0.50% or LIBOR plus 2.25%.  AtMarch 31, 2005, the interest rate applied to our outstanding balance was6.25%. As of March 31, 2005, $10.0 million in borrowings were outstandingunder the Credit Facility.  The CreditFacility matures December 31, 2006 and is secured by substantially all ofthe Company’s assets.

 

Effective December 29,2004, the Credit Facility’s borrowing base was increased from $48.0 million to$65.0 million. The borrowing base under the Credit Facility was increased as aresult of the asset acquisition that closed December 29, 2004 and drillingactivities since the last redetermination. The Company’s available borrowingcapacity under this facility was $55.0 million at March 31, 2005. Theborrowing base is currently being redetermined by the lender and the Companyexpects to be notified of any changes by the end of May 2005. 

 

The Credit Facilityprovides for certain restrictions, including but not limited to, limitations onadditional borrowings, sales of oil and natural gas properties or othercollateral, and engaging in merger or consolidation transactions. The CreditFacility also prohibits dividends and certain distributions of cash orproperties and certain liens.  The CreditFacility also contains the following financial covenants, among others:

 

**•**                  TheEBITDAX to Interest Expense ratio requires that the ratio of (a) consolidatedEBITDAX (defined as EBITDA plus similar non-cash items and exploration andabandonment expenses for

 

11

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such period) of theCompany for the four fiscal quarters then ended to (b) the consolidatedinterest expense of the Company for the four fiscal quarters then ended, not beless than 3.5 to 1.0.

 

**•**                  TheWorking Capital ratio requires that the amount of the Company’s consolidatedcurrent assets less its consolidated current liabilities, as defined in theagreement, be at least $1.0 million. For the purposes of calculating theWorking Capital ratio, current assets is adjusted for unused capacity undercredit agreement and derivative financial instruments, and current liabilitiesis adjusted for derivative financial instruments and asset retirementobligations.

 

**•**                  TheMaximum Leverage ratio requires that the ratio, as of the last day of anyfiscal quarter, of (a) Total Indebtedness (as defined in the CreditFacility) as of such fiscal quarter to (b) an amount equal to consolidatedEBITDAX for the two quarters then ended times two, not be greater than 3.0 to 1.0.

 

Consolidated EBITDAX is acomponent of negotiated covenants with our lender and is presented here as partof the Company’s disclosure of its covenant obligations.

 

**3.   SHELF REGISTRATION STATEMENT**

 

The Company filed a $150 million shelf registration statement with the SEC, which became effective in May 2004. Under the shelf registration statement, the Company may issue, from time to time, any combination of debt securities, preferred stock, common stock or warrants for debt securities or equity securities in one or more offerings to those persons who agree to purchase our securities. Net proceeds, terms and pricing of the offering of securities issued under the shelf registration statement will be determined at the time of the offerings. The shelf registration statement does not provide assurance that the Company will or could sell any such securities. The Company’s ability to utilize this shelf registration statement for the purpose of issuing, from time to time, any combination of debt securities, preferred stock, common stock or warrants for debt securities or equity securities will depend upon, among other things, market conditions and the existence of investors who wish to purchase the Company’s securities at prices acceptable to the Company.

 

The Company completed an offering on December 21,2004 of 3.5 million shares of its common stock under the Company’s shelfregistration statement, which generated net proceeds of $47.8 million, beforedirect costs of the offering of $0.6 million. These funds were used to financethe asset acquisition that closed December 29, 2004 and fund other generalcorporate purposes. On January 5, 2005, the underwriters exercised theirover-allotment option for an additional 525,000 shares of common stock, whichgenerated additional net proceeds of $7.2 million. These funds were used toreduce outstanding debt. Each of these sales was made under the Company’s shelfregistration statement. At March 31, 2005, the Company had $91.8 millionremaining for issuance under its shelf registration statement.

 

**4.   EARNINGS PER SHARE**

 

The Company accounts forearnings 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 income statement.  Basic earnings per common share amounts arecalculated using the average number of common shares outstanding during eachperiod.  Diluted earnings per commonshare assumes the exercise of all stock options and warrants having exerciseprices less than the average market price of the common stock during theperiods, using the treasury stock method.

 

The following is areconciliation of the numerators and denominators of basic and diluted earningsper common share computations, in accordance with SFAS No. 128, for thethree-month periods ended March 31, 2005 and 2004:

 

12

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| ** **                               | ** ** | **Three Months Ended March 31, 2005** | ** ** | **Three Months Ended March 31, 2004** | ** ** |
|------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                               | ** ** | **Income  (Numerator)**                    | ** ** | **Shares  (Denominator)**                  | ** ** | **Per Share  Amount** | ** ** | **Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per  Share  Amount** | ** ** |
| **Basic  EPS**                           |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Income available  to common stockholders |       | $                                          | 4,723,530  |                                       | 17,042,389 |   | $ | 0.28 |   | $ | 3,283,236 |   | 12,725,951 |   | $ | 0.26 |   |
| Effect of  dilutive securities:          |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Restricted stock                         |       | —                                     |       | 149,864                                    |       | — |   | — |   | 123,033 |   | — |   |
| Common stock  options                    |       | —                                     |       | 499,869                                    |       | (0.01 | ) | — |   | 468,855 |   | (0.01 | ) |
| **Diluted  EPS**                         |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Income available  to common stockholders |       | $                                          | 4,723,530  |                                       | 17,692,122 |   | $ | 0.27 |   | $ | 3,283,236 |   | 13,317,839 |   | $ | 0.25 |   |

 

**5.   INCOME TAXES**

 

The Company accounts for income taxes under theprovisions of SFAS No. 109, “*Accountingfor Income Taxes*,” which provides for an asset and liabilityapproach in accounting for income taxes. Under this approach, deferred tax assets and liabilities are recognizedbased on anticipated future tax consequences, using currently enacted tax laws,attributable to temporary differences between the carrying amounts of assetsand liabilities for financial reporting purposes and the amounts calculated forincome tax purposes.

 

The Company currently estimates that its effective taxrate for the year ending December 31, 2005 will be approximately35.3%.  A provision for income taxes of$2.6 million and $1.8 million was reported for the three months ended March 31,2005 and 2004, respectively. The Company was not required to pay income taxesin 2004 or 2003 because of the generation of net operating losses from drillingactivity.

 

**6.   SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCINGACTIVITIES**

 

The Company considers allhighly liquid debt instruments purchased with an original maturity of threemonths or less to be cash equivalents. A summary of non-cash investing andfinancing activities for the three months ended March 31, 2005 and 2004 ispresented below:

 
| **Description**                                                                                       | ** ** | **Number of  Shares  Issued** | ** ** | **Fair Market  Value** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|------------------------|------------|
| **Three  months ended March 31, 2005:**                                                          |       |                          |       |                   |       |
| Shares issued to  satisfy restricted stock grants                                                     |       | 37,344                        |       | $                      | 324,084    |   |
| Shares issued to  fund the Company’s matching contribution under the Company’s 401-k plan   |       | 1,910                         |       | $                      | 27,081     |   |
| **Three  months ended March 31, 2004:**                                                          |       |                          |       |                   |       |
| Shares issued to  satisfy restricted stock grants                                                     |       | 56,136                        |       | $                      | 354,183    |   |
| Shares issued to  fund the Company’s matching contribution under the Company’s 401 (k) plan |       | 1,590                         |       | $                      | 17,575     |   |

 

For the three monthsended March 31, 2005 and 2004, the non-cash portion of Asset RetirementCosts was $11,699 and $2,664, respectively. A supplemental disclosure of cash flow information for the three monthsended March 31, 2005 and 2004 is presented below:

 

13

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| ** **                            | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|---------------------------------------|------------|------------------------------------------------|------------|
| ** **                            | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| Cash paid during  the period for:     |       |                                           |       |   |   |
| Interest, net of  amounts capitalized |       | $                                              | —     |   | $ | 69,083 |   |
|                                       |            |                                                |            |  |  |  |  |

 

Interest paid for thethree months ended March 31, 2005 and 2004 excludes amounts capitalized of$223,918 and $88,555, respectively. The Company was not required to pay incometaxes in 2004 or 2003.

 

**7.   HEDGING AND DERIVATIVE ACTIVITIES**

 

Due to the volatility ofoil and natural gas prices, the Company periodically enters into price-riskmanagement transactions (e.g., swaps, collars and floors) for a portion of itsoil and natural gas production to achieve a more predictable cash flow, as wellas to reduce exposure from price fluctuations. While the use of these arrangements limits the Company’s ability tobenefit from increases in the price of oil and natural gas, it also reduces theCompany’s potential exposure to adverse price movements.  The Company’s arrangements, to the extent itenters into any, apply to only a portion of its production, provide onlypartial price protection against declines in oil and natural gas prices andlimit the Company’s potential gains from future increases in prices.  None of these instruments are used fortrading purposes. On a quarterly basis, the Company’s management sets all ofthe Company’s price-risk management policies, including volumes, types ofinstruments and counterparties. These policies are implemented by managementthrough the execution of trades by the Chief Financial Officer afterconsultation and concurrence by the President and Chairman of the Board.  The Board of Directors continuously monitorsthe Company’s policies and trades.

 

All of these price-riskmanagement transactions are considered derivative instruments and accounted forin accordance with SFAS No. 133, *“Accountingfor Derivative Instruments and Hedging Activities.”* These derivativeinstruments are intended to hedge our price risk and may be considered hedgesfor economic purposes, but certain of these transactions may not qualify forcash flow hedge accounting. All derivative instrument contracts are recorded onthe balance sheet at fair value. For those derivative instrument contracts thatqualify for cash flow hedge accounting, the effective portion of the changes inthe fair value of the contracts is recorded in other comprehensive income andthe ineffective portion of the changes in the fair value of the contracts isrecorded in revenue as they occur. While the contract is outstanding, theineffective gain or loss may increase or decrease until settlement of thecontract depending on the fair value at the measurement dates. When the hedgedproduction is sold, the realized gains and losses on the contracts are removedfrom other comprehensive income and recorded in revenue. The Company iscurrently accounting for its natural gas contracts as cash flow hedges offuture cash flows from the sale of natural gas. For those derivative instrumentcontracts that either do not qualify for cash flow hedge accounting or theCompany does not designate as hedges of future cash flows, the changes in fairvalue are not deferred through other comprehensive income, but rather recordedin revenue immediately as unrealized gains or losses. The Company did not applycash flow hedge accounting to its crude oil collars entered into in May/August of2004, because although they were economic hedges, they did not qualify for hedgeaccounting.

 

For the three monthsended March 31, 2005 and 2004, the Company included in revenue realizedand unrealized losses of $1.0 million and gains of $18,166, respectively,related to its natural gas hedges and oil derivatives. There was no ineffectivenessrecognized during the three months ended March 31, 2005 or 2004.

 
| ** **                                               | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Natural gas  hedging contract settlements                |       | $                                     | 156,500    |   | $ | — |   |
| Oil derivative  contract settlements                     |       | (258,514                              | )          | — |   |
| Hedge premium reclassification                           |       | —                                |       | (27,300 | ) |
| Oil derivative  contract unrealized change in fair value |       | (882,830                              | )          | 45,466 |   |
| Gain (loss) on  hedging and derivatives                  |       | $                                     | (984,844   | ) | $ | 18,166 |   |

 

14

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The outstanding hedges atMarch 31, 2005 and December 31, 2004 impacting the balance sheet wereas follows:

 
| **Transaction Date**    | ** ** | **Transaction  Type** | ** **               | **Beginning** | ** **                      | **Ending** | ** ** | ** **    | ** ** | ** **  | ** ** | **Fair  Value of Outstanding Hedging and  Derivative Contracts as of** | ** ** |
|-------------------------|------------|-----------------------|--------------------------|---------------|---------------------------------|------------|------------|---------------|------------|-------------|------------|------------------------------------------------------------------------|------------|
| **Price**               | ** ** | **Volumes**           | **March 31,  2005** | ** **    | **December 31,  2004 (4)** |
| **Per Unit**            | ** ** | **Per Day**           |
| ***Natural  Gas (1):*** |       |                  |                     |          |                            |       |       |          |       |        |       |                                                                   |       |   |   |
| 05/04                   |       | Collar                |                     | 01/01/2005    |                            | 03/31/2005 |       | $5.00-$10.39  |       | 10,000MMbtu |       | $                                                                      | —     |   | $ | 92,703 |   |
| 07/04                   |       | Collar                |                     | 04/01/2005    |                            | 06/30/2005 |       | $5.00-$7.53   |       | 10,000MMbtu |       | (209,874                                                               | )          | 9,162 |   |
| 07/04                   |       | Collar                |                     | 07/01/2005    |                            | 09/30/2005 |       | $5.00-$7.67   |       | 10,000MMbtu |       | (576,687                                                               | )          | (41,210 | ) |
| 10/04                   |       | Collar                |                     | 01/01/2005    |                            | 12/31/2005 |       | $6.00-$9.52   |       | 10,000MMbtu |       | (366,156                                                               | )          | 1,860,375 |   |
| ***Crude  Oil (2):***   |       |                  |                     |          |                            |       |       |          |       |        |       |                                                                   |       |   |   |
| 03/04                   |       | Collar                |                     | 04/01/2004    |                            | 12/31/2004 |       | $30.00-$35.50 |       | 400Bbl      |       | —                                                                 |       | (96,240 | ) |
| 05/04(08/04) (3)        |       | Collar                |                     | 01/01/2005    |                            | 12/31/2005 |       | $35.00-$40.00 |       | 200/290Bbl  |       | (1,447,378                                                             | )          | (468,308 | ) |
|                    |       |                  |                     |          |                            |       |       |          |       |        |       | $                                                                      | (2,600,095 | ) | $ | 1,356,482 |   |

 

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(1)   The Company’scurrent hedging activities for natural gas were entered into on a per MMbtudelivered price basis, using the Houston Ship Channel Index, with settlementfor each calendar month occurring five business days following the expirationdate.

 

(2)   Hedgeaccounting is not applied to the Company’s collars on crude oil, which wereentered into on a per barrel delivered price basis, using the West TexasIntermediate Index, with settlement for each calendar month occurring fivebusiness days following the expiration date. The change in fair value isreflected in net revenue for the applicable period.

 

(3)   InAugust 2004, the Company replaced the contract that was entered into May 2004with a new contract that changes the volume and pricing terms. The put optionis on 200 Bbl/D and the call option is on 290 Bbl/D. This transaction wascompleted at no additional cost to the Company.

 

(4)   Thefair value of the Company’s outstanding transactions is presented on thebalance sheet by counterparty. Our counterparties net our positions with them,but we cannot present the net of the two counterparty positions because we donot have legal right of offset. Therefore one counterparty is presented in theDerivative Asset and one is presented in the Derivative Liability. The crudeoil collar with a balance of ($468,308) is presented as a liability and theremaining contracts are presented as an asset. All contracts are consideredcurrent.

 

**8.   ASSET ACQUISITION**

 

On December 29, 2004, the Company consummated theacquisition of interests in certain oil and natural gas properties located inSouth Texas from Contango Oil & Gas Company (“Contango”). The finalcash purchase price for the acquisition was $40.1 million, which was adjustedfrom the original price of $50.0 million for the results of operations betweenthe July 1, 2004 effective date and the December 29, 2004 closingdate pursuant to the closing adjustment provisions. The Company also realizedother acquisition costs of approximately $135,200 related to professional feesfor assistance with the transaction. The purchase price was funded from the netproceeds of a public offering of common stock completed December 21, 2004(see Note 3).

 

The following unaudited proforma results for the three-months ended March 31, 2004 show the effect onthe Company’s consolidated results of operations as if the asset acquisitionhad occurred on January 1, 2003 and are derived from the pro forma resultsas reported on Form 8-K/A filed April 5, 2005. They are the result ofcombining the statement of income of Edge with the statements of revenues anddirect operating expenses for the acquired properties adjusted for (1) thecompletion of the public offering of common stock to finance the cash purchaseprice, (2) assumption of ARO liabilities and accretion expense for the propertiesacquired, (3) depletion, depreciation and amortization expense applied tothe adjusted basis of the properties acquired using the purchase method ofaccounting, and (3) the related income tax effects of these adjustmentsbased on the applicable statutory rates. The statements of revenues anddirect operating expenses for the acquired assets exclude all other historicalContango expenses.  As a result, certainestimates and judgments were made in preparing the pro forma adjustments,including as to the incremental expenses associated with the acquiredassets.  The pro forma information includes numerous assumptions, and is notnecessarily indicative of future results of operations:

 

15

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| ** **                    | ** ** | **For the Quarter Ended  March 31, 2004** | ** ** |
|-------------------------------|------------|------------------------------------------------|------------|
| ** **                    | ** ** | **(unaudited)**                                | ** ** |
| ** **                    | ** ** | **(In thousands, except per  share amounts)**  | ** ** |
| Revenue                       |       | $                                              | 22,363     |   |
| Net income                    |       | $                                              | 6,450      |   |
| Net income per  common share: |       |                                           |       |
| Basic                         |       | $                                              | 0.39       |   |
| Diluted                       |       | $                                              | 0.37       |   |

 

**9.   COMMITMENTS AND CONTINGENCIES**

 

From time to time the Companyis a party to various legal proceedings arising in the ordinary course ofbusiness.  While the outcome of lawsuitscannot be predicted with certainty, the Company is not currently a party to anyproceeding that it believes, if determined in a manner adverse to the Company,could have a potential material adverse effect on its financial condition,results of operations or cash flows.

 

During the second quarter of 2004, the Companyreceived notice that its franchise tax returns for the State of Texas would beaudited for the tax years 1999 through 2002. After reviewing documentssubmitted, the agent representing the Office of the Comptroller of the State ofTexas proposed adjustments to the calculation that would result in an increasedfranchise tax liability.  The agentmaintained that transfers by the parent company to its subsidiaries that theCompany classified as intercompany loans should instead be classified as equityinvestments in the subsidiary. The State of Texas originally proposed that the franchisetax liability of the subsidiaries would be increased by approximately $3.0million for the four-year period under audit.

 

During the third quarter of 2004 the agent reduced theproposed franchise tax deficiency adjustment to the Company and its subsidiariesto an aggregate of $467,000. In the fourth quarter of 2004, there was aninformal hearing at the local Comptroller’s Office during which the agentindicated he would formally assess the proposed deficiency.  On March 24, 2005, the Company receivedsuch deficiency assessment in the amount of $471,482, including penalty andinterest.  The Company responded on April 21,2005 with a request for a formal redetermination hearing.  The Company intends to continue to vigorouslycontest the assessment through appropriate administrative levels in theComptroller’s Office and any other available means.  Due to its intention to continue tovigorously contest the proposed adjustments, the Company has not recognized anyprovision for the additional franchise taxes that would result from theproposed deficiency.

 

16

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**ITEM2.   MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following is Management’s Discussion and Analysis (“MD&A”) ofsignificant factors that have affected certain aspects of our financialposition and operating results during the periods included in the accompanyingunaudited condensed consolidated financial statements. The followingMD&A is intended to help the reader understand Edge Petroleum Corporation (“Edge”).This discussion should be read inconjunction with the accompanying unaudited condensed consolidated financialstatements included elsewhere in this Form 10-Q and with Management’sDiscussion and Analysis of Financial Condition and Results of Operations andour audited consolidated financial statements included in our annual report on Form 10-Kfor the year ended December 31, 2004.

 

### **FORWARD LOOKING STATEMENTS**

###  

The statements contained in all parts of thisdocument, including, but not limited to, those relating to our outlook, theeffects of our acquisitions, our financing plans related thereto, including anyincrease in our credit line, issuance of equity or debt, contribution ofacquisition and any other benefit of such acquisition, our ability to accessthe capital markets to raise additional capital, our debt-to-total capitalratio, our drilling plans, our natural gas and oil production volumes, our 3-Dproject portfolio, our ability to hedge our risks, capital expenditures andcapital program, future capabilities, the sufficiency of capital resources andliquidity to support working capital and capital expenditure requirements,sufficiency, growth and reinvestment of cash flows, our ability to control thetiming of our future exploration and development requirements, use of NOLs, taxrates, the outcome of litigation and audits, the impact of changes in interestrates on our estimates of asset retirement obligations, production declines,the commodity pricing environment and the state of the economy and any otherstatements regarding future operations, financial results, business plans,sources of liquidity and cash needs and other statements that are nothistorical facts are forward looking statements.  When used in this document, the words “anticipate,”“estimate,” “expect,” “may,” “project,” “believe,” “budgeted,” “intend,” “plan,”“potential,” “forecast,” “might,” “predict,” “should” and similar expressionsare intended to be among the statements that identify forward lookingstatements.  Such statements involverisks and uncertainties, including, but not limited to, those relating to theresults of and our dependence on our exploratory and development drillingactivities, the volatility of oil and natural gas prices, the need to replacereserves depleted by production, operating risks of oil and natural gasoperations, our dependence on key personnel, our reliance on technologicaldevelopment and possible obsolescence of the technology currently used by us,the significant capital requirements of our exploration and development andtechnology development programs, the potential impact of government regulationsand liability for environmental matters, results of litigation and audits,expansion of our capital budgets, our ability to manage our growth and achieveour business strategy, competition from larger oil and gas companies, theuncertainty of reserve information and future net revenue estimates, propertyacquisition risks, risks relating to acquisitions and other factors detailed inour Form 10-K and other filings with the Securities and ExchangeCommission (“SEC”).  Should one or moreof these risks or uncertainties materialize, or should underlying assumptionsprove incorrect, actual outcomes may vary materially from those indicated. Allsubsequent written and oral forward looking statements attributable to theCompany or the persons acting on its behalf are expressly qualified in theirentirety by the reference to these risks and uncertainties. The Companyundertakes no obligation to publicly update or revise any forward lookingstatements, whether as a result of new information, future events or otherwise.

 

## **GENERAL OVERVIEW**

## ** **

Edge Petroleum Corporation is a Houston-basedindependent energy company that focuses its exploration, production andmarketing activities in selected onshore basins of the United States. In late1998, we undertook a top-level management change and began a shift in strategyfrom pure 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 gas properties. Our company generatesrevenues, 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 acquisition activities thatallow us to continue generating revenue, income and cash flows. In December 2003,we acquired 100 percent of the outstanding stock of Miller Exploration Company(“Miller”).  The transaction was treatedas a tax-free reorganization and accounted for as a

 

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purchase business combination. Miller continues to conduct explorationand development activities as a wholly-owned subsidiary of Edge. In December 2004,we acquired substantially all of the operating assets of Contango Oil &Gas Company (“Contango”) for a cash purchase price financed by proceeds from apublic offering of our common stock. This acquisition is herein referred to asthe Contango Asset Acquisition.

 

This overview providesour perspective on the individual sections of MD&A, as well as helpfulhints for reading these pages. Our MD&A includes the following sections:

 

**•**                  **Industry and Economic Factors** – 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** – additionalinformation regarding our approach and strategy.

 

**•**                  **Acquisitions and Divestitures** - informationabout significant changes in our business structure.

 

**•**                  **Outlook** – additional discussion relating tomanagement’s outlook to the future of our business.

 

**•**                  **Critical Accounting Policies and Estimates**– a discussion of certain accounting policies that require critical judgmentsand estimates.

 

**•**                  **Results of Operations** – an analysis of ourCompany’s consolidated results for the periods presented in our financialstatements.

 

**•**                  **Liquidity and Capital Resources -**ananalysis of cash flows, sources and uses of cash, and contractual obligations.

 

**•**                  **Risk Management Activities – Derivatives &Hedging -**supplementary information regarding our Company’sprice-risk management activities involving commodity contracts that areaccounted for at fair value.

 

**•**                  **Tax Matters** – supplementary discussion ofincome tax matters.

 

**•**                  **Recently Issued Accounting Pronouncements** –a discussion of certain accounting pronouncements recently issued that may impactour future results.

 

# **Industry and EconomicFactors**

 

In managing our business,we must deal with many factors inherent in our industry.  First and foremost is the fluctuation of oiland gas prices.  Historically, oil andgas markets have been cyclical and volatile, with future price movements, whichare difficult to predict.  While ourrevenues are a function of both production and prices, wide swings in commodityprices have most often had the greatest impact on our results of operations. Wehave no way to predict those prices or to control them without losing someadvantage of the upside potential. The oil and gas industry has continued toexperience a high commodity price environment in 2005 which has positivelyimpacted the entire industry as well as our Company.

 

Our operations entailsignificant complexities.  Advancedtechnologies requiring highly trained personnel are utilized in bothexploration and production.  Even whenthe technology is properly used, we may still not know conclusively if hydrocarbonswill be present or the rate at which they will be produced.  Exploration is a high-risk activity, oftentimes resulting in no commercially productive reserves being discovered.Moreover, costs associated with operating within our industry are substantial.

 

Our business, as withother extractive industries, is a depleting one in which each gas equivalentproduced must be replaced or our business, and a critical source of our futureliquidity, will shrink.

 

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The oil and gas industryis highly competitive.  We compete withmajor and diversified energy companies, independent oil and gas businesses andindividual operators in exploration, production, marketing and acquisitionactivities.  In addition, the industry asa whole competes with other businesses that supply energy to industrial andcommercial end users.

 

Extensive federal, stateand local regulation of the industry significantly affects our operations.  In particular, our activities are subject tostringent operational and environmental regulations.  These regulations have increased the costs ofplanning, designing, drilling, installing, operating and abandoning oil and gaswells and related facilities.  Theseregulations may become more demanding in the future.

 

# **Approach to the Business**

 

Profitable growth of ourbusiness will largely depend upon our ability to successfully find and developnew proved reserves of oil and natural gas in a cost-effective manner.  In order to achieve an overall acceptablerate of growth, we seek to maintain a prudent blend of low, moderate and higherrisk exploration and development projects. We also attempt to make selected acquisitions of oil and gas propertiesto augment our growth and provide future drilling opportunities.  To further mitigate risk, we have chosen toseek geologic and geographic diversification by operating in multiplebasins.  We periodically hedge ourexposure to volatile oil and gas prices on a portion of our production toreduce price risk. As of March 31, 2005, we had hedge contracts in placecovering approximately 44% and 29% of our remaining expected 2005 natural gasand crude oil production, respectively, or approximately 38% of totalproduction on an Mcfe basis, before any acquisitions that may occur.

 

Implementation of ourbusiness approach relies on our ability to fund ongoing exploration anddevelopment projects with cash flow provided by operating activities andexternal sources of capital. Our Board approved a 2005 capital budget of $63million. Based on current expectations for production volumes and commodityprices, we expect to fund those capital expenditures from internally generatedcash from operating activities.  We donot typically include acquisitions in our budgeted capital expenditures, butexpect to fund those with either borrowings under our credit facility orofferings of common stock or other securities under our shelf registrationstatement or other sources.

 

We reduced debt by $10.0million in the first three months of 2005 to $10.0 million at March 31,2005. As of that date, our debt to total capital ratio was approximately 5.9%,which we believe leaves us with the financial flexibility to continue toexecute our business strategies.

 

**Acquisitions and Divestitures**

 

*Acquisitions-*On December 29, 2004 we successfully completed theacquisition of oil and natural gas properties located in South Texas for afinal adjusted cash purchase price of $40.1 million, before other acquisitioncosts of approximately $135,200. The original purchase price of $50 million wassubject to adjustment for the results of operations between the July 1,2004 effective date and the December 29, 2004 closing date, pursuant tothe post-closing adjustments provision. We financed the acquisition with proceedsfrom a public offering of our common stock under our current shelf registration(see Note 3 to our consolidated financial statements). The properties acquiredconsist of 39 non-operated producing wells with working interests ranging fromapproximately 41% to 75% and net revenue interests ranging from 29% to 56%. Theaddition of these properties increased our production and activity levelsduring this quarter. These properties, located primarily in Jim Hogg County,Texas and producing primarily from the Queen City formation, are in ageographic area that has been one of our most active and successful areas offocus in recent years. In addition to estimated proved reserves, our technicalteam identified a substantial number of additional drilling locations onundeveloped acreage with attractive exploitation and exploration potential,therefore, we allocated $6 million of the purchase price to the unprovedproperty category. We began work on these undeveloped locations during thefirst three months of 2005.

 

*Divestitures-*We regularlyreview our asset base for the purpose of identifying non-core assets, thedisposition of which would increase capital resources available for otheractivities and create organizational and operational efficiencies. While wegenerally do not dispose of assets solely for the purpose of reducing debt,such

 

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dispositions canhave the result of furthering our objective of financial flexibility throughreduced debt levels. During the three months ended March 31, 2005, therewere no divestitures as compared to the first three months of 2004, duringwhich we divested oil and natural gas properties in Louisiana generating netproceeds of $40,000.

 

**Outlook**

 

We expect to continue ouracquisition program in 2005, as we seek to further our growth. We expect ourdrilling program to increase from 49 wells (26.910 net) in 2004 toapproximately 50 to 55 wells (28 to 31 net) in 2005. Our expected capitalprogram, excluding acquisitions, will be approximately $63 million. Ourexpected production volumes combined with a strong commodity-pricingenvironment, that if sustained, as expected for the remainder of the year isanticipated to produce record cash flow. In order to manage our realized andanticipated growth, we increased our headcount from 35 employees as of December 31,2003 to 51 employees as of December 31, 2004, and again to 53 as of March 31,2005 resulting in increased G&A costs for 2005. We expect to continue toadd to our staff levels for the remainder of 2005 in response to past andanticipated growth. To help protect against the possibility that commodityprices do not remain at the current levels, we have entered into several hedgescovering approximately 44% of our expected natural gas production and 29% ofour expected crude oil production streams for the remainder of 2005 to offsetthe negative impact of potential downward price movements. This equates toapproximately 38% of total production on an Mcfe basis.

 

Our outlook and theexpected results described above are both subject to change based upon factorsthat include but are not limited to drilling results, commodity prices, accessto capital, the acquisitions market and factors referred to in “Forward LookingStatements.”

 

**Critical Accounting Policies and Estimates**

 

The preparation of financial statements in conformitywith generally accepted accounting principles in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues, expenses, contingent assets and liabilitiesand the related disclosures in the accompanying financial statements.  Changes in these estimates and assumptionscould materially affect our financial position, results of operations or cashflows. Management considers an accounting estimate to be critical if:

 

**•**                  it requires assumptions to be made thatwere uncertain at the time the estimate was 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.

 

All other significant accounting policies that weemploy are presented in the notes to the consolidated financial statements. Thefollowing discussion presents information about the nature of our most criticalaccounting estimates, our assumptions or approach used and the effects ofhypothetical changes in the material assumptions used to develop each estimate.

 

*Natureof Critical Estimate Item:*Oil & Natural Gas Reserves - Our estimate of proved reserves isbased on the quantities of oil and 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.  Forexample, we must estimate the amount and timing of future operating costs,severance taxes, development costs, and workover costs, all of which may infact vary considerably from actual results. In addition, as prices and cost levels change from year to year, theeconomics of producing the reserves may change and therefore the estimate ofproved reserves also may change.  Anysignificant variance in these assumptions could materially affect the estimatedquantity and value of our reserves. Despite the inherent imprecision in theseengineering estimates, our reserves are used throughout our financialstatements.

 

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*Assumptions/Approach Used:*Units-of-productionmethod to amortize our oil and natural gas properties - The quantity ofreserves could significantly impact our depletion expense. Any reduction inproved reserves without a corresponding reduction in capitalized costs willincrease the depletion rate.

 

“Ceiling” Test  - The full-cost method of accounting for oiland gas properties requires a quarterly calculation of a limitation oncapitalized costs, often referred to as a full-cost ceiling calculation. Theceiling is the discounted present value of our estimated total proved reservesadjusted for taxes and the impact of hedges on pricing, using a 10% discountrate. To the extent that our capitalized costs (net of accumulated depletionand deferred taxes) exceed the ceiling, the excess must be written off toexpense. Once incurred, this impairment of oil and gas properties is notreversible at a later date even if oil and gas prices increase. No suchimpairment was required in the three months ended March 31, 2005 and 2004.This calculation of our proved reserves could significantly impact our ceilinglimitation used in determining whether an impairment of our capitalized costsis necessary. The ceiling calculation dictates that prices and costs in effectas of the last day of the period are generally held constant indefinitely.Therefore, the future net revenues associated with the estimated provedreserves are not based on our assessment of future prices or costs, but ratherare based on prices and costs in effect as of the end of the period. Oil andnatural gas prices used in the reserve valuation at March 31, 2005 were$55.40 per barrel and $7.32 per MMbtu.

 

*Effectif different assumptions used:*Units-of-production method to amortize our oil andnatural gas properties - A 10% increase or decrease in reserves would have decreased orincreased, respectively, our depletion expense for the quarter by approximately10%.

 

“Ceiling” limitation test  -The most likely factor to contribute to a ceiling test impairment is the priceused to calculate the reserve limitation threshold. A significant reduction inthe prices at a future measurement date could trigger a full-cost ceilingimpairment. At March 31, 2005, we had a cushion (i.e. the excess of theceiling over our capitalized costs) of $108.3 million. A 10% increase ordecrease in prices used would have increased or decreased our cushion byapproximately 36%. Our hedging program would serve to mitigate some of theimpact of any price decline. Our hedges did not impact the ceiling test thisquarter, and would not have if the price was 10% lower as these prices werewithin the collars, but had we increased the price by 10% the price would haveexceeded our hedge caps and therefore resulted in a decrease in the ceiling of$0.8 million. Another likely factor to contribute to a ceiling test impairmentis a revised estimate of reserves. A 10% increase or decrease in reserve volumewould have increased or decreased our cushion by approximately 28%.

 

*Natureof Critical Estimate Item:*Unproved Property Impairment****- We have elected to use the full-costmethod to account for our oil and gas activities. Investments in unprovedproperties are not amortized until proved reserves associated with theprospects can be determined or until impairment occurs.  Unproved properties are evaluated quarterlyfor impairment on a property-by-property basis. If the results of an assessment indicate that an unproved property isimpaired, the amount of impairment is added to the proved oil and natural gasproperty costs to be amortized.

 

*Assumptions/ApproachUsed:*At March 31,2005, we had $14.2 million allocated to unproved property. This allocation isbased on the estimation by the technical team of whether the property haspotential attributable reserves. Therefore, the assessment made by ourtechnical team of the potential reserves will determine whether costs are movedfrom the unproved category to the full-cost pool for depletion or whether animpairment is taken.

 

*Effectif different assumptions used:* A 10% increase or decrease in the unproved propertybalance (i.e. transfer to full-cost pool) would have increased or decreased ourdepletion expense by approximately 1% for the quarter ended March 31,2005.

 

*Natureof Critical Estimate Item:*Asset Retirement Obligations**-**Wehave certain obligations to remove tangible equipment and restore land at theend of oil and gas production operations. Our removal and restoration

 

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obligations are primarilyassociated with plugging and abandoning wells. Previously, the costs associatedwith this activity were capitalized to the full-cost pool and charged to incomethrough depletion. We adopted SFAS No. 143, “*Accounting for Asset Retirement Obligations*” effective January 1,2003, as discussed in Note 1 to our Consolidated Financial Statements.  SFAS No. 143 significantly changed themethod of accruing for costs an entity is legally obligated to incur related tothe retirement of fixed assets (“asset retirement obligations” or “ARO”).  Primarily, the new statement requires us toestimate asset retirement costs for all of our assets, inflation adjust thosecosts 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. We then accrete the liability quarterlyusing the period-end effective credit-adjusted-risk-free rate. As new wells aredrilled or purchased, their initial asset retirement cost and liability iscalculated and recorded. Should either the estimated life or the estimatedabandonment costs of a property change upon our quarterly review, a newcalculation is performed using the same methodology of taking the abandonmentcost and inflating it forward to its abandonment date and then discounting itback to the present using our credit-adjusted-risk-free rate. The carryingvalue of the asset retirement obligation is adjusted to the newly calculatedvalue, with a corresponding offsetting adjustment to the asset retirement cost(included in the full-cost pool); therefore, abandonment costs will almostalways approximate the estimate. When wells are sold the related liability andasset costs are removed from the balance sheet.

 

*Assumptions/Approach Used:*Estimating thefuture 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.

 

*Effectif different assumptions used:* Since there are so many variables in estimating AROs,we attempt to limit the impact of management’s judgment on certain of thesevariables by using input of qualified third parties. We engage independentengineering firms to evaluate our properties annually. We use the remainingestimated useful life from the year-end reserve reports by our independentreserve engineers in estimating when abandonment could be expected for eachproperty. We utilize a three-year average rate for inflation to diminish anysignificant volatility that may be present in the short term. We expect to seeour calculations impacted significantly if interest rates move from theircurrent lows, as the credit-adjusted-risk-free rate is one of the variablesused on a quarterly basis. Our technical team developed a standard costestimate based on historical costs, industry quotes and depth of wells. Unlesswe expect a well’s plugging to be significantly different than a normalabandonment, we use this estimate. The resulting estimate, after application ofa discount factor and some significant calculations, could differ from actualresults, despite all our efforts to make an accurate estimate.

 

*Natureof Critical Estimate Item:*Income Taxes**-**In accordance with the accounting for income taxesunder SFAS No. 109, *Accounting forIncome Taxes,* we have recorded a deferred tax asset and liability toaccount for the expected future tax benefits and consequences of events thathave been recognized in our financial statements and our tax returns. There areseveral items that result in deferred tax asset and liability impact to thebalance sheet, but the largest of which is income taxes and the impact of netoperating loss (“NOL”) carryforwards. We routinely assess the realizability ofour NOL carryforwards that resulted from substantial income tax deductions,prior year losses and acquisitions. We consider future taxable income in makingsuch assessments.  If we conclude that itis more likely than not that some portion or all of the deferred tax assetswill not be realized under accounting standards, it is reduced by a valuationallowance.

 

*Assumptions/ApproachUsed:*Numerousjudgments and assumptions are inherent in the determination of future taxableincome, including factors such as future operating conditions (particularly asrelated to prevailing oil and gas prices). The Company is not currentlyrequired to pay any federal income taxes because of the prior generation of NOL’s.

 

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*Effectif different assumptions used:* We have engaged an independent public accounting firmto assist us in applying the numerous and complicated tax law requirements.However, despite our attempt to make an accurate estimate, the ultimateutilization of our NOL carryforwards is highly dependent upon our actualproduction and the realization of taxable income in future periods. If weestimate that some or all of our NOL carryforwards are more likely than notgoing to expire or otherwise not be utilized to reduce future tax, we wouldrecord a valuation allowance to remove the benefit of those NOL carryforwardsfrom our financial statements.

 

*Natureof Critical Estimate Item:*Derivative & Hedging Activities**-**Due to the instability of oil and naturalgas prices, we may enter into, from time to time, price-risk managementtransactions (e.g., swaps, collars and floors) for a portion of our oil andnatural gas production to achieve a more predictable cash flow, as well as toreduce exposure from commodity price fluctuations. While all of thesetransactions are economic hedges of price risk, different accounting treatmentmay apply depending on if they qualify for cash flow hedge accounting. Inaccordance with SFAS No. 133, all transactions are recorded on the balancesheet at fair value.

 

Hedge Contracts - We formally assess, both at thehedge’s inception and on an ongoing basis, whether the derivatives that areused for hedging are expected to be highly effective in offsetting changes incash flows of the hedged transactions. In the event it is determined that the use of a particular derivativemay not be or has ceased to be effective in pursuing a hedging strategy, hedgeaccounting is discontinued prospectively. The ongoing measurement ofeffectiveness determines whether the change in fair value is deferred throughother comprehensive income (“OCI”) on the balance sheet or recorded immediatelyin revenue on the income statement. The effective portion of the changes in thefair value of hedge contracts is recorded initially in OCI. When the hedgedproduction is sold, the realized gains and losses on the hedge contracts areremoved from OCI and recorded in revenue. Ineffective portions of the changesin the fair value of the hedge contracts are recognized in revenue as theyoccur. While the hedge contract is outstanding, the ineffective gain or lossmay increase or decrease until settlement of the contract.

 

Derivative Contracts -For transactions not accounted for using cash flow hedge accounting, the changein the fair value of the derivative contract is reflected in revenueimmediately, i.e. not deferred through OCI, and there is no measurement ofeffectiveness.

 

*Assumptions/ApproachUsed:*Estimatingthe fair values of derivative instruments requires complex calculations,including the use of a discounted cash flow technique, estimates of risk andvolatility, and subjective judgment in selecting an appropriate discount rate.In addition, the calculations use future market commodity prices, whichalthough posted for trading purposes, are merely the market consensus offorecasted price trends. The results of the fair value calculations cannot beexpected to represent exactly the fair value of our commodity hedges. Wecurrently obtain the fair value of our positions from our counterparties. Ourpractice of relying on our counterparties who are more specialized andknowledgeable in preparing these complex calculations reduces our management’sinput.

 

*Effectif different assumptions used:* At March 31, 2005, 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 our derivative financialinstrument to increase or decrease by approximately $248,200.

 

# **Results of Operations**

# ** **

This section includesdiscussion of our results of operations for the three-month period ended March 31,2005 as compared to the same period of the prior year.  We are an independent energy company engagedin the exploration, development, acquisition and production of oil and naturalgas.  Our resources and assets aremanaged and our results reported as one operating segment.  We conduct our operations primarily along theonshore United States Gulf Coast, with our primary emphasis in South Texas,Louisiana, and southeast New Mexico.

 

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**FirstQuarter 2005 Compared to the First Quarter 2004**

 

**Revenueand Production**

 

Total revenue increased 45% from the first quarter of2004 to the comparable 2005 period.  Forthe three months ended March 31, 2005 and 2004, our product mixcontributed the following percentages of production and revenues:

 
| ** **                  | ** ** | **REVENUES (1)** | ** ** | **PRODUCTION** | ** ** |
|-----------------------------|------------|------------------|------------|----------------|------------|
| ** **                  | ** ** | **2005**         | ** ** | **2004**       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Natural Gas  (Mcf)          |       | 81               | %          | 82             | %          | 76 | % | 77 | % |
| Natural gas  liquids (Bbls) |       | 7                | %          | 7              | %          | 12 | % | 13 | % |
| Crude oil (Bbl)             |       | 12               | %          | 11             | %          | 12 | % | 10 | % |
|                        |       |             |       |           |       |   |   |   |   |
| Total (Mcfe)                |       | 100              | %          | 100            | %          | 100 | % | 100 | % |

 

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(1) Includes effect of hedging andderivative transactions.

 

The following table summarizes volume and priceinformation with respect to our oil and gas production for the three-monthperiods ended March 31, 2005 and 2004:

 
| ** **                                   | ** ** | ** **                             | ** ** | ** **                  | ** ** | **2005 Period Compared  to 2004 Period** | ** ** |
|----------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|------------------------------------------|------------|
| ** **                                   | ** ** | **Three Months Ended  March 31,** | ** ** | **$  Increase  (Decrease)** | ** ** | **%  Increase  (Decrease)**              | ** ** |
| ** **                                   | ** ** | **2005**                               | ** ** | **2004**                    | ** ** |
| **Production  Volumes:**                     |       |                                   |       |                        |       |                                     |       |   |   |
| Natural gas  (Mcf)                           |       | 3,202,230                              |       | 2,421,980                   |       | 780,250                                  |       | 32 | % |
| Natural gas  liquids (Bbls)                  |       | 84,089                                 |       | 69,485                      |       | 14,604                                   |       | 21 | % |
| Oil and  condensate (Bbls)                   |       | 83,011                                 |       | 53,828                      |       | 29,183                                   |       | 54 | % |
| Natural gas  equivalent (Mcfe)               |       | 4,204,827                              |       | 3,161,858                   |       | 1,042,969                                |       | 33 | % |
| **Average  Sales Price:**                    |       |                                   |       |                        |       |                                     |       |   |   |
| Natural gas ($ per  Mcf)(1)             |       | $                                      | 5.78       |                        | $          | 5.36                                     |       | $ | 0.42 |   | 8 | % |
| Natural gas  liquids ($ per Bbl)        |       | $                                      | 17.48      |                        | $          | 15.03                                    |       | $ | 2.45 |   | 16 | % |
| Oil and  condensate ($ per Bbl)(1)      |       | $                                      | 47.76      |                        | $          | 32.75                                    |       | $ | 15.01 |   | 46 | % |
| Natural gas  equivalent ($ per Mcfe)(1) |       | $                                      | 5.69       |                        | $          | 5.00                                     |       | $ | 0.69 |   | 14 | % |
| Natural gas  equivalent ($ per Mcfe)(2) |       | $                                      | 5.46       |                        | $          | 5.00                                     |       | $ | 0.46 |   | 9 | % |
| **Operating  Revenue:**                      |       |                                   |       |                        |       |                                     |       |   |   |
| Natural gas (1)                              |       | $                                      | 18,494,831 |                        | $          | 12,988,951                               |       | $ | 5,505,880 |   | 42 | % |
| Natural gas  liquids                         |       | 1,469,575                              |       | 1,044,404                   |       | 425,171                                  |       | 41 | % |
| Oil and  condensate (1)                      |       | 3,964,283                              |       | 1,763,136                   |       | 2,201,147                                |       | 125 | % |
| Gain (loss) on  hedging and derivatives      |       | (984,844                               | )          | 18,166                      |       | (1,003,010                               | )          | (5,521 | )% |
| Total                                        |       | $                                      | 22,943,845 |                        | $          | 15,814,657                               |       | $ | 7,129,188 |   | 45 | % |

 

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(1) Excludesthe effect of hedging and derivative transactions.

(2) Includesthe effect of hedging and derivative transactions.

 

Our revenue is sensitive tochanges 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 anddemand for oil and natural gas can have a dramatic effect on the prices wereceive 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.

 

Natural gas revenue, excluding hedging activity,increased 42% for the three months ended March 31, 2005 over the sameperiod in 2004 due to significantly higher production and higher realized prices.Average natural gas

 

24

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production increased 32% from 2.4 Bcfe in the three months ended March 31,2004 to 3.2 Bcfe in the comparable 2005 period due to production from new wellsacquired on December 29, 2004 in South Texas, new wells drilled, primarilyon our Encinitas, Gato Creek, southeast New Mexico and Miller properties,partially offset by natural declines at our O’Connor Ranch East, Brandon andDuson-Horst properties. The overall increase in production compared to theprior year period resulted in an increase in revenue of approximately $4.2million (based on 2004 comparable period pre-hedge prices).  Excluding the effect of hedges, the averagenatural gas sales price for production in the first quarter of 2005 was $5.78per Mcf compared to $5.36 per Mcf for the same period in 2004.  This increase in average price receivedresulted in increased revenue of approximately $1.3 million (based on currentyear production).

 

Revenue from the sale of NGLs increased 41% for thethree months ended March 31, 2005 over the same period in 2004. Productionvolumes for NGLs increased 21%, from 69.9 MBbls for the three months ended March 31,2004 to 84.1 MBbls for the three months ended March 31, 2005 due primarilyto increased production from new wells at Encinitas and Gato Creek, partiallyoffset by natural declines on our Brandon and Duson-Horst properties. Theincrease in NGL production increased revenue by approximately $219,500 (basedon 2004 comparable period average prices). Higher average realized prices for the three months ended March 31,2005 resulted in an increase in revenue of approximately $205,700 (based oncurrent year production).  The averagerealized price for NGLs for the three months ended March 31, 2005 was$17.48 per barrel compared to $15.03 per barrel for the same period in 2004.

 

Revenue from the sale of oil and condensate, excludingderivative activity, increased 125% for the three months ended March 31,2005 as compared to the comparable prior year period in 2004 due to higherprice environment and increased production. The average realized price for oiland condensate before the derivative losses for the three months ended March 31,2005 was $47.76 per barrel compared to $32.75 per barrel in the same period of2004.  These higher average prices forthe first quarter of 2005 resulted in an increase in revenue of approximately$1.2 million (based on current year production).  Production volumes for oil and condensateincreased 54% to 83.0 MBbls for the three months ended March 31, 2005compared to 53.8 MBbls for the same prior year period due primarily toproduction from the properties acquired on December 29, 2004 fromContango, as well as new wells drilled. The increase in oil and condensate production resulted in an increase inrevenue of approximately $955,900 (based on 2004 comparable period averageprices).

 

Losses on hedging and derivatives increasedsignificantly for the three months ended March 31, 2005 over the sameperiod in 2004 due to the change in the fair market value of the outstandingderivative contracts as a result of volatile commodity prices and cashsettlements on expiring contracts. Oil and condensate revenues were decreasedby realized and unrealized losses on our oil derivatives. For the three monthsended March 31, 2005, we recorded $258,514 of realized losses on oilderivatives settlements and $882,830 of unrealized losses representing thechange in the mark-to-market fair value of our outstanding oil derivative contracts.We did not apply hedge accounting to these transactions.  See Note 7 to our consolidated financialstatements.  These losses account for a$13.75 per barrel decrease in the realized oil price for the three months endedMarch 31, 2005 from $47.76 per barrel to $34.01 per barrel. At March 31,2004 we had an unrealized gain of $45,466, representing an increase in ourrealized oil price of $0.84 per barrel. Should the crude oil prices decreasefrom the current levels, we would realize lower revenues, but our oilderivative losses would also decrease and could possibly result in a gainposition. Included within natural gas revenue for the three months ended March 31,2005 was $156,500 representing realized gains from hedging contractsettlements.  These gains increased theeffective natural gas sales price by $0.05 per Mcf for the three months ended March 31,2005.  Should natural gas prices continueto decrease from the high levels of late 2004, this could materially affect ourrevenues that are not hedged. For the three months ended March 31, 2004,we recognized $27,300 of the premium paid for a natural gas hedge entered intoin 2003.  This loss decreased theeffective natural gas sales price by $0.01 per Mcf.

 

**Costs and Operating Expenses**

 

The table below presentsa detail of our expenses for the three months ended March 31, 2005 and2004:

 

25

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| ** **                                            | ** ** | ** **                             | ** ** | ** **                  | ** ** | **2005 Period Compared  to 2004 Period** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|------------------------------------------|------------|
| ** **                                            | ** ** | **Three Months Ended  March 31,** | ** ** | **$  Increase  (Decrease)** | ** ** | **%  Increase  (Decrease)**              | ** ** |
| ** **                                            | ** ** | **2005**                               | ** ** | **2004**                    | ** ** |
|                                                  |       |                                   |       |                        |       |                                     |       |   |   |
| Oil and natural  gas operating expenses               |       | $                                      | 2,242,465  |                        | $          | 1,205,073                                |       | $ | 1,037,392 |   | 86 | % |
| Severance and ad  valorem taxes                       |       | 1,866,488                              |       | 1,044,714                   |       | 821,774                                  |       | 79 | % |
| Depreciation,  depletion, amortization and accretion: |       |                                   |       |                        |       |                                     |       |   |   |
| Oil and gas  property and equipment                   |       | 8,540,134                              |       | 5,129,154                   |       | 3,410,980                                |       | 67 | % |
| Other assets                                          |       | 62,109                                 |       | 86,977                      |       | (24,868                                  | )          | (29 | )% |
| ARO accretion                                         |       | 33,386                                 |       | 26,285                      |       | 7,101                                    |       | 27 | % |
| General and  administrative:                          |       |                                   |       |                        |       |                                     |       |   |   |
| Deferred  compensation – repriced options        |       | 261,904                                |       | 1,111,099                   |       | (849,195                                 | )          | (76 | )% |
| Deferred  compensation – restricted stock        |       | 143,599                                |       | 96,500                      |       | 47,099                                   |       | 49 | % |
| Bad debt expense                                      |       | 11,000                                 |       | —                      |       | 11,000                                   |       | * |   |
| Other general  and administrative                     |       | 2,478,725                              |       | 1,900,827                   |       | 577,898                                  |       | 30 | % |
|                                                  |       | 15,639,810                             |       | 10,600,629                  |       | 5,039,181                                |       | 48 | % |
| Other expense,  net                                   |       | 3,189                                  |       | 139,906                     |       | (136,717                                 | )          | (98 | )% |
| Total                                                 |       | $                                      | 15,642,999 |                        | $          | 10,740,535                               |       | $ | 4,902,464 |   | 46 | % |

 

----

*Not meaningful

 

Oil and natural gas operating expenses for the threemonths ended March 31, 2005 increased 86% over the same period of 2004.The December 29, 2004 acquisition of properties in South Texas contributed41% of the increase in costs. Wells drilled since the first quarter of 2004further increased the costs for the first quarter of 2005 compared to the prioryear.  We also realized higher expensesfor the fourth quarter 2004 than originally estimated in our year-end accrualsfor our States, Encinitas, O’Connor Ranch and other properties, which equatedto 26% of the increase in costs. We have begun to experience increased costsdue to increased demand for oil field products and services. The oil andnatural gas industry tends to be cyclical in nature, and the demand for goodsand services of oil field companies, suppliers and others associated with theindustry can put extreme pressure on the economic stability and pricingstructure within the industry. Typically, as prices for oil and natural gasincrease, so do all associated costs. When commodity prices decline, associatedcosts do not necessarily decline at the same rate. These various cost increaseshave led to an increase in lease operating expenses to $0.53 per Mcfe for thethree months ended March 31, 2005 from $0.38 per Mcfe for the same prioryear period.

 

Severance and ad valoremtaxes for the three months ended March 31, 2005 increased 79% from thefirst quarter of 2004.  Severance taxexpense for the first quarter of 2005 was 60% higher than the comparable prioryear period as a result of higher revenue. Our severance tax expense is leviedon our oil and gas revenue dollars (excluding hedging and derivative impact),so if commodity prices remain high, we expect to continue to incur higherseverance tax expense. For the three months ended March 31, 2005,severance tax expense was approximately 6.2% of revenue subject to severancetaxes compared to 6.0% of revenue subject to severance taxes for the comparable2004 period. The increase in tax as a percent of revenue was due primarily to ashift in our revenue stream to properties with higher severance tax rates. Advalorem tax expense for the first quarter of 2005 was impacted by increasedaccruals for the estimated costs related to the addition of the South Texasproperties acquired on December 29, 2004. On an equivalent basis, severance and ad valorem taxes averaged $0.44per Mcfe and $0.33 per Mcfe for the three months ended March 31, 2005 and2004, respectively.

 

Depletion, depreciation,and amortization (“DD&A”) and accretion expense for the three months ended March 31,2005 totaled $8.6 million compared to $5.2 million for the three months ended March 31,2004.

 

26

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Depletion on our oil and natural gas properties increased 67% for thefirst quarter of 2005 compared to the same period of 2004 due to an increase inproduction levels and in the unit-of-production depletion rate from $1.62 perMcfe in the first quarter 2004 as compared to $2.03 per Mcfe in the firstquarter of 2005. The increase in depletion expense from the higher productionlevels in the first quarter of 2005 as compared to the same period of 2004resulted in an increase in expense of approximately $1.7 million. The increasein rate for the first quarter of 2005 compared to the first quarter of 2004added approximately $1.7 million in depletion expense. Our rate has increaseddue to increased spending on our drilling program with disproportionate reserveadditions. Depreciation of furniture and fixtures decreased 29% compared to theprior year first quarter due to several larger depreciable assets that becamefully depreciated by year-end 2004 and are not currently contributing toexpense. Accretion expense associated with our asset retirement obligations forthe three months ended March 31, 2005 increased 27% over the first quarterof 2004 for the new obligations incurred from the wells drilled in 2004 andthose South Texas properties acquired on December 29, 2004.

 

Total G&A for thethree months ended March 31, 2005 was $2.9 million, a decrease of 7%compared to the prior year first quarter total of $3.1 million. Pursuant to FIN44 discussed in Note 1 to the consolidated financial statements, G&A costsinclude deferred compensation related to repriced options, deferredcompensation related to restricted stock grants and other G&A costs. A FIN 44 charge of $261,904 was incurred forthe three months ended March 31, 2005 compared to $1.1 million in the sameperiod of 2004. Amortization related to restricted stock awards grantedover the past three years totaled $143,599 and $96,500, respectively, for thethree months ended March 31, 2005 and 2004. The increase relates to newgrants that have occurred since the first quarter of 2004. We recorded $11,000of bad debt expense and increased our allowance related to JIB Accounts Receivable.Other G&A for the three months ended March 31, 2005, which does notinclude the deferred compensation expenses discussed above, totaled $2.5million, a 31% increase from the comparable 2004 period total of $1.9 million.The increase in other G&A was attributable to higher salaries and benefits,due in part to higher staffing levels, as well as higher rent expense foradditional office space, franchise tax expense, regulatory fees for increasedoutstanding common stock and costs relating to strategic planning. For thethree months ended March 31, 2005 and 2004, overhead reimbursement feesreduced G&A costs by $50,402 and $46,477, respectively. Capitalized G&Acosts further reduced other G&A by $713,700 and $507,064 for the threemonths ended March 31, 2005 and 2004, respectively.  Other G&A on a unit of production basisfor the three months ended March 31, 2005 was $0.59 per Mcfe compared to$0.60 per Mcfe for the comparable 2004 period.

 

Other income (expense) for the three months ended March 31,2005 excludes interest expense because 100% of our interest expense for thequarter was capitalized as compared to $114,278 of expense in the same 2004period. We incurred higher interest costs for the three months ended March 31,2005 than for the same period of 2004, but we capitalized all of our expense asa result of our unproved property balance exceeding our debt balance. Interestexpense, including facility fees, was $223,918 for the first quarter of 2005 onweighted average debt of approximately $12.0 million compared to interestexpense of $202,833 on weighted average debt of approximately $20.9 million forthe first quarter of 2004.  Capitalizedinterest for the three months ended March 31, 2005 totaled $223,918compared to $88,555 in the same prior year period.  We also recorded amortization of deferredloan costs of $35,535 during the first quarter of 2005 as compared to $29,636for the same prior year period related to our amended credit facility.

 

An income tax provision was recorded for the three monthsended March 31, 2005 and 2004 of $2.6 million and $1.8 million,respectively. The increase resulted from higher pre-tax income in 2005 ascompared to 2004.

 

For the three monthsended March 31, 2005, we had net income of $4.7 million, or $0.28 basic earningsper share and $0.27 diluted earnings per share, as compared to net income of$3.3 million, or $0.26 basic earnings per share and $0.25 diluted earnings pershare in the comparable 2004 period. Basic weighted average shares outstanding increased for the three monthsended March 31, 2005 over the same period 2004 primarily due to the stockoffering completed in December 2004 and the related over-allotmentexercise in January 2005. We issued a total of 4,025,000 shares in thesetransactions.

 

27

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## **Liquidity and Capital Resources**

## ** **

Our primary ongoingsource of capital is the cash flow generated from our operating activitiessupplemented by borrowings under our credit facility.  Net cash generated from operating activitiesis a function of production volumes, commodity prices (which are inherentlyvolatile and unpredictable), operating efficiency and capital spending. Ourbusiness, as with other extractive industries, is a depleting one in which eachgas equivalent unit produced must be replaced or our business, and a criticalsource of our future liquidity, will shrink. Our overall existing productionhas a decline rate of approximately 17% per year.  Less predictable than production declinesfrom our proved reserves is the impact of constantly changing oil and naturalgas prices on cash flows and, therefore capital budgets.  We attempt to mitigate the price risk withour hedging program. Reserves and production volumes are influenced, in part,by the amount of future capital expenditures. In turn, capital expenditures areinfluenced by many factors including drilling results, oil and gas prices,industry conditions, availability and prices of goods and services and theextent to which oil and gas properties are acquired.

 

Our primary needs forcash are for exploration, development and acquisition of oil and gasproperties, and the repayment of principal and interest on outstanding debt. Weattempt to fund our exploration and development activities primarily throughinternally generated cash flows and budget capital expenditures based onprojected cash flows.  We routinelyadjust capital expenditures in response to changes in oil and natural gasprices, drilling and acquisition costs, and cash flow.  We typically have funded acquisitions fromborrowings under our credit facility and cash flow from operations.  We have historically utilized net cashprovided by operating activities, debt and equity as capital resources to obtainnecessary funding for all of our cash needs.

 

Some significant changesto working capital may also affect our liquidity in the short term. Theincrease in the derivative instrument liability is indicative of potentialfuture cash settlements on our hedge positions as the months settle. The fairvalue of our outstanding hedge and derivative contracts is reflected on thebalance sheet, and we show a liability for the positions with each of our twocounterparties. The hedge and derivative financial instrument liabilityrepresents the amount by which future strip commodity prices exceed the pricecaps on our contracts at the balance sheet date. The hedge and derivativefinancial instrument asset represents the amount by which strip commodityprices are lower than the price floors on our contracts at the balance sheetdate. Should commodity prices increase or decrease, the applicable positionswould change accordingly and the unrealized losses that are reflected inrevenue and the unrealized gains reflected in other comprehensive income couldpossibly reduce or result in gains or losses, respectively. When hedges andderivatives require cash settlement, the Company is receiving higher cashinflows on the sale of production at higher prices, therefore the use of thosefunds would adequately cover any derivative and hedge payments when they comedue.

 

We have historically used our credit facility tosupplement any deficiencies between operating cash flow and capitalexpenditures. We had $10.0 million outstanding under the credit facility at March 31,2005, which was reduced from $20.0 million at December 31, 2004 withproceeds from the underwriter’s over-allotment option to our December 2004public stock offering (see discussion below). The maturity for this creditfacility is December 31, 2006.

 

After considering the impact of these working capitalchanges and our forecasts of future results of operations, we believe that cashflows from operating activities, as supplemented by borrowings on our creditfacility, combined with our ability to control the timing of the majority ofour future exploration and development requirements will provide us with theflexibility and liquidity to meet our planned capital requirements for 2005. Inaddition, our credit facility had $55.0 million available at March 31,2005 for general corporate purposes, exploratory and developmental drilling andacquisitions of oil and gas properties.

 

During 2004 and early2005, we realized increased cash flows as a result of our public stockofferings and activity in stock option and warrant exercises. Mostsignificantly was the net proceeds of $47,810,000 that we received, beforedirect costs of $0.6 million, from our December 2004 offering of ourcommon stock and the related exercise of the underwriter's over-allotmentoption for 525,000 additional shares of our common stock, resulting in anadditional $7.2 million of net proceeds to us in January 2005. Wetypically do not rely on proceeds from offerings and the exercise of warrantsand stock options to sustain our business as they are unpredictable events.

 

28

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We had cash and cashequivalents at March 31, 2005 of $4.6 million consisting primarily ofshort-term money market investments, as compared to $2.3 million at December 31,2004.  Working capital was $8.1 millionas of March 31, 2005, as compared to $9.0 million at December 31,2004.

 

*NetCash Provided By Operating Activities*

 

Cash flows provided byoperating activities were $18.0 million for the three months ended March 31,2005 compared to $12.5 million for the three months ended March 31, 2004.The increase in cash flows provided by operating activities for the threemonths ended March 31, 2005 compared to 2004 was primarily due to higheroil and gas production revenue partially offset by higher operatingexpense.  Although fluctuations incommodity prices have been the primary reason for our short-term changes incash flow from operating activities, increased production volumes significantlyimpacted us in the past few quarters.  Inan effort to reduce the volatility realized on commodity prices, we enter intoderivative instruments.  Due to theinflated market crude oil pricing, the impact related to the derivatives to thefirst three months of 2005 has been negative, as the prices have exceeded thehighs we originally expected. We have realized the benefit of these high priceson our crude oil production, but also realized the negative impact from$258,514 of cash settlements on our crude oil derivatives. We have alsorealized $156,500 of cash gains on our natural gas hedges due to the marketnatural gas prices falling below our hedge floors. Overall, oil and gasproduction revenue increased for the three months ended March 31, 2005 ascompared to the same period in 2004 with a 33% increase in production and a 9%increase in the average net price received for our production.

 

*NetCash Used In Investing Activities*

 

We reinvest a substantial portion of our cashflows in our drilling, acquisition, land and geophysical activities.  As a result, we used $12.8 million ininvesting activities during the first three months of 2005. Capitalexpenditures of $10.8 million were attributable to our drilling program. Inaddition to drilling that was in progress at year-end 2004, we drilled six grosswells during the first quarter of 2005, all of which were successful. Leaseholdacquisitions, including seismic data and other geological and geophysicalexpenditures totaled $1.6 million and acquisition costs totaled $0.3 millionfor the three months ended March 31, 2005. The remaining capitalexpenditures were associated with computer hardware and office equipment.During the first quarter of 2004, we used $11.3 million in investing activitiesand we incurred capital expenditures of $9.4 million attributable to thedrilling of nine gross wells, all of which were successful.  Leasehold acquisitions, including seismicdata and other geological and geophysical expenditures totaled $1.7 million andacquisition costs totaled $0.1 million for the three months ended March 31,2004. The remaining capital expenditures were associated with computer hardwareand office equipment.  Proceeds from thesale of oil and gas properties totaled $40,000 during the first quarter of2004.

 

We currently anticipatecapital expenditures in 2005 to be approximately $63 million.  Approximately $51.8 million is allocated toour expected drilling and production activities; $7.9 million is allocated toland and seismic activities; and $3.3 million relates to capitalized interestand G&A and other.  We plan to fundthese expenditures from expected cash flow from operations.  We do not explicitly budget for acquisitions;however, we do expect to spend considerable effort evaluating acquisitionopportunities. We expect to fund acquisitions through traditional oil and gasreserve-based bank debt and the issuance of common stock and, if required,through additional debt and equity financings and production paymentfinancings. We currently have $55.0 million of unused borrowing capacity under ourcredit facility and $91.8 million of unused capacity under our current shelfregistration statement.

 

*NetCash Used In Financing Activities*

 

Cash flows used infinancing activities totaled $2.8 million for the three months ended March 31,2005. Net repayments of $10.0 million under our current credit facility werepartially offset by $7.2 million in proceeds from the issuance of common stockrelated to the exercise of the over-allotment option on our December 21,2004 public offering and stock options exercised in the first three months of2005. Cash flows used in financing activities totaled $31,759 for the threemonths ended March 31, 2004, and included repayments of $1.0 million underour credit

 

29

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facility, $1.3 million ofnet proceeds from the issuance of common stock and deferred loan costs of$355,629 associated with amending that facility after the Miller merger.

 

Due to our activeexploration, development and acquisition activities, we have experienced andexpect to continue to experience substantial working capital requirements.  We intend to fund our projected 2005 capitalexpenditures, commitments and working capital requirements through cash flowsfrom operations. We believe we will be able to generate capital resources andliquidity sufficient to fund our capital expenditures and meet such financialobligations as they come due.

 

*Credit Facility*

 

In March 2004, buteffective December 31, 2003, the Company entered into a new amended andrestated credit facility (the “Credit Facility”) which permits borrowings up tothe lesser of (i) the borrowing base or (ii) $100 million.  Borrowings under the Credit Facility bearinterest at a rate equal to prime plus 0.50% or LIBOR plus 2.25%.  As of March 31, 2005, $10.0 million inborrowings were outstanding under the Credit Facility and our interest rate was6.25%.  The Credit Facility matures December 31,2006 and is secured by substantially all of the Company’s assets.

 

Effective December 2004,the borrowing base under the Credit Facility was increased from $48.0 millionto $65.0 million as a result of the asset acquisition that closed December 29,2004 and our drilling activities since the last redetermination.Based on theincrease, our available borrowing capacity at March 31, 2005 was $55.0million. The borrowing base is currently being redetermined by our lender andwe expect to be notified of any changes by the end of May 2005. 

 

The Credit Facilityprovides for certain restrictions, including but not limited to, limitations onadditional borrowings, sales of oil and natural gas properties or othercollateral, and engaging in merger or consolidation transactions. The CreditFacility also prohibits dividends and certain distributions of cash orproperties and certain liens.  The CreditFacility also contains the following financial covenants, among others:

 

•                  TheEBITDAX to Interest Expense ratio requires that the ratio of (a) ourconsolidated EBITDAX (defined as EBITDA plus similar non-cash items and explorationand abandonment expenses for such period) for the four fiscal quarters thenended to (b) our consolidated interest expense for the four fiscalquarters then ended, to not be less than 3.5 to 1.0.

•                  TheWorking Capital ratio requires that the amount of our consolidated currentassets less our consolidated current liabilities, as defined in the agreement,be at least $1.0 million. For the purposes of calculating the Working Capitalratio, current assets is adjusted for unused capacity under credit agreementand derivative financial instruments, and current liabilities is adjusted forderivative financial instruments and asset retirement obligations.

•                  TheMaximum Leverage ratio requires that the ratio, as of the last day of anyfiscal quarter, of (a) Total Indebtedness (as defined in the CreditFacility) as of such fiscal quarter to (b) an amount equal to consolidatedEBITDAX for the two quarters then ended times two, not be greater than 3.0 to1.0.

 

Consolidated EBITDAX is acomponent of negotiated covenants with our lender and is presented here as partof the Company’s disclosure of its covenant obligations.

 

*Shelf Registration Statement*

 

We filed a $150 million shelf registration statement with the SEC, which became effective in May 2004. Under the shelf registration statement, we may issue, from time to time, any combination of debt securities, preferred stock, common stock or warrants for debt securities or equity securities in one or more offerings to those persons who agree to purchase our securities. Net proceeds, terms and pricing of the offering of securities issued under the shelf registration statement will be determined at the time of the offerings. The shelf registration statement does not provide assurance that we will or could sell any such securities. Our ability to utilize our shelf registration statement for the purpose of issuing, from time to time, any combination of debt securities, preferred stock, common

 

30

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stock or warrants for debt securities or equity securities will dependupon, among other things, market conditions and the existence of investors whowish to purchase our securities at prices acceptable to us.

 

We completed an offeringon December 21, 2004 of 3.5 million shares of our common stock under ourshelf registration statement, which generated net proceeds to us, before directcosts of the offering, of $47.8 million. These funds were used to finance theasset acquisition that closed on December 29, 2004 with a final adjusted purchaseprice of $40.1 million, before other acquisition costs, and fund the costs ofthe offering and other general corporate purposes. On January 5, 2005, theunderwriters exercised their over-allotment option for an additional 525,000shares of common stock, which generated net proceeds to us of $7.2 million.These funds were used to reduce our outstanding debt. Each of these sales wasmade under our shelf registration statement. At March 31, 2005, we hadapproximately $91.8 million remaining for issuance under our shelf registrationstatement.

 

*Off Balance Sheet Arrangements*

 

We currently do not have any off balance sheetarrangements.

 

*Contractual Cash Obligations*

 

There were no materialchanges outside the ordinary course of our business in lease obligations orother contractual obligations since December 31, 2004.

 

**Risk Management Activities –Derivatives & Hedging**

 

Due to the instability ofoil and natural gas prices, we may enter into, from time to time, price-riskmanagement transactions (e.g., swaps, collars and floors) for a portion of ouroil and natural gas production to achieve a more predictable cash flow, as wellas to reduce exposure from commodity price fluctuations.  While the use of these arrangements limit ourability to benefit from increases in the price of oil and natural gas, it alsoreduces our potential exposure to adverse price movements.  Our arrangements, to the extent we enter intoany, apply to only a portion of our production, provide only partial priceprotection against declines in oil and natural gas prices and limits ourpotential gains from future increases in prices. We also use price-riskmanagement transactions to protect forward pricing as a bidding strategy withrespect to acquisition offers and execution. None of these instruments are usedfor trading purposes. On a quarterly basis, our management sets all of ourprice-risk management policies, including volumes, types of instruments andcounterparties. These policies are implemented by management through theexecution of trades by the Chief Financial Officer after consultation andconcurrence by the President and Chairman of the Board.  Our Board of Directors monitors the Company’sprice-risk management policies and trades.

 

All of these price-riskmanagement transactions are considered derivative instruments and accounted forin accordance with SFAS No. 133, *“Accountingfor Derivative Instruments and Hedging Activities.”* These derivativeinstruments are intended to hedge our price risk and may be considered hedgesfor economic purposes, but certain of these transactions may not qualify forspecial cash flow hedge accounting. Therefore, depending on the type oftransaction and the circumstances, different accounting treatment may apply tothe timing and location of the income statement impact, but all derivatives arerecorded on the balance sheet at fair value. The following table providesadditional information regarding the Company’s various derivative and hedgingtransactions that were recorded at fair value on the balance sheet as of March 31,2005.

 

 

| Fair value of  contracts outstanding at December 31, 2004                          |   | $          | 1,356,482  |   |
|-----------------------------------------------------------------------------------------|--------|------------|------------|--------|
| Contracts  realized or otherwise settled during the period                              |   | (442,030   | )          |
| Fair value of  new contracts when entered into during 2005:                             |   |       |       |
| Asset                                                                                   |   | —     |       |
| Liability                                                                               |   | —     |       |
| Changes in fair  values attributable to changes in valuation techniques and assumptions |   | (3,514,547 | )          |
| Other changes in  fair values                                                           |   | —     |       |
| Fair values of  contracts outstanding at March 31, 2005                            |   | $          | (2,600,095 | )      |

 

31

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The following table details the fair value of ourcommodity-based derivative and hedging contracts by year of maturity andvaluation methodology as of March 31, 2005.

 
| ** **                                           | ** ** | **Fair Value of Contracts at March 31, 2005** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|
| **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** | ** ** |
| Prices actively  quoted:                             |       | —                                             |       | — |   | — |   | — |   | — |   |
| Prices provided  by other external sources:          |       |                                               |       |   |   |   |   |   |   |   |   |
| Asset                                                |       | —                                             |       | — |   | — |   | — |   | — |   |
| Liability                                            |       | (2,600,095                                         | )          | — |   | — |   | — |   | (2,600,095 | ) |
| Prices based on  models and other valuation methods: |       | —                                             |       | — |   | — |   | — |   | — |   |
| Total                                                |       | $                                                  | (2,600,095 | ) | $ | — |   | $ | — |   | $ | — |   | $ | (2,600,095 | ) |
|                                                      |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Tax Matters**

 

At December 31,2004, we had cumulative net operating loss carryforwards (“NOLs”) for federalincome tax purposes of approximately $73.9 million, that expire beginning 2007through 2022. The estimated NOLs presented herein assume that certain items,primarily intangible drilling costs, have been written off for tax purposes inthe current year. However, we have not made a final determination if anelection will be made to capitalize all or part of these items for tax purposesin the future.

 

**Recently Issued Accounting Pronouncements**

 

In December 2004,the FASB issued SFAS No. 123(R), “*Share-BasedPayment.*” This statement requires companies to measure the cost ofemployee services in exchange for an award of equity instruments based on agrant-date fair value of the award (with limited exceptions), and that costmust generally be recognized over the vesting period. SFAS No. 123(R)amends the original SFAS No. 123 and 95 that had allowed companies tochoose between expensing stock options or showing pro forma disclosure only.This statement eliminates the ability to account for share-based compensationtransactions using APB Opinion No. 25. We currently account for ourstock-based compensation plans under the principles prescribed by APB Opinion No. 25.Accordingly, no stock option compensation cost is reflected in net income, asall options granted under the plan had an exercise price equal to the marketvalue of the underlying common stock on the date of grant. The adoption of SFASNo. 123(R) will impact our results of operations, but will have no impacton our overall financial position. In March 2005, the SEC issued SAB No. 107.Among other things, SAB No. 107 provides interpretive guidance related tothe interaction between SFAS No. 123(R) and certain SEC rules andregulations, as well as provides the SEC staff’s views regarding the valuationof share-based payment arrangements for public companies. SFAS No. 123(R)was to become effective as of the beginning of the first interim or annualreporting period that begins after June 15, 2005, but on April 14,2005, the SEC issued press release 2005-57, which amends the compliance date ofSFAS No. 123(R) until fiscal years beginning after June 15, 2005. Weanticipate adopting the provisions of SFAS No. 123(R) in the firstquarter of 2006 using the modified prospective method for transition. Underthis method we will recognize compensation expense for all stock-based awardsgranted or modified on or after July 1, 2005, as well as any previouslygranted awards that are not fully vested as of July 1, 2005. Compensationexpense will be measured based on the fair value of the awards previouslycalculated in developing the pro forma disclosures in accordance with theprovisions of SFAS No. 123. We expect the impact to be immaterial dueto the fact that the Company has not issued options since April 2004 andthere will only be a minimal amount of unvested options as of our adoptiondate. SFAS No. 123(R) also requires the benefits of tax deductions inexcess of recognized compensation cost be reflected as a financing cash flow,rather than as an operating cash flow as currently required.

 

In March 2005, the FASB issued FASBInterpretation No. 47, *Accounting forConditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143*(“FIN 47”).  FIN 47 clarifies that the term, “conditional asset retirementobligation” as used in SFAS No. 143, *Accountingfor Asset Retirement Obligations*, refers to a legal obligation toperform an asset retirement activity in which the timing and/or method ofsettlement are conditional upon a future event that may or may not be withinthe control of the entity.  Even though uncertainty about the

 

32

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timing and/or method of settlement exists and may be conditional upon afuture event, the obligation to perform the asset retirement activity isunconditional.  Accordingly, an entity is required to recognize aliability for the fair value of a conditional asset retirement obligation ifthe fair value of the liability can be reasonably estimated.  Uncertaintyabout the timing and/or method of settlement of a conditional asset retirementobligation should be factored into the measurement of the liability whensufficient information exists.  The fair value of a liability for theconditional asset retirement obligation should be recognized when incurredgenerally upon acquisition, construction, or development or through the normaloperation of the asset.  SFAS No. 143 acknowledges that in somecases, sufficient information may not be available to reasonably estimate thefair value of an asset retirement obligation.  FIN 47 also clarifies whenan entity would have sufficient information to reasonably estimate the fairvalue of an asset retirement obligation.  FIN 47 is effective no laterthan the end of reporting periods ending after December 15, 2005. Retrospective application for interim financial information is permitted but isnot required.  Early adoption of FIN 47 is encouraged.  We arecurrently evaluating what impact FIN 47 will have on our financial statements,but at this time, we do not believe that the adoption of FIN 47 will have amaterial effect on our financial position, results of operations or cash flows.

 

***ITEM3.  QUALITATIVE AND QUANTITATIVEDISCLOSURES ABOUT MARKET RISK***

 

We are exposed to market risk from changes in interestrates and commodity prices.  We use acredit facility, which has a floating interest rate, to finance a portion ofour operations. We are not subject to fair value risk resulting from changes inour floating interest rates.  The use offloating rate debt instruments provides a benefit due to downward interest ratemovements but does not limit us to exposure from future increases in interestrates.  Based on the March 31, 2005outstanding borrowings and a floating interest rate of 6.25%, a 10% change ininterest rates would result in an increase or decrease of interest expense ofapproximately $59,700 on an annual basis.

 

In the normal course ofbusiness we enter into hedging transactions, including commodity price collars,swaps and floors to mitigate our exposure to commodity price movements, but notfor trading or speculative purposes.  During 2004, due to the instability of prices and to achieve a morepredictable cash flow, we put in place natural gas and crude oil collars for aportion of our 2005 production. Please refer to Note 7 to our consolidatedfinancial statements. While the use of these arrangements may limit the benefitto us of increases in the price of oil and natural gas, it also limits thedownside risk of adverse price movements. The following is a list of contracts outstanding as of March 31,2005:

 
| **Transaction Date** | ** ** | **Transaction Type** | ** ** | ** ** | **Beginning** | ** ** | **Ending** | ** ** | **Price  Per Unit** | ** ** | **Volumes Per  Day** | ** ** |
|----------------------|------------|----------------------|------------|------------|---------------|------------|------------|------------|---------------------|------------|----------------------|------------|
| ** **           | ** ** | ** **           | ** ** | ** ** | ** **    | ** ** | ** ** | ** ** | ** **          | ** ** | ** **           | ** ** |
| ***Natural  Gas:***  |       |                 |       |       |          |       |       |       |                |       |                 |       |
| 07/04                |       | Collar (1)           |       |       | 04/01/05      |       | 06/30/05   |       | $5.00-$7.53         |       | 10,000 MMbtu         |       |
| 07/04                |       | Collar (1)           |       |       | 07/01/05      |       | 09/30/05   |       | $5.00-$7.67         |       | 10,000 MMbtu         |       |
| 10/04                |       | Collar (1)           |       |       | 01/01/05      |       | 12/31/05   |       | $6.00-$9.52         |       | 10,000 MMbtu         |       |
|                 |       |                 |       |       |          |       |       |       |                |       |                 |       |
| ***Crude  Oil:***    |       |                 |       |       |          |       |       |       |                |       |                 |       |
| 05/04(08/04)         |       | Collar (2)(3)        |       |       | 01/01/05      |       | 12/31/05   |       | $35.00-$40.00       |       | 200/290 Bbl          |       |

 

----

(1)     The Company’scurrent hedging activities for natural gas were entered into on a per MMbtudelivered price basis, using the Houston Ship Channel Index, with settlementfor each calendar month occurring five business days following the expirationdate.

(2)     Hedgeaccounting is not applied to the Company’s collars on crude oil, which wereentered into on a per barrel delivered price basis, using the West TexasIntermediate Index, with settlement for each calendar month occurring fivebusiness days following the expiration date. The change in fair value isreflected in net revenue for the applicable periods.

(3)     InAugust 2004, the Company replaced the hedge contract that was outstandingat June 30, 2004 with a new contract that changes the volume and pricingterms. The put option is on 200 Bbl/D and the call option is on 290 Bbl/D. Thistransaction was completed at no additional cost to the Company.

 

  At March 31,2005, the fair value of the outstanding hedges was a liability of approximately$2.6 million. A 10% change in the commodity price per unit, as long as theprice is either above the ceiling or below the floor price would cause the fairvalue total of the hedge to increase or decrease by approximately $248,200.

 

33

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

#####  

In accordance with Exchange Act Rules 13a-15 and15d-15, we carried out an evaluation, under the supervision and with theparticipation of management, including our Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of our disclosure controls andprocedures as of the end of the period covered by this report.  Based on that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective as of March 31, 2005 to provide reasonableassurance that information required to be disclosed in our reports filed orsubmitted under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms.

 

Except as described in this item, there has been nochange in our internal controls over financial reporting that occurred duringthe three months ended March 31, 2005 that has materially affected, or isreasonably likely to materially affect, our internal controls over financialreporting.  In March 2005,management discovered an error in a spreadsheet application, which was designedto eliminate intercompany balances.  As aresult of the error, amounts accumulated in the property account for onesubsidiary were also included as an accrued capital expenditure by anothersubsidiary and inadvertently not eliminated in consolidation.  This caused property balances to be overstated.  This error in the property balance alsoimpacted the computation of depletion expense and therefore operating expenses,operating income, income tax expense, net income and earnings per share.  Management concluded, based on thecircumstances involving the error, that, as of December 31, 2004, amaterial weakness in internal control over financial reporting existed and theCompany’s internal control over financial reporting was not effective.  Changes were made to the Company’s internalcontrol over financial reporting in order to remediate the materialweakness.  The change in accountingprocess in the second quarter of 2004 which led to the error was made in orderto meet our shortened reporting deadlines with our then-existing staffinglevel.  In the first quarter of 2005,management effectively corrected the problem by re-instituting the accountingprocess we had used prior to the second quarter of 2004.  We were able to re-institute the old methodas a result of increasing our staffing levels to assist with the closing of ourfinancial statements.  Managementbelieves that these actions remediate the material weakness.  These changes have been tested by the Companyand are operating effectively.

 

34

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**PART II - OTHER INFORMATION**

 

**Item 1 - Legal Proceedings**

 

From time to time we area party to various legal proceedings arising in the ordinary course ofbusiness.  While the outcome of lawsuitscannot be predicted with certainty, we are not currently a party to anyproceeding that we believe, if determined in a manner adverse to the Company,could have a potential material adverse effect on our financial condition,results of operations or cash flows.

 

During the second quarter of 2004, the Companyreceived notice that its franchise tax returns for the State of Texas would beaudited for the tax years 1999 through 2002. After reviewing documentssubmitted, the agent representing the Office of the Comptroller of the State ofTexas proposed adjustments to the calculation that would result in an increasedfranchise tax liability.  The agentmaintained that transfers by the parent company to its subsidiaries that theCompany classified as intercompany loans should instead be classified as equityinvestments in the subsidiary. The State of Texas originally proposed that thefranchise tax liability of the subsidiaries would be increased by approximately$3.0 million for the four-year period under audit.

 

During the third quarter of 2004, the agent reducedthe proposed franchise tax deficiency adjustment to the Company and itssubsidiaries to an aggregate of $467,000. In the fourth quarter of 2004, therewas an informal hearing at the local Comptroller’s Office during which theagent indicated he would formally assess the proposed deficiency.  On March 24, 2005, the Company receivedsuch deficiency assessment in the amount of $471,482 including penalty andinterest.  The Company responded on April 21,2005 with a request for a formal redetermination hearing.  The Company intends to continue to vigorouslycontest the assessment through appropriate administrative levels in theComptroller’s Office and any other available means.  Due to its intention to continue tovigorously contest the proposed adjustments, the Company has not recognized anyprovision for the additional franchise taxes that would result from theproposed deficiency.

 
| **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** |   |
| ** **                     |   |

The Company filed a Current Report on Form 8-K on May4, 2005 to report, among other things, changes in the compensation ofnon-employee directors of the Company.  The 8-K inadvertently stated thatthe additional retainers approved for chairmen of specified committees of theBoard of Directors would not be payable until beginning with the 2006 annualmeeting.  However, these additional retainers were instead paid followingthe 2005 annual meeting.
|                  |   |
|-----------------------|--------|
| **Item 6 - Exhibits** |   |

 

The following exhibits are filed as partof 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 October 7, 2004 |
|                      |            |            |  |  |

 

35

----

 
|   |   |   | (Incorporated by  reference from exhibit 2.1 to the Company’s Current Report on Form 8-K  filed October 12, 2004).                                                                                                                                                                                                                                                                                                                                                                                                        |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 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).                                                                                                                                                                                                                                                                                                                                                    |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.5    | — |   | First Amendment to  Bylaws of the Company on September 28, 1999 (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).                                                                                                                                                                                                                                                                                                         |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.6    | — |   | Second Amendment to  Bylaws of the Company on May 7, 2003 (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).                                                                                                                                                                                                                                                                                                           |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 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    | — |   | Common Stock Subscription  Agreement dated as of April 30, 1999 between the Company and the  purchasers named therein (Incorporated by reference from exhibit 4.5 to the  Company’s Quarterly Report on Form 10-Q/A for the quarter ended  March 31, 1999).                                                                                                                                                                                                                                                          |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 4.3    | — |   | Registration Rights Agreement by and among Edge  Petroleum Corporation, Guardian Energy Management Corp., Kelly E. Miller and  the Debra A. Miller Trust, dated December 4, 2003 (Incorporated by  reference from exhibit 4.2 to the Company’s Registration Statement on Form S-3  filed on February 3, 2004 (Registration No. 333-112462)).                                                                                                                                                                    |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 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)).                                                                                                                                                                                                                                 |

 

36

----

 
| 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)).                                                                                                    |
|        |   |   |                                                                                                                                                                                                                                                                                                                                             |
| †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 10.12 to the Company’s Annual Report on  Form 10-K for the year ended December 31, 1998).                                                                                                 |
|        |   |   |                                                                                                                                                                                                                                                                                                                                             |
| †10.4  | — |   | Incentive Plan of Edge  Petroleum Corporation as Amended and Restated Effective as of June 1,  2004 (Incorporated by reference from exhibit 10.9 to the Company’s Quarterly  Report on Form 10-Q for the quarterly period ended June 30, 2004).                                                                              |
|        |   |   |                                                                                                                                                                                                                                                                                                                                             |
| †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). |
|        |   |   |                                                                                                                                                                                                                                                                                                                                             |
| †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). |
|        |   |   |                                                                                                                                                                                                                                                                                                                                             |
| †10.7  | — |   | Severance Agreements by  and between Edge Petroleum Corporation and the Officers of the Company named  herein (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).                                                                   |
|        |   |   |                                                                                                                                                                                                                                                                                                                                             |
| †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).                                                                  |
|        |   |   |                                                                                                                                                                                                                                                                                                                                             |
| †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.                                                                                                                                                                                                                                                                                               |
|             |        |        |                                                                                                                                                                                                                                                                                                                                                  |  |  |  |

 

37

----

 
| †10.13 | — |   | Salaries and Other Compensation of Executive  Officers.                                                                                                                                                                                           |
|-------------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |   |                                                                                                                                                                                                                                              |
| †10.14 | — |   | Description of 2004 Bonus Program for Executive  Officers.                                                                                                                                                                                        |
|        |   |   |                                                                                                                                                                                                                                              |
| *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  Michael G. Long, 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 (Subsections (a) and (b) of Section 1350, Chapter  63 of Title 18, United States Code).                  |
|        |   |   |                                                                                                                                                                                                                                              |
| *32.2       | — |   | Certification by  Michael G. Long, Chief Financial and Accounting Officer, pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and  (b) of Section 1350, Chapter 63 of Title 18, United States Code). |
|             |        |        |                                                                                                                                                                                                                                                   |  |

 

----

* Filed herewith.

†Denotes management or compensatory contract, arrangement or agreement.

 

38

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## **SIGNATURES**

 

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|   |                                                   | EDGE PETROLEUM  CORPORATION, |                 |
|--------|--------------------------------------------------------|------------------------------|----------------------|
|   |                                                   | A DELAWARE CORPORATION       |                 |
|   |                                                   | (REGISTRANT)                 |                 |
|   |                                                   |                         |                 |
|   |                                                   |                         |                 |
| Date   | May 5, 2005                                       | ** **                   | /s/ John W.  Elias   |   |
|   | John W. Elias                                          |                         |
|   | Chief Executive  Officer and  Chairman of the Board    |                         |
|   |                                                   |
|   |                                                   |                         |
| Date   | May 5, 2005                                       |                         | /s/ Michael G.  Long |   |
|   | Michael G. Long                                        |                         |
|   | Executive Vice  President and  Chief Financial Officer |                         |
|        |                                                        |                              |                      |  |  |  |  |  |  |

 

39

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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 October 7, 2004 (Incorporated by reference from exhibit 2.1 to the  Company’s Current Report on Form 8-K filed October 12, 2004).                                                                                                                                                                                                         |
|                 |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 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).                                                                                                                                                                                                                                                                                                                                                    |
|                 |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.5                  | —     |       | First Amendment to  Bylaws of the Company on September 28, 1999 (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).                                                                                                                                                                                                                                                                                                         |
|                 |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.6                  | —     |       | Second Amendment to  Bylaws of the Company on May 7, 2003 (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).                                                                                                                                                                                                                                                                                                           |
|                 |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 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). |

 

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| 4.2        | — |   | Common  Stock Subscription Agreement dated as of April 30, 1999 between the  Company and the purchasers named therein (Incorporated by reference from  exhibit 4.5 to the Company’s Quarterly Report on Form 10-Q/A for the  quarter ended March 31, 1999).                                                                                        |
|------------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |   |                                                                                                                                                                                                                                                                                                                                                                   |
| 4.3        | — |   | Registration Rights  Agreement by and among Edge Petroleum Corporation, Guardian Energy Management  Corp., Kelly E. Miller and the Debra A. Miller Trust, dated December 4,  2003 (Incorporated by reference from exhibit 4.2 to the Company’s  Registration Statement on Form S-3 filed on February 3, 2004  (Registration No. 333-112462)). |
|       |   |   |                                                                                                                                                                                                                                                                                                                                                                   |
| 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)).                                                                                                                          |
|       |   |   |                                                                                                                                                                                                                                                                                                                                                                   |
| †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 10.12 to the Company’s Annual  Report on Form 10-K for the year ended December 31, 1998).                                                                                                                       |
|       |   |   |                                                                                                                                                                                                                                                                                                                                                                   |
| †10.4 | — |   | Incentive  Plan of Edge Petroleum Corporation as Amended and Restated Effective as of  June 1, 2004 (Incorporated by reference from exhibit 10.9 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period ended  June 30, 2004).                                                                                                   |
|       |   |   |                                                                                                                                                                                                                                                                                                                                                                   |
| †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).                       |
|       |   |   |                                                                                                                                                                                                                                                                                                                                                                   |
| †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).                      |
|       |   |   |                                                                                                                                                                                                                                                                                                                                                                   |
| †10.7 | — |   | Severance  Agreements by and between Edge Petroleum Corporation and the Officers of the  Company named herein (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).                                                                                         |

 

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| †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).     |
|        |   |   |                                                                                                                                                                                                                                                                                |
| †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.                                                                                                                                                                                                                                 |
|        |   |   |                                                                                                                                                                                                                                                                                |
| †10.13 | — |   | Salaries and Other  Compensation of Executive Officers.                                                                                                                                                                                                                             |
|        |   |   |                                                                                                                                                                                                                                                                                |
| †10.14 | — |   | Description of 2004  Bonus Program for Executive Officers.                                                                                                                                                                                                                          |
|        |   |   |                                                                                                                                                                                                                                                                                |
| *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 Michael G. Long, 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 (Subsections (a) and (b) of  Section 1350, Chapter 63 of Title 18, United States Code).                                                    |
|        |   |   |                                                                                                                                                                                                                                                                                |
| *32.2       | — |   | Certification  by Michael G. Long, Chief Financial and Accounting Officer, pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and  (b) of Section 1350, Chapter 63 of Title 18, United States Code).                                   |

 

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* Filed herewith.

†Denotes management or compensatory contract, arrangement or agreement.

 

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