**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**FORM 10-Q**

**x****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**For thequarterly period ended September 30, 2006**

**OR**

**o****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**For thetransition period from                       to                        **

**Commissionfile number 0-22149**

**EDGE PETROLEUM CORPORATION**

(Exact name of registrantas 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 telephonenumber, including area code)

Indicate by checkmarkwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

x Yes  o  No

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filed, or a non-accelerated filer. Seedefinition of “accelerated filer and larger accelerated filer” in Rule 12b-2 ofthe Exchange Act.:
| o  Large accelerated filer |   | x  Accelerated filer |   | o  Non-accelerated filer |
|----------------------------|--------|----------------------|--------|--------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). o Yes  x No

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

| **Class**    |   | **Outstanding  at November 7, 2006** |
|--------------|--------|--------------------------------------|
| Common Stock |   | 17,437,861                           |

 

 

 

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**EDGEPETROLEUM CORPORATION**

**Table ofContents**
|                             | ** **                                                                                           | ** **                                                                                                                                  | ** ** |
|-----------------------------|------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                        | Part I.  Financial Information                                                                       |                                                                                                                                        |       |
|                        | Item 1.  Financial Statements:                                                                       |                                                                                                                                        |       |
|                        |                                                                                                 | Consolidated  Balance Sheets as of September 30, 2006 and December 31, 2005                                                                 |       |   |
|                        |                                                                                                 | Consolidated Statements of  Operations for the Three and Nine Months Ended September 30, 2006 and  September 30, 2005                       |       |   |
|                        |                                                                                                 | Consolidated Statements of  Other Comprehensive Income(Loss) for the Three and Nine Months Ended  September 30, 2006 and September 30, 2005 |       |   |
|                        |                                                                                                 | Consolidated Statements of  Cash Flows for the Nine Months Ended September 30, 2006 and September 30,  2005                                 |       |   |
|                        |                                                                                                 | Consolidated  Statement of Stockholders’ Equity as of September 30, 2006 and December 31,  2005                                        |       |   |
|                        |                                                                                                 | 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 1A. Risk Factors                                                                                |                                                                                                                                        |       |
|                        | 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**

 
| ** **                                                                                                                                                                                                                      | ** ** | **September 30,  2006**                              | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                      | ** ** | **  (Unaudited)  **                   | ** ** | ** **                  | ** ** |
| ** **                                                                                                                                                                                                                      | ** ** | **(in thousands, except share data)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                      | ** ** | ** **                                                | ** ** | ** **                  | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                                                 |       |                                                      |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                      |       | $                                                         | 2,276      |                        | $          | 666 |   |
| Accounts  receivable, trade, net of allowance                                                                                                                                                                                   |       | 17,801                                                    |       | 24,980                      |       |
| Accounts  receivable, joint interest owners, net of allowance                                                                                                                                                                   |       | 1,034                                                     |       | 2,100                       |       |
| Deferred income  taxes                                                                                                                                                                                                          |       | —                                                    |       | 2,518                       |       |
| Derivative  financial instruments                                                                                                                                                                                               |       | 7,029                                                     |       | —                      |       |
| Other current  assets                                                                                                                                                                                                           |       | 4,424                                                     |       | 6,437                       |       |
| Total current  assets                                                                                                                                                                                                           |       | 32,564                                                    |       | 36,701                      |       |
| PROPERTY AND EQUIPMENT,  net – full cost method of accounting for oil and natural gas properties  (including unproved costs of $38.7 million and $36.9 million at September 30,  2006 and December 31, 2005, respectively) |       | 247,843                                                   |       | 306,456                     |       |
| DERIVATIVE FINANCIAL  INSTRUMENT                                                                                                                                                                                                |       | 882                                                       |       | —                      |       |
| OTHER ASSETS                                                                                                                                                                                                                    |       | 151                                                       |       | 223                         |       |
| TOTAL ASSETS                                                                                                                                                                                                                    |       | $                                                         | 281,440    |                        | $          | 343,380 |   |
| ** **                                                                                                                                                                                                                      | ** ** | ** **                                                | ** ** | ** **                  | ** ** |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                                  | ** ** | ** **                                                | ** ** | ** **                  | ** ** |
| CURRENT LIABILITIES:                                                                                                                                                                                                            |       |                                                      |       |                        |       |
| Accounts payable,  trade                                                                                                                                                                                                        |       | $                                                         | 1,114      |                        | $          | 5,571 |   |
| Accrued  liabilities                                                                                                                                                                                                            |       | 12,484                                                    |       | 17,894                      |       |
| Accrued interest  payable                                                                                                                                                                                                       |       | 425                                                       |       | 17                          |       |
| Deferred tax  liability                                                                                                                                                                                                         |       | 1,514                                                     |       | —                      |       |
| Asset retirement  obligation – current                                                                                                                                                                                     |       | 213                                                       |       | 203                         |       |
| Derivative  financial instruments                                                                                                                                                                                               |       | —                                                    |       | 2,479                       |       |
| Total current  liabilities                                                                                                                                                                                                      |       | 15,750                                                    |       | 26,164                      |       |
| ASSET RETIREMENT  OBLIGATION – long-term                                                                                                                                                                                   |       | 2,942                                                     |       | 2,564                       |       |
| DEFERRED TAX LIABILITY                                                                                                                                                                                                          |       | 10,569                                                    |       | 37,897                      |       |
| LONG-TERM DEBT                                                                                                                                                                                                                  |       | 100,000                                                   |       | 85,000                      |       |
| Total  liabilities                                                                                                                                                                                                              |       | 129,261                                                   |       | 151,625                     |       |
| 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; 60,000,000 shares authorized; 17,429,255 and 17,216,776  shares issued and outstanding at September 30, 2006 and December 31, 2005,  respectively                                               |       | 174                                                       |       | 172                         |       |
| Additional  paid-in capital                                                                                                                                                                                                     |       | 140,744                                                   |       | 137,842                     |       |
| Retained  earnings                                                                                                                                                                                                              |       | 11,261                                                    |       | 55,454                      |       |
| Accumulated  other comprehensive loss                                                                                                                                                                                           |       | —                                                    |       | (1,713                      | )          |
| Total  stockholders’ equity                                                                                                                                                                                                |       | 152,179                                                   |       | 191,755                     |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                 |       | $                                                         | 281,440    |                        | $          | 343,380 |   |

 

See accompanyingnotes to consolidated financial statements.

3

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**EDGE PETROLEUM CORPORATION**

** **

**CONSOLIDATED STATEMENTS OFOPERATIONS (Unaudited)**

 
| ** **                                                    | ** ** | **Three Months Ended September 30,**              | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2006**                                                              | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                    | ** ** | **(in thousands, except per share amounts)** | ** ** |
| OIL AND NATURAL  GAS REVENUE:                                 |       |                                                                  |       |                                                    |       |   |   |   |   |
| Oil and natural gas sales                                     |       | $                                                                     | 30,227     |                                                    | $          | 30,979 |   | $ | 94,321 |   | $ | 81,136 |   |
| Gain (loss) on hedging and derivatives                        |       | 5,714                                                                 |       | (1,394                                                  | )          | 10,492 |   | (2,397 | ) |
| Total revenue                                                 |       | 35,941                                                                |       | 29,585                                                  |       | 104,813 |   | 78,739 |   |
|                                                          |       |                                                                  |       |                                                    |       |   |   |   |   |
| OPERATING  EXPENSES:                                          |       |                                                                  |       |                                                    |       |   |   |   |   |
| Oil and natural gas operating expenses                        |       | 2,417                                                                 |       | 2,370                                                   |       | 6,866 |   | 6,414 |   |
| Severance and ad valorem taxes                                |       | 2,280                                                                 |       | 1,846                                                   |       | 7,105 |   | 5,497 |   |
| Depletion, depreciation, amortization and accretion           |       | 16,979                                                                |       | 8,311                                                   |       | 49,317 |   | 25,886 |   |
| Impairment of oil and natural gas properties                  |       | 96,942                                                                |       | —                                                  |       | 96,942 |   | — |   |
| General and administrative expenses:                          |       |                                                                  |       |                                                    |       |   |   |   |   |
| Bad debt expense                                              |       | —                                                                |       | 54                                                      |       | — |   | 65 |   |
| General and administrative expenses                           |       | 4,001                                                                 |       | 4,503                                                   |       | 10,473 |   | 9,917 |   |
| Total operating expenses                                      |       | 122,619                                                               |       | 17,084                                                  |       | 170,703 |   | 47,779 |   |
| OPERATING INCOME  (LOSS)                                      |       | (86,678                                                               | )          | 12,501                                                  |       | (65,890 | ) | 30,960 |   |
|                                                          |       |                                                                  |       |                                                    |       |   |   |   |   |
| OTHER INCOME AND  EXPENSE:                                    |       |                                                                  |       |                                                    |       |   |   |   |   |
| Interest income                                               |       | 36                                                                    |       | 29                                                      |       | 106 |   | 85 |   |
| Interest expense, net of amounts capitalized                  |       | (804                                                                  | )          | —                                                  |       | (2,017 | ) | — |   |
| Amortization of deferred loan costs                           |       | (41                                                                   | )          | (36                                                     | )          | (124 | ) | (107 | ) |
| INCOME (LOSS)  BEFORE INCOME TAXES                            |       | (87,487                                                               | )          | 12,494                                                  |       | (67,925 | ) | 30,938 |   |
| INCOME TAX  (EXPENSE) BENEFIT                                 |       | 30,607                                                                |       | (4,351                                                  | )          | 23,732 |   | (10,862 | ) |
| NET INCOME  (LOSS)                                            |       | $                                                                     | (56,880    | )                                                       | $          | 8,143 |   | $ | (44,193 | ) | $ | 20,076 |   |
|                                                          |       |                                                                  |       |                                                    |       |   |   |   |   |
| BASIC EARNINGS  (LOSS) PER SHARE                              |       | $                                                                     | (3.27      | )                                                       | $          | 0.47 |   | $ | (2.55 | ) | $ | 1.17 |   |
| DILUTED EARNINGS  (LOSS) PER SHARE                            |       | $                                                                     | (3.27      | )                                                       | $          | 0.45 |   | $ | (2.55 | ) | $ | 1.13 |   |
|                                                          |       |                                                                  |       |                                                    |       |   |   |   |   |
| BASIC WEIGHTED  AVERAGE NUMBER OF COMMON SHARES OUTSTANDING   |       | 17,419                                                                |       | 17,138                                                  |       | 17,344 |   | 17,100 |   |
| DILUTED WEIGHTED  AVERAGE NUMBER OF COMMON SHARES OUTSTANDING |       | 17,419                                                                |       | 17,908                                                  |       | 17,344 |   | 17,802 |   |

 

See accompanyingnotes to consolidated financial statements.

4

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**EDGEPETROLEUM CORPORATION**

** **

**CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS) (Unaudited)**

 
| ** **                                                                  | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2006**                                                 | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                  | ** ** | **(in thousands)**                                  | ** ** |
| NET INCOME  (LOSS)                                                          |       | $                                                        | (56,880    | )                                                       | $          | 8,143 |   | $ | (44,193 | ) | $ | 20,076 |   |
|                                                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| OTHER  COMPREHENSIVE LOSS, net of tax:                                      |       |                                                     |       |                                                    |       |   |   |   |   |
| Change in fair value of outstanding hedging and  derivative instruments (1) |       | —                                                   |       | (6,450                                                  | )          | — |   | (6,762 | ) |
| Reclassification of hedging and derivative gains (2)                   |       | —                                                   |       | 35                                                      |       | — |   | (968 | ) |
| Other comprehensive loss                                                    |       | —                                                   |       | (6,415                                                  | )          | — |   | (7,730 | ) |
| COMPREHENSIVE  INCOME (LOSS)                                                |       | $                                                        | (56,880    | )                                                       | $          | 1,728 |   | $ | (44,193 | ) | $ | 12,346 |   |
|                                                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| (1) net of income taxes of                                                  |       | $                                                        | —     |                                                    | $          | (3,473 | ) | $ | — |   | $ | (3,641 | ) |
| (2) net of  income taxes of                                                 |       | $                                                        | —     |                                                    | $          | 19 |   | $ | — |   | $ | (521 | ) |

 

See accompanyingnotes to the consolidated financial statements.

5

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**EDGE PETROLEUM CORPORATION**

** **

**CONSOLIDATED STATEMENTS OF CASHFLOWS (Unaudited)**

 
| ** **                                                                                | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | **(in thousands)**                                 | ** ** |
| ** **                                                                                | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Net income (loss)                                                                         |       | $                                                       | (44,193    | ) | $ | 20,076 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                                    |       |   |   |
| Unrealized  (gain) loss on the fair value of derivatives                                  |       | (7,755                                                  | )          | 364 |   |
| Loss on non-oil  and gas property                                                         |       | —                                                  |       | 2 |   |
| Deferred income  taxes                                                                    |       | (23,732                                                 | )          | 10,862 |   |
| Depletion,  depreciation, and amortization                                                |       | 49,180                                                  |       | 25,784 |   |
| Impairment of  oil and natural gas properties                                             |       | 96,942                                                  |       | — |   |
| Amortization of  deferred loan costs                                                      |       | 124                                                     |       | 107 |   |
| Accretion of  asset retirement obligation                                                 |       | 137                                                     |       | 102 |   |
| Non-cash share-based  compensation cost                                                   |       | 1,894                                                   |       | 2,740 |   |
| Bad debt expense                                                                          |       | —                                                  |       | 65 |   |
| Changes in assets and  liabilities:                                                       |       |                                                    |       |   |   |
| Decrease  (increase) in accounts receivable, trade                                        |       | 7,179                                                   |       | (6,293 | ) |
| Decrease in  accounts receivable, joint interest owners                                   |       | 1,066                                                   |       | 3,761 |   |
| Increase in  other assets                                                                 |       | (703                                                    | )          | (8,548 | ) |
| (Decrease)  increase in accounts payable, trade                                           |       | (4,457                                                  | )          | 704 |   |
| (Decrease)  increase in accrued liabilities                                               |       | (5,368                                                  | )          | 6,516 |   |
| Increase in  accrued interest payable                                                     |       | 408                                                     |       | — |   |
|                                                                                      |       |                                                    |       |   |   |
| Net cash  provided by operating activities                                                |       | 70,722                                                  |       | 56,242 |   |
|                                                                                      |       |                                                    |       |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                                | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Oil and natural  gas property and equipment additions                                     |       | (87,821                                                 | )          | (61,938 | ) |
| Decrease in  drilling advances                                                            |       | 2,573                                                   |       | — |   |
| Proceeds from  the sale of oil and natural gas properties                                 |       | 568                                                     |       | — |   |
|                                                                                      |       |                                                    |       |   |   |
| Net cash used in  investing activities                                                    |       | (84,680                                                 | )          | (61,938 | ) |
|                                                                                      |       |                                                    |       |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Borrowings from  long-term debt                                                           |       | 30,000                                                  |       | 13,000 |   |
| Payments on  long-term debt                                                               |       | (15,000                                                 | )          | (13,000 | ) |
| Net proceeds  from issuance of common stock                                               |       | 576                                                     |       | 7,231 |   |
| Deferred loan  costs                                                                      |       | (8                                                      | )          | (7 | ) |
|                                                                                      |       |                                                    |       |   |   |
| Net cash  provided by financing activities                                                |       | 15,568                                                  |       | 7,224 |   |
| ** **                                                                                | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| **NET INCREASE IN CASH AND CASH  EQUIVALENTS**                                            |       | 1,610                                                   |       | 1,528 |   |
| ** **                                                                                |       |                                                    |       |   |   |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**                                       |       | 666                                                     |       | 2,267 |   |
| ** **                                                                                |       |                                                    |       |   |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                              |       | $                                                       | 2,276      |   | $ | 3,795 |   |

 

See accompanying notes to consolidated financial statements.

6

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**EDGE PETROLEUM CORPORATION**

** **

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY(Unaudited)**
| ** **                                                           | ** ** | **Common Stock**   | ** ** | **Additional ** | ** ** | **Retained**             | ** ** | **Accumulated  Other  Comprehensive ** | ** ** | **Total  Stockholders’ ** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|----------------------|------------|--------------------------|------------|---------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                           | ** ** | **Shares**              | ** ** | **Amount**           | ** ** | **Paid-in Capital** | ** ** | **Earnings**                                | ** ** | **Income (Loss)**              | ** ** | **Equity** | ** ** |
| ** **                                                           | ** ** | **(in thousands)** | ** ** |
|                                                                 |       |                    |       |                 |       |                     |       |                                        |       |                                |       |   |   |
| BALANCE,  DECEMBER 31, 2005                                          |       | 17,217                  |       | $                    | 172        |                     | $          | 137,842                                     |       | $                                   | 55,454     |   | $ | (1,713 | ) | $ | 191,755 |   |
|                                                                 |       |                    |       |                 |       |                     |       |                                        |       |                                |       |   |   |
| Issuance of  common stock                                            |       | 212                     |       | 2                    |       | 1,306                    |       | —                                      |       | —                              |       | 1,308 |   |
|                                                                 |       |                    |       |                 |       |                     |       |                                        |       |                                |       |   |   |
| Compensation  cost — restricted stock                           |       | —                  |       | —               |       | 1,093                    |       | —                                      |       | —                              |       | 1,093 |   |
|                                                                 |       |                    |       |                 |       |                     |       |                                        |       |                                |       |   |   |
| Compensation  cost — stock option expense                       |       | —                  |       | —               |       | 69                       |       | —                                      |       | —                              |       | 69 |   |
|                                                                 |       |                    |       |                 |       |                     |       |                                        |       |                                |       |   |   |
| Change in  valuation of hedging instruments                          |       | —                  |       | —               |       | —                   |       | —                                      |       | 1,713                               |       | 1,713 |   |
|                                                                 |       |                    |       |                 |       |                     |       |                                        |       |                                |       |   |   |
| Tax benefit  associated with exercise of non-qualified stock options |       | —                  |       | —               |       | 434                      |       | —                                      |       | —                              |       | 434 |   |
|                                                                 |       |                    |       |                 |       |                     |       |                                        |       |                                |       |   |   |
| Net loss                                                             |       | —                  |       | —               |       | —                   |       | (44,193                                     | )          | —                              |       | (44,193 | ) |
|                                                                 |       |                    |       |                 |       |                     |       |                                        |       |                                |       |   |   |
| BALANCE, SEPTEMBER 30,  2006                                         |       | 17,429                  |       | $                    | 174        |                     | $          | 140,744                                     |       | $                                   | 11,261     |   | $ | — |   | $ | 152,179 |   |

 

See accompanyingnotes to consolidated financial statements.

7

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**EDGEPETROLEUM CORPORATION**

**NOTES TOTHE CONSOLIDATED FINANCIAL STATEMENTS**

**1.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

Thefinancial statements included herein have been prepared by Edge PetroleumCorporation, a Delaware corporation (“we”, “our”, “us” or the “Company”),without audit pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”), and reflect all adjustments which are, in theopinion of management, necessary to present a fair statement of the results forthe interim periods on a basis consistent with the annual audited consolidatedfinancial statements. All such adjustments are of a normal recurring natureexcept for the impairment of the Company’s oil and natural gas properties, asdiscussed below. The results of operations for the interim periods are notnecessarily indicative of the results to be expected for an entire year.Certain information, accounting policies and footnote disclosures normallyincluded in financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America have been omittedpursuant to such rules and regulations, although we believe that thedisclosures are adequate to make the information presented not misleading.These financial statements should be read in conjunction with our auditedconsolidated financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2005.

***Oil and Natural Gas Properties*** - 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 that areunique to the oil and gas industry. There are two allowable methods ofaccounting for oil and gas business activities: the successful-efforts methodand the full-cost method. There are several significant differences betweenthese methods. Among these differences is that, under the successful-effortsmethod, costs such as geological and geophysical (“G&G”), exploratory dryholes and delay rentals are expensed as incurred whereas under the full-costmethod these types of charges are capitalized to their respective full-costpool. The Company utilizes the full-cost method of accounting for oil andnatural gas properties. 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 natural gas properties are located within theUnited States of America and constitute one cost center. The Company alsocapitalizes a portion of interest expense on borrowed funds.

In the measurementof impairment of oil and gas properties, the successful-efforts method ofaccounting follows the guidance provided in Statement of Financial AccountingStandards (“SFAS”) No. 144, *Accounting forthe Impairment or Disposal of Long-Lived Assets*, where the firstmeasurement for impairment is to compare the net book value of the relatedasset to its undiscounted future cash flows using commodity prices consistentwith management expectations. The full-cost method follows guidance provided inSEC Regulation S-X Rule 4-10, where impairment is determined by the “ceilingtest,” whereby to the extent that such capitalized costs subject toamortization in the full-cost pool (net of accumulated depletion, depreciationand amortization, and related tax effects) exceed the present value (using a10% discount rate) of estimated future net after-tax cash flows from proved oiland natural gas reserves, such excess costs are charged to expense. Onceincurred, an impairment of oil and natural gas properties is not reversible ata later date. A ceiling test impairment could result in a significant loss fora reporting period; however, future depletion expense would be correspondinglyreduced. In accordance with SAB No.103, *Updateof Codification of Staff Accounting Bulletins*, derivativeinstruments qualifying as cash flow hedges are to be included in thecomputation of limitation on capitalized costs. As of September 30, 2006, theCompany was not applying cash flow hedge accounting to any derivative contracts(see Note 7), therefore the ceiling test at September 30, 2006 was not impactedby the value of our derivatives.

Impairment of oiland natural gas properties is assessed on a quarterly basis in conjunction withthe Company’s quarterly and annual SEC filings. The Company recorded a non-cashceiling test impairment of oil and natural gas properties for the nine monthsended September 30, 2006 of $96.9 million ($63.0 million net of tax). Noceiling test impairment was required during the comparable 2005 period. Theimpairment was primarily the result of a decline in natural gas prices atSeptember 30, 2006. At December 31, 2005, the quoted market prices, adjusted

8

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for differentials,utilized in calculating the full-cost ceiling were $10.05 per MMBtu for naturalgas and $61.04 per barrel for crude oil. Our impairment of $96.9 million atSeptember 30, 2006 was calculated based upon prices of $4.18 per MMBtu fornatural gas and $62.92 per barrel for crude oil. Subsequent to the end of thereporting period, quoted market prices for natural gas increased such that webelieve we would have avoided a write-down if, as would have been allowed underapplicable accounting guidelines, we had elected to use such subsequent pricesin calculating the ceiling test at September 30, 2006.

Oil and naturalgas properties are amortized based on a unit-of-production method usingestimates of proved reserve quantities. Oil and natural gas liquids (“NGL”s)are converted to gas equivalent basis (“Mcfe”) at the rate of one barrel equalssix Mcf. In accordance with SEC Staff Accounting Bulletin (“SAB”) No. 106, *Interaction of Statement 143 and the Full Cost Rules,*the amortizable base includes estimated future development anddismantlement costs, and restoration and abandonment costs, net of estimated salvagevalues. Investments in unproved properties are not amortized until provedreserves associated with the prospects can be determined or until impairmentoccurs. Oil and natural gas properties included costs of $38.7 million and$36.9 million at September 30, 2006 and December 31, 2005, respectively,related to unproved property, which were excluded from capitalized costs beingamortized. Unproved properties are evaluated quarterly, and as needed, forimpairment on a property-by-property basis. If the results of an assessmentindicate that an unproved property is impaired, the amount of impairment isadded to the proved oil and natural gas property costs to be amortized.

Sales of provedand unproved properties are accounted for as adjustments of capitalized costswith no gain or loss recognized, unless such adjustments would significantlyalter the relationship between capitalized costs and proved reserves.

***Inventories***–******Inventories consist principally oftubular goods and production equipment for wells and facilities. They arestated at the lower of weighted-average cost or market.

***Accounts Receivable and Allowancefor Doubtful Accounts*** - The Company routinely assesses therecoverability of all material trade and other receivables to determine ourability to collect the receivables in full. Accounts Receivable, Tradeincludes an “allowance” for doubtful accounts of $0.5 million at September 30,2006 and December 31, 2005. Accounts Receivable, Joint Interest Owners includes“allowances” for doubtful accounts of $3,200 and $4,771 at September 30, 2006and December 31, 2005, respectively.

***Asset Retirement Obligations***–******The Company recordsa liability for legal obligations associated with the retirement of tangiblelong-lived assets in the period in which they are incurred in accordance withSFAS No. 143, *Accounting for AssetRetirement Obligations.* Under SFAS No. 143, when liabilities fordismantlement and abandonment costs, excluding salvage values, are initiallyrecorded, the carrying amount of the related oil and gas properties isincreased. Accretion of the liability is recognized each period using theinterest method of allocation, and the capitalized cost is depleted over theuseful life of the related asset. The changes to the Asset Retirement Obligations(“ARO”) for oil and natural gas properties and related equipment during thenine months ended September 30, 2006 and 2005 are as follows:

|                                             | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                  | ** ** | **(in thousands)**                                 | ** ** |
| ARO, Beginning  of Period                   |       | $                                                       | 2,767      |   | $ | 2,189 |   |
| Liabilities  incurred in the current period |       | 370                                                     |       | 266 |   |
| Liabilities  settled in the current period  |       | (129                                                    | )          | (119 | ) |
| Accretion  expense                          |       | 137                                                     |       | 102 |   |
| Revisions                                   |       | 10                                                      |       | — |   |
| ARO, End of  Period                         |       | $                                                       | 3,155      |   | $ | 2,438 |   |
| Current Portion                             |       | $                                                       | 213        |   | $ | 202 |   |
| Long-Term Portion                           |       | $                                                       | 2,942      |   | $ | 2,236 |   |

 

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Duringthe nine months ended September 30, 2006, ARO liabilities incurred include 35new well obligations and liabilities settled include seven wells that wereplugged and eleven that were sold.

***Share-BasedCompensation***–TheCompany established the Incentive Plan of Edge Petroleum Corporation (the “IncentivePlan”) in conjunction with its initial public offering in March 1997. TheIncentive Plan is discretionary and provides for the granting of awards,including options for the purchase of the Company’s common stock and for theissuance of restricted and/or unrestricted common stock to directors, officers,employees and independent contractors of the Company. The options andrestricted stock granted to date vest over periods of 2 to 3 years. The Companyamended the Incentive Plan (i) in December 2003 to increase the sharesavailable under the plan from 1.2 million shares to 1.7 million shares and (ii)in June 2006, to increase the number of shares available under the Plan from1.7 million shares to 2.2 million shares. Of the aggregate 2.2 million sharesof common stock reserved for grants under the Incentive Plan, 754,506 shareswere available for future grants at September 30, 2006.

As a component of his employment agreement with theCompany, John Elias, CEO and Chairman of the Board, has been granted optionawards and a restricted stock award outside of the Incentive Plan. Mr. Eliashas also been granted options and restricted stock under the Incentive Plan.The options vest and become exercisable over a two or three year periodsubsequent to issue. The restricted stock is issued ratably over three years inaccordance with the award’s vesting schedule, beginning on the firstanniversary of the date of grant. Compensation expense is amortized over thevesting period and offset to additional paid in capital (“APIC”). Theamortization of compensation expense related to this award is included in generaland administrative expenses on the consolidated statement of operations. Belowis a summary of options and restricted stock grants made to Mr. Elias outsideof the Incentive Plan:
| **Date Granted**        | ** ** | **Shares  Outstanding** | ** ** | **Exercise  Price** | ** ** | **Date Exercisable**                                                          | ** **                                                                |
|------------------------------|------------|-------------------------|------------|---------------------|------------|------------------------------------------------------------------------------------|---------------------------------------------------------------------------|
| ***Options  (1):***          |       |                    |       |                |       |                                                                               |                                                                      |
| 01/08/1999                   |       | 200,000                 |       | $                   | 4.22       |                                                                               | One-third  upon issue and one-third upon each of January 1, 2000 and 2001 |   |
| 01/03/2000                   |       | 50,000                  |       | $                   | 3.16       |                                                                               | 100%  January 2002                                                        |   |
| 01/03/2001                   |       | 50,000                  |       | $                   | 8.88       |                                                                               | 100%  January 2003                                                        |   |
| 01/03/2002                   |       | 50,000                  |       | $                   | 5.18       |                                                                               | 100%  January 2004                                                        |   |
| 04/01/2002                   |       | 24,000                  |       | $                   | 5.59       |                                                                               | 100%  April 2004                                                          |   |
| 01/23/2003                   |       | 50,000                  |       | $                   | 3.88       |                                                                               | 100%  January 2005                                                        |   |
| 04/01/2004                   |       | 37,000                  |       | $                   | 13.99      |                                                                               | 100%  January 2006                                                        |   |
| ***Restricted  Stock (2):*** |       |                    |       |                |       |                                                                               |                                                                      |
| 04/02/2001                   |       | 14,000                  |       |                |       | Ratably over three  years beginning on the first  anniversary of the date of grant |                                                                      |

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(1)             Exercise price equalsthe fair market value on the date of grant.

(2)             Valuewas $7.75 per share, the market value on the date of grant.

For the three- and nine-month periods ended September30, 2006, the Company recognized $0.5 million and $1.2 million, respectively,for share-based compensation expense. Expense is comprised of $0.3 millionassociated with stock options and $0.2 million associated with restricted stockfor the three months ended September 30, 2006. Expense is comprised of $0.1million associated with stock options and $1.1 million associated withrestricted stock for the nine months ended September 30, 2006. For the three-and nine-month periods ended September 30, 2005, the Company recognized $2.0million and $2.6 million, respectively, for share-based compensation. For thethree months ended September 30, 2005, expense is comprised of approximately$0.3 million associated with restricted stock and $1.7 million associated withthe repricing of certain

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stock options. Expense iscomprised of approximately $0.7 million associated with restricted stock and$1.9 million associated with the repricing of certain stock options for thenine months ended September 30, 2005.

EffectiveJanuary 1, 2006, the Company adopted SFAS No. 123 (R), *Share-Based Payment,* utilizing themodified prospective approach. Prior to the adoption of SFAS No. 123(R), theCompany accounted for stock option grants in accordance with AccountingPrinciples Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees,*(the intrinsic value method), andaccordingly, recognized no compensation expense for stock option grants. In1999, the Company repriced certain employee and director stock options. TheCompany accounted for these repriced stock options in accordance with FinancialAccounting Standards Board (“FASB”) Interpretation No. 44 (“FIN 44”), *Accounting for Certain Transactions involving Stock Based Compensation –An Interpretation of APB No. 25* which prescribed the variable planaccounting treatment for repriced options. Under variable plan accounting,compensation expense is adjusted for increases or decreases in the fair marketvalue of the Company’s common stock to the extent that the market value exceedsthe exercise price of the option until the options are exercised, forfeited, orexpire unexercised.

Underthe modified prospective approach, SFAS No. 123(R) applies to new awards and toawards that were outstanding on January 1, 2006 that are subsequently modified,repurchased or cancelled. Under the modified prospective approach, compensationcost recognized in the first quarter of fiscal 2006 includes compensation costfor all share-based payments granted prior to, but not yet vested, as ofJanuary 1, 2006, based on the grant-date fair value estimated in accordancewith the original provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation*, and compensation cost for allshare-based payments granted subsequent to January 1, 2006, based on thegrant-date fair value estimated in accordance with the provisions of SFAS No.123(R). Prior periods were not restated to reflect the impact of adopting thenew standard.

As aresult of adopting SFAS No. 123(R), the Company’s loss before taxes and netloss for the nine months ended September 30, 2006 are $0.3 million and $0.2million lower, respectively, than if the Company had continued to account forshare-based compensation under APB No. 25. Basic and diluted loss per share for the nine months ended September 30,2006 would have been $(2.54) if the Company had not adopted SFAS No. 123(R),compared to reported basic and diluted loss per share of $(2.55).

TheCompany receives a tax deduction for certain stock options exercised during theperiod the options are exercised, generally for the excess of the price atwhich the options are sold over the exercise prices of the options. Inaddition, the Company receives a tax deduction for restricted stock grants thatvest during the period for the excess of the fair value on the vesting datecompared to the grant date fair value. SFAS No. 123(R) requires that theseexcess tax benefits be reported in the consolidated statement of cash flows asfinancing activities. SFAS No. 123(R) provides that the excess tax benefit andcredit to APIC for the windfall should not be recorded until the deductionreduces income taxes payable. Because the Company is in a net operating loss (“NOL”)position for tax purposes, and does not have taxes payable at this time, it hasnot realized a tax benefit from the deduction. Therefore, the Company excludesthese deductions from the windfall pool and does not present the tax benefitsfrom the exercise of stock options as financing activities. As of September 30,2006, $1.5 million of NOL carryforwards will be credited to APIC in futureperiods when the tax benefit is realized and reduces taxes payable.

The following table illustrates the effect onoperating results and per share information had the Company accounted for share-basedcompensation in accordance with SFAS No. 123(R) for the three- and nine-monthsended September 30, 2005:
| ** **                                                                                          | ** ** | **Periods Ended  September 30, 2005**                  | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **Three Months**                                                 | ** ** | **Nine Months** | ** ** |
| ** **                                                                                          | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Net income:                                                                                         |       |                                                                  |       |   |   |
| As reported                                                                                         |       | $                                                                     | 8,143      |   | $ | 20,076 |   |
| Add: Share-based employee compensation reported in  net income, net of taxes                        |       | 1,320                                                                 |       | 1,696 |   |
| Deduct: Share-based employee compensation under the  fair value method for all awards, net of taxes |       | (214                                                                  | )          | (586 | ) |
| Pro forma net  income                                                                               |       | $                                                                     | 9,249      |   | $ | 21,186 |   |
|                                                                                                |       |                                                                  |       |   |   |
| Basic net income  per share:                                                                        |       |                                                                  |       |   |   |
| As reported                                                                                         |       | $                                                                     | 0.47       |   | $ | 1.17 |   |
| Add: share-based employee compensation reported in  net income, net of taxes                        |       | 0.08                                                                  |       | 0.10 |   |
| Deduct: share-based employee compensation under the  fair value method for all awards, net of taxes |       | (0.01                                                                 | )          | (0.03 | ) |
| Pro forma basic  net income per share                                                               |       | $                                                                     | 0.54       |   | $ | 1.24 |   |
|                                                                                                |       |                                                                  |       |   |   |
| Diluted net  income per share:                                                                      |       |                                                                  |       |   |   |
| As reported                                                                                         |       | $                                                                     | 0.45       |   | $ | 1.13 |   |
| Add: share-based employee compensation reported in  net income, net of taxes                        |       | 0.08                                                                  |       | 0.10 |   |
| Deduct: share-based employee compensation under the  fair value method for all awards, net of taxes |       | (0.01                                                                 | )          | (0.03 | ) |
| Pro forma diluted net  income per share                                                             |       | $                                                                     | 0.52       |   | $ | 1.20 |   |

#  

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# Stock Options

Therehave been no stock option grants in 2006 or 2005. For future grants, theCompany expects to use the Black-Scholes option pricing model to estimate thefair value of stock options which requires the Company to make the followingassumptions:

·                  Therisk-free interest rate is based on the applicable year Treasury bond at dateof grant.

·                  Thedividend yield on the Company’s common stock is assumed to be zero since theCompany does not pay dividends.

·                  Themarket price volatility of the Company’s common stock is based on historicalprices.

·                  The term of thegrants is based on the simplified method as described in SAB No. 107, *Share-Based Payment*.

Theassumptions above are based on multiple factors, including historical exercisepatterns of employees in relatively homogenous groups with respect to exerciseand post-vesting employment termination behaviors, expected future exercisingpatterns for these same homogeneous groups and the implied volatility of ourstock price.

Inaddition, the Company estimates a forfeiture rate at the inception of theoption grant based on historical data and adjusts this prospectively as newinformation regarding forfeitures becomes available.

Forthe nine months ended September 30, 2006, the Company recognized $68,937 instock option compensation expense. All option grants were fully vested as ofApril 1, 2006; therefore, no further compensation expense associated with stockoptions will be expensed in future periods unless new grants are awarded. Nostock option awards were granted during the three-month and nine-month periodsended September 30, 2006.

Thefollowing table represents stock option activity for the nine months endedSeptember 30, 2006:
| ** **                                             | ** ** | **Number of  Shares** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contract Life** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|-------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding  options at December 31, 2005              |       | 735,450                    |       | $                                         | 5.93       |                                                 |       |                                |       |   |
| Granted                                                |       | —                     |       | —                                    |       |                                                 |       |                                |       |
| Exercised                                              |       | (84,750                    | )          | 6.80                                      |       |                                                 |       |                                |       |
| Forfeited                                              |       | —                     |       | —                                    |       |                                                 |       |                                |       |
| Outstanding  options at September 30, 2006             |       | 650,700                    |       | $                                         | 5.82       |                                                 | 4.2 years  |                                | $          | 6,949,476 |   |
| Outstanding options  exercisable at September 30, 2006 |       | 650,700                    |       | $                                         | 5.82       |                                                 | 4.2 years  |                                | $          | 6,949,476 |   |

 

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Thetotal intrinsic value (current market price less the option strike price) ofoptions exercised during the nine months ended September 30, 2006 was $1.5million and the Company received $0.6 million in cash in connection with theseexercises.

# **Restricted Stock**

In addition to stockoptions, the Company issues restricted stock and restricted stock units. Forawards issued to date, shares of common stock associated with the restrictedstock awards will be issued, subject to continued employment, ratably overthree years in accordance with the award’s vesting schedule, beginning on thefirst anniversary of the date of grant. Compensation expense from restrictedstock and restricted stock units is amortized over the vesting period andoffset to APIC. The share-based expense for these awards was determined basedon the market price of the Company’s stock at the date of grant applied to thetotal number of shares that were anticipated to fully vest and then amortizedover the vesting period. As of September 30, 2006, the Company had unamortized share-basedcompensation of $2.4 million associated with these awards. The cost is expectedto be recognized over a weighted-average period of 1.5 years. The total fairvalue of shares vested during the nine months ended September 30, 2006 was $2.2million. Upon adoption of SFAS No. 123(R), the Company recorded an immaterialcumulative effect of change in accounting principle as a result of the changein policy from recognizing forfeitures as they occur to recognizing expensebased on its expectation of the awards that will vest over the requisiteservice period for its restricted stock and restricted stock unit awards. Thisamount was recorded as compensation cost in general and administrative expensesin the consolidated statement of operations.

The following table represents the compensationexpense that was included in general and administrative expenses in the consolidatedstatement of operations related to these restricted stock grants for theperiods indicated below:
|                                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Non-cash  compensation expense for restricted stock |       | $                                                    | 234,772    |                                                | $          | 273,057 |   | $ | 1,093,160 |   | $ | 679,401 |   |
|                                                     |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

Thefollowing table below summarizes restricted stock activity for the nine monthsended September 30, 2006:
|                                                        | ** ** | **Shares** | ** ** | **Weighted-Average  Price** | ** ** |
|--------------------------------------------------------|------------|------------|------------|-----------------------------|------------|
| Unvested  restricted stock units at December 31, 2005  |       | 218,954    |       | $                           | 14.90      |   |
| Granted                                                |       | 101,400    |       | 25.74                       |       |
| Vested                                                 |       | (91,886    | )          | 12.89                       |       |
| Forfeited                                              |       | (16,970    | )          | 20.98                       |       |
| Unvested restricted  stock units at September 30, 2006 |       | 211,498    |       | $                           | 16.70      |   |

 

***Accounting Pronouncements***–In March 2005, the FASB issued FIN 47, *Accountingfor Conditional Asset Retirement Obligations, an interpretation of FASBStatement No. 143*. FIN 47 clarifies that the term, “conditionalasset retirement obligation” as used in SFAS No. 143, *Accounting for Asset Retirement Obligations*,refers to a legal obligation to perform an asset retirement activity in whichthe timing and/or method of settlement are conditional upon a future event thatmay or may not be within the control of the entity. Even though uncertaintyabout the timing and/or method of settlement exists and may be conditional upona future event, the obligation to perform the asset retirement activity isunconditional. Accordingly, an entity is required to recognize a liability forthe fair value of a conditional asset retirement obligation if the fair valueof the liability can be reasonably estimated. Uncertainty about the timingand/or method of settlement of a conditional asset retirement obligation shouldbe factored into the measurement of the liability when sufficient informationexists. The fair value of a liability for the conditional asset retirementobligation should be recognized when incurred generally upon acquisition,construction, or development or through the normal operation of the asset. SFASNo. 143 acknowledges that in some cases, sufficient information may not beavailable to reasonably estimate the fair value of an asset retirementobligation. FIN 47 also clarifies when an entity would have sufficientinformation to reasonably estimate the fair value of an asset retirementobligation. FIN 47 is effective for fiscal years ending after December 15,2005. Retrospective application for

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interim financialinformation is permitted but is not required. The adoption of FIN 47 is notexpected to have a material effect on the Company’s consolidated financialposition, results of operations or cash flows.

InJune 2005, the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections*, *a replacement ofAccounting Principles Board (“APB”) Opinion No. 20 and FASB StatementNo. 3,*which changes the requirements for the accounting forand reporting of a change in accounting principle. It also applies to changesrequired by an accounting pronouncement in the unusual instance that thepronouncement does not include specific transition provisions. Application iseffective for accounting changes and correction of errors made in fiscal yearsbeginning after December 15, 2005. The adoption of SFAS No. 154 is not expectedto have a material effect on the Company’s consolidated financial position,results of operations or cash flows.

InFebruary 2006, the FASB issued SFAS No. 155, *Accountingfor Certain Hybrid Financial Instruments,*which improves financialreporting by eliminating the exemption from applying SFAS No. 133 to interestsin securitized financial assets so that similar instruments are accounted forsimilarly regardless of the form of the instruments and allows a preparer toelect fair value measurement at acquisition, at issuance, or when a previouslyrecognized financial instrument is subject to a remeasurement (new basis)event, on an instrument-by-instrument basis, in cases in which a derivativewould otherwise have to be bifurcated. Providing a fair value measurementelection also results in more financial instruments being measured at what theFASB regards as the most relevant attribute for financial instruments, fairvalue. SFAS No. 155 is effective for all financial instruments acquired orissued after the beginning of an entity’s first fiscal year that begins afterSeptember 15, 2006. The Company is currently evaluating the impact of thisstandard on its financial position, results of operations and cash flows.

InMarch 2006, the FASB issued SFAS No. 156, *Accountingfor Servicing of Financial Assets*, which requires all separatelyrecognized servicing assets and servicing liabilities be initially measured atfair value. SFAS No. 156 permits, but does not require, the subsequentmeasurement of servicing assets and servicing liabilities at fair value.Adoption is required as of the beginning of the first fiscal year that beginsafter September 15, 2006. Early adoption is permitted. The adoption ofSFAS No. 156 is not expected to have a material effect on our consolidatedfinancial position, results of operations or cash flows.

In June 2006, the FASB issued FIN 48, *Accounting for Uncertainty in Income Taxes, an Interpretation of FASBStatement No. 109*, which clarifies the accounting foruncertainty in income taxes recognized in accordance withSFAS No. 109, *Accounting for IncomeTaxes*. FIN 48 prescribes a benefit recognition model with atwo-step approach, a more-likely-than-not recognition criterion and ameasurement attribute that measures the position as the largest amount of taxbenefit that is greater than 50% likely of being ultimately realized uponultimate settlement. If it is not more likely than not that the benefit will besustained on its technical merits, no benefit will be recorded. FIN 48also requires that the amount of interest expense to be recognized related touncertain tax positions be computed by applying the applicable statutory rateof interest to the difference between the tax position recognized in accordancewith FIN 48 and the amount previously taken or expected to be taken in atax return. The change in net assets as a result of applying this pronouncementwill be considered a change in accounting principle with the cumulative effectof the change treated as an offsetting adjustment to the opening balance ofretained earnings or goodwill, if allowed under existing accounting standards,in the period of transition. FIN 48 is effective as of January 1,2007 and the Company is currently assessing the impact that FIN 48 willhave on its financial statements.

In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurements,* which provides guidance for usingfair value to measure assets and liabilities. The standard also gives expandedinformation about the extent to which companies measure assets and liabilitiesat fair value, the information used to measure fair value, and the effect of fairvalue measurements on earnings. SFAS No. 157 does not expand the use of fairvalue in any new circumstances. SFAS No. 157 establishes a fair valuehierarchy that prioritizes the information used to develop fair valueassumptions. SFAS No. 157 is effective for financial statements issued forfiscal years beginning after November 15, 2007. Early adoption is encouraged.The Company is currently assessing the impact, if any, that SFAS No. 157 willhave on its financial statements.

InSeptember 2006, the SEC issued SAB No. 108, *Considering the Effects ofPrior Year Misstatements When Quantifying Misstatements in Current YearFinancial Statements* (“SAB No. 108”). SAB No. 108 addressesquantifying the financial statement effects of misstatements, specifically how theeffects of prior year uncorrected errors must be considered in quantifyingmisstatements in the current year financial statements. The guidance in

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SAB No. 108 iseffective for fiscal years ending after November 15, 2006. The Company does notbelieve SAB No. 108 will have a material impact on its financial statements.

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

**2.     LONG TERM DEBT**

OnNovember 30, 2005, the Company amended its Third Amended and Restated CreditAgreement (the “Credit Facility”), which it had originally entered into inMarch 2004 (effective December 31, 2003) and previously amended on May 31,2005. The Credit Facility permits borrowings up to the lesser of (i) theborrowing base and (ii) $150.0 million. Effective November 30, 2005, the CreditFacility’s borrowing base was increased from $70.0 million to $110.0 million.The borrowing base under the Credit Facility was increased as a result of theChapman Ranch Field acquisitions in 2005 and the Company’s drilling activitiessince the last redetermination. Effective May 25, 2006, the Credit Facility’sborrowing base was increased from $110.0 million to $115.0 million as a resultof the Company’s recent drilling activities. The Company’s available borrowingcapacity under the facility was $15.0 million at September 30, 2006. Ourborrowing base is currently being redetermined by our lender and we expect tobe notified of any changes late in the fourth quarter of 2006.

TheCredit Facility matures December 31, 2007 and is secured by substantially allof the Company’s assets. Borrowings under the Credit Facility bear interest atrates that are variable based on the percentage usage of the facility.Borrowings can be at Prime plus a margin of 0% to 0.25% or at Libor plus amargin of 1.75% to 2.125%. Outstanding availability will bear interest rates of0.25% to 0.50% based on utilization levels. At September 30, 2006 the interestrates applied to the Company’s outstanding Prime and Libor borrowings were8.500% and 7.455%, respectively. As of September 30, 2006, $100.0 million intotal borrowings were outstanding under the Credit Facility.

TheCredit Facility provides for certain restrictions, including but not limitedto, limitations on additional borrowings, sales of oil and natural gasproperties or other collateral, and engaging in merger or consolidationtransactions. The Credit Facility also prohibits dividends and certaindistributions of cash or properties and certain liens. The Credit Facility alsocontains 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 and abandonmentexpenses for such period) of the Company for the four fiscal quarters thenended to (b) the consolidated interest expense of the Company for the fourfiscal quarters then ended, not be less 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 theCredit Facility Agreement, be at least $1.0 million. For the purposes ofcalculating the Working Capital ratio, the total of current assets is adjustedfor unused capacity under the Credit Facility Agreement, and derivativefinancial instruments and the total of current liabilities is adjusted for thecurrent portion of indebtedness under the Credit Facility Agreement, derivativefinancial instruments and asset retirement obligations.

·                  The MaximumLeverage ratio requires that the ratio, as of the last day of any fiscalquarter, of (a) Total Indebtedness (as defined in the Credit FacilityAgreement) 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.

ConsolidatedEBITDAX is a component of negotiated covenants with our lender and is discussedhere as part of the Company’s disclosure of its covenant obligations.

15

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**3.     SHELF REGISTRATION STATEMENT**

During the secondquarter 2005, the Company filed a registration statement with the SEC whichregistered offerings up to $390 million of any combination of debt securities,preferred stock, common stock or warrants for debt securities or equitysecurities of the Company. Net proceeds, terms and pricing of the offering ofsecurities issued under the shelf registration statement will be determined atthe time of the offerings. The shelf registration statement does not provideassurance that the Company will or could sell any such securities. The Company’sability to utilize the shelf registration statement for the purpose of issuing,from time to time, any combination of debt securities, preferred stock, commonstock or warrants will depend upon, among other things, market conditions andthe existence of investors who wish to purchase the Company’s securities atprices acceptable to the Company. At September 30, 2006, the Company had $390million available for issuance under its 2005 shelf registration statement.

**4.     EARNINGS PER SHARE**

TheCompany accounts for earnings per share in accordance with SFAS No. 128, *Earnings per Share*, which establishes therequirements for presenting earnings per share (“EPS”). SFAS No. 128 requiresthe presentation of “basic” and “diluted” EPS on the face of the statement ofoperations. Basic earnings per common share amounts are calculated using theweighted average number of common shares outstanding during each period.Diluted earnings per common share assumes the exercise of all stock options andwarrants having exercise prices less than the average market price of thecommon stock during the periods, using the treasury stock method.

Thefollowing is a reconciliation of the numerators and denominators of basic anddiluted earnings per common share computations, in accordance with SFAS No.128, for the three and nine-month periods ended September 30, 2006 and 2005:
| ** **                                      | ** ** | **Three Months Ended September 30, 2006**    | ** ** | **Three Months Ended September 30, 2005** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Income(Loss)  (Numerator)**                                         | ** ** | **Shares  (Denominator)**                                          | ** ** | **Per Share  Amount** | ** ** | **Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per  Share  Amount** | ** ** |
| ** **                                      | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Basic  EPS**                                  |       |                                                                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income (loss)  available to common stockholders |       | $                                                                     | (56,880    | )                                                                  | 17,419     |   | $ | (3.27 | ) | $ | 8,143 |   | 17,138 |   | $ | 0.47 |   |
| Effect of  dilutive securities:                 |       |                                                                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| Restricted stock                                |       | —                                                                |       | —                                                             |       | (0.00 | ) | — |   | 212 |   | (0.01 | ) |
| Common stock  options                           |       | —                                                                |       | —                                                             |       | (0.00 | ) | — |   | 558 |   | (0.01 | ) |
| **Diluted  EPS**                                |       |                                                                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income (loss) available  to common stockholders |       | $                                                                     | (56,880    | )                                                                  | 17,419     |   | $ | (3.27 | ) | $ | 8,143 |   | 17,908 |   | $ | 0.45 |   |

 
| ** **                                      | ** ** | **Nine Months Ended September 30, 2006**     | ** ** | **Nine Months Ended September 30, 2005** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Income(Loss)  (Numerator)**                                         | ** ** | **Shares  (Denominator)**                                         | ** ** | **Per Share  Amount** | ** ** | **Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per  Share  Amount** | ** ** |
| ** **                                      | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Basic  EPS**                                  | * *   | * *                                                              | * *   | * *                                                          | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| Income (loss)  available to common stockholders |       | $                                                                     | (44,193    | )                                                                 | 17,344     |   | $ | (2.55 | ) | $ | 20,076 |   | 17,100 |   | $ | 1.17 |   |
| Effect of  dilutive securities:                 |       |                                                                  |       |                                                              |       |   |   |   |   |   |   |   |   |
| Restricted stock                                |       | —                                                                |       | —                                                            |       | (0.00 | ) | — |   | 187 |   | (0.01 | ) |
| Common stock  options                           |       | —                                                                |       | —                                                            |       | (0.00 | ) | — |   | 515 |   | (0.03 | ) |
| **Diluted  EPS**                                |       |                                                                  |       |                                                              |       |   |   |   |   |   |   |   |   |
| Income (loss) available  to common stockholders |       | $                                                                     | (44,193    | )                                                                 | 17,344     |   | $ | (2.55 | ) | $ | 20,076 |   | 17,802 |   | $ | 1.13 |   |

 

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When a loss fromcontinuing operations exists, as in the three and nine months ended September30, 2006, no potential common shares shall be included in the computation ofany diluted per share amount because it would result in an antidilutive effecton per share amounts. 

**5.     INCOME TAXES**

The Companyaccounts for income taxes under the provisions of SFAS No. 109, *Accounting for Income Taxes*, whichprovides for an asset and liability approach in accounting for income taxes.Under this approach, deferred tax assets and liabilities are recognized basedon 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.

TheCompany currently estimates that its effective tax rate for the year endingDecember 31, 2006 will be approximately 34.94%. An income tax benefit of $23.7million (34.94% of pre-tax loss) and a provision for income taxes of $10.9million (35.11% of pre-tax income) was reported for the nine months endedSeptember 30, 2006 and 2005, respectively. Our income tax provisions areprimarily non-cash as we have NOL carryforwards available that were generatedfrom drilling activity. Currently we anticipate that we will pay only federalalternative minimum tax in 2006. The Company was required to pay federalalternative minimum taxes in the fourth quarter of 2005.

**6.     SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AND NON-CASHINVESTING AND FINANCING ACTIVITIES**

TheCompany considers all highly liquid debt instruments purchased with an originalmaturity of three months or less to be cash equivalents. A summary of non-cashinvesting and financing activities for the nine months ended September 30, 2006and 2005 is presented below:

| Description                                                                                          | ** ** | **Number of  Shares  Issued** | ** ** | **Fair Market   Value** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                           | ** ** | **(in thousands)**            | ** ** |
| **Nine  months ended September 30, 2006:**                                                           |       |                               |       |                              |       |
| Shares issued to satisfy restricted stock grants                                                     |       | 92                                 |       | $                                 | 1,277      |   |
| Shares issued to fund the Company’s matching  contribution under the Company’s 401(k) plan |       | 16                                 |       | $                                 | 332        |   |
| **Nine  months ended September 30, 2005:**                                                           |       |                               |       |                              |       |
| Shares issued to satisfy restricted stock grants                                                     |       | 55                                 |       | $                                 | 528        |   |
| Shares issued to  fund the Company’s matching contribution under the Company’s 401(k) plan |       | 8                                  |       | $                                 | 130        |   |

 

For the nine months ended September 30, 2006 and 2005,the non-cash portion of Asset Retirement Costs was $251,305 and $147,577,respectively. A supplemental disclosure of cash flow information for the ninemonths ended September 30, 2006 and 2005 is presented below:

17

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|                                            | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                                                   | ** ** |
| Cash paid during  the period for:          |       |                                                                      |       |   |   |
| Interest                                   |       | $                                                                         | 5,281      |   | $ | 743 |   |
| Federal  alternative minimum tax payments* |       | 94                                                                        |       | — |   |
|                                            |            |                                                                           |            |  |  |  |  |

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* During 2005 the Company paid federal alternativeminimum taxes only in the fourth quarter.

**7.     HEDGING AND DERIVATIVE ACTIVITIES**

Dueto the volatility of oil and natural gas prices, the Company periodicallyenters into price-risk management transactions (e.g., swaps, collars andfloors) for a portion of its oil and natural gas production to achieve morepredictable revenue, as well as to reduce exposure from price fluctuations.While the use of these arrangements may limit the Company’s ability to benefitfrom increases in the price of oil and natural gas, it also reduces the Company’spotential exposure to adverse price movements. The Company’s arrangements, tothe extent it enters into any, apply to only a portion of its production andprovide only partial price protection against declines in oil and natural gasprices. None of these instruments are used for trading purposes. The use of derivativeinstruments involves the risk that the counterparties to such instruments willbe unable to meet the financial obligations of such contracts. On a quarterlybasis, the Company’s management reviews all of the Company’s price-riskmanagement 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. The Board of Directorscontinuously monitors the Company’s policies and trades.

Allof these price-risk management transactions are considered derivativeinstruments and accounted for in accordance with SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities* (as amended)*.* These derivative instruments areintended to hedge the Company’s price risk and may be considered hedges foreconomic purposes, but certain of these transactions may not qualify for cashflow hedge accounting. All derivative instrument contracts are recorded on thebalance sheet at fair value and the cash flows resulting from settlement ofthese derivative transactions are classified in operating activities on thestatement of cash flows. For those derivatives in which mark-to-marketaccounting treatment is applied, the changes in fair value are not deferredthrough other comprehensive income on the balance sheet. Rather they areimmediately recorded in total revenue on the statement of operations. For thosederivatives that are designated and qualify for cash flow hedge accounting, theeffective portion of the changes in the fair value of the contracts is recordedin other comprehensive income on the balance sheet and the ineffective portionof the changes in the fair value of the contracts is recorded in total revenueon the statement of operations as they occur. When the hedged production issold, the realized gains and losses on the contracts are removed from othercomprehensive income and recorded in revenue. While the contract isoutstanding, the unrealized and ineffective gain or loss may increase ordecrease until settlement of the contract depending on the fair value at themeasurement dates.

Duringthe first quarter of 2006, the Company determined that the cash flow hedgeaccounting treatment previously applied to its natural gas contracts should bediscontinued due to projected changes in the 2006 physical production volumeshedged and to give the Company more flexibility in how it markets its physicalproduction. In 2006, the Company has applied mark-to-market accountingtreatment to all outstanding derivative contracts, therefore the changes infair value are not deferred through other comprehensive income, but ratherrecorded in revenue immediately as unrealized gains or losses. Going forward,the Company will continue to evaluate the terms of new contracts entered intoto determine whether cash flow hedge accounting treatment or mark-to-marketaccounting treatment will be applied. In the past, the Company has usedmark-to-market accounting treatment for its crude oil contracts and cash flowhedge accounting treatment for its natural gas contracts, therefore unrealized gainsand losses on the change in fair value of natural gas contracts between periodsmay not be comparable.

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Forthe nine months ended September 30, 2006 and 2005, the Company included intotal revenue the following realized and unrealized gains and losses:

|                                                     | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                          | ** ** | **(in thousands)**                                 | ** ** |
| Natural gas collar  realized settlements            |       | $                                                       | 2,737      |   | $ | (810 | ) |
| Crude oil collar  realized settlements              |       | —                                                  |       | (1,223 | ) |
| Natural gas collar  unrealized change in fair value |       | 7,117                                                   |       | — |   |
| Crude oil collar  unrealized change in fair value   |       | 638                                                     |       | (364 | ) |
| Gain (loss) on hedging  and derivatives             |       | $                                                       | 10,492     |   | $ | (2,397 | ) |

 

The fair value ofoutstanding hedging and derivative contracts at September 30, 2006 and December31, 2005 reflected on the balance sheet were as follows: 
| ** **                | ** **   | ** **                | ** **   | ** **    | ** **   | ** **   | ** **   | **Price**         | ** **   | **Volumes**      | ** **   | **Fair Value of Outstanding Contracts as of** | ** **   |
|---------------------------|--------------|---------------------------|--------------|---------------|--------------|--------------|--------------|-------------------|--------------|------------------|--------------|-----------------------------------------------------------------------------|--------------|
| **Transaction Date** | ** **   | **Transaction Type** | ** **   | **Beginning** | ** **   | **Ending**   | ** **   | **Per Unit** | ** **   | **Per Day** | ** **   | ** September 30, 2006 **                                | ** **   | ** December 31, 2005 ** | ** ** |
| ** **                | ** **   | ** **                | ** **   | ** **    | ** **   | ** **   | ** **   | ** **        | ** **   | ** **       | ** **   | **(in thousands)**                                                     | ** **   |
| ***Natural Gas (1):***    |         |                      |         |          |         |         |         |              |         |             |         |                                                                        |         |   |   |
| 08/05                     |         | Natural  Gas Collar       |         | 01/01/2006    |         | 12/31/2006   |         | $                 | 7.00-$10.50  |             | 10,000MMbtu  |                                                                        | $            | 1,727 |   | $ | (2,498 | ) |
| 08/05                     |         | Natural  Gas Collar       |         | 01/01/2006    |         | 12/31/2006   |         | $                 | 7.00-$16.10  |             | 10,000MMbtu  |                                                                        | 1,778        |   | (137 | ) |
| 08/06                     |         | Natural Gas Collar        |         | 01/01/2007    |         | 12/31/2007   |         | $                 | 7.50-$11.50  |             | 5,000  MMbtu |                                                                        | 1,750        |   | — |   |
| 08/06                     |         | Natural Gas Collar        |         | 01/01/2007    |         | 12/31/2007   |         | $                 | 7.50-$12.00  |             | 5,000 MMbtu  |                                                                        | 1,862        |   | — |   |
| ***Crude  Oil (2):***     | *** *** | *** ***              | *** *** | *** ***  | *** *** | *** *** | *** *** | *** ***      | *** *** | *** ***     | *** *** | *** ***                                                                | *** *** | *** *** | *** *** |
| 08/05                     |         | Crude  Oil Collar         |         | 01/01/2006    |         | 12/31/2006   |         | $                 | 55.00-$80.00 |             | 400Bbl       |                                                                        | 5            |   | 156 |   |
| 08/06                     |         | Crude Oil Collar          |         | 01/01/2007    |         | 12/31/2007   |         | $                 | 70.00-$87.50 |             | 400  Bbl     |                                                                        | 789          |   | — |   |
|                      |         |                      |         |          |         |         |         |              |         |             |         |                                                                        |         |   |   |
|                      |         |                      |         |          |         |         |         |              |         |             |         | $                                                                           | 7,911        |   | $ | (2,479 | ) |

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(1)          The Company’s current natural gas collars were enteredinto on a per MMbtu delivered price basis, using the Houston Ship ChannelIndex, with settlement for each calendar month occurring five business daysfollowing the expiration date.  During2005, cash flow hedge accounting was applied to these contracts, which was thendiscontinued in 2006. During 2006, mark-to-market accounting treatment has beenapplied to these contracts and the change in fair value is reflected in totalrevenue during the year.

(2)          Cash flow hedge accounting is not applied to theCompany’s crude oil collars, which were entered into on a per barrel deliveredprice basis, using the West Texas Intermediate Light Sweet Crude Oil Index,with settlement for each calendar month occurring five business days followingthe expiration date. Mark-to-market accounting treatment is applied to thesecontracts and the change in fair value is reflected in total revenue during theyear.

**8.     ACQUISITIONS & DIVESTITURES**

On October 13,2005, the Company consummated the acquisition of working interests in oil andnatural gas properties located on the Chapman Ranch Field in Nueces County,Texas. The final cash purchase price was $28.0 million, including theincremental purchase price and the results of operations between the September1, 2005 effective date and the October 13, 2005 closing date, pursuant to theclosing adjustment provisions of the relevant agreement. On November 30, 2005,the Company also consummated the acquisition of the stock of a private company,Cinco Energy Corporation (“Cinco”), whose primary asset is ownership of workinginterests in oil and natural gas properties located on the Chapman Ranch Field.The preliminarily adjusted cash purchase price of $47.3 million was adjustedfrom the base purchase price of $35.8 million for, among other things, workingcapital as of September 1, 2005 and an incremental purchase price, pursuant tothe closing provisions of the relevant agreement. The Company financed theacquisitions through borrowings under its credit facility, the borrowing baseof which increased in connection with these transactions and other recentactivities since the last redetermination.

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The following unaudited pro forma results for 2005show the effect on the Company’s consolidated results of operations as if theCinco transaction had occurred on January 1, 2005. The pro forma results arethe result of combining the statement of income for the Company with thestatement of income for Cinco adjusted for (1) assumption of ARO liabilitiesand accretion expense for the properties acquired, (2) depletion expenseapplied to the adjusted basis of the properties acquired using the purchasemethod of accounting, (3) conversion of Cinco from the successful effortsmethod of accounting to the full cost method, (4) interest expense on addedborrowings necessary to finance the acquisition and (5) the related income taxeffects of these adjustments based on the applicable statutory rates. The proforma information is based upon numerous assumptions, and is not necessarilyindicative of future results of operations:

|                               | ** **   | **For the Three  Months Ended**                                   | ** **   | **For the Nine  Months Ended** | ** ** |
|-------------------------------|--------------|----------------------------------------------------------------------------------|--------------|-----------------------------------------------|------------|
| ** **                    | ** **   | **September 30, 2005**                                                 | ** **   |
| ** **                    | *** *** | **(unaudited)**(in thousands, except per share amounts) | *** *** |
| Revenue                       |         | $                                                                                | 29,585       |                                          | $          | 82,969 |   |
| Net income                    |         | $                                                                                | 7,209        |                                          | $          | 19,467 |   |
| Net income per common  share: |         |                                                                             |         |                                          |       |
| Basic                         |         | $                                                                                | 0.42         |                                          | $          | 1.14 |   |
| Diluted                       |         | $                                                                                | 0.40         |                                          | $          | 1.09 |   |

 

On April 25, 2006, the Company consummated thedivestiture of its Buckeye properties located in Live Oak County, Texas for abase sale price of $600,000 which was reduced to $567,645 after post closingadjustments.

**9.     COMMITMENTS AND CONTINGENCIES**

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

**Texas Comptroller Audit** - During thesecond quarter of 2004, the Company received notice that a subsidiary’sfranchise tax returns for the State of Texas would be audited for the tax years1999 through 2002. After reviewing the documents submitted, the agentrepresenting the Office of the Comptroller of the State of Texas proposedadjustments to the calculation that would result in an increased franchise taxliability.  The agent maintained that transfers by the Company to itssubsidiary, that had been classified as intercompany loans, should instead beclassified as equity investments in the subsidiary. The State of Texas originallyproposed that the franchise tax liability of the subsidiaries would beincreased by approximately $3.0 million for the four-year period under audit.

Duringthe third quarter of 2006, the Company and the Comptroller agreed upon a methodof computing the Company’s franchise tax liability to the State of Texas fortax years 1999 through 2002 that resulted in a total one-time payment of$144,474, plus penalties of $9,228, which was taken in full during the ninemonths ended September 30, 2006.  TheCompany anticipates that interest on this settlement will amount toapproximately $55,000, which was accrued at September 30, 2006.

**Wadeand Joyce Montet, et al., v. Edge Petroleum Corp of Texas, et al., consolidatedwith Rolland L. Broussard, et al., v. Edge Petroleum Corp of Texas, et al****.** - This is a consolidated suit, filed instate court in Vermilion Parish, Louisiana in September 2003. Plaintiffs aremineral/royalty owners under the Norcen-Broussard

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No. 1 and 2 wells, MargTex Reservoir C, Sand Unit A (Edge’s old Bayou Vermilion Prospect).  Theyclaim the operator at the time, Norcen Explorer, now Anadarko, failed to “blocksqueeze” the sections of the No. 2 well, as a prudent operator, according totheir allegations, would have done, to protect the gas reservoir from beingflooded with water from adjacent underground formations. Plaintiffs furtherallege Norcen was negligent in not creating a field-wide unit to protect theirinterests.  The allegations relate toactions taken beginning in the early 1990’s. Plaintiffs have named the Companyand other working interest owners in the leases as defendants, including NorcenExplorer’s successors in interest, Anadarko. Plaintiffs originally soughtunspecified damages for lost royalties and damages due to alleged devaluationof their mineral and property interests, plus interest and attorneys’ fees. Inearly 2005, the Company filed a motion for summary judgment in the caseasserting, among other defenses, that:  (i) there has been no breach ofcontract, (ii) there is no express or implied duty imposed on us to blocksqueeze the well or form a field-wide unit, (iii) the units were properlyformed by the Conservation Commissioner in accordance with the statutory schemein Louisiana, (iv) plaintiffs’ claims are barred by limitations, and (v) otherdefenses. Along with the other defendants, the Company also filed a specialpreemptory challenge of no cause of action under the leases and the LouisianaMineral Code for failure to exhaust administrative remedies and due to lack ofa demand. In May and June 2005, the court ruled against us on the motion forsummary judgment and the preemptory challenges. Of the 18.75% after-payoutworking interest that was originally reserved in the leases, the Company owneda 2.8% working interest at the time of the alleged acts or omissions. OnSeptember 6, 2005, the Company was granted leave by the court to file athird-party demand to join the other working interest owners who hold theremainder of the 18.75% working interest as third-party defendants in thiscase, and those pleadings have been served on the parties. These third-partiesconsist, for the most part, of partnerships that are directly or indirectlycontrolled by John Sfondrini, a director of the Company, and hold an aggregate14.7% working interest. Vincent Andrews, also a director of the Company, owns aminority interest in the corporate general partner of one of the partnerships.These partnerships were among the third party defendants that the Company hassought to join in the case, and these partnerships have for the most part filedanswers denying any liability to the Company. The Company participated for its2.8% share of the well costs and revenues for the Broussard No. 2 well, as didthe other defendants for their share, including the third-party defendantpartnerships who participated for 14.7%. The Company strongly believes theparties should only be liable for their proportionate share of any damagesaward should a finding of liability occur in the case. The Company intends tovigorously contest the plaintiffs’ claims.

Asof the date of this report, it is not possible to determine what, if any, theCompany’s exposure might be in this matter. Plaintiffs have asserted damages,including interest, to be as high as $63 million.  The plaintiffs’ expert witness, in hisDecember 2005 deposition, offered his theory that plaintiffs’ gross damages arein the range of $19 to $22 million. That number is based on his theory that thealleged failure to block squeeze the well resulted in the under-production ofgas worth $300 million. Plaintiffs’ royalty share of that figure yields the $19to $22 million range of alleged damages. Based on the expert’s testimony,damages attributable to the full 18.75% interest would be in the range of $3.75million gross or net to our 2.8% share would be in the range of $560,000(excluding interest and attorneys’ fees). Along with the other defendants, theCompany hired its own expert witnesses who have refuted these claims,particularly the expert’s assertions that failure to block squeeze the wellcaused any damages to the reservoir. The deposition of a Norcen engineer whoprepared the completion plan for the Broussard No. 2 well and supervised thecompletion operations, taken in April 2006, confirms the testimony of thedefense experts as to why the well was not block squeezed.  The plaintiffshave also retained a damages expert who has given a report that the damages inthis case are in the range of $30 million, excluding interest and attorneys’fees.  The Company’s share of that amountbased on the full 18.75% would be approximately $5.6 million and net to our2.8% share would be approximately $840,000. The Company participated inmediation of this lawsuit on July 18, 2006 but the parties failed to reach anagreement.  In July 2006, plaintiffs’attorney sent a demand to the defendants for total damages claimed byplaintiffs, with legal interest, totaling $63 million.  The Company’s share of that amount based onthe full 18.75% interest would be in the range of $12.2 million and net to our2.8% interest would be in the range of $1.8 million.  In September 2006, the defendant groupoffered $4.5 million to settle the case. Following this meeting, the parties have engaged in negotiations buthave failed to reach agreement on a settlement amount.  Consequently, the Company is preparing toproceed to trial.  The trial date,originally set for August 28, 2006, has been postponed until the week ofDecember 11, 2006 when the case is now set for trial.  On July 31, 2006 the Judge granted thedefendant groups’ motion for partial summary judgment dismissing plaintiffs’tort-based claims. Also on the same date, the Judge granted the defendantgroups’ motion for partial summary judgment seeking to deny the plaintiffs anaward of attorneys fees and also to dismiss any claim of plaintiffs thatdefendants had an obligation to form a field-wide unit, but denied thedefendants’ motion to exclude evidence of pre-suit damages based on failure

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of plaintiffs togive notice of their claims as required by the Louisiana Mineral Code and alsodenied defendants’ motion in limine to exclude testimony of plaintiffs’ expertwitness.

The Company mayhave insurance coverage for all or part of this claim up to the policy limitsof $1 million per occurrence and $2 million in the aggregate. A claim wassubmitted to Mid-Continent Casualty Company, our casualty carrier, who iscurrently providing a defense under a reservation of rights letter.   However, on July 3, 2006, Mid-Continentfiled a suit for declaratory judgment against us in federal district court inHouston, Texas seeking to determine whether it has a duty to indemnify theCompany and certain other defendants for this loss under the policies atissue.   Mid-Continent has asked thecourt to declare they have no obligation to indemnify the Company and thethird-party defendants based on certain technical definitions under thepolicies and the fact that the plaintiffs’ claims are based on alleged breachesof contract.  The Company intends to vigorouslydispute the coverage issues with Mid-Continent and has filed an answer andcounterclaim for breach of contract.  Itis also pursuing coverage claims under other insurance policies that couldcover a portion of our share of a loss in this case.

The Companycontinues to believe that an unfavorable outcome in this case is notprobable.  If, however, there is afinding of liability and damages are awarded, the Company believes thatultimately it should only be liable for its 2.8% share of any such award unlessa co-party defendant, including any of the third-party defendants, cannotsatisfy their share of any final judgment or settlement amount or are found notto be liable to the Company on its third-party demand.  In that event, the Company could be heldresponsible for more than its 2.8% share. The Company believes it has meritorious defenses and intends to continueto vigorously contest this suit and its third-party demands against thepartnerships, and has not established any reserve with respect to these claims.

**David Blake, et al. v. Edge Petroleum Corporation**– On September 19, 2005, David Blake and David Blake, Trustee of the David andNita Blake 1992 Children’s Trust filed suit against the Company in statedistrict court in Goliad County, Texas alleging breach of contract for failureand refusal to transfer overriding royalty interests to plaintiffs in at leastfive leases in Goliad County, Texas and failure and refusal to pay monies toBlake pursuant to such overriding royalty interests for wells completed on theleases. The plaintiffs seek relief of (1) specific performance of the allegedagreement, including granting of overriding royalty interests by the Company toBlake; (2) monetary damages for failure to grant the overriding royalty interests;(3) exemplary damages for his claims of business disparagement and slander; (4)monetary damages for tortuous interference; and (5) attorneys’ fees and courtcosts. Venue of the case was transferred to Harris County by agreement of thelitigants.  The Company has servedplaintiffs with discovery and has filed a counterclaim and an amendedcounterclaim joining various related entities that are controlled byplaintiffs.  In addition, plaintiffs havefiled an amended complaint alleging claims of slander of title and tortuousinterference related to its alleged right to receive an overriding royaltyinterest from a third party. Plaintiffs currently have on file an amendedmotion for summary judgment, to which the Company has filed a response.  In addition, the Company has filed a motionfor summary judgment on the plaintiffs’ case. The court has not ruled on either motion.  Discovery in the case has commenced.  The Company has responded aggressively tothis lawsuit, and believes it has meritorious defenses and counterclaims.

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

The following is Management’sDiscussion and Analysis (“MD&A”) of significant factors that have affectedcertain aspects of our financial position and operating results during theperiods included in the accompanying unaudited condensed consolidated financialstatements. The following MD&A is intended to help the readerunderstand Edge Petroleum Corporation (“Edge”). This discussion should be read in conjunction with the accompanyingunaudited condensed consolidated financial statements included elsewhere inthis Form 10-Q and with MD&A of Financial Condition and Results ofOperations and our audited consolidated financial statements included in ourannual report on Form 10-K for the year ended December 31, 2005 (2005 AnnualReport).

### **FORWARDLOOKING STATEMENTS**

Certain of the statementscontained in all parts of this document, including, but not limited to, thoserelating to our drilling plans (including scheduled and budgeted wells), theeffect of changes in strategy and business discipline, future tax matters, our3-D project portfolio, future general and administrative expenses on a per unitof production basis, changes in wells operated and reserves, future growth andexpansion, future exploration, future seismic data (including timing andresults), expansion of operation, our ability to generate additional prospects,our review of outside prospects and acquisitions, additional reserves andreserve increases, our ability to replace production and manage our asset base,enhancement of visualization and interpretation strengths, expansion andimprovement of capabilities, integration of new technology into operations,credit facilities, redetermination of our borrowing base, attraction of newmembers to the technical team, future compensation programs, new focus on coreareas, new prospects and drilling locations, new alliances, future capitalexpenditures (or funding thereof) and working capital, sufficiency of futureworking capital, borrowings and capital resources and liquidity, projectedrates of return, retained earnings and dividend policies, projected cash flowsfrom operations, future commodity price environment, expectation or timing ofreaching payout, the outcome, effects or timing of any legal proceedings orcontingencies, the impact of any change in accounting policies on our financialstatements, the number, timing or results of any wells, the plans for timing,interpretation and results of new or existing seismic surveys or seismic data,future production or reserves, future acquisition of leases, lease options orother land rights, any other statements regarding future operations, financialresults, opportunities, growth, business plans and strategy and otherstatements that are not historical facts are forward-looking statements. Theseforward-looking statements reflect our current view of future events andfinancial performance. When used in this document, the words “budgeted,” “anticipate,”“estimate,” “expect,” “may,” “project,” “believe,” “intend,” “plan,” “potential,”“forecast,” “might,” “predict,” “should” and similar expressions are intendedto be among the expressions that identify forward-looking statements. These forward-lookingstatements speak only as of their dates and should not be unduly relied upon.We undertake no obligation to publicly update or revise any forward-lookingstatement, whether as a result of new information, future events, or otherwise.Such statements involve risks and uncertainties, including, but not limited to,those set forth under “ITEM 1A. RISK FACTORS” of our 2005 Annual Report andother factors detailed in this document and our other filings with theSecurities and Exchange Commission (the “SEC”). Should one or more of theserisks or uncertainties materialize, or should underlying assumptions proveincorrect, actual outcomes may vary materially from those indicated. Allsubsequent written and oral forward-looking statements attributable to us or topersons acting on our behalf are expressly qualified in their entirety byreference to these risks and uncertainties.

## **GENERAL OVERVIEW**

Edge is a Houston-based independent energy companythat focuses its exploration, development, production, acquisition 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 ourcurrent strategy which focuses on a balanced program of exploration,exploitation and development and acquisition of oil and gas properties. Wegenerate revenues, income and cash flows by producing and marketing oil andnatural gas produced from our oil and natural gas properties. We makesignificant capital expenditures in our exploration, development, andproduction activities that allow us to continue generating revenue, income andcash flows. We have also spent considerable efforts on acquisitions, includingboth corporate and asset acquisitions, that have contributed to our growth inrecent years.

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Thisoverview provides our perspective on the individual sections of MD&A. OurMD&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 judgments andestimates.

·                  **Results of Operations** – an analysis of ourconsolidated results for the periods presented in our financial statements.

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

·                  **Risk Management Activities**–**Derivatives & Hedging**–****supplementary information regarding ourprice-risk management activities involving commodity contracts.

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

·                  **Recently Issued Accounting Pronouncements** –a discussion of certain recently issued accounting pronouncements that mayimpact our future results.

# **Industry and Economic Factors**

Inmanaging our business, we must deal with many factors inherent in ourindustry.  First and foremost is thefluctuation of oil and gas prices. Historically, oil and gas markets have been volatile, which makes pricemovements difficult to predict.  Whileour revenues are a function of both production and prices, wide swings incommodity prices have most often had the greatest impact on our results ofoperations. We have little ability to predict those prices or to control themwithout losing some advantage of the upside potential.

Ouroperations entail significant complexities. Advanced technologies requiringhighly trained personnel are utilized in both exploration and production.  Even when the technology is properly used, wemay still not know conclusively if hydrocarbons will be present or the rate atwhich they will be produced.  Explorationis a high-risk activity, often times resulting in no commercially productivereserves being discovered. Moreover, costs associated with operating within ourindustry are substantial. The high commodity price environment in late 2005 ledto increased costs in our industry, which together with increased demand forrigs, equipment, supplies and services, have made it difficult at times for usto further our growth, and make timely execution of our planned activitiesdifficult.

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

Theoil and gas industry is highly competitive. We compete with major and diversified energy companies, independent oiland gas businesses and individual operators in exploration, production,marketing and acquisition activities.  Inaddition, the industry as a whole competes with other businesses that supplyenergy to industrial and commercial end users.

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

# **Approach to the Business**

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

Weperiodically hedge our exposure to volatile oil and gas prices on a portion ofour production to reduce price risk. As of September 30, 2006, we hadderivative contracts in place covering approximately 50% and 42% of ourremaining expected 2006 natural gas and crude oil production,respectively.  As of September 30, 2006,approximately 46% of total 2006 estimated production on an Mcfe basis washedged with derivative contracts, but before any other acquisitions that mayoccur.

Implementation ofour business approach relies on our ability to fund ongoing exploration anddevelopment projects with cash flow provided by operating activities andexternal sources of capital. During the first quarter of 2006, our Boardapproved a revised 2006 capital budget of $98 million. Based upon currentexpectations for production volumes and commodity prices, we expect to fundthose capital expenditures from internally-generated cash from operatingactivities and modest borrowings under our Credit Facility (as defined below).We do not typically include acquisitions in our budgeted capital expenditures,but expect to fund those with either borrowings under our Credit Facility,proceeds from offerings of common stock or other securities under our shelfregistration statement or other sources.

Our long-term debtbalance as of September 30, 2006 was $100.0 million and our debt-to-totalcapital ratio was approximately 39.7%. During the second quarter of 2005, wetook steps to increase our shelf registration statement capacity to $390million from approximately $90 million (see Note 3 to our consolidatedfinancial statements), which became effective on July 1, 2005. We believe wehave the financial flexibility to continue to execute our business strategies.

**Acquisitions and Divestitures**

*Acquisitions -*We have become increasingly active in acquisitions inrecent years.  We have looked toacquisitions to enable us to achieve our growth objectives and we expectacquisitions will continue to play a significant role in our future plans forgrowth. Acquisitions add meaningful incremental increases in reserves andproduction and may range in size from acquiring a working interest innon-operated producing property to an entire field or company. Unlike drillingcapital, which is planned and budgeted, acquisition capital is neither budgetednor allocated.  Specific timing ofacquisitions cannot be predicted. Although we consider a wide variety of acquisitions,a significant part of our growth strategy is expected to be focused towardproducing property acquisitions, which we believe have exploitablepotential.  Because of our financialflexibility, we are positioned to take advantage of producing propertyacquisition opportunities as they may arise. We believe through hard work, technical ability and creative thinking ofour people, we will continue to grow through both acquisitions and drilling.Any such acquisition could involve the payment by us of a substantial amount ofcash or the issuance of a substantial number of additional shares or othersecurities.

Duringthe fourth quarter of 2005, we completed two acquisitions, including (i) thestock of a private company, whose primary asset is ownership of workinginterests in oil and natural gas properties located on the Chapman Ranch Fieldin south Texas and (ii) additional working interests in the Chapman Ranch Fieldowned by two other private companies for an aggregate cash purchase price ofapproximately $62.8 million (of which $35.8

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was attributableto the stock purchase and $27.0 million was attributable to the workinginterest asset purchase). Pursuant to closing adjustment provisions in theagreements, the purchase price was subject to adjustment for the results ofoperations between the September 1, 2005 effective date and the closing datesand an incremental purchase price related to the operator of the propertiesobtaining high-cost gas certification. The stock purchase was adjusted to $47.3million and the asset purchase was adjusted to $28.0 million. The propertiesacquired from these entities are located in Nueces County, Texas and consistedof six producing wells, one well undergoing completion operations, one welldrilling and an ownership in approximately 1,300 net acres of developed andundeveloped leasehold.

*Divestitures -*We regularly review our asset base forthe purpose of identifying non-core assets, the disposition of which wouldincrease capital resources available for other activities and createorganizational and operational efficiencies. While we generally do not disposeof assets solely for the purpose of reducing debt, such dispositions can havethe result of furthering our objective of financial flexibility through reduceddebt levels. During the first half of 2006, we sold our Buckeye properties inLive Oak County, Texas for a base sale price of $600,000, which was reduced to$567,645 after post closing adjustments.

**Outlook**

·                  Duringthe nine months ended September 30, 2006, a total of 45 wells were drilled with38 apparent successes, for an overall success rate of 84%.

·                  We expect to drill between 52 and 55 wells (30 and31 net, respectively) in 2006 and we estimate capital spending for the year tobe approximately $98 million. Our ability to materially increasethe number of wells to be drilled is heavily dependent upon the timely accessto oilfield services, particularly drilling rigs.

·                  Drillingactivities in the Fayetteville Shale play were initiated during the secondquarter of 2006 and we expect that activity to continue through the remainderof 2006 and into 2007.

·                  Wecontinue to spend considerable effort in 2006 finding and evaluatingacquisition opportunities, as we seek to further our growth.

·                  Tohelp protect against the possibility of downward commodity price movements andlost revenue, we have several derivatives in place to hedge a portion of ourexpected remaining natural gas and crude oil production streams for 2006 and2007. While there has been no cash impact from our oil derivatives contracts,our gas derivatives contracts have contributed $2.7 million to our cash flowsthus far in 2006. We discontinued cash flow hedge accounting treatment on ournatural gas collars, and thus all of our derivative transactions are nowaccounted for using mark-to-market accounting treatment (see Note 7 to ourconsolidated financial statements).

·                  Werecorded a $96.9 million ($63.0 million net of tax) non-cash impairmentrelating to our oil and natural gas properties during the third quarter of 2006resulting from our full-cost ceiling test. Natural gas prices fell below $5.00per MMBtu at September 30, 2006, but have subsequently risen above $6.00 perMMBtu which we believe would have allowed us to avoid the impairment if, aswould have been allowed under applicable accounting guidelines, we had electedto use such subsequent prices in determining the calculation of our ceilingtest at September 30, 2006. However, oil and natural gas prices are expected tocontinue to be volatile in the future. The benefit of the write-down is that it is expected to decrease futuredepletion expense and we believe that it will more appropriately state ourcapitalized costs.

·                  We expect tomodestly add to our staff levels in 2006 both as a result of recent growth andanticipated future growth.

Ouroutlook and the expected results described above are both subject to changebased upon factors that include but are not limited to drilling results,commodity prices, access to capital, the acquisitions market and factorsreferred to in “Forward Looking Statements.”

**Critical Accounting Policies andEstimates**

The preparation offinancial statements in conformity with generally accepted accountingprinciples in the United States of America requires management to makeestimates and assumptions that affect the reported amounts

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of assets, liabilities,revenues, expenses, contingent assets and liabilities and the relateddisclosures 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 othersignificant accounting policies that we employ are presented in the notes tothe consolidated financial statements. The following discussion presentsinformation about the nature of our most critical accounting estimates, ourassumptions or approach used and the effects of hypothetical changes in thematerial assumptions used to develop each estimate.

*Nature of Critical Estimate Item:*Oil and Natural Gas Reserves - Our estimate of proved reserves 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.

*Assumptions/ApproachUsed:*Units-of-production method to amortize our oil andnatural gas properties - The quantity of reserves could significantlyimpact our depletion expense. Any reduction in proved reserves without acorresponding reduction in capitalized costs will increase the depletion rate.

* *“Ceiling” Test - Thefull-cost method of accounting for oil and gas properties requires a quarterlycalculation of a limitation on capitalized costs, often referred to as afull-cost ceiling test. The ceiling is the discounted present value of ourestimated total proved reserves adjusted for taxes and the impact of cash flowhedges on pricing, using a 10% discount rate. To the extent that ourcapitalized costs (net of accumulated depletion and deferred taxes) exceed theceiling, the excess must be written off to expense. Once incurred, thisimpairment of oil and gas properties is not reversible at a later date even ifoil and gas prices increase.  A ceilingtest impairment could result in a significant loss for a reporting period;however, future depletion expense would be correspondingly reduced.  During the nine months ended September 30,2006 the Company recorded a ceiling test impairment of $96.9 million ($63.0million net of tax).  No such impairmentwas required in the nine months ended September 30, 2005.  The ceiling test calculation dictates thatprices and costs in effect as of the last day of the period are to be used incalculating the discounted present value of our estimated total provedreserves. Oil and natural gas prices used in the reserve valuation at September30, 2006 were $62.92 per barrel and $4.18 per MMbtu.

*Effect if Different Assumptions Used:*Units-of-production method to amortizeour oil and natural gas properties - A 10% increase or decrease in reserves would havedecreased or increased, respectively, our depletion expense for the year byapproximately 10%.

“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 inprices at a measurement date could trigger a full-cost ceiling impairment. Sucha reduction from June 30, 2006 to September 30, 2006 was primarily responsiblefor the impairment in our third quarter of 2006.  Following this impairment at September 30,2006, we had no cushion (i.e. the excess of the ceiling over our capitalizedcosts).  A 10% increase or decrease inprices used would have increased or decreased our impairment by approximately30%, net of tax, respectively.  Ourhedging program would serve to mitigate some of the economic impact

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of any pricedecline.  However, since we no longerapply cash flow hedge accounting to our derivative contracts, our hedgingprogram does not impact the ceiling test. Had we applied cash flow hedgeaccounting to our outstanding derivative contracts, the impairment would havebeen reduced by approximately $17.3 million. Another likely factor tocontribute to a ceiling test impairment is a revised estimate of reservevolume. A 10% increase or decrease in reserve volume would have decreased orincreased our impairment by approximately 20%, net of tax, respectively.  As noted above, we used pricing and costs asof the last day of the period to determine our ceiling limitation test.  Subsequent to the end of the reportingperiod, quoted market prices for natural gas increased such that we believe wewould have avoided a write-down if, as would have been allowed under applicableaccounting guidelines, we had elected to use such subsequent prices incalculating our ceiling test at September 30, 2006.

*Nature of 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 the prospectscan be determined or until impairment occurs. Unproved properties are evaluated quarterly, and as needed, forimpairment 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/Approach Used:*At September 30, 2006, we had $38.7 million allocatedto unproved property. This allocation is based on our estimation of whether theproperty has potential attributable reserves. Therefore, our assessment of thepotential reserves will determine whether costs are moved from the unprovedcategory to the full-cost pool for depletion or whether an impairment is taken.

*Effect if Different Assumptions Used:* A 10% increase or decrease in theunproved property balance (i.e., transfer to full-cost pool) would havedecreased or increased our depletion expense by approximately 1% for the threemonths ended September 30, 2006.

*Nature of 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 obligations are primarily associated withplugging and abandoning wells. Prior to the adoption of Statement of FinancialAccounting Standards (“SFAS”) No. 143, *Accountingfor Asset Retirement Obligations,* costs associated with thisactivity were capitalized to the full-cost pool and charged to income throughdepletion.  SFAS No. 143 significantlychanged the method of accruing for costs an entity is legally obligated toincur related to the retirement of fixed assets (“asset retirement obligations”or “ARO”).  Primarily, SFAS No. 143requires us to estimate asset retirement costs for all of our assets, adjustthose costs for inflation to the forecast abandonment date, discount thatamount using a credit-adjusted-risk-free rate back to the date we acquired theasset or obligation to retire the asset and record an ARO liability in thatamount with a corresponding addition to our asset value. When new obligationsare incurred, i.e. a new well drilled or acquired, we add a layer to the AROliability. We then accrete the liability layers quarterly using the applicableperiod-end effective credit-adjusted-risk-free rates for each layer. Shouldeither the estimated life or the estimated abandonment costs of a propertychange upon our quarterly review, a new calculation is performed using the samemethodology of taking the abandonment cost and inflating it forward to itsabandonment date and then discounting it back to the present using ourcredit-adjusted-risk-free rate. The carrying value of the asset retirementobligation is adjusted to the newly calculated value, with a correspondingoffsetting adjustment to the asset retirement cost (included in the full-costpool); therefore, abandonment costs will almost always approximate theestimate. When well obligations are relieved by sale of the property orplugging and abandoning the well, the related liability and asset costs areremoved from our balance sheet.

*Assumptions/ApproachUsed:*Estimating the future asset removal costs is difficultand requires management to make estimates and judgments because most of theremoval obligations are many years in the future, and contracts and regulationsoften have vague descriptions of what constitutes removal.  Asset removal

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technologies and costs are constantly changing, as areregulatory, political, environmental, safety and public relationsconsiderations. Inherent in the estimate of the present value calculation ofour AROs are numerous assumptions and judgments including the ultimatesettlement amounts, inflation factors, credit-adjusted-risk-free-rates, timingof settlement, and changes in the legal, regulatory, environmental andpolitical environments.

*Effect if Different Assumptions Used:* Since there are so many variables inestimating AROs, we attempt to limit the impact of management’s judgment oncertain of these variables by using input of qualified third parties. We engageindependent engineering firms to evaluate our properties annually. We use theremaining estimated useful life from the year-end reserve reports prepared byour independent reserve engineers in estimating when abandonment could beexpected for each property. We utilize a three-year average rate for inflationto diminish any significant volatility that may be present in the short term.We expect to see our calculations impacted significantly if interest ratescontinue to rise, as the credit-adjusted-risk-free rate is one of the variablesused on a quarterly basis. We have developed a standard cost estimate based onhistorical costs, industry quotes and depth of wells. Unless we expect a well’splugging to be significantly different than a normal abandonment, we use thisestimate. The resulting estimate, after application of a discount factor andsome significant calculations, could differ from actual results, despite allour efforts to make an accurate estimate.

*Nature of Critical Estimate Item:*Income Taxes**-**In accordance with SFAS No. 109, *Accounting for Income Taxes,* we haverecorded a deferred tax asset and liability to account for the expected futuretax benefits and consequences of events that have been recognized in ourfinancial statements and our tax returns. There are several items that resultin deferred tax asset and liability impact to the balance sheet, but thelargest of which is income taxes and the impact of net operating loss (“NOL”)carryforwards. We routinely assess our ability to use all of our NOLcarryforwards that resulted from substantial income tax deductions, prior yearlosses and acquisitions. We consider future taxable income in making suchassessments.  If we conclude that it ismore likely than not that some portion or all of the deferred tax assets willnot 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). We are not currently required to payany federal income taxes because of the prior generation of  NOL carryforwards.

*Effectif Different Assumptions Used:* We have engaged an independentpublic accounting firm to assist us in applying the numerous and complicatedtax law requirements. However, despite our attempt to make an accurateestimate, the ultimate utilization of our NOL carryforwards is highly dependentupon our actual production and the realization of taxable income in futureperiods. If we estimate that some or all of our NOL carryforwards are morelikely than not going to expire or otherwise not be utilized to reduce futuretax, we would record a valuation allowance to remove the benefit of those NOLcarryforwards from our financial statements.

*Natureof Critical Estimate Item:*Derivative and HedgingActivities**-**Due to theinstability of oil and natural gas prices, we may enter into, from time totime, price-risk management transactions (e.g., swaps, collars and floors) fora portion of our oil and natural gas production to achieve a more predictablerevenue, as well as to reduce exposure from commodity price fluctuations. Whileall of these transactions are economic hedges of price risk, differentaccounting treatment may apply depending on if they qualify for cash flow hedgeaccounting. In accordance with SFAS No. 133, *Accountingfor Derivative Instruments and Hedging Activities (as amended),*alltransactions are recorded on the balance sheet 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. The ongoing measurement of effectiveness determines whether the changein

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fair value is deferred through other comprehensiveincome (“OCI”) on the balance sheet or recorded immediately in revenue on theincome statement. The effective portion of the changes in the fair value ofhedge contracts is recorded initially in OCI. When the hedged production issold, the realized gains and losses on the hedge contracts are removed from OCIand recorded in revenue. Ineffective portions of the changes in the fair valueof the hedge contracts are recognized in revenue as they occur. The cash flowsresulting from settlement of these hedge transactions are included in cash fromoperating activities on the statement of cash flows.  While the hedge contract is outstanding, thefair value may increase or decrease until settlement of the contract. In theevent it is determined that the use of a particular derivative may not be orhas ceased to be effective in pursuing a hedging strategy, hedge accounting isdiscontinued prospectively. During the first quarter of 2006, we discontinuedcash flow hedge accounting treatment applied to our natural gas contracts dueto projected changes in the 2006 physical production volumes hedged and to giveus flexibility in how we market our physical production. Therefore, allcontracts are utilizing mark-to-market accounting treatment at September 30,2006, as discussed below.

DerivativeContracts - For transactions not accounted for using cash flow hedgeaccounting, the change in the fair value of the derivative contract isreflected in revenue immediately, and not deferred through OCI, and there is nomeasurement of effectiveness.

*Assumptions/Approach Used:*Estimating the fair values of derivative instrumentsrequires complex calculations, including the use of a discounted cash flowtechnique, estimates of risk and volatility, and subjective judgment inselecting an appropriate discount rate. In addition, the calculations usefuture market commodity prices, which although posted for trading purposes, aremerely the market consensus of forecasted price trends. The results of the fairvalue calculations cannot be expected to represent exactly the fair value ofour commodity derivatives. We currently obtain the fair value of our positionsfrom our counterparties. Our practice of relying on our counterparties who aremore specialized and knowledgeable in preparing these complex calculationsreduces our management’s input.  It alsoapproximates the fair value of the contracts as that would be the cost to us toterminate a contract at that point in time. Due to the fact that we applymark-to-market accounting treatment, the offset to the balance sheet asset orliability, or the change in fair value of the contracts, is included in revenueon the income statement rather than in OCI on the balance sheet.

*Effect if Different Assumptions Used:* At September 30, 2006, a 10% change inthe commodity price per unit, as long as the price is either above the ceilingor below the floor price, would cause the fair value total of our derivativefinancial instruments to increase or decrease by approximately $0.8 million.Had we applied cash flow hedge accounting treatment to all of our derivativecontracts outstanding at September 30, 2006, our net loss for the nine monthswould have been $38.0 million.

# **Results of Operations**

This section includesdiscussion of our results of operations for the three and nine-month periodsended September 30, 2006 as compared to the same periods of the prioryear.  We are an independent energycompany engaged in the exploration, development, acquisition and production ofoil and natural gas.  Our resources andassets are managed and our results reported as one operating segment.  We conduct our operations primarily along theonshore United States Gulf Coast, with our emphasis in south Texas, Louisiana,Mississippi and southeast New Mexico. We completed two acquisitions in the fourth quarter of2005, which impacted revenues, production and costs for the first nine monthsof 2006 and, due to timing, may affect the comparability of periods presented.

**Third Quarter 2006 Compared to the Third Quarter2005**

**Revenue and Production**

Total revenue increased 21% from the third quarter of2005 to the comparable 2006 period.  Forthe three months ended September 30, 2006 and 2005, our product mix contributedthe following percentages of revenues and production volumes:

 

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| ** **                | ** ** | ** **                                               | ** ** | **PRODUCTION VOLUMES** | ** ** |
|---------------------------|------------|----------------------------------------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **REVENUES **(1)                                    | ** ** | **(MCFE)**                  | ** ** |
| ** **                | ** ** | **Three months ended September 30,** | ** ** |
| ** **                | ** ** | **2006**                                                 | ** ** | **2005**                    | ** ** | **    2006    ** | ** ** | **    2005    ** | ** ** |
| Natural gas               |       | 76                                                       | %          | 83                          | %          | 80 | % | 78 | % |
| Natural gas liquids       |       | 5                                                        | %          | 4                           | %          | 8 | % | 11 | % |
| Crude oil and  condensate |       | 19                                                       | %          | 13                          | %          | 12 | % | 11 | % |
|                      |       |                                                     |       |                        |       |   |   |   |   |
| Total                     |       | 100                                                      | %          | 100                         | %          | 100 | % | 100 | % |

 

----

(1) Includes effect ofhedging and derivative transactions.

The followingtable summarizes volume and price information with respect to our oil and gasproduction for the three months ended September 30, 2006 and 2005:     
| ** **                                    | ** ** | ** **                                                                                            | ** ** | ** **      | ** ** | **2006 Period Compared** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------------------------------|------------|
| ** **                                    | ** ** | ** **                                                                                            | ** ** | ** **      | ** ** | **to 2005 Period**       | ** ** |
| ** **                                    | ** ** | **Three Months Ended  September 30,**                                                  | ** ** | **$  Increase** | ** ** | **%  Increase**                    | ** ** |
| ** **                                    | ** ** | **2006**                                                                                              | ** ** | **2005**        | ** ** | **(Decrease) **               | ** ** | **(Decrease)** | ** ** |
| ** **                                    | ** ** | **(in thousands, except per Bbl/Mcf/Mcfe prices and percentages)** | ** ** |
| **Production Volumes:**                       | ** ** | ** **                                                                                            | ** ** | ** **      | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Natural gas  (MMcf)                           |       | 3,561                                                                                                 |       | 2,992           |       | 569                                |       | 19 | % |
| Natural gas  liquids (MBbls)                  |       | 60                                                                                                    |       | 73              |       | (13                                | )          | (18 | )% |
| Crude oil and  condensate (MBbls)             |       | 89                                                                                                    |       | 70              |       | 19                                 |       | 27 | % |
| Natural gas  equivalent (MMcfe)               |       | 4,455                                                                                                 |       | 3,851           |       | 604                                |       | 16 | % |
| **Average Sales Price****(1)****:**           | ** ** | ** **                                                                                            | ** ** | ** **      | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Natural gas ($ per  Mcf)(2)              |       | $                                                                                                     | 6.32       |            | $          | 8.54                               |       | $ | (2.22 | ) | (26 | )% |
| Natural gas  liquids ($ per Bbl)         |       | 29.47                                                                                                 |       | 17.01           |       | 12.46                              |       | 73 | % |
| Crude oil and  condensate ($ per Bbl)(2) |       | 66.73                                                                                                 |       | 59.89           |       | 6.84                               |       | 11 | % |
| Natural gas  equivalent ($ per Mcfe)(2)  |       | 6.78                                                                                                  |       | 8.04            |       | (1.26                              | )          | (16 | )% |
| Natural gas  equivalent ($ per Mcfe)(3)  |       | 8.07                                                                                                  |       | 7.68            |       | 0.39                               |       | 5 | % |
| **Operating Revenue:**                        | ** ** | ** **                                                                                            | ** ** | ** **      | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Natural gas (2)                               |       | $                                                                                                     | 22,499     |            | $          | 25,540                             |       | $ | (3,041 | ) | (12 | )% |
| Natural gas  liquids                          |       | 1,757                                                                                                 |       | 1,245           |       | 512                                |       | 41 | % |
| Crude oil and  condensate (2)                 |       | 5,971                                                                                                 |       | 4,194           |       | 1,777                              |       | 42 | % |
| Gain (loss) on  hedging and derivatives       |       | 5,714                                                                                                 |       | (1,394          | )          | 7,108                              |       | * |   |
| Total revenue                                 |       | $                                                                                                     | 35,941     |            | $          | 29,585                             |       | $ | 6,356 |   | 21 | % |

 

----

(1) Prices arecalculated based on whole numbers, not rounded numbers.

(2) Excludes theeffect of hedging and derivative transactions.

(3) Includes theeffect of hedging and derivative transactions.

*Not meaningful, as different accounting treatmentbetween reporting periods affects comparability.

**Averagesales price**–For the three months ended September 30, 2006, average sales prices, excludinghedging and derivatives activity, exceeded those for the same prior year periodfor natural gas liquids, crude oil and condensate, but not for natural gas. Our sales revenue is sensitive to thevolatility of commodity prices.  A substantial portion of our production is soldat prevailing market prices, which fluctuate in response to many factors thatare outside of our control. Imbalances in the supply and demand for oil andnatural gas can have a dramatic effect on the prices we receive for ourproduction.  Political instability andavailability of alternative fuels could impact worldwide supply, while theeconomy, weather and other factors outside of our control could impact demand.

**Naturalgas revenue** -For the three months ended September 30, 2006, natural gas revenue, excludinghedging and derivative activity, decreased 12% over the same period in 2005 dueto 26% lower commodity prices

31

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partially offset by 19%higher production volumes. The overall increase in production compared to theprior year period resulted in an increase in revenue of approximately $4.9million (based on 2005 comparable period pre-hedge prices), which was theresult of production from new wells drilled on our Queen City project and theChapman Ranch Field properties acquired in the fourth quarter of 2005,partially offset by declines on our older properties, including Encinitas, GatoCreek and Miller. The decrease in average price received resulted in decreasedrevenue of approximately $7.9 million (based on current period production).

**Naturalgas liquids (“NGL”) revenue**- For the three months ended September 30, 2006, NGLrevenue increased 41% over the same period in 2005 due to an increase in pricesrealized, partially offset by lower production. This price increase resulted inan increase in revenue of approximately $0.7 million (based on current periodproduction).  NGL volumes were lowerduring the three months ended September 30, 2006 as compared to the same periodin 2005 as a result of declining production at our Encinitas, Gato Creek and Louisianaproperties. The decrease in NGL production decreased revenue by approximately$0.2 million (based on 2005 comparable period average prices).

**Crude oiland condensate revenue**- For the three months ended September 30, 2006, oiland condensate sales revenue, excluding hedging and derivative activity,increased 42% from the comparable period in 2005, largely due to the 11%increase in crude oil prices. The increased average realized price for oil andcondensate for the three months ended September 30, 2006 resulted in anincrease in revenue of approximately $0.6 million (based on current periodproduction).  Production volumes for oiland condensate increased 27% for the three months ended September 30, 2006 comparedto the same prior year period, due primarily to new wells drilled on our QueenCity and southeast New Mexico projects, as well as from the Chapman Ranch Fieldproperties acquired in the fourth quarter of 2005. These increases werepartially offset by declines on our Miller, Encinitas and Gato Creekproperties. The increase in oil and condensate production resulted in anincrease in revenue of approximately $1.2 million (based on 2005 comparableperiod pre-hedge prices).

**Hedgingand derivatives**–For the three months ended September 30, 2006 we recorded a net gain on hedgingand derivative contracts as compared to a net loss in the same period in 2005.During the first quarter of 2006, we discontinued cash flow hedge accountingtreatment applied to our natural gas collars, due to projected changes in 2006physical production volumes hedged and to give us more flexibility to determineinto which market we wish to sell our physical production (which had previouslybeen restricted by the fact that cash flow hedge accounting treatment requiresa certain relationship between the hedge terms and the physical sale terms toexist). This change in accounting treatment affects the comparability of theperiods (see Note 7 to our consolidated financial statements) because thechange in fair market value of the natural gas hedge contracts in 2005 wasdeferred through OCI on the balance sheet rather than presented in totalrevenue on the income statement, as presented in 2006. The volume and pricecontract terms vary from period to period and therefore interact differentlywith the changing pricing environment. While we are unable to predict themarket prices, we enter into contracts that we expect will protect us in theevent of significant downturns in the market, which has proven to be a benefitto us in the first nine months of 2006 with declining natural gas pricesresulting in cash settlement inflows from our hedge counterparties to offsetthe lower prices received for our physical production. The following tablesummarizes the various components of the total gain (loss) on hedging andderivatives for the three months ended September 30, 2006 and 2005 and theimpact each component had on our realized prices.
| ** **                                                                        | ** ** | **Three Months Ended September 30,**            | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                                            | ** ** | **2005** | ** ** |
| ** **                                                                        | ** ** | **$**                                                               | ** ** | **$ per unit **(1) | ** ** | **$** | ** ** | **$ per unit**(1) | ** ** |
| ** **                                                                        | ** ** | **(in thousands, except per unit prices)** | ** ** |
| Natural gas  contract settlements (Mcf)                                           | ** ** | $                                                                   | 776        |   | $ | 0.22 |   | $ | (966 | ) | $ | (0.32 | ) |
|                                                                              |       |                                                                |       |   |   |   |   |   |   |
| Crude oil  contract settlements (Bbl)                                             |       | —                                                              |       | — |   | (618 | ) | (8.83 | ) |
|                                                                              |       |                                                                |       |   |   |   |   |   |   |
| Mark-to-market  unrealized change in fair value of gas derivative contracts (Mcf) |       | 3,993                                                               |       | 1.12 |   | — |   | — |   |
| Mark-to-market  reversal of prior period unrealized change in fair value (Bbl)    |       | (48                                                                 | )          | (0.53 | ) | 119 |   | 1.70 |   |
| Mark-to-market  unrealized change in fair value of oil derivative contracts (Bbl) |       | 993                                                                 |       | 11.10 |   | 71 |   | 1.02 |   |
| Gain (loss) on hedging and derivatives (Mcfe)                                     |       | $                                                                   | 5,714      |   | $ | 1.29 |   | $ | (1,394 | ) | $ | (0.36 | ) |

 

----

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

32

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Should natural gasprices continue to decrease from the high levels of late 2005 and early 2006,this could materially affect our revenues that are not hedged.

**Costs and Operating Expenses**

The table below details our expenses for the threemonths ended September 30, 2006 and 2005.
| ** **                                            | ** ** | ** **                                            | ** ** | ** **   | ** ** | **2006 Period Compared** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------|------------|--------------|------------|------------------------------------|------------|
| ** **                                            | ** ** | ** **                                            | ** ** | ** **   | ** ** | ** to 2005 Period** | ** ** |
| ** **                                            | ** ** | **Three Months Ended**                      | ** ** | **$**        | ** ** | **%**                              | ** ** |
| ** **                                            | ** ** | **September 30,**                                | ** ** | **Increase** | ** ** | **Increase **                 | ** ** |
| ** **                                            | ** ** | **2006**                                              | ** ** | **2005**     | ** ** | **(Decrease)**                     | ** ** | **(Decrease)** | ** ** |
| ** **                                            | ** ** | **(in thousands, except percentages)** | ** ** |
| Oil and natural gas  operating expenses               |       | $                                                     | 2,417      |         | $          | 2,370                              |       | $ | 47 |   | 2 | % |
| Severance and ad  valorem taxes                       |       | 2,280                                                 |       | 1,846        |       | 434                                |       | 24 | % |
| Depletion,  depreciation, amortization and accretion: |       |                                                  |       |         |       |                               |       |   |   |
| Oil and gas  property and equipment                   |       | 16,829                                                |       | 8,209        |       | 8,620                              |       | 105 | % |
| Other assets                                          |       | 102                                                   |       | 68           |       | 34                                 |       | 50 | % |
| ARO accretion                                         |       | 48                                                    |       | 34           |       | 14                                 |       | 41 | % |
| Impairment of oil and  natural gas properties         |       | 96,942                                                |       | —       |       | 96,942                             |       | 100 | % |
| General and  administrative expenses:                 |       |                                                  |       |         |       |                               |       |   |   |
| Bad debt expense                                      |       | —                                                |       | 54           |       | (54                                | )          | (100 | )% |
| General and  administrative expenses                  |       | 4,001                                                 |       | 4,503        |       | (502                               | )          | (11 | )% |
|                                                  |       | 122,619                                               |       | 17,084       |       | 105,535                            |       | 618 | % |
| Other income and  expense, net                        |       | 809                                                   |       | 7            |       | 802                                |       | * |   |
| Total                                                 |       | $                                                     | 123,428    |         | $          | 17,091                             |       | $ | 106,337 |   | 622 | % |

 

----

*Not meaningful

**Oil andnatural gas operating expenses** - For the three months ended September 30, 2006operating expenses increased 2% from the same period of 2005.  While we have experienced some impact fromthe tight field services market in 2006, the majority of the increase is theresult of higher activity levels. We experienced increased costs as a result ofadding properties, specifically the newly acquired Chapman Ranch Fieldproperties and new wells drilled at Gato Creek, southeast New Mexico and in JimHogg County, Texas. Average oil and natural gas operating expenses were $0.54per Mcfe and $0.62 per Mcfe for the three months ended September 30, 2006 and2005, respectively.

**Severance and ad valorem taxes**- For the three months ended September 30, 2006, severance and ad valorem taxesincreased 24% from the third quarter of 2005. Severance tax expense for the three months ended September 30, 2006 wascomparable to the prior year period.  Ourseverance tax expense is levied on our oil and gas revenue (excluding hedgingand derivative impact). For the three months ended September 30, 2006,severance tax expense was approximately 5.4% of revenue subject to severancetaxes compared to 5.3% of revenue subject to severance taxes for the thirdquarter of 2005. Ad valorem tax expense for the third quarter of 2006 wasimpacted by

33

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increased accrualsfor the estimated costs related to the addition of the Chapman Ranch Fieldproperties acquired in the fourth quarter 2005 and increases in estimated costsfrom the taxing authorities. On an equivalent basis, severance and ad valoremtaxes averaged $0.51 per Mcfe and $0.48 per Mcfe for the three months endedSeptember 30, 2006 and 2005, respectively.

**Depletion, depreciation, and amortization (“DD&A”)and accretion**- DD&A and accretion expense for thethree months ended September 30, 2006 totaled $17.0 million compared to $8.3million for the same period in 2005. Depletion on our oil and natural gas properties continues to increasedue to increases in our unit-of-production depletion rate as well as increasedproduction volumes. The depletion rate increased from $2.13 per Mcfe in thethird quarter 2005 to $3.78 per Mcfe in the third quarter of 2006, addingapproximately $7.3 million in depletion expense. Our rate has increased due toincreased spending on our drilling program with disproportionately lowerreserve additions. One example of this includes the Chapman Ranch Fieldacquisitions which added $0.52 per Mcfe to the depletion rate in the fourthquarter of 2005. Since the first quarter of 2006, the rate increased $0.15 perMcfe. The increase in depletion expense from the higher production levels inthe third quarter of 2006 as compared to the same period of 2005 resulted in anincrease in expense of approximately $1.3 million. Depreciation of furnitureand fixtures for the third quarter of 2006 includes additional expense relatedto certain assets that were deemed to be fully depreciated, thus speeding upthe depreciation and amortization expense taken. Accretion expense associatedwith our asset retirement obligations for the three months ended September 30,2006 increased 41% over the third quarter of 2005 for the new obligationsincurred from the wells drilled since September 30, 2005 and the addition ofproperties acquired in the fourth quarter of 2005.

**Impairment of oil and natural gas properties**– During the third quarter of 2006 we recorded a non-cash full-cost ceilingtest impairment of oil and natural gas properties in the amount of $96.9million ($63.0 million net of tax), as discussed in Note 1 to the consolidatedfinancial statements.  No such impairmentwas necessary in the third quarter of 2005. The write-down was primarily the result of the decline in natural gas pricesat September 30, 2006.  The natural gasprice used to calculate the full-cost ceiling at September 30, 2006 wassignificantly lower than at year-end 2005 when no impairment was necessary.

**General and administrative (“G&A”) expenses**- For the three months ended September 30, 2006, total G&A was $4.0million, a decrease of 12% compared to the prior year third quarter total of$4.6 million.  G&A for the threemonths ended September 30, 2006 decreased 11% from the comparable 2005 period.This decrease is mainly attributable to the termination of FIN 44 accountingtreatment for repriced options, in conjunction with the adoption of SFAS No.123(R). In 2006, we discontinued the application of FIN 44 with a third quarterreversal of $0.3 million credit recorded in the first half of 2006. There willnot be any additional adjustments for charges or credits to compensation costrelated to repriced options, as compared to $1.7 million in compensationexpense recorded in the third quarter of 2005 for repriced options.  The decrease in G&A related to thetermination of FIN 44 was offset by increases resulting from compensation costrelated to stock option expense pursuant to the adoption of SFAS No. 123(R)discussed in Note 1, compensation cost related to restricted stock grants, andother G&A costs. Upon adoption ofSFAS No. 123(R) in the first quarter of 2006, we recorded $41,738 incompensation expense for stock options that had not vested as of adoption ofSFAS No. 123(R). Those options have since vested. In the third quarter of 2006,we recorded additional compensation expense associated with the adoption ofSFAS No. 123(R) in the amount of $27,199, after further review of theprovisions of SFAS No. 123(R). We do not expect any future impact to resultfrom our adoption of SFAS No. 123(R), as we have not issued stock options since2004. There was no comparable expense in the same 2005 reporting period becausewe were applying APB Opinion No. 25, which allowed us to exclude expenserelated to stock options (see Note 1 to the consolidated financialstatements).  Amortization relatedto restricted stock awards granted over the past three years has increased dueto new grants that have occurred since the third quarter of 2005. Changes inG&A, excluding share-based compensation costs, include increases due tohigher salaries and benefits, as a result of adding seven employees sinceSeptember 30, 2005, as well as costs paid to our external auditors, and legalcosts for pending litigation.  During thethird quarter of 2006 we paid a franchise tax settlement of approximately $0.2million to the state of Texas, which increased our franchise tax expense for2006 as compared to 2005.  Theseincreases were partially offset by decreases in office supplies and costsincurred in 2005 for strategic planning. For the three months ended September30, 2006 and 2005, overhead reimbursement fees reducing G&A costs werecomparable. Capitalized G&A costs further reduced G&A by $0.8 millionand $0.7 million for the three months ended September 30, 2006 and 2005,respectively.  G&A on aunit-of-production basis for the three months ended September 30, 2006 was$0.90 per Mcfe compared to $1.17 per Mcfe for the comparable 2005 period.  Included in total G&A is approximately$54,000

34

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of bad debtexpense recorded in the third quarter of 2005 related to several uncollectiblejoint interest billings receivable.  Wehad no bad debt expense in the comparable period in 2006.

**Otherincome and expense** - During the three months ended September 30, 2006, our other incomeand expense increased from a negligible amount in the comparable 2005 period,primarily due to an increase in gross interest expense, which was partiallyoffset by an increase in interest income and capitalized interest. For thethird quarter of 2006, 62% of our gross interest expense was capitalized, ascompared to 100% in the same 2005 period. We calculate the amount of interestwe can capitalize based on the comparison of our unproved property costs andour weighted average debt balance. In 2005, our debt was lower than theunproved property balance, whereas the 2006 weighted average debt balanceexceeds the unproved property balance. We also incurred higher gross interestcosts for the three months ended September 30, 2006 than for the same period of2005 due to higher outstanding debt balances.

|                             | ** ** | **Three Months Ended September 30,** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|
| ** **                  | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                  | ** ** |
| Gross interest expense      |       | $                                                        | 2,124      |   | $ | 263 |   |
| Less: capitalized  interest |       | (1,320                                                   | )          | (263 | ) |
| Interest expense, net       |       | $                                                        | 804        |   | $ | — |   |
|                        |       |                                                     |       |   |   |
| Weighted average debt       |       | $                                                        | 105,685    |   | $ | 14,228 |   |

 

We also recordedamortization of deferred loan costs related to our Credit Facility and interestincome earned on our outstanding daily cash balances during the three monthsended September 30, 2006 and 2005, both of which were comparable amounts.

**Incometax expense** -An income tax benefit of $30.6 million was recorded for the three months endedSeptember 30, 2006, whereas in 2005 we recorded income tax expense of $4.4million for the comparable period. The income tax benefit as of September 30,2006 results primarily from the impairment of oil and natural gas properties,which created a net loss for the third quarter of 2006.  There has not been a substantial change toour effective income tax rate.

**Earnings per share** - For thethree months ended September 30, 2006, earnings per share decreased incomparison to the same period in 2005, mainly as a result of the net loss inthe third quarter of 2006. Basic weighted average shares outstanding for thethree months ended September 30, 2006 increased slightly as compared to thesame 2005 period primarily due to the exercise of stock options throughout theinterim periods.

**NineMonths Ended September 30, 2006 Compared to the Nine Months Ended September 30,2005**

**Revenue and Production**

Total revenue increased 33% from the first nine monthsof 2005 to the comparable 2006 period. For the nine months ended September 30, 2006 and 2005, our product mixcontributed the following percentages of revenues and production volumes:
| ** **               | ** ** | **REVENUES **(1)                                   | ** ** | **PRODUCTION VOLUMES(MCFE)** | ** ** |
|--------------------------|------------|---------------------------------------------------------|------------|-----------------------------------|------------|
| ** **               | ** ** | **Nine Months Ended September 30,** | ** ** |
| ** **               | ** ** | **2006**                                                | ** ** | **2005**                          | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| Natural gas              |       | 79                                                      | %          | 82                                | %          | 80 | % | 76 | % |
| Natural gas  liquids     |       | 4                                                       | %          | 5                                 | %          | 8 | % | 12 | % |
| Crude oil and condensate |       | 17                                                      | %          | 13                                | %          | 12 | % | 12 | % |
|                     |       |                                                    |       |                              |       |   |   |   |   |
| Total                    |       | 100                                                     | %          | 100                               | %          | 100 | % | 100 | % |

 

----

(1)Includeseffect of hedging and derivative transactions.

35

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The following tablesummarizes volume and price information with respect to our oil and gasproduction for the nine months ended September 30, 2006 and 2005:
| ** **                                   | ** ** | ** **                                                                                            | ** ** | ** **   | ** ** | **2006 Period Compared** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|--------------|------------|------------------------------------|------------|
| ** **                                   | ** ** | ** **                                                                                            | ** ** | ** **   | ** ** | **to 2005 Period**       | ** ** |
| ** **                                   | ** ** | **Nine Months Ended**                                                                       | ** ** | **$**        | ** ** | **%**                              | ** ** |
| ** **                                   | ** ** | **September 30,**                                                                                | ** ** | **Increase** | ** ** | **Increase**                       | ** ** |
| ** **                                   | ** ** | **2006**                                                                                              | ** ** | **2005**     | ** ** | **(Decrease)**                     | ** ** | **(Decrease)** | ** ** |
| ** **                                   | ** ** | **(in thousands, except per Bbl/Mcf/Mcfe prices and percentages)** | ** ** |
| **Production  Volumes:**                     | * *   | * *                                                                                              |       |         |       |                               |       |   |   |
| Natural gas (MMcf)                           |       | 10,568                                                                                                |       | 9,277        |       | 1,291                              |       | 14 | % |
| Natural gas liquids (MBbls)                  |       | 186                                                                                                   |       | 240          |       | (54                                | )          | (23 | )% |
| Crude oil and condensate (MBbls)             |       | 261                                                                                                   |       | 233          |       | 28                                 |       | 12 | % |
| Natural gas equivalent (MMcfe)               |       | 13,247                                                                                                |       | 12,115       |       | 1,132                              |       | 9 | % |
| **Average  Sales Price****(1)****:**         | ** ** | ** **                                                                                            | ** ** | ** **   | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Natural gas ($ per Mcf)(2)              |       | $                                                                                                     | 6.89       |         | $          | 6.99                               |       | $ | (0.10 | ) | (1 | )% |
| Natural gas liquids ($ per Bbl)         |       | 24.33                                                                                                 |       | 17.22        |       | 7.11                               |       | 41 | % |
| Crude oil and condensate ($ per Bbl)(2) |       | 64.95                                                                                                 |       | 52.10        |       | 12.85                              |       | 25 | % |
| Natural gas equivalent ($ per Mcfe)(2)  |       | 7.12                                                                                                  |       | 6.70         |       | 0.42                               |       | 6 | % |
| Natural gas equivalent ($ per Mcfe)(3)  |       | 7.91                                                                                                  |       | 6.50         |       | 1.41                               |       | 22 | % |
| **Operating  Revenue:**                      | ** ** | ** **                                                                                            | ** ** | ** **   | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Natural gas (2)                              |       | $                                                                                                     | 72,854     |         | $          | 64,876                             |       | $ | 7,978 |   | 12 | % |
| Natural gas liquids                          |       | 4,513                                                                                                 |       | 4,140        |       | 373                                |       | 9 | % |
| Crude oil and condensate (2)                 |       | 16,954                                                                                                |       | 12,120       |       | 4,834                              |       | 40 | % |
| Gain (loss) on hedging and derivatives       |       | 10,492                                                                                                |       | (2,397       | )          | 12,889                             |       | * |   |
| Total revenue                                |       | $                                                                                                     | 104,813    |         | $          | 78,739                             |       | $ | 26,074 |   | 33 | % |

 

----

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

(2) Excludes the effect of hedging and derivative transactions.

(3) Includes theeffect of hedging and derivative transactions.

*Not meaningful,as different accounting treatment between reporting periods affectscomparability.

 

**Averagesales price**– For the ninemonths ended September 30, 2006, average sales prices, excluding hedging andderivatives activity, exceeded those for the same prior year period for naturalgas liquids, crude oil and condensate, but not for natural gas. Our sales revenue is sensitive to thevolatility of commodity prices.

**Naturalgas revenue** -For the first nine months of 2006, natural gas revenue, excluding hedging andderivative activity, increased 12% over the same period in 2005, due to higherproduction volumes partially offset by lower prices. The increase in productionvolumes compared to the prior year period resulted in an increase in revenue ofapproximately $9.0 million (based on 2005 comparable period pre-hedge prices).The increased volumes came from production from new wells drilled on our QueenCity project and the Chapman Ranch Field properties acquired in the fourthquarter of 2005, partially offset by declines in production from our olderproperties, including Encinitas, Gato Creek and Miller.   The average price decrease resulted indecreased revenue of approximately $1.0 million (based on current periodproduction).

**NGLrevenue**- Forthe nine months ended September 30, 2006, NGL sales revenue increased 9% overthe same period in 2005 as a result of increased commodity prices.  Higher average realized prices for the ninemonths ended September 30, 2006 partially offset the decline in revenue fromlower volumes and resulted in an increase in revenue of approximately $1.3million (based on current period production).  NGL production volumes declined at our Encinitas, Gato Creek andLouisiana properties, leading to decreased revenue of approximately $0.9million (based on 2005 comparable period average prices).

36

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**Crude oiland condensate revenue**- For the nine months ended September 30, 2006, oiland condensate sales revenue, excluding hedging and derivative activity,increased 40% as compared to the same period in 2005, due to both higher priceenvironment and production volumes. The higher average prices for the firstnine months of 2006 resulted in an increase in revenue of approximately $3.3million (based on current period production). Production volumes for oil and condensate increased 12% for the ninemonths ended September 30, 2006 compared to the same prior year period, dueprimarily to new wells drilled on our Queen City and southeast New Mexicoprojects, as well as from the Chapman Ranch Field properties acquired in thefourth quarter of 2005. These increases were partially offset by declines inproduction from our Miller, Encinitas and Gato Creek properties. The overallincrease in oil and condensate production resulted in an increase in revenue ofapproximately $1.5 million (based on 2005 comparable period pre-hedge prices).

**Hedgingand derivatives**–For the nine months ended September 30, 2006, we recorded a net gain on hedgingand derivative contracts as compared to a net loss in the same period in 2005.The change in accounting treatment applied to our derivative contracts affectsthe comparability of the periods (see Note 7 to our consolidated financialstatements) because the change in fair market value of the natural gas hedgecontracts in 2005 was deferred through OCI on the balance sheet, rather thanpresented in total revenue on the income statement as in 2006. In addition, wehave different contract terms in 2006 than in 2005, which interact differentlywith the changing pricing environment. In the first nine months of 2006, thefalling natural gas price has negatively impacted our physical sales, but theportion we had hedged was protected by those contracts in place this year. Thefollowing table summarizes the various components of the total gain (loss) onhedging and derivatives for the nine months ended September 30, 2006 and 2005and the impact each component had on our realized prices.
| ** **                                                                        | ** ** | **Nine Months Ended September 30,**             | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                                            | ** ** | **2005** | ** ** |
| ** **                                                                        | ** ** | **$**                                                               | ** ** | **$ per unit (1)** | ** ** | **$** | ** ** | **$ per unit(1)** | ** ** |
| ** **                                                                        | ** ** | **(in thousands, except per unit prices)** | ** ** |
| Natural gas  contract settlements (Mcf)                                           |       | $                                                                   | 2,737      |   | $ | 0.26 |   | $ | (810 | ) | $ | (0.09 | ) |
|                                                                              |       |                                                                |       |   |   |   |   |   |   |
| Crude oil  contract settlements (Bbl)                                             |       | —                                                              |       | — |   | (1,223 | ) | (5.26 | ) |
|                                                                              |       |                                                                |       |   |   |   |   |   |   |
| Mark-to-market  unrealized change in fair value of gas derivative contracts (Mcf) |       | 7,117                                                               |       | 0.67 |   | — |   | — |   |
|                                                                              |       |                                                                |       |   |   |   |   |   |   |
| Mark-to-market  reversal of prior period unrealized change in fair value (Bbl)    |       | (110                                                                | )          | (0.42 | ) | 754 |   | 3.24 |   |
|                                                                              |       |                                                                |       |   |   |   |   |   |   |
| Mark-to-market  unrealized change in fair value of oil derivative contracts (Bbl) |       | 748                                                                 |       | 2.87 |   | (1,118 | ) | (4.80 | ) |
|                                                                              |       |                                                                |       |   |   |   |   |   |   |
| Gain (loss) on hedging and derivatives (Mcfe)                                     |       | $                                                                   | 10,492     |   | $ | 0.79 |   | $ | (2,397 | ) | $ | (0.20 | ) |

 

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

 

Should natural gasprices continue to decrease from the high levels of late 2005 and early 2006,this could materially affect our revenues that are not hedged.

37

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**Costs and Operating Expenses**

The table below details our expenses for the ninemonths ended September 30, 2006 and 2005.
| ** **                                            | ** ** | ** **                                            | ** ** | ** **   | ** ** | **2006 Period Compared** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------|------------|--------------|------------|------------------------------------|------------|
| ** **                                            | ** ** | ** **                                            | ** ** | ** **   | ** ** | **to 2005 Period**       | ** ** |
| ** **                                            | ** ** | **Nine Months Ended**                       | ** ** | **$**        | ** ** | **%**                              | ** ** |
| ** **                                            | ** ** | **September 30,**                                | ** ** | **Increase** | ** ** | **Increase**                       | ** ** |
| ** **                                            | ** ** | **2006**                                              | ** ** | **2005**     | ** ** | **(Decrease)**                     | ** ** | **(Decrease)** | ** ** |
| ** **                                            | ** ** | **(in thousands, except percentages)** | ** ** |
| Oil and natural  gas operating expenses               |       | $                                                     | 6,866      |         | $          | 6,414                              |       | $ | 452 |   | 7 | % |
| Severance and ad  valorem taxes                       |       | 7,105                                                 |       | 5,497        |       | 1,608                              |       | 29 | % |
| Depletion,  depreciation, amortization and accretion: |       |                                                  |       |         |       |                               |       |   |   |
| Oil and gas property and equipment                    |       | 48,844                                                |       | 25,589       |       | 23,255                             |       | 91 | % |
| Other assets                                          |       | 336                                                   |       | 195          |       | 141                                |       | 72 | % |
| ARO accretion                                         |       | 137                                                   |       | 102          |       | 35                                 |       | 34 | % |
| Impairment of  oil and natural gas properties         |       | 96,942                                                |       | —       |       | 96,942                             |       | 100 | % |
| General and  administrative expenses:                 |       |                                                  |       |         |       |                               |       |   |   |
| Bad debt expense                                      |       | —                                                |       | 65           |       | (65                                | )          | 100 | % |
| General and administrative expenses                   |       | 10,473                                                |       | 9,917        |       | 556                                |       | 6 | % |
|                                                  |       | 170,703                                               |       | 47,779       |       | 122,924                            |       | 257 | % |
| Other income and  expense, net                        |       | 2,035                                                 |       | 22           |       | 2,013                              |       | * |   |
| Total                                                 |       | $                                                     | 172,738    |         | $          | 47,801                             |       | $ | 124,937 |   | 261 | % |

 

----

*Not meaningful

 

**Oil andnatural gas operating expenses** - For the nine months ended September 30, 2006,operating expenses increased 7% from the same period of 2005. We experiencedincreases in costs for the newly acquired Chapman Ranch Field properties andnew wells drilled at Gato Creek, southeast New Mexico and Jim Hogg County,Texas. Average oil and natural gas operating expenses were $0.52 per Mcfe and$0.53 per Mcfe for the nine months ended September 30, 2006 and 2005,respectively.

**Severance and ad valorem taxes**- For the nine months ended September 30, 2006, severance and ad valorem taxesincreased 29% from the first nine months of 2005.  Our severance tax expense is levied on ouroil and gas revenue dollars (excluding hedging and derivative impact), andtypically increases as revenues increase. We experienced 8% higher severancetax expense as compared to 2005. This increase resulted from the addition ofthe Chapman Ranch Field properties acquired in late 2005. Although theycontributed to the overall increase, the Chapman Ranch Field properties receivea very low rate due to severance tax abatements. We also received refunds forprior periods during the second and third quarters of 2006 related to theseproperties. For the nine months ended September 30, 2006, severance tax expensewas approximately 5.4% of revenue subject to severance taxes, compared to 5.8%of revenue subject to severance taxes for the comparable 2005 period. Advalorem tax expense for the first nine months of 2006 was impacted by increasedaccruals for the estimated costs related to the addition of the Chapman RanchField properties acquired in the fourth quarter 2005 and increases in estimatedcosts from the taxing authorities.  On anequivalent basis, severance and ad valorem taxes averaged $0.54 per Mcfe and$0.45 per Mcfe for the nine months ended September 30, 2006 and 2005,respectively.

**DD&A and accretion**- Forthe nine months ended September 30, 2006, DD&A and accretion expensetotaled $49.3 million compared to $25.9 million for the same period in2005.  Depletion on our oil and naturalgas properties increased 91% for the first nine months of 2006 compared to thesame period of 2005 due to an increase in our unit-of-production depletion rateand production levels. The depletion rate increased from $2.11 per Mcfe in thefirst nine months of 2005 to $3.69 per Mcfe in the first nine months of 2006,adding approximately $20.9 million in depletion expense. Our rate has increaseddue to increased spending on our drilling program with disproportionately lowerreserve additions. One significant example of disproportionate additions to theamortizable base includes the Chapman Ranch Field acquisitions which addedapproximately $0.52 per Mcfe to the depletion rate in the fourth quarter of2005. The increase in depletion expense from the higher production levels inthe first nine months of 2006 as compared to the same period of 2005 resultedin an increase in expense of approximately $2.4 million. Depreciation offurniture and fixtures increased 72% from the prior year comparable period dueto additional expense taken on assets deemed to be fully depreciated in thesecond quarter of 2006. Accretion expense associated with our asset retirementobligations for the nine months ended September 30, 2006 increased 34% over thefirst nine months of 2005 for the new obligations incurred from the wellsdrilled in 2005 and the addition of properties acquired in the fourth quarterof 2005.

38

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**Impairment of oil and natural gas properties**- At September 30, 2006 we recorded a non-cash full-cost ceiling testimpairment of oil and natural gas properties in the amount of $96.9 million($63.0 million net of tax), as discussed in Note 1 to the consolidatedfinancial statements.  No such impairmentwas necessary in 2005.  The write-downwas primarily the result of the decline in natural gas prices at September 30,2006.  The natural gas price used tocalculate the full-cost ceiling at September 30, 2006 was significantly lowerthan at year-end 2005 when no impairment was necessary.

**G&A** - For the ninemonths ended September 30, 2006, total G&A was $10.5 million, an increaseof 5% compared to the same prior year period total of $10.0 million.  Theoverall increase in G&A is attributable to the amortization related torestricted stock, a franchise tax settlement paid to the State of Texas, andother G&A costs, which were partially offset by a decrease due to thetermination of FIN 44 accounting treatment for repriced options.  In conjunction with the adoption ofSFAS No. 123(R), we discontinued the application of FIN 44 with a third quarterreversal of $0.3 million credit recorded in the first half of 2006. There willnot be any additional adjustments for charges or credits to compensationexpense related to repriced options.  Werecorded $1.9 million in compensation expense for repriced options during thenine months ended September 30, 2005.  Upon adoption of SFAS No. 123(R), asdiscussed in Note 1 to the consolidated financial statement, in the firstquarter of 2006, we recorded $41,738 in compensation expense for stock optionsthat had not vested as of adoption of SFAS No. 123(R). Those options have sincevested. In the third quarter of 2006, we recorded additional compensationexpense associated with the adoption of SFAS No. 123(R) in the amount of$27,199, after further review of the calculation of share-based compensationexpense.  Amortization related torestricted stock awards granted over the past three years has increased due tonew grants that have occurred since September 30, 2005. G&A costs for thenine months ended September 30, 2006, excluding share-based compensationexpense, increased from the comparable 2005 period due to higher salaries andbenefits, as a result of adding seven employees since September 30, 2005, aswell as higher rent expense for additional office and storage space, parkingcosts for added employees, director and officer liability insurance, and legalcosts for pending litigation. During the third quarter of 2006 we paid afranchise tax settlement of approximately $0.2 million to the state of Texas,which increased our franchise tax expense for 2006 as compared to 2005 (seeNote 9 to the consolidated financial statements).  These increases were partially offset bydecreases in regulatory fees, Sarbanes-Oxley consulting fees, and costsincurred in 2005 for strategic planning meetings.  For the nine monthsended September 30, 2006 and 2005, overhead reimbursement fees reducing G&Acosts increased 84% in 2006 as compared to 2005 as a result of increasing ouroperated properties. Capitalized G&A costs further reduced G&A costs by$2.4 million and $2.0 million for the nine months ended September 30, 2006 and2005, respectively.  G&A on aunit-of-production basis for the nine months ended September 30, 2006 was $0.79per Mcfe compared to $0.82 per Mcfe for the comparable 2005 period.  We recorded $65,000 of bad debt expense inthe first nine months of 2005 related to several uncollectible joint interestbillings receivable.  We recorded no suchbad debt expense in 2006.

**Otherincome and expense** - During the nine months ended September 30, 2006, other income andexpense increased from a negligible amount in the comparable 2005 period,primarily due to an increase in gross interest expense, which was partiallyoffset by increases in interest income and capitalized interest. For the firstnine months of 2006, 65% of our interest expense was capitalized, as comparedto 100% being capitalized in the same 2005 period. We also incurred higherinterest costs for the nine months ended September 30, 2006 than for the sameperiod of 2005 due to higher outstanding debt balances.

|                             | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|-----------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                  | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                                   | ** ** |
| Gross interest  expense     |       | $                                                                         | 5,706      |   | $ | 743 |   |
| Less:  capitalized interest |       | (3,689                                                                    | )          | (743 | ) |
| Interest  expense, net      |       | $                                                                         | 2,017      |   | $ | — |   |
|                        |       |                                                                      |       |   |   |
| Weighted average debt       |       | $                                                                         | 101,491    |   | $ | 12,487 |   |

 

We also recordedamortization of deferred loan costs related to our Credit Facility and interestincome earned on our outstanding daily cash balances during the nine monthsended September 30, 2006 and 2005, both of which were comparable amounts.

39

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**Incometax expense** -An income tax benefit was recorded for the nine months ended September 30, 2006of $23.7 million and income tax expense of $10.9 million for the same 2005period. The income tax benefit as of September 30, 2006 results from theimpairment of oil and natural gas properties, which created a net loss for thenine months ended September 30, 2006. There has not been a substantial change to our effective income taxrate.

**Earnings per share** - For the first nine months of 2006,earnings per share decreased in comparison to the same period in 2005 due todecreased net income, which resulted from the ceiling test impairment recordedin the third quarter of 2006. Basic weighted average shares outstanding for thenine months ended September 30, 2006 increased approximately 1% as compared tothe same 2005 period primarily due to the exercise of stock options throughoutthe interim periods.

## **Liquidity and Capital Resources**

Ourprimary ongoing source of capital is the cash flow generated from our operatingactivities, supplemented by borrowings under our Credit Facility.  Net cash generated from operating activitiesis a function of production volumes and commodity prices, both of which areinherently volatile and unpredictable, as well as operating efficiency andcapital spending. Our business, as with other extractive businesses, is adepleting one in which each gas equivalent unit produced must be replaced orour asset base and capacity to generate revenues in the future will shrink. Ouroverall expected future production decline is estimated to be approximately 22%per year. Less predictable than production declines from our proved reserves isthe impact of constantly changing oil and natural gas prices on cash flows and,therefore, capital budgets.  We attemptto mitigate the price risk with our hedging program. Reserves and productionvolumes are influenced, in part, by the amount of future capital expenditures.In turn, capital expenditures are influenced by many factors, includingdrilling results, oil and gas prices, industry conditions, prices, availabilityof goods and services and the extent to which oil and gas properties areacquired.

Ourprimary cash requirements are for exploration, development and acquisition ofoil and gas properties, and the repayment of principal and interest onoutstanding debt. We attempt to fund our exploration and development activitiesprimarily through internally-generated cash flows and budget capitalexpenditures based on projected cash flows. We routinely adjust capitalexpenditures in response to changes in oil and natural gas prices, drilling andacquisition costs, and cash flow. We have historically used our Credit Facilityto supplement any deficiencies between operating cash flow and capitalexpenditures. We typically have funded acquisitions from borrowings under ourCredit Facility, cash flow from operations and sales of common stock.

Significantchanges to working capital may affect our liquidity in the short term. Thechange in our derivative instrument from a liability at December 31, 2005 to anasset at September 30, 2006 is indicative of potential future cash receipts onour derivative positions, which are scheduled to settle in future months. Thefair value of our outstanding derivative contracts, reflected in the derivativefinancial instrument on the balance sheet, is an asset because the price floorson our contracts exceed the future strip commodity prices at the balance sheetdate, such that if the contracts were to settle at the balance sheet date wewould have gains. The fair market value represents the potential settlement forthose contracts if the market prices remain unchanged, but, should commodityprices increase or decrease, the fair value of those outstanding contractswould change and the settlements at maturity would also change. When ourderivative financial instruments require us to pay a cash settlement, we arereceiving higher cash inflows on the sale of unhedged production at higherprices, providing us with funds which would adequately cover any settlementswhen they come due.

We had $100.0million of total borrowings outstanding under our Credit Facility at September30, 2006. Our Credit Facility matures on December 31, 2007. We have receivedsignificant funds through equity transactions in the past, including throughofferings of our common stock and the exercise of warrants and stock options.We typically do not, however, rely on proceeds from the exercise of warrantsand stock options to sustain our business, as the timing of those proceeds isunpredictable.

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 certain of ourfuture exploration and development

40

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requirements, willprovide us with the flexibility and liquidity to meet our planned capitalrequirements for 2006.   As of September30, 2006, we have $15.0 million in unused borrowing capacity under our currentCredit Facility, the borrowing base for which is being redetermined by ourlender in the fourth quarter.

We had cash and cash equivalents at September 30, 2006of $2.3 million consisting primarily of short-term money market investments, ascompared to $0.7 million at December 31, 2005. Working capital was $16.8 million as of September 30, 2006, as comparedto $10.5 million at December 31, 2005. Our sources and uses of cash were asfollows:

|                                              | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(in thousands)**                                                   | ** ** |
| *Net  Cash Provided By Operating Activities* |       | $                                                                         | 70,722     |   | $ | 56,242 |   |
| *Net  Cash Used In Investing Activities*     |       | (84,680                                                                   | )          | (61,938 | ) |
| *Net Cash Provided by Financing  Activities* |       | 15,568                                                                    |       | 7,224 |   |
|                                              |            |                                                                           |            |  |  |  |  |

 

**Net Cash Provided By OperatingActivities***-*Theincrease in cash flows provided by operating activities for the nine monthsended September 30, 2006 compared to 2005 was primarily due to higher oil andgas production revenue partially offset by higher operating expenses.  Although fluctuations in commodity priceshave been the primary reason for our short-term changes in cash flow fromoperating activities, increased production volumes significantly impacted us inthe past few quarters. In an effort to reduce the volatility realized oncommodity prices, we enter into derivative instruments.  Although we have seen declines in natural gasprices since year-end 2005, we have realized cash settlements from ourderivatives to offset a portion of those price declines. Overall, oil and gasproduction revenue increased for the nine months ended September 30, 2006 ascompared to the same period in 2005, with a 22% increase in the average netprice received for our production and a 9% increase in production volumes.

**Net Cash Used InInvesting Activities***-*Wereinvest a substantial portion of our cash flows from operating activities inour drilling, acquisition, land and geophysical activities.  Capital expenditures of $75.7 million wereattributable to our drilling and operating program. In addition to drillingthat was in progress at year-end 2005, we drilled 45 gross wells during thenine months ended September 30, 2006, all but seven of which were apparentsuccesses. Leasehold acquisitions, including seismic data and other geologicaland geophysical expenditures, totaled $11.9 million for the nine months endedSeptember 30, 2006. The remaining capital expenditures were associated withcomputer hardware, office equipment and other miscellaneous capital charges.Proceeds from the sale of oil and gas properties totaled $0.6 million duringthe nine months ended September 30, 2006, which represents the divestiture ofour Buckeye properties that closed in April 2006. During the first nine monthsof 2005, capital expenditures of $45.1 million were attributable to ourdrilling program. In addition to drilling that was in progress at year-end2004, we drilled 40 gross wells during the nine months ended September 30,2005, all but two of which was successful. Leasehold acquisitions, includingseismic data and other geological and geophysical expenditures, totaled $11.6million and acquisition costs totaled $4.6 million for the nine months endedSeptember 30, 2005. The remaining capital expenditures were associated withcomputer hardware and office equipment.

Due to our active exploration,development and acquisition activities, we have experienced, and expect tocontinue to experience, substantial working capital requirements.  We currently anticipate capital expendituresin 2006 to be approximately $98.0 million. Approximately $78.0 million isallocated to our expected drilling and production activities; $12.0 million isallocated to land, legal and seismic activities; and $8.0 million relates tocapitalized interest, G&A and other. We intend to fund our total projected2006 capital expenditures, and other commitments and working capitalrequirements, with cash flow from operations and modest borrowings under ourcredit facility. Should there be a change in our pricing or productionassumptions, we believe that we have sufficient financial flexibility fromother financing sources to meet our financial obligations as they come due, andwe would recommend to our Board an adjustment to our capital expendituresprogram accordingly so as to avoid unnecessary incremental borrowings that maybe needed for acquisitions. We do not explicitly budget for acquisitions;however, we do expect to spend considerable effort evaluating acquisitionopportunities. We expect to fund acquisitions

41

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throughtraditional reserve-based bank debt and/or the issuance of equity and, ifrequired, through additional debt and equity financings.

**Net Cash Provided ByFinancing Activities***-*During the nine months ended September 30, 2006, our net borrowingsunder our Credit Facility (as defined below) were $15.0 million due to theaccelerated timing of our drilling schedule. We received $0.6 million inproceeds from stock options exercised in the first nine months of 2006. For thenine months ended September 30, 2005, we received $7.2 million in proceeds fromthe issuance of common stock related to the exercise of the over-allotmentoption on our December 21, 2004 public offering of common stock and stockoptions exercised in the first nine months of 2005.

Weutilize our Credit Facility to supplement timing differences in our projectedcash inflows and outflows and smaller acquisitions. We also have $390 millionavailable under our current shelf registration statement for largeracquisitions. We believe we will be able to generate capital resources andliquidity sufficient to meet our financial obligations as they come due.

*Credit Facility*

OnNovember 30, 2005, we amended our Third Amended and Restated Credit Agreement(the “Credit Facility”), which we had originally entered into in March 2004(effective December 31, 2003) and previously amended on May 31, 2005.  The Credit Facility permits borrowings up tothe lesser of (i) the borrowing base and (ii) $150.0 million. EffectiveNovember 30, 2005, the borrowing base under the Credit Facility was increasedfrom $70.0 million to $110.0 million as a result of the Chapman Ranch Fieldacquisitions and our drilling activities since the last redetermination. Theborrowing base was redetermined by the lender in May 2006 and increased to$115.0 million as a result of recent drilling activities. Based on theincrease, our available borrowing capacity at September 30, 2006 was $15.0million. The borrowing base is currently being redetermined by our lender andwe expect to be notified of any changes to the borrowing base late in thefourth quarter of 2006.

TheCredit Facility matures December 31, 2007 and is secured by substantially allof our assets. Borrowings under the Credit Facility bear interest at rates thatare variable based on the percentage usage of the facility. Borrowings can beat Prime plus a margin of up to 0.25% or at Libor plus a margin of 1.75% to2.125%.  As of September 30, 2006, ourinterest rates on our outstanding Prime and Libor borrowings were 8.500% and7.455%, respectively. As of September 30, 2006, $100.0 million in totalborrowings were outstanding under the Credit Facility.

TheCredit Facility provides for certain restrictions, including but not limitedto, limitations on additional borrowings, sales of oil and natural gasproperties or other collateral, and engaging in merger or consolidationtransactions. The Credit Facility also prohibits dividends and certaindistributions of cash or properties and certain liens.  The Credit Facility also contains thefollowing 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 andexploration and abandonment expenses for such period) for the four fiscalquarters then ended to (b) our consolidated interest expense for the fourfiscal quarters 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 Credit FacilityAgreement, be at least $1.0 million. For the purposes of calculating theWorking Capital ratio, the total of current assets is adjusted for unusedcapacity under the Credit Facility Agreement, and derivative financialinstruments and the total of current liabilities is adjusted for the currentportion of indebtedness under the Credit Facility Agreement, derivativefinancial instruments and asset retirement obligations.

·                  The MaximumLeverage ratio requires that the ratio, as of the last day of any fiscalquarter, of (a) Total Indebtedness (as defined in the Credit FacilityAgreement) 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.

42

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ConsolidatedEBITDAX is a component of negotiated covenants with our lenders and isdiscussed here as disclosure of our covenant obligations.

*ShelfRegistration Statement*

During the secondquarter 2005, we filed a registration statement with the SEC which registeredofferings of up to $390 million of any combination of debt securities,preferred stock, common stock or warrants for debt securities or equitysecurities of the Company. Net proceeds, terms and pricing of the offering ofsecurities issued under the shelf registration statement will be determined atthe time of the offerings. The shelf registration statement does not provideassurance that we will or could sell any such securities. Our ability toutilize our shelf registration statement for the purpose of issuing, from timeto time, any combination of debt securities, preferred stock, common stock orwarrants for debt securities or equity securities will depend upon, among otherthings, market conditions and the existence of investors who wish to purchaseour securities at prices acceptable to us. In connection with the filing of the2005 registration statement, we deregistered the remaining shares thenavailable for sale under our earlier $150 million shelf registration statementfiled in 2004. At September 30, 2006, we had $390 million remaining forissuance under our 2005 shelf registration statement.

*OffBalance Sheet Arrangements*

We currently do not haveany off balance sheet arrangements.

**RiskManagement Activities – Derivatives & Hedging**

Dueto the volatility of oil and natural gas prices, we periodically enter intoprice-risk management transactions (e.g., swaps, collars and floors) for aportion of our oil and natural gas production to achieve a more predictablecash flow, as well as to reduce exposure from commodity pricefluctuations.  While the use of thesearrangements limits our ability to benefit from increases in the price of oiland natural gas, it also reduces our potential exposure to adverse pricemovements.  Our arrangements, to theextent we enter into any, apply to only a portion of our production, provideonly partial price protection against declines in oil and natural gas pricesand limit our potential gains from future increases in prices. None of theseinstruments are used for trading purposes. On a quarterly basis, our managementreviews all of our 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.  Our Board of Directors monitors ourprice-risk management policies and trades.

Allof these price-risk management transactions are considered derivativeinstruments and accounted for in accordance with SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities*(as amended)*.* These derivative instruments areintended to hedge our price risk and may be considered hedges for economicpurposes. There are two types of accounting treatments for derivatives, (i)mark-to-market accounting and (ii) cash flow hedge accounting. For discussionof these accounting treatments, see Note 7 to our consolidated financialstatements.  During the first quarter of2006, we discontinued cash flow hedge accounting treatment previously appliedto our natural gas derivatives. Therefore, all derivatives are recorded on thebalance sheet at fair value and the changes in fair value are presented intotal revenue on the income statement, rather than deferred through OCI on thebalance sheet. The following table provides additional information regardingour various derivative transactions that were recorded at fair value on thebalance sheet as of September 30, 2006.

|                                                                                         | ** ** | **(in thousands)** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Fair value of  contracts outstanding at December 31, 2005                               |       | $                       | (2,479     | ) |
| Contracts  realized or otherwise settled during the period                              |       | 2,737                   |       |
| Fair value of  new contracts when entered into during 2006:                             |       |                    |       |
| Asset                                                                                   |       | 4,401                   |       |
| Liability                                                                               |       | —                  |       |
| Changes in fair  values attributable to changes in valuation techniques and assumptions |       | —                  |       |
| Other changes in  fair values                                                           |       | 3,252                   |       |
| Fair values of  contracts outstanding at September 30, 2006                             |       | $                       | 7,911      |   |

 

43

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The following table details the fair value of ourcommodity-based derivative contracts by year of maturity and valuationmethodology as of September 30, 2006.
| ** **                                           | ** ** | **Fair Value of Contracts at September 30, 2006** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| **Source of Fair Value**              | ** ** | **Maturity less  than 1 year**                                        | ** ** | **Maturity 1-3  years** | ** ** | **Maturity 4-  5 years** | ** ** | **Maturity in  excess of 5  years** | ** ** | **Total fair  value** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                                                              | ** ** |
| Prices actively  quoted:                             |       | —                                                                               |       | — |   | — |   | — |   | — |   |
| Prices provided  by other external sources:          |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Asset                                                |       | 7,029                                                                                |       | 882 |   | — |   | — |   | 7,911 |   |
| Liability                                            |       | —                                                                               |       | — |   | — |   | — |   | — |   |
| Prices based on  models and other valuation methods: |       | —                                                                               |       | — |   | — |   | — |   | — |   |
| Total                                                |       | $                                                                                    | 7,029      |   | $ | 882 |   | $ | — |   | $ | — |   | $ | 7,911 |   |
|                                                      |            |                                                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**TaxMatters**

AtSeptember 30, 2006, we had cumulative net operating loss carryforwards (“NOLs”)for federal income tax purposes of approximately $73.1 million. The estimatedNOLs presented herein assume that certain items, primarily intangible drillingcosts, have been written off for tax purposes in the current year. However, wehave not made a final determination if an election will be made to capitalizeall or part of these items for tax purposes in the future.

**RecentlyIssued Accounting Pronouncements**

InMarch 2005, the FASB issued FIN 47, *Accountingfor Conditional Asset Retirement Obligations, an interpretation of FASBStatement No. 143*.  FIN 47 clarifies that the term, “conditionalasset retirement obligation” as used in SFAS No. 143, *Accounting for Asset Retirement Obligations*,refers to a legal obligation to perform an asset retirement activity in whichthe timing and/or method of settlement are conditional upon a future event thatmay or may not be within the control of the entity.  Even thoughuncertainty about the timing and/or method of settlement exists and may beconditional upon a future event, the obligation to perform the asset retirementactivity is unconditional.  Accordingly, an entity is required torecognize a liability for the fair value of a conditional asset retirementobligation if the fair value of the liability can be reasonably estimated. Uncertainty about the timing and/or method of settlement of a conditional assetretirement obligation should be factored into the measurement of the liabilitywhen sufficient 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 some cases,sufficient information may not be available to reasonably estimate the fairvalue of an asset retirement obligation.  FIN 47 also clarifies when anentity would have sufficient information to reasonably estimate the fair valueof an asset retirement obligation.  FIN 47 is effective for fiscal yearsending after December 15, 2005.  Retrospective application for interimfinancial information is permitted but is not required.  The adoption ofFIN 47 is not expected to have a material effect on our consolidated financialposition, results of operations or cash flows.

InJune 2005, the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections*, *a replacement ofAccounting Principles Board (“APB”) Opinion No. 20 and FASB StatementNo. 3,*which changes the requirements for the accounting forand reporting of a change in accounting principle. It also applies to changesrequired by an accounting pronouncement in the unusual instance that thepronouncement does not include specific transition provisions. Application iseffective for accounting changes and correction of errors made in fiscal yearsbeginning after December 15, 2005. The adoption of SFAS No. 154 is not expectedto have a material effect on our consolidated financial position, results ofoperations or cash flows.

In February 2006, the FASB issued SFAS No. 155, *Accounting for Certain Hybrid Financial Instruments,*whichimproves financial reporting by eliminating the exemption from applying SFASNo. 133 to interests in securitized financial assets so that similarinstruments are accounted for similarly regardless of the form of theinstruments and allows a preparer to elect fair value measurement atacquisition, at issuance, or when a previously

44

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recognizedfinancial instrument is subject to a remeasurement (new basis) event, on aninstrument-by-instrument basis, in cases in which a derivative would otherwisehave to be bifurcated. Providing a fair value measurement election also resultsin more financial instruments being measured at what the FASB regards as themost relevant attribute for financial instruments, fair value. SFAS No. 155 iseffective for all financial instruments acquired or issued after the beginningof an entity’s first fiscal year that begins after September 15, 2006. We arecurrently evaluating the impact of this standard on our financial position,results of operations and cash flows.

In March 2006, the FASB issued SFAS No. 156, *Accounting for Servicing of Financial Assets*, which requiresall separately recognized servicing assets and servicing liabilities beinitially measured at fair value. SFAS No. 156 permits, but does not require,the subsequent measurement of servicing assets and servicing liabilities atfair value. Adoption is required as of the beginning of the first fiscal yearthat begins after September 15, 2006. Early adoption is permitted. Theadoption of SFAS No. 156 is not expected to have a material effect on ourconsolidated financial position, results of operations or cash flows.

In June 2006, the FASB issued FIN 48, *Accounting for Uncertainty in Income Taxes, an Interpretation of FASBStatement No. 109*, which clarifies the accounting foruncertainty in income taxes recognized in accordance withSFAS No. 109, *Accounting for IncomeTaxes*. FIN 48 prescribes a benefit recognition model with atwo-step approach, a more-likely-than-not recognition criterion and ameasurement attribute that measures the position as the largest amount of taxbenefit that is greater than 50% likely of being ultimately realized uponultimate settlement. If it is not more likely than not that the benefit will besustained on its technical merits, no benefit will be recorded. FIN 48also requires that the amount of interest expense to be recognized related touncertain tax positions be computed by applying the applicable statutory rateof interest to the difference between the tax position recognized in accordancewith FIN 48 and the amount previously taken or expected to be taken in atax return. The change in net assets as a result of applying this pronouncementwill be considered a change in accounting principle, with the cumulative effectof the change treated as an offsetting adjustment to the opening balance ofretained earnings or goodwill, if allowed under existing accounting standards,in the period of transition. FIN 48 is effective as of January 1,2007 and we are currently assessing the impact that FIN 48 will have onour financial statements.

In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurements,* which provides guidance for usingfair value to measure assets and liabilities. The standard also gives expanded information about the extent to whichcompanies measure assets and liabilities at fair value, the information used tomeasure fair value, and the effect of fair value measurements on earnings. SFASNo. 157 does not expand the use of fair value in any new circumstances.  SFAS No. 157 establishes a fair valuehierarchy that prioritizes the information used to develop fair valueassumptions.  SFAS No. 157 is effectivefor financial statements issued for fiscal years beginning after November 15,2007.  Early adoption is encouraged.  We are currently assessing the impact, ifany, that SFAS No. 157 will have on our financial statements.

InSeptember 2006, the SEC issued SAB No. 108, *Considering the Effects ofPrior Year Misstatements When Quantifying Misstatements in Current YearFinancial Statements* (“SAB No. 108”).  SAB No. 108 addresses quantifying thefinancial statement effects of misstatements, specifically, how the effects ofprior year uncorrected errors must be considered in quantifying misstatementsin the current year financial statements. The guidance in SAB No. 108 is effective for fiscal years ending afterNovember 15, 2006.  We do not believe SABNo. 108 will have a material impact on our financial statements.

***ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK***

We are exposed to market risk from changes in interestrates and commodity prices.  We use aCredit Facility with a floating interest rate. We are not subject to fair valuerisk resulting from changes in our floating interest rates.  The use of floating rate debt instrumentsprovides a benefit due to downward interest rate movements but does not limitus to exposure from future increases in interest rates.  Based on the September 30, 2006 outstandingborrowings and interest rates of 8.500% and 7.455% applied to variousborrowings, a 10% change in interest rates would result in an increase ordecrease of interest expense of approximately $0.8 million on an annual basis.

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Inthe normal course of business, we enter into hedging transactions, includingcommodity price collars, swaps and floors, to mitigate our exposure tocommodity price movements, but not for trading or speculative purposes.  During 2005, we put in place several naturalgas and crude oil collars for a portion of our 2006 production to achieve amore predictable cash flow.  In 2006, weput in place two natural gas collars and one crude oil collar for a portion ofour 2007 production.  Please refer toNote 7 to our consolidated financial statements. While the use of thesearrangements may limit the benefit to us of increases in the price of oil andnatural gas, it also limits the downside risk of adverse price movements.  The use of derivative instruments alsoinvolves the risk that the counterparties to such instruments will be unable tomeet the financial obligations of such contracts.  The following is a list of contractsoutstanding as of September 30, 2006:

| Transaction  Date       | ** **   | **Transaction  Type** | ** **   | **Beginning** | ** **   | **Ending**   | ** **   | **Price  Per Unit** | ** **   | **Volumes Per  Day** | ** **   | **Fair Value  Outstanding as of  September 30, 2006** | ** **   |
|-------------------------|--------------|-----------------------|--------------|---------------|--------------|--------------|--------------|--------------------------|--------------|---------------------------|--------------|--------------------------------------------------------------------------------|--------------|
| ** **              | ** **   | ** **            | ** **   | ** **    | ** **   | ** **   | ** **   | ** **               | ** **   | ** **                | ** **   | **(in thousands)**                                                        | ** **   |
| ***Natural  Gas (1):*** | *** *** | *** ***          | *** *** | *** ***  | *** *** | *** *** | *** *** | *** ***             | *** *** | *** ***              | *** *** | *** ***                                                                   | *** *** |
| 08/05                   |         | Collar                |         | 01/01/06      |         | 12/31/06     |         | $7.00-$10.50             |         | 10,000 MMbtu              |         | $                                                                              | 1,727        |   |
| 08/05                   |         | Collar                |         | 01/01/06      |         | 12/31/06     |         | $7.00-$16.10             |         | 10,000 MMbtu              |         | 1,778                                                                          |         |
| 08/06                   |         | Collar                |         | 01/01/07      |         | 12/31/07     |         | $7.50-$11.50             |         | 5,000 MMbtu               |         | 1,750                                                                          |         |
| 08/06                   |         | Collar                |         | 01/01/07      |         | 12/31/07     |         | $7.50-$12.00             |         | 5,000 MMbtu               |         | 1,862                                                                          |         |
| ***Crude  Oil (2):***   | *** *** | *** ***          | *** *** | *** ***  | *** *** | *** *** | *** *** | *** ***             | *** *** | *** ***              | *** *** | *** ***                                                                   | *** *** |
| 08/05                   |         | Collar                |         | 01/01/06      |         | 12/31/06     |         | $55.00-$80.00            |         | 400 Bbl                   |         | 5                                                                              |         |
| 08/06                   |         | Collar                |         | 01/01/07      |         | 12/31/07     |         | $70.00-$87.50            |         | 400 Bbl                   |         | 789                                                                            |         |
|                    |         |                  |         |          |         |         |         |                     |         |                      |         | $                                                                              | 7,911        |   |

 

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(1)          Our current natural gas collars were entered into on aper MMbtu delivered price basis, using the Houston Ship Channel Index, withsettlement for each calendar month occurring five business days following theexpiration date.  During 2005, cash flowhedge accounting was applied to these contracts, which was then discontinued in2006. During 2006, mark-to-market accounting treatment has been applied to thesecontracts and the change in fair value is reflected in total revenue during theyear.

(2)          Cash flow hedge accounting is not applied to our crudeoil collars, which were entered into on a per barrel delivered price basis,using the West Texas Intermediate Light Sweet Crude Oil Index, with settlementfor each calendar month occurring five business days following the expirationdate. Mark-to-market accounting treatment is applied to these contracts and thechange in fair value is reflected in total revenue during the year.

At September 30, 2006, the fair value of theoutstanding derivatives was an asset of approximately $7.9 million. A 10%change in the commodity price per unit, as long as the price is either abovethe ceiling or below the floor price, would cause the fair value total of thehedge to increase or decrease by approximately $0.8 million.

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

In accordance withExchange Act Rules 13a-15 and 15d-15, we carried out an evaluation, under thesupervision and with the participation of management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of ourdisclosure controls and procedures as of the end of the period covered by thisreport.  Based on that evaluation, ourChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective as of September 30, 2006 toprovide reasonable assurance that information required to be disclosed in ourreports filed or submitted under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms.

There has been nochange in our internal controls over financial reporting that occurred duringthe three months ended September 30, 2006 that has materially affected, or isreasonably likely to materially affect, our internal controls over financialreporting.

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**PART II - OTHER INFORMATION**

**Item 1 - Legal Proceedings**

Fromtime to time we are a party to various legal proceedings arising in the ordinarycourse of business.  While the outcome oflawsuits cannot be predicted with certainty, we are not currently a party toany proceeding that we believe, if determined in a manner adverse to theCompany, could have a material adverse effect on our financial condition,results of operations or cash flows, except as set forth below.

**Texas Comptroller Audit** - During thesecond quarter of 2004, we received notice that a subsidiary’s franchise taxreturns for the State of Texas would be audited for the tax years 1999 through2002. After reviewing the documents submitted, the agent representing theOffice of the Comptroller of the State of Texas proposed adjustments to thecalculation that would result in an increased franchise tax liability. The agent maintained that transfers by us to this subsidiary, which we hadclassified 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.

Duringthe third quarter of 2006, with the Comptroller, we agreed upon a method ofcomputing our franchise tax liability to the State of Texas for tax years 1999through 2002 that resulted in a total one-time payment of $144,474, pluspenalties of $9,228, which was taken in full during the nine months endedSeptember 30, 2006.  We anticipate thatinterest on this settlement will amount to approximately $55,000, which was accruedat September 30, 2006.

**Wadeand Joyce Montet, et al., v. Edge Petroleum Corp of Texas, et al., consolidatedwith Rolland L. Broussard, et al., v. Edge Petroleum Corp of Texas, et al.**- This is a consolidated suit, filed in state court in Vermilion Parish,Louisiana in September 2003. Plaintiffs are mineral/royalty owners under theNorcen-Broussard No. 1 and 2 wells, Marg Tex Reservoir C, Sand Unit A (Edge’sold Bayou Vermilion Prospect).  They claim the operator at the time,Norcen Explorer, now Anadarko, failed to “block squeeze” the sections of theNo. 2 well, as a prudent operator, according to their allegations, would havedone, to protect the gas reservoir from being flooded with water from adjacentunderground formations. Plaintiffs further allege Norcen was negligent in notcreating a field-wide unit to protect their interests. The allegations relateto actions taken beginning in the early 1990’s. Plaintiffs have named us and other working interest owners in the leasesas defendants, including Norcen Explorer’s successors in interest, Anadarko.Plaintiffs originally sought unspecified damages for lost royalties and damagesdue to alleged devaluation of their mineral and property interests, plusinterest and attorneys’ fees. In early 2005, we filed a motion for summaryjudgment in the case asserting, among other defenses, that:  (i) there hasbeen no breach of contract, (ii) there is no express or implied duty imposed onus to block squeeze the well or form a field-wide unit, (iii) the units were properlyformed by the Conservation Commissioner in accordance with the statutory schemein Louisiana, (iv) plaintiffs’ claims are barred by limitations, and (v) otherdefenses. Along with the other defendants, we also filed a special preemptorychallenge of no cause of action under the leases and the Louisiana Mineral Codefor failure to exhaust administrative remedies and due to lack of a demand. InMay and June 2005, the court ruled against us on the motion for summaryjudgment and the preemptory challenges. Of the 18.75% after-payout workinginterest that we originally reserved in the leases, we owned a 2.8% workinginterest at the time of the alleged acts or omissions. On September 6, 2005, wewere granted leave by the court to file a third-party demand to join the otherworking interest owners who hold the remainder of the 18.75% working interestas thirds-party defendants in this case, and those pleadings have been servedon the parties. These third-parties consist, for the most part, of partnershipsthat are directly or indirectly controlled by John Sfondrini, a director of theCompany, and hold an aggregate 14.7% working interest. Vincent Andrews, also adirector of the Company, owns a minority interest in the corporate generalpartner of one of the partnerships. These partnerships were among the thirdparty defendants that we have sought to join in the case, and thesepartnerships have for the most part filed answers denying any liability to us.We participated for our 2.8% share of the well costs and revenues for theBroussard No. 2 well, as did the other defendants for their share, includingthe third-party defendant partnerships who participated for 14.7%. We stronglybelieve the parties should only be liable for their proportionate share of anydamages award should a finding of liability occur in the case. We intend tovigorously contest the plaintiffs’ claims.

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Asof the date of this report, it is not possible to determine what, if any, ourexposure might be in this matter. Plaintiffs have asserted damages, includinginterest, to be as high as $63 million. The plaintiffs’ expert witness, in his December 2005 deposition, offeredhis theory that plaintiffs’ gross damages are in the range of $19 to $22million. That number is based on his theory that the alleged failure to blocksqueeze the well resulted in the under-production of gas worth $300 million.Plaintiffs’ royalty share of that figure yields the $19 to $22 million range ofalleged damages. Based on the expert’s testimony, damages attributable to thefull 18.75% interest would be in the range of $3.75 million gross or net to our2.8% share would be in the range of $560,000 (excluding interest and attorneys’fees). Along with the other defendants, we hired our own expert witnesses whohave refuted these claims, particularly the expert’s assertions that failure toblock squeeze the well caused any damages to the reservoir. The deposition of aNorcen engineer who prepared the completion plan for the Broussard No. 2 welland supervised the completion operations, taken in April 2006, confirms thetestimony of the defense experts as to why the well was not block squeezed. Theplaintiffs have also retained a damages expert who has given a report that thedamages in this case are in the range of $30 million, excluding interest andattorneys’ fees.  Our share of thatamount based on the full 18.75% would be approximately $5.6 million and net toour 2.8% share would be approximately $840,000. We participated in mediation of this lawsuit on July 18, 2006 but theparties failed to reach an agreement.  InJuly 2006, plaintiffs’ attorney sent a demand to the defendants for totaldamages claimed by plaintiffs, with legal interest, totaling $63 million.  Our share of that amount based on the full18.75% interest would be in the range of $12.2 million and net to our 2.8%interest would be in the range of $1.8 million. In September 2006, the defendant group offered $4.5 million to settlethe case.  Following this meeting, theparties have engaged in negotiations but have failed to reach agreement on asettlement amount.  Consequently, theCompany is preparing to proceed to trial. The trial date, originally set for August 28, 2006, has been postponeduntil the week of December 11, 2006 when the case is now set for trial. On July31, 2006 the Judge granted the defendant groups’ motion for partial summaryjudgment dismissing plaintiffs’ tort-based claims. Also on the same date, theJudge granted the defendant groups’ motion for partial summary judgment seekingto deny the plaintiffs an award of attorneys fees and also to dismiss any claimof plaintiffs that defendants had an obligation to form a field-wide unit, butdenied the defendants’ motion to exclude evidence of pre-suit damages based onfailure of plaintiffs to give notice of their claims as required by theLouisiana Mineral Code and also denied defendants’ motion in limine to excludetestimony of plaintiffs’ expert witness.

We may haveinsurance coverage for all or part of this claim up to the policy limits of $1million per occurrence and $2 million in the aggregate. A claim was submittedto Mid-Continent Casualty Company, our casualty carrier, who is currentlyproviding a defense under a reservation of rights letter.   However, on July 3, 2006, Mid-Continent fileda suit for declaratory judgment against us in federal district court inHouston, Texas seeking to determine whether it has a duty to indemnify us andcertain other defendants for this loss under the policies at issue.Mid-Continent has asked the court to declare they have no obligation toindemnify us and the third-party defendants based on certain technicaldefinitions under the policies and the fact that the plaintiffs’ claims arebased on alleged breaches of contract. We intend to vigorously dispute the coverage issues with Mid-Continentand have filed an answer and counterclaim for breach of contract.  We are also pursuing coverage claims underother insurance policies that could cover a portion of our share of a loss inthis case.

We continue to believethat an unfavorable outcome in this case is not probable.  If, however, there is a finding of liabilityand damages are awarded, we believe that ultimately we should only be liablefor our 2.8% share of any damage award unless a co-party defendant, includingany of the third-party defendants, cannot satisfy their share of any finaljudgment or settlement amount or are found not to be liable to us on ourthird-party demand.  In that event, wecould be held responsible for more than our 2.8% share.  We believe we have meritorious defenses andintend to continue to vigorously contest this suit and our third-party demandsagainst the partnerships, and we have not established any reserve with respectto these claims.

**David Blake, et al. v. Edge Petroleum Corporation**– On September 19, 2005, David Blake and David Blake, Trustee of the David andNita Blake 1992 Children’s Trust filed suit against us in state district courtin Goliad County, Texas alleging breach of contract for failure and refusal totransfer overriding royalty interests to plaintiffs in at least five leases inGoliad County, Texas and failure and refusal to pay monies to Blake pursuant tosuch overriding royalty interests for wells completed on the leases. Theplaintiffs seek relief of (1) specific performance of the alleged agreement,including granting of overriding royalty interests by the Company to Blake; (2)monetary damages for failure to grant the overriding royalty interests; (3)exemplary damages for his claims of business disparagement and slander; (4)monetary damages for tortuous interference; and (5) attorneys’ fees and

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court costs. Venueof the case was transferred to Harris County by agreement of thelitigants.  We have served plaintiffswith discovery and has filed a counterclaim and an amended counterclaim joiningvarious related entities that are controlled by plaintiffs.  In addition, plaintiffs have filed an amendedcomplaint alleging claims of slander of title and tortuous interference relatedto its alleged right to receive an overriding royalty interest from a thirdparty. Plaintiffs currently have on file an amended motion for summaryjudgment, to which we have filed a response. In addition, we have filed a motion for summary judgment on theplaintiffs’ case.  The court has notruled on either motion.  Discovery inthis case has commenced.  We have respondedaggressively to this lawsuit, and believe we have meritorious defenses andcounterclaims.

 **Item 1A — Risk Factors**

In addition to theother information set forth in this report, you should carefully consider thefactors discussed in Part I, “Item 1A. Risk Factors” in our 2005 AnnualReport, which could materially affect our business, financial condition orfuture results.  The risks described inour 2005 Annual Report are not the only risks facing our Company.  Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also maymaterially adversely affect our business, financial condition and/or operatingresults.
| **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 Holder**        |   | None |
| **Item 5 - Other Information**                                          |   | None |

 

**Item 6 - Exhibits**

Thefollowing exhibits are filed as part of this report:

# **INDEX TOEXHIBITS**

| 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). |
|        |       |   |   |   |
| 2.4         |       | — |   | Purchase and Sale Agreement, dated as of September  21, 2005 among Pearl Energy Partners, Ltd., and Cibola Exploration Partners,  L.P., as Sellers; and Edge Petroleum Exploration Company as Buyer and Edge  Petroleum Corporation as Guarantor (Incorporated by reference from exhibit  2.01 to the Company’s Current Report on Form 8-K filed October 19, 2005). |
|        |       |   |   |   |
| 2.5         |       | — |   | Stock Purchase Agreement by and among Jon L. Glass,  Craig D. Pollard, Leigh T. Prieto, Yorktown Energy Partners V, L.P.,  Yorktown Energy Partners VI, L.P., Cinco Energy Corporation, and Edge  Petroleum Exploration Company and Edge Petroleum Corporation dated September  21, 2005 |
|             |            |  |  |  |  |

 

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|        |   |   |   | (Incorporated by reference from exhibit 2.5 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 2005).                                                                                                                                                                                                                                                                                                                                                                                                              |
|--------|--------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 2.6    |   | — |   | Letter Agreement dated November 18, 2005 by and  among Edge Petroleum Exploration Company, Cinco Energy Corporation and  Sellers (Incorporated by reference from exhibit 2.02 to the Company’s Current  Report on Form 8-K filed December 6, 2005). Pursuant to Item 601(b)(2) of  Regulation S-K, the Company had omitted certain Schedules to the Letter  Agreement (all of which are listed therein) from this Exhibit 2.6. It hereby  agrees to furnish a supplemental copy of any such omitted item to the SEC on  its request.                          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 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 3.2 to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended September 30,  1999).                                                                                                                                                                                                                                                                                                                                              |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 3.6    |   | — |   | Second Amendment to Bylaws of the Company on May 7,  2003 (Incorporated by reference from exhibit 3.4 to the Company’s Quarterly  Report on Form 10-Q for the quarterly period ended March 31, 2003).                                                                                                                                                                                                                                                                                                                                                         |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.1    |   | — |   | Third Amended and Restated Credit Agreement dated  December 31, 2003 among Edge Petroleum Corporation, Edge Petroleum  Exploration Company, Edge Petroleum Operating Company, Inc., Miller Oil  Corporation and Miller Exploration Company, as borrowers, the lenders thereto  and Union Bank of California, N.A., a national banking association, as Agent (Incorporated  by reference from Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q  for the quarterly period ended March 31, 2004).                                                      |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.2    |   | — |   | Agreement and Amendment No. 1 to Third Amended and  Restated Credit Agreement dated May 31, 2005 among Edge Petroleum  Corporation, Edge Petroleum Exploration Company, Edge Petroleum Operating  Company, Inc., Miller Exploration Company and Miller Oil Corporation, as  borrowers, the lenders thereto and Union Bank of California, N.A., a national  banking association, as agent for the lenders (Incorporated by reference from  Exhibit 4.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly  period ended June 30, 2005).          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.3    |   | — |   | Agreement and Amendment No. 2 to the Third Amended  and Restated Credit Agreement dated November 30, 2005 among Edge Petroleum  Corporation, Edge Petroleum Exploration Company, Edge Petroleum Operating  Company, Inc., Miller Oil Corporation, Miller Exploration Company, and Cinco  Energy Corporation, as borrowers, the lenders thereto and Union Bank of  California, N.A., a national banking association, as Agent (Incorporated by  reference from exhibit 4.3 to the Company’s Annual Report on Form 10-K for  the year ended December 31, 2005). |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.4    |   | — |   | Miller Exploration Company Stock Option and  Restricted Stock Plan of 1997 (Incorporated by reference from exhibit 10.1(a)  to Miller Exploration Company’s Annual Report on Form 10-K for the year ended  December 31, 1997 (File No. 000-23431)).                                                                                                                                                                                                                                                                                                 |

 

50

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| 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  exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year ended  December 31, 1998).                                                                                              |
|        |   |   |   |                                                                                                                                                                                                                                                                                                                                   |
| †10.4  |   | — |   | Amended and Restated Incentive Plan of Edge  Petroleum Corporation as Amended and Restated Effective as of August 1,  2006 (Incorporated by reference from exhibit 10.4 to the Company’s Quarterly  Report on Form 10-Q for the six months ended June 30, 2006).                                                             |
|        |   |   |   |                                                                                                                                                                                                                                                                                                                                   |
| †10.5  |   | — |   | Edge Petroleum Corporation Incentive Plan “Standard  Non-Qualified Stock Option Agreement” by and between Edge Petroleum  Corporation and the Officers named therein (Incorporated by reference from  exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly  period ended September 30, 1999).  |
|        |   |   |   |                                                                                                                                                                                                                                                                                                                                   |
| †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 therein (Incorporated by  reference from exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q  for the quarterly period ended September 30, 1999).                                                                   |
|        |   |   |   |                                                                                                                                                                                                                                                                                                                                   |
| †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)).                                                                                             |

 

51

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| †10.11 |   | — |   | Form of Edge Petroleum Corporation John W. Elias  Non-Qualified Stock Option Agreement (Incorporated by reference from exhibit  4.6 to the Company’s Registration Statement on Form S-8 filed May 30, 2001  (Registration No. 333-61890)). |
|-------------|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |   |   |                                                                                                                                                                                                                                            |
| †10.12 |   | — |   | Summary of Compensation of Non-Employee Directors  (Incorporated by reference from Exhibit 10.12 to the Company’s Annual Report  on Form 10-K for the year ended December 31, 2005).                                                       |
|        |   |   |   |                                                                                                                                                                                                                                            |
| †10.13 |   | — |   | 2005 Bonus Plan for Executive Officers (Incorporated  by reference from Exhibit 10.12 to the Company’s Annual Report on Form 10-K  for the year ended December 31, 2005).                                                                  |
|        |   |   |   |                                                                                                                                                                                                                                            |
| †10.14 |   | — |   | 2004 Bonus Program (Incorporated by reference from  Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year ended  December 31, 2005).                                                                                      |
|        |   |   |   |                                                                                                                                                                                                                                            |
| †10.15 |   | — |   | New Base Salaries and Long-Term Incentive Awards for  Certain Executive Officers (Incorporated by reference from exhibit 10.1 to  the Company’s Current Report on Form 8-K filed August 25, 2006).                                         |
|        |   |   |   |                                                                                                                                                                                                                                            |
| *31.1       |   | — |   | Certification by John W. Elias, Chief Executive  Officer, pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities  Exchange Act of 1934.                                                                                              |
|        |   |   |   |                                                                                                                                                                                                                                            |
| *31.2       |   | — |   | Certification by Michael G. Long, Chief Financial  Officer, pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities  Exchange Act of 1934.                                                                                            |
|        |   |   |   |                                                                                                                                                                                                                                            |
| *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.

52

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**SIGNATURES**

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

 
|                                        | EDGE PETROLEUM CORPORATION,   |
|----------------------------------------|-------------------------------|
|                                   | A DELAWARE CORPORATION        |
|                                   | (REGISTRANT)                  |
|                                   |                          |
|                                   |                          |
| Date   November 9, 2006 |                          | /s/ John W.  Elias |   |
|                                   |                          | John W. Elias |   |
|                                   |                          | President, Chief  Executive Officer and |   |
|                                   |                          | Chairman of the  Board |   |
|                                   |                          |   |   |
|                                   |                          |   |   |
| Date   November 9, 2006 |                          | /s/ Michael G.  Long |   |
|                                   | Michael G. Long               |   |
|                                   | Executive Vice  President and |   |
|                                   | Chief Financial  Officer      |   |

 

 

53

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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).                                                                                                                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 2.4         | —     | Purchase and Sale Agreement, dated as of September  21, 2005 among Pearl Energy Partners, Ltd., and Cibola Exploration Partners,  L.P., as Sellers; and Edge Petroleum Exploration Company as Buyer and Edge  Petroleum Corporation as Guarantor (Incorporated by reference from exhibit  2.01 to the Company’s Current Report on Form 8-K filed October 19, 2005).                                                                                                                                                                  |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 2.5         | —     | Stock Purchase Agreement by and among Jon L. Glass,  Craig D. Pollard, Leigh T. Prieto, Yorktown Energy Partners V, L.P., Yorktown  Energy Partners VI, L.P., Cinco Energy Corporation, and Edge Petroleum  Exploration Company and Edge Petroleum Corporation dated September 21, 2005  (Incorporated by reference from exhibit 2.5 to the Company’s Quarterly Report  on Form 10-Q for the quarterly period ended September 30, 2005).                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 2.6         | —     | Letter Agreement dated November 18, 2005 by and  among Edge Petroleum Exploration Company, Cinco Energy Corporation and Sellers  (Incorporated by reference from exhibit 2.02 to the Company’s Current Report  on Form 8-K filed December 6, 2005). Pursuant to Item 601(b)(2) of Regulation  S-K, the Company had omitted certain Schedules to the Letter Agreement (all  of which are listed therein) from this Exhibit 2.6. It hereby agrees to  furnish a supplemental copy of any such omitted item to the SEC on its  request. |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 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 3.2 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999).                                                                                                                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 3.6         | —     | Second Amendment to Bylaws of the Company on May 7,  2003 (Incorporated by reference from exhibit 3.4 to the Company’s Quarterly  Report on Form 10-Q for the quarterly period ended March 31, 2003).                                                                                                                                                                                                                                                                                                                                |
|             |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  |

 

54

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| 4.1        | — | Third Amended and Restated Credit Agreement dated  December 31, 2003 among Edge Petroleum Corporation, Edge Petroleum  Exploration Company, Edge Petroleum Operating Company, Inc., Miller Oil  Corporation and Miller Exploration Company, as borrowers, the lenders thereto  and Union Bank of California, N.A., a national banking association, as Agent (Incorporated  by reference from Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q  for the quarterly period ended March 31, 2004).                                                      |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.2        | — | Agreement and Amendment No. 1 to Third Amended and  Restated Credit Agreement dated May 31, 2005 among Edge Petroleum Corporation,  Edge Petroleum Exploration Company, Edge Petroleum Operating Company, Inc.,  Miller Exploration Company and Miller Oil Corporation, as borrowers, the  lenders thereto and Union Bank of California, N.A., a national banking  association, as agent for the lenders (Incorporated by reference from Exhibit  4.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period  ended June 30, 2005).          |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.3        | — | Agreement and Amendment No. 2 to the Third Amended  and Restated Credit Agreement dated November 30, 2005 among Edge Petroleum  Corporation, Edge Petroleum Exploration Company, Edge Petroleum Operating  Company, Inc., Miller Oil Corporation, Miller Exploration Company, and Cinco  Energy Corporation, as borrowers, the lenders thereto and Union Bank of  California, N.A., a national banking association, as Agent (Incorporated by  reference from exhibit 4.3 to the Company’s Annual Report on Form 10-K for  the year ended December 31, 2005). |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.4        | — | Miller Exploration Company Stock Option and  Restricted Stock Plan of 1997 (Incorporated by reference from exhibit 10.1(a)  to Miller Exploration Company’s Annual Report on Form 10-K for the year ended  December 31, 1997 (File No. 000-23431)).                                                                                                                                                                                                                                                                                                           |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.5        | — | Amendment No. 1 to the Miller Exploration Company  Stock Option and Restricted Stock Plan of 1997 (Incorporated by reference to  Exhibit 4.2 from Miller Exploration Company’s Registration Statement on Form  S-8 filed on April 11, 2001 (Registration No. 333-58678)).                                                                                                                                                                                                                                                                                     |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.6        | — | Amendment No. 2 to the Miller Exploration Company  Stock Option and Restricted Stock Plan of 1997 (Incorporated by reference  from Exhibit 4.3 to Miller Exploration Company’s Registration Statement on  Form S-8 filed on April 11, 2001 (Registration No. 333-58678)).                                                                                                                                                                                                                                                                                     |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.7        | — | Form of Miller Stock Option Agreement (Incorporated  by reference from exhibit 10.1(b) to Miller Exploration Company’s Annual  Report on Form 10-K for the year ended December 31, 1997 (File No.  000-23431)).                                                                                                                                                                                                                                                                                                                                               |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| †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 | — | Amended and Restated Incentive Plan of Edge  Petroleum Corporation as Amended and Restated Effective as of August 1, 2006  (Incorporated by reference from exhibit 10.4 to the Company’s Quarterly  Report on Form 10-Q for the six months ended June 30, 2006).                                                                                                                                                                                                                                                                                              |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| †10.5 | — | Edge Petroleum Corporation Incentive Plan “Standard  Non-Qualified Stock Option Agreement” by and between Edge Petroleum  Corporation and the Officers named therein (Incorporated by reference                                                                                                                                                                                                                                                                                                                                                          |

 

55

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|             |   | 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 therein (Incorporated by  reference from exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q  for the quarterly period ended September 30, 1999).                                                                   |
|        |   |                                                                                                                                                                                                                                                                                                                                   |
| †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  (Incorporated by reference from Exhibit 10.12 to the Company’s Annual Report  on Form 10-K for the year ended December 31, 2005).                                                                                                                                              |
|        |   |                                                                                                                                                                                                                                                                                                                                   |
| †10.13 | — | 2005 Bonus Plan for Executive Officers (Incorporated  by reference from Exhibit 10.12 to the Company’s Annual Report on Form 10-K  for the year ended December 31, 2005).                                                                                                                                                         |
|        |   |                                                                                                                                                                                                                                                                                                                                   |
| †10.14 | — | 2004 Bonus Program (Incorporated by reference from  Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year ended  December 31, 2005).                                                                                                                                                                             |
|        |   |                                                                                                                                                                                                                                                                                                                                   |
| †10.15 | — | New Base Salaries and Long-Term Incentive Awards for  Certain Executive Officers (Incorporated by reference from exhibit 10.1 to  the Company’s Current Report on Form 8-K filed August 25, 2006).                                                                                                                                |
|        |   |                                                                                                                                                                                                                                                                                                                                   |
| *31.1       | — | Certification by John W. Elias, Chief Executive  Officer, pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities  Exchange Act of 1934.                                                                                                                                                                                     |
|        |   |                                                                                                                                                                                                                                                                                                                                   |
| *31.2       | — | Certification by Michael G. Long, Chief Financial  Officer, pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities  Exchange Act of 1934.                                                                                                                                                                                   |
|        |   |                                                                                                                                                                                                                                                                                                                                   |
| *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.

56

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