**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q/A**

 

**Amendment No. 1 to Form 10-Qfiled November 12, 2004**

 

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30,2004**

 

**OR**

 

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

 

**For the transition period from              to**

 

**Commission file number 0-22149**

 

**EDGE PETROLEUM CORPORATION**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                     | ** ** | **76-0511037**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                             |       |                                  |
| **1301 Travis, Suite 2000  Houston, Texas 77002**           |
| (Address of principal  executive offices)  (Zip code)            |
|                                                             |       |                                  |
| **(713) 654-8960**                                               |
| (Registrant’s telephone  number, including area code)       |

 

Indicate by checkmark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15 (d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   Yes ý No o

 

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

 

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 10, 2004** |
|--------------|------------|--------------------------------------------|
|         |       |                                       |
| Common Stock |       | 13,025,568                                 |

 

 

----

 

**EXPLANATORY NOTE**

 

ThisAmendment No. 1 to the Form 10-Q of Edge Petroleum Corporation (“Edge”,the “Company”, “we”, “our”  or “us”) forthe quarterly period ended September 30, 2004 (the “Form 10-Q”),which was originally filed on November 12, 2004, is being filed to restatethe financial statements and other disclosure included therein. In March 2005,prior to filing the annualfinancial statements for 2004, we discovered an error in a consolidatingfinancial statements spreadsheet application used to eliminate intercompanybalances. The revisions set forth in this Amendment No. 1 stem from anintercompany balance that was not eliminated in such application, but insteadwas inadvertently recorded to Property and Equipment causing property balancesto be overstated. This error relates to a change in accounting processes thatoccurred during the second quarter of 2004 and therefore prior year resultswere not affected. Also, second quarter results were not materially affected,so no change has been made to second quarter financial statements. This errorin the property balance also impacted our computation of depletion expense andtherefore operating expenses, operating income, income tax expense, net incomeand earnings per share.  Accordingly, wehave restated our consolidated balance sheet, income statement, statement ofstockholders’ equity and statement of cash flows in the Form 10-Q to reflectthese revisions (see Note 1 to our consolidated financial statements for areconciliation of our restated results to previously reported results).  We have also restated applicable disclosuresin *ITEM 1. “Notes to the ConsolidatedFinancial Statements”* and *ITEM 2.“MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS. *Management has concluded, based on thecircumstances involving the spreadsheet error discussed above, that as ofDecember 31, 2004, a material weakness in internal control over financialreporting existed with respect to the design of the Company’s controls over theelimination of intercompany balances and transactions.  See *ITEM4. “CONTROLS AND PROCEDURES.”*

 

ThisAmendment No. 1 sets forth the entire Form 10-Q, as amended. Thisamendment does not reflect events occurring after the original filing of the Form 10-Q,and does not modify or update the disclosures therein in any way other than asrequired to reflect the amendments as described above and set forth below. Inaddition, the filing of this amended Form 10-Q/A shall not be deemed anadmission that the original filing, when made, included any untrue statement ofmaterial fact or omitted to state a material fact necessary to make a statementmade therein not misleading.

 

**EDGE PETROLEUM CORPORATION**

 

**Table of Contents**

 
| Part I.  Financial Information                                                                                                                         |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1. Financial  Statements:                                                                                                                              |   |
| Consolidated Balance  Sheets as of September 30, 2004 and December 31, 2003                                                                       |   |
| Consolidated  Statements of Operations for each of the Three and Nine Months in the Periods  Ended September 30, 2004 and September 30, 2003 |   |
| Consolidated  Statements of Cash Flows for each of the Nine Months in the Periods Ended  September 30, 2004 and September 30, 2003                |   |
| Consolidated  Statements of Stockholders’ Equity as of September 30, 2004 and  December 31, 2003                                             |   |
| Notes  to the Consolidated Financial Statements                                                                                                             |   |
| Item  2. Managements Discussion and Analysis of Financial Condition and Results of  Operations                                                              |   |
| Item  3. Qualitative and Quantitative Disclosures About Market Risk                                                                                         |   |
| Item 4. Controls and  Procedures                                                                                                                            |   |
| Part II. Other  Information                                                                                                                            |   |
| Item 1. Legal Proceedings                                                                                                                                   |   |
| Item  2. Unregistered Sale of Equity Securities and Use of Proceeds                                                                                         |   |
| Item 3.  Defaults Upon Senior Securities                                                                                                                    |   |
| Item  4. Submission of Matters to a Vote of Security Holders                                                                                                |   |
| Item 5. Other Information                                                                                                                                   |   |
| Item  6. Exhibits                                                                                                                                           |   |
| Signatures                                                                                                                                                  |   |

 

----

 

**PART I. FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

**EDGEPETROLEUM CORPORATION**

 

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                              | ** ** | **September 30,  2004**            | ** **  | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                              | ** ** | **RESTATED  (See Note 1)  (Unaudited)** | ** **  | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                              |       |                                    |        |                        |       |
| CURRENT  ASSETS:                                                                                                                                                                                                                        |       |                                    |        |                        |       |
| Cash  and cash equivalents                                                                                                                                                                                                              |       | $                                       | 2,492,606   |                        | $          | 1,327,081 |   |
| Accounts  receivable, trade, net of allowance of $525,248 at September 30, 2004  and December 31, 2003                                                                                                                        |       | 12,670,527                              |        | 8,889,734                   |       |
| Accounts  receivable, joint interest owners, net of allowance of $82,000 at  September 30, 2004 and December 31, 2003                                                                                                         |       | 2,163,203                               |        | 1,797,877                   |       |
| Deferred  tax asset                                                                                                                                                                                                                     |       | 1,390,345                               |        | 1,138,492                   |       |
| Derivative  financial instruments                                                                                                                                                                                                       |       | —                                  |        | 120,801                     |       |
| Other  current assets                                                                                                                                                                                                                   |       | 1,453,228                               |        | 1,186,987                   |       |
| Total  current assets                                                                                                                                                                                                                   |       | 20,169,909                              |        | 14,460,972                  |       |
| PROPERTY  AND EQUIPMENT, Net – full-cost method of accounting for oil and natural gas  properties (including unproved costs of $9.1 million and $5.0 million at  September 30, 2004 and December 31, 2003, respectively) |       | 118,676,344                             |        | 97,980,757                  |       |
| DEFERRED  TAX ASSET                                                                                                                                                                                                                     |       | 669,960                                 |        | 5,570,137                   |       |
| OTHER  ASSETS                                                                                                                                                                                                                           |       | 319,032                                 |        | —                      |       |
| TOTAL  ASSETS                                                                                                                                                                                                                           |       | $                                       | 139,835,245 |                        | $          | 118,011,866 |   |
|                                                                                                                                                                                                                                    |       |                                    |        |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                           |       |                                    |        |                        |       |
| CURRENT  LIABILITIES:                                                                                                                                                                                                                   |       |                                    |        |                        |       |
| Accounts  payable, trade                                                                                                                                                                                                                |       | $                                       | 122,407     |                        | $          | 1,732,935 |   |
| Accrued  liabilities                                                                                                                                                                                                                    |       | 17,717,340                              |        | 11,456,036                  |       |
| Asset  retirement obligation                                                                                                                                                                                                            |       | 411,092                                 |        | 323,513                     |       |
| Derivative  financial instruments                                                                                                                                                                                                       |       | 2,159,880                               |        | —                      |       |
| Total  current liabilities                                                                                                                                                                                                              |       | 20,410,719                              |        | 13,512,484                  |       |
| ASSET  RETIREMENT OBLIGATION                                                                                                                                                                                                            |       | 1,591,628                               |        | 1,488,482                   |       |
| DERIVATIVE  FINANCIAL INSTRUMENTS                                                                                                                                                                                                       |       | 117,083                                 |        | —                      |       |
| LONG-TERM  DEBT                                                                                                                                                                                                                         |       | 22,000,000                              |        | 21,000,000                  |       |
| Total  liabilities                                                                                                                                                                                                                      |       | 44,119,430                              |        | 36,000,966                  |       |
| COMMITMENTS  AND CONTINGENCIES (See Note 11)                                                                                                                                                                                            |       |                                    |        |                        |       |
| STOCKHOLDERS’  EQUITY                                                                                                                                                                                                              |       |                                    |        |                        |       |
| Preferred  stock, $0.01 par value; 5,000,000 shares authorized; none issued and  outstanding                                                                                                                                            |       | —                                  |        | —                      |       |
| Common  stock, $0.01 par value; 25,000,000 shares authorized; 13,012,740 and  12,581,032 shares issued and outstanding at September 30, 2004 and  December 31, 2003, respectively                                             |       | 130,127                                 |        | 125,810                     |       |
| Additional  paid-in capital                                                                                                                                                                                                             |       | 79,639,744                              |        | 75,282,007                  |       |
| Retained  earnings                                                                                                                                                                                                                      |       | 16,788,768                              |        | 6,966,557                   |       |
| Accumulated  other comprehensive loss                                                                                                                                                                                                   |       | (842,824                                | )           | (363,474                    | )          |
| Total  stockholders’ equity                                                                                                                                                                                                        |       | 95,715,815                              |        | 82,010,900                  |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                        |       | $                                       | 139,835,245 |                        | $          | 118,011,866 |   |

 

See accompanying notes toconsolidated financial statements.

 

3

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**EDGEPETROLEUM CORPORATION**

** **

**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

 
| ** **                                                                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                               | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                               | ** ** | **Restated  (See Note 1)**                | ** ** | ** **                               | ** ** | **Restated  (See Note 1)** | ** ** | ** ** | ** ** |
| OIL  AND NATURAL GAS REVENUE:                                                            |       |                                      |       |                                     |       |   |   |   |   |
| Oil  and natural gas sales                                                               |       | $                                         | 15,181,874 |                                     | $          | 9,719,008 |   | $ | 47,203,800 |   | $ | 27,888,053 |   |
| Loss  on hedging and derivatives                                                         |       | (1,939,409                                | )          | (824,470                                 | )          | (2,299,274 | ) | (4,160,350 | ) |
| Total  revenue                                                                           |       | 13,242,465                                |       | 8,894,538                                |       | 44,904,526 |   | 23,727,703 |   |
| OPERATING  EXPENSES:                                                                     |       |                                      |       |                                     |       |   |   |   |   |
| Lease  operating expenses                                                                |       | 1,176,732                                 |       | 597,550                                  |       | 3,601,898 |   | 1,743,352 |   |
| Severance  and ad valorem taxes                                                          |       | 891,194                                   |       | 561,787                                  |       | 3,146,116 |   | 1,602,846 |   |
| Depletion,  depreciation, amortization and accretion                                     |       | 5,133,452                                 |       | 3,727,034                                |       | 15,517,254 |   | 9,334,243 |   |
| General  and administrative expenses:                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Deferred  compensation – repriced options                                           |       | (153,808                                  | )          | —                                   |       | 1,294,677 |   | — |   |
| Deferred  compensation – restricted stock                                           |       | 143,500                                   |       | 93,604                                   |       | 354,600 |   | 270,043 |   |
| Other  general and administrative expenses                                               |       | 1,844,062                                 |       | 1,157,259                                |       | 5,476,342 |   | 3,844,277 |   |
| Total  operating expenses                                                                |       | 9,035,132                                 |       | 6,137,234                                |       | 29,390,887 |   | 16,794,761 |   |
| OPERATING  INCOME                                                                        |       | 4,207,333                                 |       | 2,757,304                                |       | 15,513,639 |   | 6,932,942 |   |
| OTHER  INCOME AND EXPENSE:                                                               |       |                                      |       |                                     |       |   |   |   |   |
| Interest  income                                                                         |       | 8,087                                     |       | 8,292                                    |       | 16,118 |   | 13,440 |   |
| Interest  expense, net of amounts capitalized                                            |       | (22,204                                   | )          | (128,651                                 | )          | (241,887 | ) | (470,086 | ) |
| Amortization  of deferred loan costs                                                     |       | (35,948                                   | )          | —                                   |       | (106,332 | ) | — |   |
| INCOME  BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE                   |       | 4,157,268                                 |       | 2,636,945                                |       | 15,181,538 |   | 6,476,296 |   |
| INCOME  TAX EXPENSE                                                                      |       | (1,474,374                                | )          | (946,109                                 | )          | (5,359,327 | ) | (2,313,302 | ) |
| INCOME  BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE                                    |       | 2,682,894                                 |       | 1,690,836                                |       | 9,822,211 |   | 4,162,994 |   |
| CUMULATIVE  EFFECT OF ACCOUNTING CHANGE                                                  |       | —                                    |       | —                                   |       | — |   | (357,825 | ) |
| NET  INCOME                                                                              |       | 2,682,894                                 |       | 1,690,836                                |       | 9,822,211 |   | 3,805,169 |   |
| OTHER  COMPREHENSIVE INCOME (LOSS), net of taxes:                                        |       |                                      |       |                                     |       |   |   |   |   |
| Unrealized  hedge fair value gain (loss)                                                 |       | (578,834                                  | )          | 1,000,658                                |       | (749,887 | ) | 120,140 |   |
| Reclassification  to earnings of realized (gain) loss upon settlement of hedge contracts |       | 312,332                                   |       | 171,792                                  |       | 270,537 |   | 637,958 |   |
| Other  comprehensive income (loss)                                                       |       | (266,502                                  | )          | 1,172,450                                |       | (479,350 | ) | 758,098 |   |
| COMPREHENSIVE  INCOME                                                                    |       | $                                         | 2,416,392  |                                     | $          | 2,863,286 |   | $ | 9,342,861 |   | $ | 4,563,267 |   |
| BASIC  EARNINGS PER SHARE:                                                               |       |                                      |       |                                     |       |   |   |   |   |
| Income  before cumulative effect of accounting change                                    |       | $                                         | 0.21       |                                     | $          | 0.18 |   | $ | 0.76 |   | $ | 0.44 |   |
| Cumulative  effect of accounting change                                                  |       | —                                    |       | —                                   |       | — |   | (0.04 | ) |
| Net  income per share                                                                    |       | $                                         | 0.21       |                                     | $          | 0.18 |   | $ | 0.76 |   | $ | 0.40 |   |
| DILUTED  EARNINGS PER SHARE:                                                             |       |                                      |       |                                     |       |   |   |   |   |
| Income  before cumulative effect of accounting change                                    |       | $                                         | 0.20       |                                     | $          | 0.17 |   | $ | 0.73 |   | $ | 0.43 |   |
| Cumulative  effect of accounting change                                                  |       | —                                    |       | —                                   |       | — |   | (0.04 | ) |
| Net  income per share                                                                    |       | $                                         | 0.20       |                                     | $          | 0.17 |   | $ | 0.73 |   | $ | 0.39 |   |
| BASIC  WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING                              |       | 12,999,659                                |       | 9,523,648                                |       | 12,889,109 |   | 9,488,896 |   |
| DILUTED  WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING                            |       | 13,668,542                                |       | 9,869,379                                |       | 13,506,831 |   | 9,697,890 |   |
|                                                                                          |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanyingnotes to consolidated financial statements.

 

4

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**EDGEPETROLEUM CORPORATION**

** **

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)**

 
| ** **                                                                         | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
| ** **                                                                         | ** ** | **Restated  (See Note 1)**               | ** ** | ** ** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                          | ** ** | ** **                               | ** ** | ** ** | ** ** |
| Net  income                                                                        |       | $                                        | 9,822,211  |   | $ | 3,805,169 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                     |       |   |   |
| Cumulative  effect of accounting change                                            |       | —                                   |       | 357,825 |   |
| Loss  on the fair value of derivatives                                             |       | 1,254,911                                |       | — |   |
| Deferred  income taxes                                                             |       | 5,359,327                                |       | 2,313,302 |   |
| Depletion,  depreciation, amortization and accretion                               |       | 15,517,254                               |       | 9,334,243 |   |
| Amortization  of deferred loan costs                                               |       | 106,332                                  |       | — |   |
| Deferred  compensation                                                             |       | 1,649,277                                |       | 270,043 |   |
| Changes  in assets and liabilities:                                                |       |                                     |       |   |   |
| Increase  in accounts receivable, trade                                            |       | (3,369,143                               | )          | (2,915,624 | ) |
| Increase  in accounts receivable, joint interest owners                            |       | (365,326                                 | )          | (96,698 | ) |
| Increase  in other assets                                                          |       | (266,241                                 | )          | (343,368 | ) |
| Decrease  in accounts payable, trade                                               |       | (1,610,528                               | )          | (312,119 | ) |
| Increase  in accrued liabilities                                                   |       | 6,344,574                                |       | 3,879,236 |   |
| Increase  in accrued interest payable                                              |       | —                                   |       | 5,448 |   |
| Net  cash provided by operating activities                                         |       | 34,442,648                               |       | 16,297,457 |   |
|                                                                               |       |                                     |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                          |       |                                     |       |   |   |
| Oil  and natural gas property and equipment additions                              |       | (36,067,116                              | )          | (25,531,943 | ) |
| Proceeds  from the sale of oil and natural gas properties                          |       | 45,000                                   |       | 330,096 |   |
| Net  cash used in investing activities                                             |       | (36,022,116                              | )          | (25,201,847 | ) |
|                                                                               |       |                                     |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                          |       |                                     |       |   |   |
| Borrowings  from long-term debt                                                    |       | 4,000,000                                |       | 10,700,000 |   |
| Payments  of long-term debt                                                        |       | (3,000,000                               | )          | (1,200,000 | ) |
| Net  proceeds from issuance of common stock                                        |       | 2,170,357                                |       | 84,603 |   |
| Deferred  loan costs                                                               |       | (425,364                                 | )          | — |   |
| Net  cash provided by financing activities                                         |       | 2,744,993                                |       | 9,584,603 |   |
| **NET INCREASE IN CASH AND CASH EQUIVALENTS**                                      |       | 1,165,525                                |       | 680,213 |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                 |       | 1,327,081                                |       | 2,568,176 |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                       |       | $                                        | 2,492,606  |   | $ | 3,248,389 |   |
|                                                                                    |            |                                          |            |  |  |  |  |  |

 

See accompanying notes toconsolidated financial statements.

 

5

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**EDGEPETROLEUM CORPORATION**

 

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

 
| ** **                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional   Paid-in   Capital** | ** ** | **Retained   Earnings**    | ** ** | **Accumulated   Other   Comprehensive   Loss** | ** ** | **Total   Stockholders’   Equity** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|------------|------------|------------------------------------|------------|----------------------------|------------|------------------------------------------------|------------|-----------------------------------------|------------|
| **Common Stock**                                                     |
| **Shares**                                                           | ** ** | **Amount** |
| ** **                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                         | ** ** | **Restated  (See Note 1)** | ** ** | ** **                                     | ** ** | **Restated  (See Note 1)**              | ** ** |
| BALANCE,  DECEMBER 31, 2003                                     |       | 12,581,032 |       | $          | 125,810    |                               | $          | 75,282,007                 |       | $                                              | 6,966,557  |                                    | $          | (363,474 | ) | $ | 82,010,900 |   |
| Issuance  of common stock                                            |       | 431,708    |       | 4,317      |       | 2,249,310                          |       | —                     |       | —                                         |       | 2,253,627                               |       |
| Deferred  compensation - restricted stock                            |       | —     |       | —     |       | 354,600                            |       | —                     |       | —                                         |       | 354,600                                 |       |
| Deferred  compensation - repriced options                            |       | —     |       | —     |       | 1,294,677                          |       | —                     |       | —                                         |       | 1,294,677                               |       |
| Change  in valuation of hedging instruments                          |       | —     |       | —     |       | —                             |       | —                     |       | (479,350                                       | )          | (479,350                                | )          |
| Tax  benefit associated with exercise of non-qualified stock options |       | —     |       | —     |       | 459,150                            |       | —                     |       | —                                         |       | 459,150                                 |       |
| Net  income                                                          |       | —     |       | —     |       | —                             |       | 9,822,211                  |       | —                                         |       | 9,822,211                               |       |
| BALANCE,  September 30, 2004                                    |       | 13,012,740 |       | $          | 130,127    |                               | $          | 79,639,744                 |       | $                                              | 16,788,768 |                                    | $          | (842,824 | ) | $ | 95,715,815 |   |

 

See accompanyingnotes to consolidated financial statements.

 

6

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**EDGE PETROLEUM CORPORATION**

 

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS –As Restated**

** **

**1.**                                      RESTATEMENT OFPRIOR PERIOD FINANCIAL STATEMENTS

** **

Asdiscussed in the Explanatory Note to this Form 10-Q/A, an error was discoveredin March 2005 that led to the restatement of the consolidated financialstatements and certain disclosures as of and for the three and nine monthsended September 30, 2004. Management has concluded, based on thecircumstances involving the spreadsheet error discussed above, that as ofDecember 31, 2004, a material weakness in internal control over financialreporting existed with respect to the design of the Company’s controls over theelimination of intercompany balances and transactions.  See *ITEM 4.“CONTROLS AND PROCEDURES.”*Theamounts set forth in this Form 10Q/A are restated, where applicable. Thefollowing is a comparison of the previously reported and restated amounts forthe affected line items of the Consolidated Statements of Operations:

 
| ** **                                            | ** ** | **Three Months Ended  September 30, 2004** | ** ** | **Nine Months Ended  September 30, 2004** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                            | ** ** | **As Previously  Reported**                     | ** ** | **Adjustments**                                | ** ** | **Restated** | ** ** | **As Previously  Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Depletion,  depreciation, amortization and accretion  |       | $                                               | 5,446,446  |                                           | $          | (312,994 | ) | $ | 5,133,452 |   | $ | 15,830,248 |   | $ | (312,994 | ) | $ | 15,517,254 |   |
| Total  operating expenses                             |       | 9,348,126                                       |       | (312,994                                       | )          | 9,035,132 |   | 29,703,881 |   | (312,994 | ) | 29,390,887 |   |
| OPERATING  INCOME                                     |       | 3,894,339                                       |       | 312,994                                        |       | 4,207,333 |   | 15,200,645 |   | 312,994 |   | 15,513,639 |   |
| INCOME  TAX EXPENSE                                   |       | (1,354,722                                      | )          | (119,652                                       | )          | (1,474,374 | ) | (5,239,675 | ) | (119,652 | ) | (5,359,327 | ) |
| NET  INCOME                                           |       | 2,489,552                                       |       | 193,342                                        |       | 2,682,894 |   | 9,628,869 |   | 193,342 |   | 9,822,211 |   |
| COMPREHENSIVE  INCOME                                 |       | 2,223,050                                       |       | 193,342                                        |       | 2,416,392 |   | 9,149,519 |   | 193,342 |   | 9,342,861 |   |
|                                                  |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| BASIC  EARNINGS PER SHARE:                            |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Income  before cumulative effect of accounting change |       | $                                               | 0.19       |                                           | $          | 0.02 |   | $ | 0.21 |   | $ | 0.75 |   | $ | 0.01 |   | $ | 0.76 |   |
| Net  income per share                                 |       | $                                               | 0.19       |                                           | $          | 0.02 |   | $ | 0.21 |   | $ | 0.75 |   | $ | 0.01 |   | $ | 0.76 |   |
| DILUTED  EARNINGS PER SHARE:                          |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Income  before cumulative effect of accounting change |       | $                                               | 0.18       |                                           | $          | 0.02 |   | $ | 0.20 |   | $ | 0.71 |   | $ | 0.02 |   | $ | 0.73 |   |
| Net  income per share                                 |       | $                                               | 0.18       |                                           | $          | 0.02 |   | $ | 0.20 |   | $ | 0.71 |   | $ | 0.02 |   | $ | 0.73 |   |
|                                                       |            |                                                 |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing is a comparison of the previously reported and restated amounts forthe affected line items of the Consolidated Balance Sheets:

 

7

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| ** **                                                                                                                                                                    | ** ** | **September 30, 2004** | ** **  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|-------------|
| ** **                                                                                                                                                                    | ** ** | **As Previously  Reported** | ** **  | **Adjustments** | ** ** | **As   Restated** | ** ** |
|                                                                                                                                                                          |       |                        |        |   |   |   |   |
| PROPERTY  AND EQUIPMENT, Net – full-cost method of accounting for oil and natural gas  properties (including unproved costs of $9.1 million at September 30,  2004) |       | $                           | 124,407,453 |   | $ | (5,731,109 | ) | $ | 118,676,344 |   |
| DEFERRED  TAX ASSET                                                                                                                                                           |       | 789,612                     |        | (119,652 | ) | 669,960 |   |
| TOTAL  ASSETS                                                                                                                                                                 |       | 145,686,006                 |        | (5,850,761 | ) | 139,835,245 |   |
|                                                                                                                                                                          |       |                        |        |   |   |   |   |
| Accrued  liabilities                                                                                                                                                          |       | 23,761,443                  |        | (6,044,103 | ) | 17,717,340 |   |
| Total  current liabilities                                                                                                                                                    |       | 26,454,822                  |        | (6,044,103 | ) | 20,410,719 |   |
| Total  liabilities                                                                                                                                                            |       | 50,163,533                  |        | (6,044,103 | ) | 44,119,430 |   |
| Retained  earnings                                                                                                                                                            |       | 16,595,426                  |        | 193,342 |   | 16,788,768 |   |
| Total  stockholders’ equity                                                                                                                                              |       | 95,522,473                  |        | 193,342 |   | 95,715,815 |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                              |       | 145,686,006                 |        | (5,850,761 | ) | 139,835,245 |   |
|                                                                                                                                                                               |            |                             |             |  |  |  |  |  |  |  |

 

Thefollowing is a comparison of the previously reported and restated amounts forthe affected line items of the Consolidated Statements of Cash Flows:

 

| ** **                                           | ** ** | **Nine Months Ended  September 30, 2004** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                           | ** ** | **As Previously  Reported**                    | ** ** | **Adjustments** | ** ** | **As   Restated** | ** ** |
| Net  income                                          |       | $                                              | 9,628,869  |   | $ | 193,342 |   | $ | 9,822,211 |   |
|                                                 |       |                                           |       |   |   |   |   |
| Deferred  income taxes                               |       | 5,239,675                                      |       | 119,652 |   | 5,359,327 |   |
| Depletion,  depreciation, amortization and accretion |       | 15,830,248                                     |       | (312,994 | ) | 15,517,254 |   |
| Increase  (decrease) in accrued liabilities          |       | 12,388,677                                     |       | (6,044,103 | ) | 6,344,574 |   |
| Net  cash provided by operating activities           |       | 40,486,751                                     |       | (6,044,103 | ) | 34,442,648 |   |
| Oil  and gas property and equipment additions        |       | (42,111,219                                    | )          | 6,044,103 |   | (36,067,116 | ) |
| Net  cash flow used in investing activities          |       | (42,066,219                                    | )          | 6,044,103 |   | (36,022,116 | ) |
|                                                      |            |                                                |            |  |  |  |  |  |  |  |

 

**2.**          SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES

** **

The financial statementsincluded herein have been prepared by Edge Petroleum Corporation, a Delawarecorporation (“we”, “our”, “us” or the “Company”), without audit pursuant to therules and regulations of the Securities and Exchange Commission (“SEC”),and reflect all adjustments which are, in the opinion of management, necessaryto present a fair statement of the results for the interim periods on a basisconsistent with the annual audited consolidated financial statements.  All such adjustments are of a normalrecurring nature.  The results ofoperations for the interim periods are not necessarily indicative of theresults to be expected for an entire year. Certain information, accounting policies and footnote disclosuresnormally included in financial statements prepared

 

8

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in accordance withaccounting principles generally accepted in the United States of America havebeen omitted pursuant to such rules and regulations, although we believethat the disclosures are adequate to make the information presented notmisleading. These financial statements should be read in conjunction with ouraudited consolidated financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2003 and each of our quarterly reports on Form 10-Qfor the corresponding prior 2004 quarterly periods.

 

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

 

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

 

Oil and natural gas properties are amortized based ona unit-of-production method using estimates of proved reserve quantities.  Investments in unproved properties are notamortized until proved reserves associated with the prospects can be determinedor until impairment occurs.  Oil andnatural gas properties include costs of $9.1 million and $5.0 million at September 30,2004 and December 31, 2003, respectively, related to unproved property,which were excluded from capitalized costs being amortized. Unproved propertiesare evaluated quarterly, and as needed, for impairment on aproperty-by-property basis.  If theresults of an assessment indicate that an unproved property is impaired, theamount of impairment is added to the proved oil and natural gas property coststo be amortized.  In accordance with SECStaff Accounting Bulletin (“SAB”) No. 106, *“Interaction of Statement 143 and the Full Cost Rules,”*theamortizable base includes estimated future development and dismantlement costs,and restoration and abandonment costs, net of estimated salvage values.

 

In addition, the capitalized costs of oil and naturalgas properties are subject to a “ceiling test,” whereby to the extent that suchcapitalized costs subject to amortization in the full-cost pool (net ofaccumulated depletion, depreciation and amortization, asset retirementobligations and related deferred taxes) exceed the present value (using a 10%discount rate) of estimated future net after-tax cash flows from proved oil andnatural gas reserves, such excess costs are charged to expense.  Once incurred, an impairment of oil andnatural gas properties is not reversible at a later date.  In accordance with SAB No.103, “*Update of Codification of Staff Accounting Bulletins*,”derivative instruments qualifying as cash flow hedges are included in thecomputation of limitation on capitalized costs. The period-end price was between the cap and floor established by theCompany’s hedge contracts at September 30, 2004 and thus no impact wasincluded in the calculation.  Impairmentof oil and natural gas properties is assessed on a quarterly basis inconjunction with the Company’s quarterly and annual filings with the SEC.  No impairment related to the ceiling test wasrequired during the nine-month periods ended September 30, 2004 or 2003.

 

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

 

9

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In March 2004, the Emerging Issues Task Force (“EITF”)reached a consensus that mineral rights, as defined in EITF Issue No. 04-2,*“Whether Mineral Rights Are Tangible orIntangible Assets,”* are tangible assets and that they should beremoved as examples of intangible assets in SFAS Nos. 141, *“Business Combinations,”* and SFAS No. 142,*“Goodwill and Other Intangible Assets.”*The Financial Accounting Standards Board (“FASB”) has recently ratified thisconsensus and directed the FASB staff to amend SFAS Nos. 141 and 142 throughthe issuance of FASB Staff Positions (“FSP”) Nos. FAS 141-1 and FAS 142-1, *“Interaction of FASB Statements No. 141,Business Combinations, and No. 142,****Goodwilland Other Intangible Assets, and EITF Issue No. 04-2, “Whether MineralRights Are Tangible or Intangible Assets.”* In addition, FSP FAS 142-2, *“**Application of FASB Statement No. 142, Goodwilland Other Intangible Assets, to Oil- and Gas-Producing Entities”*confirms that SFAS No. 142 does not change the balance sheetclassification or disclosures of mineral rights of oil and gas producingenterprises. Historically, we have included the costs of such mineral rights astangible assets, which is consistent with the EITF’s consensus. As such, EITF 04-2and the related FSPs have not affected our consolidated financial statements.

 

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

 

At January 1, 2003, the Company recorded thepresent value of its future Asset Retirement Obligations (“ARO”) for oil andnatural gas properties and related equipment. The cumulative effect of theadoption of SFAS No. 143 and the change in accounting principle was acharge to net income during the first quarter of 2003 of $357,825, net of taxesof $192,675. The changes to the ARO during the periods ended September 30,2004 and 2003 are as follows:

 

| ** **                                  | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------|------------|
| ** **                                  | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
| ARO,  Beginning of Period                   |       | $                                        | 1,811,995  |   | $ | 942,736 |   |
| Liabilities  incurred in the current period |       | 233,828                                  |       | 504,292 |   |
| Liabilities  settled in the current period  |       | (123,231                                 | )          | (64,443 | ) |
| Accretion  expense                          |       | 80,128                                   |       | 44,652 |   |
| Revisions                                   |       | —                                   |       | (9,714 | ) |
| ARO,  End of Period                         |       | $                                        | 2,002,720  |   | $ | 1,417,523 |   |
|                                        |       |                                     |       |   |   |
| Current  Portion                            |       | $                                        | 411,092    |   | $ | 96,249 |   |
| Long  Term Portion                          |       | $                                        | 1,591,628  |   | $ | 1,321,274 |   |
|                                             |            |                                          |            |  |  |  |  |  |  |

 

ARO liabilities incurredduring the nine months ended September 30, 2004 include 28 new wellobligations. Liabilities settled during the nine months ended September 30,2004 included nine wells that were plugged and one well that was sold.

 

***Stock-BasedCompensation***- The Company accounts for stockcompensation plans under the intrinsic value method of Accounting PrinciplesBoard (“APB”) Opinion No. 25, “*Accountingfor Stock Issued to Employees*.” No compensation expense is recognized for stock options that had anexercise price equal to or greater than the market value of the underlyingcommon stock on the date of grant.  Asallowed by SFAS No. 123, “*Accountingfor Stock-Based Compensation*,” the Company has continued to applyAPB Opinion No. 25 for purposes of determining net income.  In December 2002, the FASB issued SFAS No. 148,“*Accounting for Stock-*

 

10

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

 

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

 
| ** **                                                                                                                           | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2004**                                    | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net  income as reported                                                                                                              |       | $                                           | 2,682,894  |                                       | $          | 1,690,836 |   | $ | 9,822,211 |   | $ | 3,805,169 |   |
| Add:                                                                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Stock-based  employee compensation expense included in reported net income, net of related  income tax                               |       | (6,700                                      | )          | —                                     |       | 1,072,030 |   | — |   |
| Deduct:                                                                                                                              |       |                                        |       |                                       |       |   |   |   |   |
| Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related income tax |       | (106,092                                    | )          | (53,769                                    | )          | (314,380 | ) | (168,030 | ) |
| Pro  forma net income                                                                                                                |       | $                                           | 2,570,102  |                                       | $          | 1,637,067 |   | $ | 10,579,861 |   | $ | 3,637,139 |   |
|                                                                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Earnings  Per Share:                                                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Basic  – as reported                                                                                                            |       | $                                           | 0.21       |                                       | $          | 0.18 |   | $ | 0.76 |   | $ | 0.40 |   |
| Basic  – pro forma                                                                                                              |       | $                                           | 0.20       |                                       | $          | 0.17 |   | $ | 0.82 |   | $ | 0.38 |   |
|                                                                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Diluted  – as reported                                                                                                          |       | $                                           | 0.20       |                                       | $          | 0.17 |   | $ | 0.73 |   | $ | 0.39 |   |
| Diluted  – pro forma                                                                                                            |       | $                                           | 0.19       |                                       | $          | 0.17 |   | $ | 0.78 |   | $ | 0.38 |   |

 

The Company is alsosubject to reporting requirements of FASB Interpretation No. (“FIN”) 44, “*Accounting for Certain**Transactions involvingStock Compensation”* that requires a non-cash charge to deferredcompensation expense if the market price of the Company’s common stock at theend of a reporting period is greater than the exercise price of certain stockoptions.  After the first such adjustmentis made, each subsequent period is adjusted upward or downward to the extentthat the market price exceeds the exercise price of the options.  The charge is related to non-qualified stockoptions granted to employees and directors in prior years and re-priced in May 1999,as well as certain options newly issued in conjunction with the repricing. Apre-tax charge of $1.3 million was required for the nine months ended September 30,2004.  No charge related to FIN 44 wasrequired during the nine-month period ended September 30, 2003.

 

***AccountingPronouncements –***  In March 2004, the FASB issued anexposure draft entitled “*Share-BasedPayment, an Amendment of FASB Statement No. 123 and 95*.”  This proposed statement addresses theaccounting for share-based payment transactions in which an enterprise receivesemployee services in exchange for (a) equity instruments of the enterpriseor (b) liabilities that are based on the fair value of the enterprise’sequity instruments or that may be settled by the issuance of such equityinstruments.  The proposed statementwould eliminate the ability to account for share-based compensationtransactions using APB Opinion No. 25 and generally would require insteadthat such transactions be accounted for using a fair-value-based method.  The FASB continued deliberations throughoutthe third quarter and expects to issue a final statement in the fourth quarterof 2004. As proposed, this statement would be effective for the Company on January 1,2005.  We are currently evaluating theimpact that may result from adoption of this proposed statement.

 

In September 2004, the SEC issued SAB No. 106regarding the application of SFAS No. 143 by oil and gas producingentities that follow the full cost accounting method. SAB No. 106,effective in the fourth quarter of 2004,

 

11

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statesthat after adoption of SFAS No. 143, the future cash outflows associatedwith settling asset retirement obligations that have been accrued on thebalance sheet should be excluded from the present value of estimated future netcash flows used for the full cost ceiling test calculation. It also confirmsthat the estimated dismantlement and abandonment costs, net of estimatedsalvage values, should be included in amortizable base used in computingunit-of-production depletion. This standard will also require companies todisclose in the accounting impact of SFAS No. 143 on their oil and gasproducing activities, including the calculation of the ceiling test anddepreciation, depletion and amortization. The Company currently does not expectthe adoption of SAB No. 106 in the fourth quarter of 2004 to have anymaterial impact on its financial statements, nor does it expect adoption tohave a material effect on the results of the ceiling test calculation.

 

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

 

**3. LONG TERM DEBT**

 

Effective December 31,2003, the Company entered into a new amended and restated credit facility (the “CreditFacility”) which permits borrowings up to the lesser of (i) the borrowingbase or (ii) $100 million. Borrowings under the Credit Facility bear interest at a rate equal toprime plus 0.50% or LIBOR plus 2.25%.  AtSeptember 30, 2004, the interest rate applied to our outstanding balancewas 4.06%. As of September 30, 2004, $22.0 million in borrowings wereoutstanding under the Credit Facility. The Credit Facility matures December 31, 2006 and is secured bysubstantially all of the Company’s assets.

 

Effective June 8,2004, the borrowing base under the Credit Facility was increased to $45.0million from $40.0 million; primarily as a result of our drilling activitiessince the last redetermination. At September 30, 2004, the Company’savailable borrowing capacity under this facility was $23.0 million.

 

Effective November 1,2004, the Credit Facility’s borrowing base was increased from $45.0 million to$48.0 million.

 

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

•                  TheEBITDAX to Interest Expense ratio requires that the ratio of (a) consolidatedEBITDAX (defined as EBITDA plus similar non-cash items and exploration andabandonment expenses for such period) of the Company for the four fiscalquarters then ended to (b) the consolidated interest expense of theCompany for the four fiscal 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 theagreement, be at least $1.0 million.

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

 

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

 

**4.****              SHELFREGISTRATION STATEMENT**

 

The Company filed a $150million shelf registration statement, which became effective in May 2004.Under the shelf registration statement, the Company may issue, from time totime, any combination of debt securities, preferred stock, common stock orwarrants for debt securities or equity securities in one or more offerings tothose persons who agree to purchase our securities. At September 30, 2004,the Company had $150 million

 

12

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remaining for issuanceunder the shelf registration. Our ability to utilize the shelf registrationstatement will depend upon, among other things, market conditions and theexistence of investors who wish to purchase our securities at prices and termsacceptable to us.

 

**5.****          EARNINGSPER SHARE**

 

The Company accounts forearnings per share in accordance with SFAS No. 128, “*Earnings per Share*,” which establishes therequirements for presenting earnings per share (“EPS”).  SFAS No. 128 requires the presentationof “basic” and “diluted” EPS on the face of the income statement.  Basic earnings per common share amounts arecalculated using the average number of common shares outstanding during eachperiod.  Diluted earnings per commonshare assumes the exercise of all stock options and warrants having exerciseprices less than the average market price of the common stock during theperiods, using the treasury stock method.

 

The following is areconciliation of the numerators and denominators of basic and diluted earningsper common share computations, in accordance with SFAS No. 128, for thethree-month and nine-month periods ended September 30, 2004 and 2003:

 
| ** **                               | ** ** | **Three Months Ended September 30, 2004** | ** ** | **Three Months Ended September 30, 2003** | ** ** |
|------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                               | ** ** | **Income  (Numerator)**                        | ** ** | **Shares  (Denominator)**                      | ** ** | **Per   Share  Amount** | ** ** | **Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per   Share  Amount** | ** ** |
| **Basic EPS**                            |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Income  available to common stockholders |       | $                                              | 2,682,894  |                                           | 12,999,659 |   | $ | 0.21 |   | $ | 1,690,836 |   | 9,523,648 |   | $ | 0.18 |   |
| Effect  of dilutive securities:          |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Restricted  stock                        |       | —                                         |       | 156,310                                        |       | — |   | — |   | 112,451 |   | — |   |
| Common  stock options                    |       |                                           |       | 512,573                                        |       | (0.01 | ) |   |   | 183,756 |   | (0.01 | ) |
| Warrants                                 |       | —                                         |       | —                                         |       | — |   | — |   | 49,524 |   | — |   |
| **Diluted EPS**                          |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Income  available to common stockholders |       | $                                              | 2,682,894  |                                           | 13,668,542 |   | $ | 0.20 |   | $ | 1,690,836 |   | 9,869,379 |   | $ | 0.17 |   |
|                                          |            |                                                |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **Nine Months Ended September 30, 2004** | ** ** | **Nine Months Ended September 30, 2003** | ** ** |
|------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                               | ** ** | **Income  (Numerator)**                       | ** ** | **Shares  (Denominator)**                     | ** ** | **Per   Share  Amount** | ** ** | **Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per   Share  Amount** | ** ** |
| **Basic EPS**                            |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
| Income  available to common stockholders |       | $9,822,211                                    |       | 12,889,109                                    |       | $0.76 |   | $3,805,169 |   | 9,488,896 |   | $0.40 |   |
| Effect  of dilutive securities:          |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
| Restricted  stock                        |       | —                                        |       | 139,223                                       |       | (0.01 | ) | — |   | 104,912 |   | (0.01 | ) |
| Common  stock options                    |       | —                                        |       | 478,499                                       |       | (0.02 | ) | — |   | 104,082 |   | — |   |
| **Diluted EPS**                          |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
| Income  available to common stockholders |       | $9,822,211                                    |       | 13,506,831                                    |       | $0.73 |   | $3,805,169 |   | 9,697,890 |   | $0.39 |   |

 

13

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**6.****          INCOMETAXES**

 

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

 

The Company currently estimates that its effective taxrate for the year ending December 31, 2004 will be approximately35.3%.  A provision for income taxes of$5.4 million and $2.3 million was reported for the nine months ended September 30,2004 and 2003, respectively. The Company was not required to pay income taxesin 2003 or 2002 because of the utilization of net operating loss carryforwards.

 

**7.****          SUPPLEMENTALDISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES**

 

The Company considers allhighly liquid debt instruments purchased with an original maturity of threemonths or less to be cash equivalents. A summary of non-cash investing andfinancing activities for the nine months ended September 30, 2004 and 2003is presented below:

 
| **Description**                                                                                      | ** ** | **Number of  Shares  Issued** | ** ** | **Fair Market  Value** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|------------------------|------------|
| **Nine months ended September 30, 2004:**                                                       |       |                          |       |                   |       |
| Shares  issued to satisfy restricted stock grants                                                    |       | 61,136                        |       | $                      | 384,708    |   |
| Shares  issued to fund the Company’s matching contribution under the Company’s 401-k  plan |       | 5,785                         |       | $                      | 83,270     |   |
| **Nine months ended September 30, 2003:**                                                       |       |                          |       |                   |       |
| Shares  issued to satisfy restricted stock grants                                                    |       | 73,962                        |       | $                      | 390,238    |   |
| Shares  issued to fund the Company’s matching contribution under the Company’s 401-k  plan |       | 11,785                        |       | $                      | 51,451     |   |

 

For the nine months endedSeptember 30, 2004 and 2003, the non-cash portion of Asset RetirementCosts was $110,597 and $1,165,428, respectively.  A supplemental disclosure of cash flowinformation for the nine months ended September 30, 2004 and 2003 ispresented below:

 

| ** **                            | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|---------------------------------------|------------|---------------------------------------------------|------------|
| ** **                            | ** ** | **2004**                                          | ** ** | **2003** | ** ** |
| Cash  paid during the period for:     |       |                                              |       |   |   |   |   |
| Interest,  net of amounts capitalized |       | $                                                 | 241,887    |   | $ | 336,939 |   |

 

Interest paid for thenine months ended September 30, 2004 and 2003 excludes amounts capitalizedof $378,118 and $189,697, respectively. The Company was not required to payincome taxes in 2003 or 2002.

 

**8.****          HEDGINGAND DERIVATIVE ACTIVITIES**

 

Due to the volatility ofoil and natural gas prices, the Company periodically enters into price-riskmanagement transactions (e.g., swaps, collars and floors) for a portion of itsoil and natural gas production to achieve a more predictable cash flow, as wellas to reduce exposure from price fluctuations. While the use of these arrangements limits the Company’s ability tobenefit from increases in the price of oil and natural gas, it also reduces theCompany’s potential exposure to adverse price movements.  The Company’s arrangements, to the extent itenters into any, apply to only a portion of its production, provide onlypartial price protection against declines in oil and natural gas prices andlimit the Company’s potential gains from future increases in prices.  None of these 

 

14

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instruments are used fortrading purposes. On a quarterly basis, the Company’s management sets all ofthe Company’s price-risk management policies, including volumes, types ofinstruments and counterparties. These policies are implemented by managementthrough the execution of trades by the Chief Financial Officer afterconsultation and concurrence by the President and Chairman of the Board.  The Board of Directors continuously monitorsthe Company’s policies and trades.

 

All of these price-riskmanagement transactions are considered derivative instruments and accounted forin accordance with SFAS No. 133, *“Accountingfor Derivative Instruments and Hedging Activities”*. These derivativeinstruments are intended to hedge our price risk and may be considered hedgesfor economic purposes, but certain of these transactions may not qualify forcash flow hedge accounting. All derivative instrument contracts are recorded onthe balance sheet at fair value. For those derivative instrument contracts thatqualify for cash flow hedge accounting, the effective portion of the changes inthe fair value of the contracts is recorded in other comprehensive income andthe ineffective portion of the changes in the fair value of the contracts isrecorded in revenue as they occur. While the contract is outstanding, theineffective gain or loss may increase or decrease until settlement of thecontract depending on the fair value at the measurement dates. When the hedgedproduction is sold, the realized gains and losses on the contracts are removedfrom other comprehensive income and recorded in revenue. The Company iscurrently accounting for its natural gas contracts as cash flow hedges offuture cash flows from the sale of natural gas. For those derivative instrumentcontracts that either do not qualify for cash flow hedge accounting or theCompany does not designate as hedges of future cash flows, the changes in fairvalue are not deferred through other comprehensive income, but rather recordedin revenue immediately as unrealized gains or losses. The Company did not applycash flow hedge accounting to its crude oil collars entered into in March andMay/August of 2004, because although they were economic hedges, they didnot qualify for hedge accounting.

 

For the nine months endedSeptember 30, 2004 and 2003, the Company included in revenue realized andunrealized losses of $2.3 million and $4.2 million, respectively, related toits natural gas hedges and oil derivatives. There was no ineffectivenessrecognized during the nine months ended September 30, 2004 or 2003.

 
| ** **                                               | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                               | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
| Natural  gas hedging contract settlements                |       | $                                        | (222,000   | ) | $ | (4,160,350 | ) |
| Oil  derivative contract settlements                     |       | (410,713                                 | )          | — |   |
| Hedge  premium reclassification                          |       | (411,650                                 | )          | — |   |
| Oil  derivative contract unrealized change in fair value |       | (1,254,911                               | )          | — |   |
| Loss  on hedging and derivatives                         |       | $                                        | (2,299,274 | ) | $ | (4,160,350 | ) |

 

A portion of the oilcollar that extends into the fourth quarter of 2005 was classified as long termand the remaining contracts were classified as current based on the maturity ofthe contracts. The outstanding derivatives and hedges at September 30,2004 and December 31, 2003 impacting the balance sheet were as follows:

 
| ** **            | ** ** | ** **           | ** **   | ** **    | ** ** | ** ** | ** ** | ** **          | ** ** | ** **            | ** ** | **Unrealized Hedging Gains (Losses)  As of** | ** ** |
|-----------------------|------------|----------------------|--------------|---------------|------------|------------|------------|---------------------|------------|-----------------------|------------|----------------------------------------------|------------|
| **Transaction  Date** | ** ** | **Transaction Type** | ** **   | **Beginning** | ** ** | **Ending** | ** ** | **Price  Per Unit** | ** ** | **Volumes   Per Day** | ** ** | **September 30,  2004**                 | ** ** | **December 31, 2003** | ** ** |
| ***Natural Gas:***    |       |                 |         |          |       |       |       |                |       |                  |       |                                         |       |   |   |
| 12/03                 |       | Natural Gas Collar   | (1)          | 01/01/04      |       | 03/31/04   |       | $4.50-$7.05         |       | 5,000                 |       | $                                            | —     |   | $ | 37,688 |   |
| 08/03                 |       | Natural Gas Collar   | (1) (2) | 040/1/04      |       | 09/30/04   |       | $4.50-$6.00         |       | 10,000                |       | —                                       |       | 42,996 |   |
| 08/03                 |       |                 |         |          |       |       |       |                |       |                  |       |                                         |       |   |   |
|                  |       |                 |         | 10/01/04      |       | 12/31/04   |       |                |       |                  |       |                                         |       |   |   |
|                  |       | Natural Gas Collar   | (1) (2) | 01/01/04      |       | 03/31/04   |       | $4.50-$7.00         |       | 10,000                |       | (346,634                                     | )          | 40,117 |   |
| 02/04                 |       | Natural Gas Collar   | (1)          | 04/01/04      |       | 09/30/04   |       | $4.50-$6.20         |       | 5,000                 |       | —                                       |       | — |   |
| 03/04                 |       | Natural Gas Collar   | (1)          | 10/01/04      |       | 12/31/04   |       | $4.50-$7.25         |       | 5,000                 |       | (138,163                                     | )          | — |   |
| 05/04                 |       | Natural Gas Collar   | (1)          | 01/01/05      |       | 03/31/05   |       | $5.00-$10.39        |       | 10,000                |       | (212,843                                     | )          | — |   |
| 07/04                 |       | Natural Gas Collar   | (1)          | 04/01/05      |       | 06/30/05   |       | $5.00-$7.53         |       | 10,000                |       | (166,387                                     | )          | — |   |
| 07/04                 |       | Natural Gas Collar   | (1)          | 07/01/05      |       | 09/30/05   |       | $5.00-$7.67         |       | 10,000                |       | (158,025                                     | )          | — |   |
| ***Crude Oil:***      |       |                 |         |          |       |       |       |                |       |                  |       |                                         |       |   |   |
| 03/04                 |       | Crude Oil Collar     | (3)          | 04/01/04      |       | 12/31/04   |       | $30.00-$35.50       |       | 400                   |       | (620,428                                     | )          | — |   |
| 05/04  (08/04)        |       | Crude Oil Collar     | (3) (4) | 01/01/05      |       | 12/31/05   |       | $35.00-$40.00       |       | 200/290               |       | (634,483                                     | )          | — |   |
|                  |       |                 |         |          |       |       |       |                |       |                  |       | $                                            | (2,276,963 | ) | $ | 120,801 |   |

 

15

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(1)                TheCompany’s current hedging activities for natural gas were entered into on a perMMbtu delivered price basis, using the Houston Ship Channel Index, withsettlement for each calendar month occurring five business days following theexpiration date.

(2)                Thiscontract was entered into at a cost of $686,250.

(3)                Hedgeaccounting is not applied to the Company’s collars on crude oil, which wereentered into on a per barrel delivered price basis, using the West TexasIntermediate Index, with settlement for each calendar month occurring fivebusiness days following the expiration date. The change in fair value isreflected in net revenue for the nine months ended September 30, 2004.

(4)                InAugust 2004, the Company replaced the contract that was outstanding at June 30,2004 with a new contract that changes the volume and pricing terms. The putoption is on 200 Bbl/D and the call option is on 290 Bbl/D. This transactionwas completed at no additional cost to the Company.

 

Hedges entered into afterSeptember 30, 2004 were as follows:

 
| ** **            | ** ** | ** **         | ** ** | **Effective Dates** | ** ** | ** ** | ** ** | ** **          | ** ** |
|-----------------------|------------|--------------------|------------|---------------------|------------|------------|------------|---------------------|------------|
| **Transaction  Date** | ** ** | **Hedge Type**     | ** ** | **Beginning**       | ** ** | **Ending** | ** ** | **Price Per  Unit** | ** ** | **Volume Per Day** | ** ** |
| 10/04                 |       | Natural Gas Collar | (1)        | 1/1/05              |       | 12/31/05   |       | $6.00-$9.52         |       | 10,000 MMBTU |   |

 

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(1)          TheCompany’s current hedging activities for natural gas were entered into on a perMMbtu delivered price           basis, Houston ShipChannel Index, with settlement for each calendar month occurring five businessdays           followingthe expiration date.

 

**9.****          MILLEREXPLORATION COMPANY MERGER**

 

On December 4, 2003,Edge acquired 100% of the outstanding common stock of Miller ExplorationCompany (“Miller”) in a transaction pursuant to which Miller became awholly-owned subsidiary of Edge. The acquisition of Miller was accounted forusing the purchase method of accounting.

 

The following unauditedpro forma financial information has been prepared to present the combinedresults of Edge and Miller for the nine months ended September 30, 2003,as if the merger had occurred at the beginning of the period presented. Thisunaudited pro forma consolidated statement of operations data does not includeadjustments to reflect any cost savings or other operational efficiencies thatmay be realized as a result of the merger of Edge and Miller, or any futuremerger-related restructuring or integration expenses. The pro forma datapresented is based on numerous assumptions and is not necessarily indicative offuture results of operations of the merged companies.

 

| ** **                                                                | ** ** | **Nine Months Ended  September 30, 2003** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                | ** ** | **(In thousands, except per  share data)**     | ** ** |
| STATEMENT  OF OPERATIONS DATA                                             |       |                                           |       |
| Oil  and natural gas revenue                                              |       | $                                              | 32,181     |   |
| Income  before cumulative effect of accounting change                     |       | $                                              | 6,906      |   |
| Basic  earnings per share before cumulative effect of accounting change   |       | $                                              | 0.57       |   |
| Diluted  earnings per share before cumulative effect of accounting change |       | $                                              | 0.56       |   |

 

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**10.****   SUBSEQUENTEVENTS**

 

On October 7, 2004 the Company executed an AssetPurchase Agreement to acquire oil and natural gas properties located in SouthTexas from Contango Oil & Gas Company for a cash purchase price ofapproximately $50 million. These properties are located primarily in Jim HoggCounty, Texas. The Company expects approximately $5 million of the $50 millionpurchase price to be allocated to the unproved property category. Theproperties to be acquired consist of 38 non-operated producing wells withcurrent net production of approximately 12 MMcfe per day as of October 2004,of which 90% is natural gas.

 

The purchase price is subject to adjustment for theresults of operations after July 1, 2004 and title and environmentaldefects, if any. The acquisition is subject to certain closing conditions,including waivers or appropriate adjustments to the purchase price in the eventof exercise of preferential purchase rights, obtaining certain consents fromlessors and Contango’s shareholder approval. The transaction is expected toclose on or before December 31, 2004. The Company plans to finance theplanned acquisition through borrowings under the unused portion of its creditline, which is expected to increase as a result of this transaction, and theissuance of equity securities under its outstanding shelf registrationstatement.

 

**11.****   COMMITMENTSAND CONTINGENCIES**

 

From time to time theCompany is a party to various legal proceedings arising in the ordinary courseof business.  While the outcome oflawsuits cannot be predicted with certainty, the Company is not currently aparty to any proceeding that it believes, if determined in a manner adverse tothe Company, could have a potential material adverse effect on its financialcondition, results of operations or cash flows.

 

During the secondquarter of 2004, the Company received notice that its franchise tax returns forthe State of Texas would be audited for the tax years 1999 through 2002. Afterreviewing documents submitted, the agent representing the Office of theComptroller of the State of Texas proposed adjustments to the calculation thatwould result in an increased franchise tax liability.  The agent maintained that transfers by theparent company to its subsidiaries that the Company classified as intercompanyloans should instead be classified as equity investments in the subsidiary. TheState of Texas originally proposed that the franchise tax liability of thesubsidiaries would be increased by approximately $3.0 million for the four-yearperiod under audit.

 

During the third quarter the agent reduced theproposed franchise tax deficiency adjustment to the Company and itssubsidiaries to $467,000. The Company intends to vigorously contest thisproposed franchise tax assessment through appropriate administrative levels inthe Comptroller’s Office. The next step in the administrative process is ahearing at the Comptroller’s Office scheduled for November 2004.  Should the Company’s administrative appealsprove unsuccessful, the Company plans to seek further appellate relief throughavailable judicial means.  Due to itsintention to continue to vigorously contest the proposed adjustments, the Companyhas not recognized any provision for the additional franchise taxes that wouldresult from the proposed deficiency.

 

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

 

The following is Management’s Discussion and Analysis (“MD&A”) ofsignificant factors that have affected certain aspects of our financialposition and operating results during the periods included in the accompanyingunaudited condensed consolidated financial statements. The followingMD&A is intended to help the reader understand Edge Petroleum Corporation (“Edge”).This discussion should be read inconjunction with the accompanying unaudited condensed consolidated financialstatements included elsewhere in this Form 10-Q and with Management’sDiscussion and Analysis of Financial Condition and Results of Operations andour audited consolidated financial statements included in our annual report on Form 10-Kfor the year ended December 31, 2003 and each of our quarterlyreports on Form 10-Q for the corresponding prior 2004 quarterly periods.

 

### **FORWARD LOOKING STATEMENTS**

###  

The statements contained in all parts of thisdocument, including, but not limited to, those relating to our outlook, theeffects of our merger with Miller Exploration Company (“Miller”), theconsummation of the Contango Oil and Gas Company (“Contango”) acquisition, ourfinancing plans related thereto, including any increase in our credit line,issuance of equity or debt, contribution of acquisition and any other benefitof such acquisition, our ability to access the capital markets to raiseadditional capital, our debt-to-total capital ratio, our drilling plans, ournatural gas and oil production volumes, our 3-D project portfolio, our abilityto hedge our risks, capital expenditures and capital program, futurecapabilities, the sufficiency of capital resources and liquidity to supportworking capital and capital expenditure requirements, sufficiency, growth andreinvestment of cash flows, our ability to control the timing of our futureexploration and development requirements, use of NOLs, tax rates, the outcomeof litigation and audits, the impact of changes in interest rates on ourestimates of asset retirement obligations, the commodity pricing environmentand the state of the economy and any other statements regarding futureoperations, financial results, business plans, sources of liquidity and cashneeds and other statements that are not historical facts are forward lookingstatements.  When used in this document,the words “anticipate,” “estimate,” “expect,” “may,” “project,” “believe,” “budgeted,”“intend,” “plan,” “potential,” “forecast,” “might,” “predict,” “should” andsimilar expressions are intended to be among the statements that identifyforward looking statements.  Suchstatements involve risks and uncertainties, including, but not limited to,those relating to the results of and our dependence on our exploratory anddevelopment drilling activities, the volatility of oil and natural gas prices,the need to replace reserves depleted by production, operating risks of oil andnatural gas operations, our dependence on key personnel, our reliance ontechnological development and possible obsolescence of the technology currentlyused by us, the significant capital requirements of our exploration anddevelopment and technology development programs, the potential impact ofgovernment regulations and liability for environmental matters, results oflitigation and audits, expansion of our capital budgets, our ability to manageour growth and achieve our business strategy, competition from larger oil andgas companies, the uncertainty of reserve information and future net revenueestimates, property acquisition risks, our ability and Contango’s ability tofulfill each of the closing conditions to the Contango property acquisition,risks relating to acquisitions and other factors detailed in our Form 10-Kand other filings with the Securities and Exchange Commission (“SEC”).  Should one or more of these risks oruncertainties materialize, or should underlying assumptions prove incorrect,actual outcomes may vary materially from those indicated. All subsequentwritten and oral forward looking statements attributable to the Company or thepersons acting on its behalf are expressly qualified in their entirety by thereference to these risks and uncertainties. The Company undertakes noobligation to publicly update or revise any forward looking statements, whetheras a result of new information, future events or otherwise.

 

## **GENERAL OVERVIEW**

## ** **

Edge Petroleum Corporation is a Houston-basedindependent energy company that focuses its exploration, production andmarketing activities in selected onshore basins of the United States. In late1998, we undertook a top-level management change and began a shift in strategyfrom pure exploration which focused more on prospect generation to our currentstrategy which focuses on a balanced program of exploration, exploitation anddevelopment and acquisition of oil and gas properties. Our company generatesrevenues, income and cash flows by producing and marketing oil and natural gasproduced from our oil and natural gas properties. We make significant capitalexpenditures in our exploration, development, and acquisition activities thatallow us to continue generating 

 

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revenue, income and cash flows. In December 2003,we acquired 100 percent of the outstanding stock of Miller.  The transaction was treated as a tax-free reorganizationand accounted for as a purchase business combination. Miller continues toconduct exploration and development activities as a wholly-owned subsidiary ofEdge.

 

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

 

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

 

•                  **Approach to the Business** – additionalinformation regarding our approach and strategy.

 

•                  **Mergers & Acquisitions** -information about 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.

 

•                  **Restatement** – a discussion of the restatement triggeringthis amended Form 10-Q.

 

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

 

•                  **Liquidity -**an analysis of cash flows anduses of cash.

 

•                  **Capital Resources –** an analysis of oursources of cash and contractual obligations.

 

•                  **Risk Management Activities –**supplementaryinformation regarding our Company’s price-risk management activities involvingcommodity contracts that are accounted for at fair value.

 

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

 

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

 

# **Industry and EconomicFactors**

# ** **

In managing our business,we must deal with many factors inherent in our industry.  First and foremost is the fluctuation of oiland gas prices.  Historically, oil andgas markets have been cyclical and volatile, with future price movements difficultto predict.  While our revenues are afunction of both production and prices, wide swings in commodity prices havemost often had the greatest impact on our results of operations. The economy asa whole has struggled thus far during 2004, but the oil and gas industry hasexperienced a high commodity price environment, which has positively impactedthe entire industry as well as our Company.

 

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

 

The oil and gas industryis highly competitive.  We compete withmajor and diversified energy companies, independent oil and gas businesses andindividual operators.  In addition, theindustry as a whole competes with other businesses that supply energy toindustrial and commercial end users.

 

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

 

# **Approach to the Business**

# ** **

Profitable growth of ourbusiness will largely depend upon our ability to successfully find and developnew proved reserves of oil and natural gas in a cost-effective manner.  In order to achieve an overall acceptablerate of growth, we maintain a blended portfolio of low, moderate and higherrisk exploration and development projects. We also attempt to make selected acquisitions of oil and gas propertiesto augment our growth and provide future drilling opportunities.  We believe that this approach should allowfor consistent increases in our oil and gas reserves, while minimizing thechance of failure.  To further mitigaterisk, we have chosen to seek geologic and geographic diversification byoperating in multiple basins.  Weperiodically hedge our exposure to volatile oil and gas prices on a portion ofour production to reduce price risk. As of September 30, 2004, we haveentered into hedge contracts covering approximately 55% and 60% of ourremaining expected 2004 natural gas and crude oil production,respectively.  During the second andthird quarter, we entered into new hedge contracts resulting in approximately 40-50%and 35% of our expected 2005 natural gas and crude oil production,respectively, before any acquisitions, being hedged.

 

Implementation of ourbusiness approach relies on our ability to fund ongoing exploration anddevelopment projects with cash flow provided by operating activities andexternal sources of capital.  In late2003, we announced plans for record capital expenditures of approximately $28million for 2004.   In May 2004, weannounced plans to expand the 2004 capital budget to approximately $39 millionand in October 2004 our Board approved an increased 2004 capital budget of$52 million. We do not typically include acquisitions in our budgeted capitalexpenditures.  Based on currentexpectations for production volumes and commodity prices, we expect to fundthose capital expenditures from internally generated cash from operatingactivities plus some incremental borrowing on our line of credit.

 

Debt has increased by$1.0 million in the first nine months of 2004 to $22.0 million at September 30,2004. As of that date, our debt to total capital ratio was approximately 19%,which we believe leaves us with the financial flexibility to continue toexecute our business strategies.

 

**Mergers and Acquisitions**

 

On December 4, 2003 we completed our acquisition of Miller. Miller was an independent oil and gas exploration and production company with exploration efforts concentrated primarily in the Mississippi Salt Basin of central Mississippi.  We acquired Miller for the development and exploitation projects in Miller’s core area, increased financial flexibility, and expansion of our core areas.

 

Under the terms of the merger agreement, each share of issued and outstanding common stock of Miller was converted into 1.22342 shares of Edge common stock.  We issued approximately 2.6 million shares of Edge common stock to the shareholders of Miller in exchange for all of the outstanding common stock of Miller. The merger was treated as a tax-free reorganization and accounted for as a purchase business combination under generally accepted accounting principles.

 

The fair value of assets acquired from Miller totaled $15.7 million and included $6.4 million of cash.  We incurred $1.2 million in costs associated with the merger resulting in net cash acquired in the merger of $5.2 million for the year ended December 31, 2003. During the nine months ended September 30, 2004 we incurred approximately $233,000 of expenses associated with the transaction.

 

The acquired Millerproperties were estimated to contain at least 5.6 Bcfe of proved reserves at December 31,2003, of which approximately 60% was natural gas and 100% was classified asproved developed. The acreage

 

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position wasapproximately 83,800 gross (17,200 net) acres with an option to acquire 80,000gross (68,000 net) acres at December 31, 2003. We operate the majority ofthe acquired properties. Production from Miller properties for the nine monthsended September 30, 2004 was approximately 1.5 Bcfe.

 

On October 7, 2004, we executed an Asset PurchaseAgreement to acquire oil and natural gas properties located in South Texas fromContango for a cash purchase price of approximately $50 million. Theseproperties, located primarily in Jim Hogg County, Texas and producing primarilyfrom the Queen City formation, are in a geographic area that has been one ofour most active and successful areas of focus in recent years. In addition toestimated proved reserves, our technical team has also identified a substantialnumber of additional drilling locations on undeveloped acreage with attractiveexploitation and exploration potential. We expect approximately $5 million ofthe $50 million purchase price to be allocated to the unproved propertycategory. The properties to be acquired consist of 38 non-operated producingwells with an average 68% working interest and 52% net revenue interest. As of October 2004,net production from the properties is approximately 12 MMcfe per day, and is90% natural gas.

 

The purchase price is subject to adjustment for theresults of operations after July 1, 2004 and title and environmentaldefects, if any. The acquisition is subject to certain closing conditions,including obtaining waivers or appropriate adjustments to the purchase price inthe event of exercise of preferential purchase rights, obtaining certainconsents from lessors and Contango’s shareholder approval. The transaction isexpected to close on or before December 31, 2004. We plan to finance theplanned acquisition through borrowings under the unused portion of our creditline, which is expected to increase as a result of this transaction, and theissuance of common stock. Following any such issuance of common stock, weintend to maintain our financial goal of a debt-to-total capital ratio of lessthan 30%.

 

**Outlook**

 

We expect our drillingprogram to increase from 36 wells (17.922 net) in 2003 to approximately 50wells (28.0 net) in 2004. Our expected capital program, excluding acquisitions,will be approximately $52 million, approximately 85% greater than 2003. Ourexpected production volumes combined with a strong commodity-pricingenvironment expected for the remainder of the year is anticipated to producerecord cash flow. In order to manage the realized and anticipated growth overthe year, we have increased our headcount from 35 employees as of September 30,2003 to 51 employees as of September 30, 2004 resulting in increasedG&A costs.  To help protect againstthe possibility that commodity prices do not remain at the current levels, wehave entered into several hedges covering approximately 55% of our expectednatural gas production and 60% of our expected crude oil production streams forthe remainder of 2004 to offset the negative impact of potential downward pricemovements. During the second and third quarter, we entered into new hedgecontracts resulting in approximately 40-50% of our expected 2005 natural gasand 35% of our expected 2005 crude oil production being hedged.  We also expect to continue to spendconsiderable effort in 2004 on acquisitions, as we seek to further our growth.

 

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

 

**Critical Accounting Policies and Estimates**

 

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

 

•                  it requires assumptions to be made that were uncertainat the time the estimate was made, and

 

•                  changes in the estimate or different estimates thatcould have been selected could have a material impact on our consolidatedresults of operations or financial condition.

 

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

 

*Natureof Critical Estimate Item:*Oil & Natural Gas Reserves - Our estimate of proved reserves isbased on the quantities of oil and gas which geological and engineering datademonstrate, with reasonable certainty, to be recoverable in the future yearsfrom known reservoirs under existing economic and operating conditions.  The accuracy of any reserve estimate is afunction of the quality of available data, engineering and geological interpretation,and judgment.  For example, we mustestimate the amount and timing of future operating costs, severance taxes,development costs, and workover costs, all of which may in fact varyconsiderably from actual results.  Inaddition, as prices and cost levels change from year to year, the economics ofproducing the reserves may change and therefore the estimate of proved reservesalso may change.  Any significantvariance in these assumptions could materially affect the estimated quantityand value of our reserves. Despite the inherent imprecision in theseengineering estimates, our reserves are used throughout our financialstatements.

 

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

 

* *“Ceiling” Test  - The full-cost method of accounting for oiland gas properties requires a quarterly calculation of a limitation oncapitalized costs, often referred to as a full-cost ceiling calculation. Theceiling is the discounted present value of our estimated total proved reservesadjusted for taxes and the impact of hedges on pricing, using a 10% discount rate.To the extent that our capitalized costs (net of accumulated depletion anddeferred taxes) exceed the ceiling, the excess must be written off to expense.Once incurred, this impairment of oil and gas properties is not reversible at alater date even if oil and gas prices increase. No such impairment was requiredin the nine months ended September 30, 2004 and 2003. This calculation ofour proved reserves could significantly impact our ceiling limitation used indetermining whether an impairment of our capitalized costs is necessary. Theceiling calculation dictates that prices and costs in effect as of the last dayof the period are generally held constant indefinitely. Therefore, the futurenet revenues associated with the estimated proved reserves are not based on ourassessment of future prices or costs, but rather are based on prices and costsin effect as of the end of the period. Oil and natural gas prices used in thereserve valuation at September 30, 2004 were $29.78 per barrel and $6.80per MMBtu.

 

*Effectif different assumptions used:*Units-of-production method to amortize our oil andnatural gas properties - A 10% decrease in reserves would have increased our depletionexpense for the quarter by 11%; however, a 10% increase in our reserves would havedecreased our depletion expense for the quarter by 8%.

 

“Ceiling” limitation test  -The most likely factor to contribute to a ceiling test impairment is the priceused to calculate the reserve limitation threshold. A significant reduction inthe prices at a future measurement date could trigger a full-cost ceilingimpairment. At September 30, 2004, we had a cushion (i.e. the excess ofthe ceiling over our capitalized costs) of $75.4 million. A 10% decrease inprices used would have decreased our cushion by 23%, but a 10% increase inprices would have increased our cushion by 13%. Our hedging program would serveto mitigate some of the impact of any price decline. Our hedges did not impactthe ceiling test this quarter, and would not have if the price was 10% lower asthese prices were within the collars, but had we increased the price by 10% theprice would have exceeded our hedge caps and therefore resulted in a decreasein the ceiling of $0.5 million. Another likely factor to contribute to aceiling test impairment is a revised estimate of reserves. A 10% decrease inreserve volume would have decreased our cushion by 23% and a 10% increase inreserve volumes would have increased our cushion by 14%.

 

*Natureof Critical Estimate Item:*Unproved Property Impairment****- We have elected to use the full-costmethod to account for our oil and gas activities. Investments in unprovedproperties are not amortized until proved

 

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reserves associated withthe prospects can be determined or until impairment occurs.  Unproved properties are evaluated quarterlyfor impairment on a property-by-property basis. If the results of an assessment indicate that an unproved property isimpaired, the amount of impairment is added to the proved oil and natural gasproperty costs to be amortized.

 

*Assumptions/ApproachUsed:*At September 30,2004, we had $9.1 million allocated to unproved property. This allocation isbased on the estimation by the technical team of whether the property haspotential attributable reserves. Therefore, the assessment made by ourtechnical team of the potential reserves will determine whether costs are movedfrom the unproved category to the full-cost pool for depletion or whether animpairment is taken.

 

*Effectif different assumptions used:* A 10% increase or decrease in the unproved propertybalance (i.e. transfer to full-cost pool) would have increased or decreased ourdepletion expense by approximately 2% for the quarter ended September 30,2004.

 

*Natureof Critical Estimate Item:*Asset Retirement Obligations**-**Wehave certain obligations to remove tangible equipment and restore land at theend of oil and gas production operations. Our removal and restoration obligations are primarily associated withplugging and abandoning wells. Previously, the costs associated with thisactivity were capitalized to the full-cost pool and charged to income throughdepletion. We adopted SFAS No. 143, “*Accountingfor Asset Retirement Obligations*” effective January 1, 2003, asdiscussed in Note 2 to our Consolidated Financial Statements.  SFAS No. 143 significantly changed themethod of accruing for costs an entity is legally obligated to incur related tothe retirement of fixed assets (“asset retirement obligations” or “ARO”).  Primarily, the new statement requires us toestimate asset retirement costs for all of our assets, inflation adjust thosecosts to the forecast abandonment date, discount that amount using acredit-adjusted-risk-free rate back to the date we acquired the asset orobligation to retire the asset and record an ARO liability in that amount witha corresponding addition to our asset value. We then accrete the liabilityquarterly using the period-end effective credit-adjusted-risk-free rate. As newwells are drilled or purchased, their initial asset retirement cost andliability is calculated and recorded. Should either the estimated life or theestimated abandonment costs of a property change upon our quarterly review, anew calculation is performed using the same methodology of taking theabandonment cost and inflating it forward to its abandonment date and thendiscounting it back to the present using our credit-adjusted-risk-free rate.The carrying value of the asset retirement obligation is adjusted to the newlycalculated value, with a corresponding offsetting adjustment to the assetretirement cost (included in the full-cost pool); therefore, abandonment costswill almost always approximate the estimate. When wells are sold the relatedliability and asset costs are removed from the Balance Sheet.

 

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

 

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

 

23

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application of a discountfactor and some significant calculations, could differ from actual results,despite all our efforts to make an accurate estimate.

 

*Natureof Critical Estimate Item:*Income Taxes**-**In accordance with the accounting for income taxesunder SFAS No. 109, we have recorded a deferred tax asset to account forthe expected future tax consequences of events that have been recognized in ourfinancial statements and our tax returns. There are several items that resultin deferred tax asset impact to the balance sheet, but the largest of which isincome taxes and the impact of net operating loss (“NOL”) carryforwards. Weroutinely assess the realizability of our NOL carryforwards that resulted fromsubstantial income tax deductions, prior year losses and acquisitions. Weconsider future taxable income in making such assessments.  If we conclude that it is more likely thannot that some portion or all of the deferred tax assets will not be realizedunder accounting standards, it is reduced by a valuation allowance.

 

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

 

*Effect if different assumptions used:* Wehave engaged an independent public accounting firm to assist us in applying thenumerous and complicated tax law requirements. However, despite our attempt tomake an accurate estimate, the ultimate utilization of our NOL carryforwards ishighly dependent upon our actual production and the realization of taxableincome in future periods. If we estimate that some or all of our NOLcarryforwards are more likely than not going to expire or otherwise not beutilized to reduce future tax, we would record a valuation allowance to removethe benefit of those NOL carryforwards from our financial statements.

 

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

 

Hedge Contracts - We formally assess, both at thehedge’s inception and on an ongoing basis, whether the derivatives that are usedfor hedging are expected to be highly effective in offsetting changes in cashflows of the hedged transactions.  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. The ongoing measurement of effectiveness determineswhether the change in fair value is deferred through other comprehensive income(“OCI”) on the balance sheet or recorded immediately in revenue on the incomestatement. The effective portion of the changes in the fair value of hedgecontracts is recorded initially in OCI. When the hedged production is sold, therealized gains and losses on the hedge contracts are removed from OCI andrecorded in revenue. Ineffective portions of the changes in the fair value ofthe hedge contracts are recognized in revenue as they occur. While the hedgecontract is outstanding, the ineffective gain or loss may increase or decreaseuntil settlement of the contract.

 

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

 

*Assumptions/ApproachUsed:*Estimatingthe fair values of derivative instruments requires complex calculations,including the use of a discounted cash flow technique, estimates of risk andvolatility, and subjective judgment in selecting an appropriate discount rate.In addition, the calculations use future market commodity prices, whichalthough posted for trading purposes, are merely the market consensus of

 

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forecasted price trends.The results of the fair value calculations cannot be expected to representexactly the fair value of our commodity hedges. We currently obtain the fairvalue of our positions from our counterparties. Our practice of relying on ourcounterparties who are more specialized and knowledgeable in preparing thesecomplex calculations reduces our management’s input.

 

*Effectif different assumptions used:* At September 30, 2004, a 10% change in thecommodity price per unit, as long as the price is either above the ceiling orbelow the floor price, would cause the fair value total of our derivativefinancial instrument to increase or decrease by approximately $217,400.

 

# **Restatement**

# ** **

In March 2005, prior to filing the annual financial statementsfor 2004, we discovered an error in a consolidating financial statementsspreadsheet application used to eliminate intercompany balances. The revisions setforth in this Amendment No. 1 stem from an intercompany balance that was noteliminated in such application, but instead was inadvertently recorded toProperty and Equipment causing property balances to be overstated. This errorrelates to a change in accounting processes that occurred during the secondquarter of 2004 and therefore prior year results were not affected. Also,second quarter results were not materially affected, so no change has been madeto second quarter financial statements. This error in the property balance alsoimpacted our computation of depletion expense and therefore operating expenses,operating income, income tax expense, net income and earnings per share.  Accordingly, we have restated ourconsolidated balance sheet, income statement, statement of stockholder’s equityand statement of cash flows in the Form 10-Q to reflect these revisions (seeNote 1 to our consolidated financial statements for a reconciliation of ourrestated results to previously reported results).  Management has concluded, based on thecircumstances involving the spreadsheet error discussed above, that as ofDecember 31, 2004, a material weakness in internal control over financialreporting existed with respect to the design of the Company’s controls over theelimination of intercompany balances and transactions.  See *ITEM4. “CONTROLS AND PROCEDURES.”*

 

# **Results of Operations**

# ** **

This section includesdiscussion of our results of operations for the three-month and nine-monthperiods ended September 30, 2004 as compared to the same periods of theprior year.  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 primary emphasis in South Texas,Louisiana, Southeast New Mexico, and Southern Mississippi.

 

**ThirdQuarter 2004 Compared to the Third Quarter 2003**

 

**Revenueand Production**

 

Total revenue increased 49% from the third quarter of2003 to the comparable 2004 period.  Forthe three months ended September 30, 2004 and 2003, our product mixcontributed the following percentages of production and revenues:

 
| ** **                  | ** ** | **REVENUES (1)** | ** ** | **PRODUCTION** | ** ** |
|-----------------------------|------------|------------------|------------|----------------|------------|
| ** **                  | ** ** | **2004**         | ** ** | **2003**       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Natural  Gas (Mcf)          |       | 89               | %          | 84             | %          | 74 | % | 79 | % |
| Natural  gas liquids (Bbls) |       | 8                | %          | 6              | %          | 14 | % | 13 | % |
| Crude  oil (Bbl)            |       | 3                | %          | 10             | %          | 12 | % | 8 | % |
|                        |       |             |       |           |       |   |   |   |   |
| Total  (Mcfe)               |       | 100              | %          | 100            | %          | 100 | % | 100 | % |

 

----

(1) Includes effect of hedging and derivativetransactions.

 

The following table summarizes volume and priceinformation with respect to our oil and gas production for the three-monthperiods ended September 30, 2004 and 2003:

 

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| ** **                                   | ** ** | ** **                                 | ** ** | ** **   | ** ** | **2004 Period Compared  to 2003 Period** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|--------------|------------|------------------------------------------|------------|
| ** **                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | **%  Increase**                          | ** ** |
| ** **                                   | ** ** | **2004**                                   | ** ** | **2003**     | ** ** | **(Decrease)**                           | ** ** | **(Decrease)** | ** ** |
| **Production Volumes:**                      |       |                                       |       |         |       |                                     |       |   |   |
| Natural  gas (Mcf)                           |       | 2,077,791                                  |       | 1,717,559    |       | 360,232                                  |       | 21 | % |
| Natural  gas liquids (Bbls)                  |       | 63,857                                     |       | 49,308       |       | 14,549                                   |       | 30 | % |
| Oil  and condensate (Bbls)                   |       | 56,415                                     |       | 29,918       |       | 26,497                                   |       | 89 | % |
| Natural  gas equivalent (Mcfe)               |       | 2,799,423                                  |       | 2,192,915    |       | 606,508                                  |       | 28 | % |
| **Average Sales Price:**                     |       |                                       |       |         |       |                                     |       |   |   |
| Natural  gas ($ per Mcf)(1)             |       | $                                          | 5.74       |         | $          | 4.84                                     |       | $ | 0.89 |   | 18 | % |
| Natural  gas liquids ($ per Bbl)        |       | $                                          | 16.27      |         | $          | 10.05                                    |       | $ | 6.22 |   | 62 | % |
| Oil  and condensate ($ per Bbl)(1)      |       | $                                          | 39.17      |         | $          | 30.18                                    |       | $ | 8.99 |   | 30 | % |
| Natural  gas equivalent ($ per Mcfe)(1) |       | $                                          | 5.42       |         | $          | 4.43                                     |       | $ | 0.99 |   | 22 | % |
| Natural  gas equivalent ($ per Mcfe)(2) |       | $                                          | 4.73       |         | $          | 4.06                                     |       | $ | 0.67 |   | 17 | % |
| **Operating Revenue:**                       |       |                                       |       |         |       |                                     |       |   |   |
| Natural  gas (1)                             |       | $                                          | 11,933,309 |         | $          | 8,320,546                                |       | $ | 3,612,763 |   | 43 | % |
| Natural  gas liquids                         |       | 1,038,811                                  |       | 495,448      |       | 543,363                                  |       | 110 | % |
| Oil  and condensate (1)                      |       | 2,209,754                                  |       | 903,014      |       | 1,306,740                                |       | 145 | % |
| Loss  on hedging and derivatives             |       | (1,939,409                                 | )          | (824,470     | )          | (1,114,939                               | )          | (135 | )% |
| Total                                        |       | $                                          | 13,242,465 |         | $          | 8,894,538                                |       | $ | 4,347,927 |   | 49 | % |

 

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(1) Excludesthe effect of hedging and derivative transactions.

(2) Includesthe effect of hedging and derivative transactions.

 

Our revenue is sensitive tochanges in prices received for our products. A substantial portion of our production is sold at prevailing marketprices, which fluctuate in response to many factors that are outside of ourcontrol.  Imbalances in the supply anddemand for oil and natural gas can have a dramatic effect on the prices wereceive for our production.  Politicalinstability and availability of alternative fuels could impact worldwidesupply, while the economy, weather and other factors outside of our controlcould impact demand.

 

Natural gas revenue, excluding hedging activity,increased 43% for the three months ended September 30, 2004 over the sameperiod in 2003 due to significantly higher production and higher realizedprices. Average natural gas production increased 21% from 18.7 MMcf/D in thethree months ended September 30, 2003 to 22.6 MMcf/D in the comparable2004 period due to production from new wells drilled and acquired, primarily inour O’Connor Ranch East, Gato Creek, Encinitas and Miller properties, partiallyoffset by natural declines at our Austin Field and O’Connor Ranchproperties.  This increase in productioncompared to the prior year period resulted in an increase in revenue ofapproximately $1.7 million (based on 2003 comparable period pre-hedgeprices).  Excluding the effect of hedges,the average natural gas sales price for production in the third quarter of 2004was $5.74 per Mcf compared to $4.85 per Mcf for the same period in 2003.  This increase in average price receivedresulted in increased revenue of approximately $1.9 million (based on currentyear production).

 

Revenue from the sale of NGLs increased 110% for thethree months ended September 30, 2004 over the same period in 2003.Production volumes for NGLs increased 30%, from 536 Bbls/D for the three monthsended September 30, 2003 to 694 Bbls/D for the three months ended September 30,2004 due primarily to increased production from new wells drilled andacquired.  The increase in NGL productionincreased revenue by approximately $146,000 (based on 2003 comparable periodaverage prices).  Higher average realizedprices for the three months ended September 30, 2004 resulted in anincrease in revenue of approximately $397,000 (based on current yearproduction).  The average realized pricefor NGLs for the three months ended September 30, 2004 was $16.27 perbarrel compared to $10.05 per barrel for the same period in 2003.

 

Revenue from the sale of oil and condensate, excludingderivative activity, increased 145% for the three months ended September 30,2004 as compared to the comparable prior year period in 2003 due to increasedproduction and realized prices. Production volumes for oil and condensateincreased 89% to 613 Bbls/D for the

 

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three months ended September 30, 2004 compared to 325 Bbls/D forthe same prior year period due primarily to production from the propertiesacquired from Miller, as well as new wells drilled.  The increase in oil and condensate productionresulted in an increase in revenue of approximately $800,000 (based on 2003comparable period average prices). The average realized price for oil andcondensate before the derivative losses for the three months ended September 30,2004 was $39.17 per barrel compared to $30.18 per barrel in the same period of2003.  These higher average prices forthe third quarter of 2004 resulted in an increase in revenue of approximately$507,000 (based on current year production).

 

Losses on hedging and derivatives increased 135% forthe three months ended September 30, 2004 over the same period in 2003 dueto the change in the fair market value of the outstanding derivative contractsas a result of volatile commodity prices and cash settlements on expiringcontracts. Oil and condensate revenues were decreased by realized andunrealized losses on our oil derivatives. For the three months ended September 30,2004 we recorded $307,437 of realized losses on oil derivatives settlements and$1.4 million of unrealized losses representing the change in the mark-to-marketfair value of our outstanding oil derivative contracts. We did not apply hedgeaccounting to these transactions.  SeeNote 8 to our Consolidated Financial Statements.  These losses account for a $30.87 per barreldecrease in the realized oil price for the three months ended September 30,2004 from $39.17 per barrel to $8.30 per barrel. There was no oil derivativeactivity during the three months ended September 30, 2003. Should thecrude oil prices decrease from the current levels, we would realize lowerrevenues, but our oil derivative losses would also decrease and could possiblyresult in a gain position. For the three months ended September 30, 2004,we recognized $197,800 of the premium paid for a natural gas hedge entered intoin 2003.  This loss decreased theeffective natural gas sales price by $0.10 per Mcf.  Included within natural gas revenue for thethree months ended September 30, 2003 was $824,470 representing realizedlosses from hedging contract settlements. These losses decreased the effective natural gas sales price by $0.48per Mcf for the three months ended September 30, 2003.  Should natural gas prices decrease from thecurrent high levels, this could materially affect our revenues that are nothedged.

 

**Costs and Operating Expenses**

 

The table below presentsa detail of our expenses for the three months ended September 30, 2004 and2003:

 
| ** **                                            | ** ** | ** **                                 | ** ** | ** ** | ** ** | **2004 Period Compared  to 2003 Period** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|------------|------------|------------------------------------------|------------|
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** | ** ** | ** ** | ** **                               | ** ** |
| ** **                                            | ** ** | **2004**                                   | ** ** | **2003**   | ** ** | **Increase   (Decrease)**                | ** ** | **% Increase (Decrease)** | ** ** |
|                                                  |       |                                       |       |       |       |                                     |       |   |   |
| Lease  operating expenses                             |       | $                                          | 1,176,732  |       | $          | 597,550                                  |       | $ | 579,182 |   | 97 | % |
| Severance  and ad valorem taxes                       |       | 891,194                                    |       | 561,787    |       | 329,407                                  |       | 59 | % |
| Depreciation,  depletion, amortization and accretion: |       |                                       |       |       |       |                                     |       |   |   |
| Oil  and gas property and equipment                   |       | 5,002,010                                  |       | 3,572,173  |       | 1,429,837                                |       | 40 | % |
| Other  assets                                         |       | 103,815                                    |       | 140,062    |       | (36,247                                  | )          | (26 | )% |
| ARO  accretion                                        |       | 27,627                                     |       | 14,799     |       | 12,828                                   |       | 87 | % |
| General  and administrative expenses:                 |       |                                       |       |       |       |                                     |       |   |   |
| Deferred  compensation – repriced options        |       | (153,808                                   | )          | —     |       | (153,808                                 | )          |   | * |
| Deferred  compensation – restricted stock        |       | 143,500                                    |       | 93,604     |       | 49,896                                   |       | 53 | % |
| Other  general and administrative expenses            |       | 1,844,062                                  |       | 1,157,259  |       | 686,803                                  |       | 59 | % |
|                                                  |       | 9,035,132                                  |       | 6,137,234  |       | 2,897,898                                |       | 47 | % |
| Other  expense, net                                   |       | 50,065                                     |       | 120,359    |       | (70,294                                  | )          | (58 | )% |
| Total                                                 |       | $                                          | 9,085,197  |       | $          | 6,257,593                                |       | $ | 2,827,604 |   | 45 | % |

 

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* Not meaningful

 

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Lease operating expenses for the three months ended September 30,2004 increased 97% over the same period of 2003. The 2003 acquisition ofproperties in South Texas and the Miller merger contributed 61% of the increasein costs. Wells drilled since the third quarter of 2003 further increased thecosts for the third quarter of 2004 compared to the prior year.  We have experienced some cost increases onoutside operated properties on the O’Connor Ranch field and on operated propertiesat Gato Creek. In addition, the Miller and States properties acquired in 2003have slightly higher costs than our other properties. These cost increases haveled to an increase in lease operating expenses to $0.42 per Mcfe for the threemonths ended September 30, 2004 from $0.27 per Mcfe for the same prioryear period.

 

Severance and ad valoremtaxes for the three months ended September 30, 2004 increased 59% from thethird quarter of 2003.  Severance taxexpense for the third quarter of 2004 was 72% higher than the comparable prioryear period as a result of higher revenue. Our severance tax expense is leviedon our oil and gas revenue dollars (excluding hedging and derivative impact),so if commodity prices remain high, we expect to continue to incur higherseverance tax expense.  For the threemonths ended September 30, 2004, severance tax expense was approximately5.2% of revenue subject to severance taxes compared to 4.8% of revenue subjectto severance taxes for the comparable 2003 period. The increase in tax as apercent of revenue was due primarily to a shift in our revenue stream toproperties with higher severance tax rates. Ad valorem costs were comparable inthe third quarter of 2003 and the third quarter of 2004.  On an equivalent basis, severance and advalorem taxes averaged $0.32 per Mcfe and $0.26 per Mcfe for the three monthsended September 30, 2004 and 2003, respectively.

 

Depletion, depreciation,and amortization (“DD&A”) and accretion expense for the three months ended September 30,2004 totaled $5.1 million compared to $3.7 million for the three months ended September 30,2003.  Depletion on our oil and naturalgas properties increased 40% for the third quarter of 2004 compared to the sameperiod of 2003 due to an increase in production levels and in theunit-of-production depletion rate from $1.63 in 2003 as compared to $1.79 in2004. The increase in depletion expense from the higher production levels inthe third quarter of 2004 as compared to the same period of 2003 resulted in anincrease in expense of approximately $988,000. The increase in rate for the third quarter of 2004 compared to 2003added approximately $441,800 in depletion expense. Our rate has increased dueto increased spending on our drilling program with disproportionate reserveadditions. Depreciation of furniture and fixtures decreased 26% compared to theprior year third quarter due to several larger depreciable assets that becamefully depreciated by year-end 2003 and are not currently contributing to expense.Accretion expense associated with our asset retirement obligations for thethree months ended September 30, 2004 increased 87% over 2003 for the newobligations incurred from the Miller merger, South Texas property acquisitionand new wells drilled.

 

Total G&A for thethree months ended September 30, 2004 was $1.8 million, an increase of 47%compared to the prior year third quarter total of $1.3 million.  Pursuant to FIN 44 discussed in Note 2 to theconsolidated financial statements, G&A costs include deferred compensationrelated to repriced options, deferred compensation related to restricted stockgrants and other G&A costs. A FIN44 credit of $153,808 was incurred for the three months ended September 30,2004 compared to no activity in the comparable prior year period. Amortizationrelated to restricted stock awards granted over the past three years totaled$143,500 and $93,604, respectively, for the three months ended September 30,2004 and 2003. The increase relates to new grants that have occurred since2003. Other G&A for the three months ended September 30, 2004, whichdoes not include the deferred compensation expenses discussed above, totaled$1.8 million, a 59% increase from the comparable 2003 period total of $1.2million.  The increase in other G&Awas attributable to higher salaries and benefits, due in part to higherstaffing levels, as well as higher professional fees related to Sarbanes-Oxleyregulatory requirements and the costs of other work by our new independentaccountants.  For the three months ended September 30,2004 and 2003, overhead reimbursement fees reduced G&A costs by $49,716 and$30,798, respectively.  CapitalizedG&A costs further reduced other G&A by $552,070 and $571,667,respectively, for the three months ended September 30, 2004 and 2003.  Other G&A on a unit of production basisfor the three months ended September 30, 2004 was $0.66 per Mcfe comparedto $0.53 per Mcfe for the comparable 2003 period.

 

28

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Included in other income (expense) was interestexpense of $22,204 for the three months ended September 30, 2004 comparedto $128,651 in the same 2003 period. The decrease is due to increasedcapitalization of interest and lower interest rates. Interest expense,including facility fees, was $188,843 for the third quarter of 2004 on weightedaverage debt of $19.0 million compared to interest expense of $194,336 onweighted average debt of approximately $21.5 million for the third quarter of2003.  Capitalized interest for the threemonths ended September 30, 2004 totaled $166,639 compared to $65,685 inthe same prior year period due to our higher unproved property balance atperiod end.  We also recordedamortization of deferred loan costs of $35,948 during the third quarter of 2004related to our amended credit facility.

 

An income tax provision was recorded for the threemonths ended September 30, 2004 and 2003 of $1.5 million and $0.9 million,respectively.  The increase resulted fromhigher pre-tax income in 2004 as compared to 2003.

 

For the three monthsended September 30, 2004, we had net income of $2.7 million, or $0.21basic earnings per share and $0.20 diluted earnings per share, as compared tonet income of $1.7 million, or $0.18 basic and $0.17 diluted earnings per sharein the comparable 2003 period.  Basicweighted average shares outstanding increased slightly for stock optionexercises for the three months ended September 30, 2004 and 2003.  The significant increase in sharesoutstanding between September 30, 2004 and 2003 was due primarily to theissuance of 2.6 million shares of stock in the merger with Miller in December 2003as well as the exercise of stock options and warrants and the vesting andissuance of restricted stock during the fourth quarter 2003 and first ninemonths of 2004.

 

**NineMonths Ended September 30, 2004 Compared to the Nine Months Ended September 30,2003**

 

**Revenueand Production**

 

Total revenue increased 89% from the third quarter of2003 to the comparable 2004 period.  Forthe nine months ended September 30, 2004, our product mix contributed thefollowing percentages of production and revenues:

 
| ** **                  | ** ** | **REVENUES (1)** | ** ** | **PRODUCTION** | ** ** |
|-----------------------------|------------|------------------|------------|----------------|------------|
| ** **                  | ** ** | **2004**         | ** ** | **2003**       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Natural  Gas (Mcf)          |       | 84               | %          | 81             | %          | 76 | % | 76 | % |
| Natural  gas liquids (Bbls) |       | 7                | %          | 7              | %          | 13 | % | 15 | % |
| Crude  oil (Bbl)            |       | 9                | %          | 12             | %          | 11 | % | 9 | % |
|                        |       |             |       |           |       |   |   |   |   |
| Total  (Mcfe)               |       | 100              | %          | 100            | %          | 100 | % | 100 | % |

 

----

(1) Includes effect of hedging andderivative transactions.

 

The following table summarizes volume and priceinformation with respect to our oil and gas production for the nine-monthperiods ended September 30, 2004 and 2003:

 
| ** **                                   | ** ** | ** **                                | ** ** | ** ** | ** ** | **2004 Period Compared  to 2003 Period** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|------------|------------|------------------------------------------|------------|
| ** **                                   | ** ** | **Nine Months Ended  September 30,** | ** ** | ** ** | ** ** | ** **                               | ** ** |
| ** **                                   | ** ** | **2004**                                  | ** ** | **2003**   | ** ** | **Increase   (Decrease)**                | ** ** | **%  Increase   (Decrease)** | ** ** |
| **Production Volumes:**                      |       |                                      |       |       |       |                                     |       |   |   |
| Natural  gas (Mcf)                           |       | 6,797,836                                 |       | 4,195,998  |       | 2,601,838                                |       | 62 | % |
| Natural  gas liquids (Bbls)                  |       | 190,944                                   |       | 131,629    |       | 59,315                                   |       | 45 | % |
| Oil  and condensate (Bbls)                   |       | 156,075                                   |       | 84,744     |       | 71,331                                   |       | 84 | % |
| Natural  gas equivalent (Mcfe)               |       | 8,879,950                                 |       | 5,494,236  |       | 3,385,714                                |       | 62 | % |
| **Average Sales Price:**                     |       |                                      |       |       |       |                                     |       |   |   |
| Natural  gas ($ per Mcf)(1)             |       | $                                         | 5.67       |       | $          | 5.59                                     |       | $ | 0.08 |   | 1 | % |
| Natural  gas liquids ($ per Bbl)        |       | $                                         | 15.40      |       | $          | 12.88                                    |       | $ | 2.52 |   | 20 | % |
| Oil  and condensate ($ per Bbl)(1)      |       | $                                         | 36.70      |       | $          | 32.47                                    |       | $ | 4.23 |   | 13 | % |
| Natural  gas equivalent ($ per Mcfe)(1) |       | $                                         | 5.32       |       | $          | 5.08                                     |       | $ | 0.24 |   | 5 | % |
| Natural  gas equivalent ($ per Mcfe)(2) |       | $                                         | 5.06       |       | $          | 4.32                                     |       | $ | 0.74 |   | 17 | % |
| **Operating Revenue:**                       |       |                                      |       |       |       |                                     |       |   |   |
| Natural  gas (1)                             |       | $                                         | 38,535,571 |       | $          | 23,440,741                               |       | $ | 15,094,830 |   | 64 | % |
| Natural  gas liquids                         |       | 2,939,992                                 |       | 1,695,787  |       | 1,244,205                                |       | 73 | % |
| Oil  and condensate (1)                      |       | 5,728,237                                 |       | 2,751,525  |       | 2,976,712                                |       | 108 | % |
| Loss  on hedging and derivatives             |       | (2,299,274                                | )          | (4,160,350 | )          | 1,861,076                                |       | 45 | % |
| Total                                        |       | $                                         | 44,904,526 |       | $          | 23,727,703                               |       | $ | 21,176,823 |   | 89 | % |
|                                              |            |                                           |            |            |            |                                          |            |  |  |  |  |  |  |  |  |  |

 

----

(1) Excludesthe effect of hedging and derivative transactions.

(2) Includesthe effect of hedging and derivative transactions.

 

29

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Natural gas revenue, excluding hedging activity,increased 64% for the nine months ended September 30, 2004 as compared tothe same period in 2003 due to significantly higher production. Average naturalgas production increased 62% from 15.4 MMcf/D in the nine months ended September 30,2003 to 24.8 MMcf/D in the comparable 2004 period due to production from newwells drilled and acquired, primarily our O’Connor Ranch East, Gato Creek,Encinitas and Miller properties, partially offset by natural declines at ourAustin Field and O’Connor Ranch properties. This increase in production compared to the prior year period resultedin an increase in revenue of approximately $14.5 million (based on 2003comparable period pre-hedge prices). Excluding the effect of hedges, the average natural gas sales price forproduction in the first nine months of 2004 was $5.67 per Mcf compared to $5.59per Mcf for the same period in 2003. This increase in average price received resulted in increased revenue ofapproximately $560,000 (based on current year production).

 

Revenue from the sale of NGLs for the nine monthsended September 30, 2004 increased 73% from the same 2003 period due toboth increased production and higher realized prices. Production volumes forNGLs increased 45%, from 482 Bbls/D for the nine months ended September 30,2003 to 697 Bbls/D for the same period in 2004 due primarily to increasedproduction from new wells drilled and acquired. The increase in NGL production increased revenue by approximately$764,000 (based on 2003 comparable period average prices).  Higher average realized prices for the ninemonths ended September 30, 2004 resulted in an increase in revenue ofapproximately $480,000 (based on current year production).

 

Revenue from the sale of oil and condensate, excludingderivative activity, for the nine months ended September 30, 2004increased 108% from the comparable prior year period due primarily toproduction from our Miller properties acquired in late 2003.  Production volumes for oil and condensateincreased 84% to 570 Bbls/D for the nine months ended September 30, 2004compared to 310 Bbls/D for the same period in 2003.  The increase in oil and condensate productionresulted in an increase in revenue of approximately $2.3 million (based on 2003comparable period pre-derivative prices). Excluding the effect of the oilderivatives, the average realized price for oil and condensate for the ninemonths ended September 30, 2004 was $36.70 per barrel compared to $32.47per barrel in the same period of 2003. This higher average price for the first nine months of 2004 resulted inan increase in revenue of approximately $661,000 (based on current yearproduction).

 

Losses on hedging andderivatives decreased 45% for the nine months ended September 30, 2004over the same period in 2003 due to the change in fair market value of ouroutstanding derivative contracts as a result of volatile commodity prices andcash settlements on expiring contracts. For the nine months ended September 30,2004, we realized natural gas hedge losses of $222,000.  In addition, we recognized $411,650 of thepremium paid for a hedge entered into in 2003. These losses decreased the effective natural gas sales price by $0.09per Mcf. Included within natural gas revenue for the nine months ended September 30,2003 was $4.2 million representing realized losses from hedging activity.  These losses decreased the effective naturalgas sales price by $0.99 per Mcf for the nine months ended September 30,2003. For the nine months ended September 30, 2004, we realized crude oilderivative losses of $410,713. In addition, we recorded mark-to-market unrealizedlosses on the change in fair value of the outstanding oil derivative contractsof $1.3 million for the nine months ended September 30, 2004 as

 

30

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compared to none in 2003.We did not apply hedge accounting to these transactions.  See Note 8 to our Consolidated FinancialStatements. The net loss related to the oil collars decreased the average priceper barrel by $10.67.  Should the crudeoil prices decrease from the current highs, we would realize lower revenues,but our oil derivative losses would also decrease and could possibly result ina gain position.

 

**Costs andOperating Expenses**

** **

The table below presentsa detail of our expenses for the nine months ended September 30, 2004 and2003:

 
| ** **                                            | ** ** | **Nine Months Ended   September 30,** | ** ** | **2004 Period Compared   to 2003 Period** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **Increase  (Decrease)** | ** ** | **% Increase  (Decrease)** | ** ** |
|                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Lease  operating expenses                             |       | $                                          | 3,601,898  |                                      | $          | 1,743,352 |   | $ | 1,858,546 |   | 107 | % |
| Severance  and ad valorem taxes                       |       | 3,146,116                                  |       | 1,602,846                                 |       | 1,543,270 |   | 96 | % |
| Depreciation,  depletion, amortization and accretion: |       |                                       |       |                                      |       |   |   |   |   |
| Oil  and gas property and equipment                   |       | 15,154,311                                 |       | 8,803,799                                 |       | 6,350,512 |   | 72 | % |
| Other  assets                                         |       | 282,815                                    |       | 485,792                                   |       | (202,977 | ) | (42 | )% |
| ARO  accretion                                        |       | 80,128                                     |       | 44,652                                    |       | 35,476 |   | 79 | % |
| General  and administrative expenses:                 |       |                                       |       |                                      |       |   |   |   |   |
| Deferred  compensation – repriced options        |       | 1,294,677                                  |       | —                                    |       | 1,294,677 |   |   | *  |
| Deferred  compensation – restricted stock        |       | 354,600                                    |       | 270,043                                   |       | 84,557 |   | 31 | % |
| Other  general and administrative expenses            |       | 5,476,342                                  |       | 3,844,277                                 |       | 1,632,065 |   | 42 | % |
|                                                  |       | 29,390,887                                 |       | 16,794,761                                |       | 12,596,126 |   | 75 | % |
| Other  expense, net                                   |       | 332,101                                    |       | 456,646                                   |       | (124,545 | ) | (27 | )% |
| Total                                                 |       | $                                          | 29,722,988 |                                      | $          | 17,251,407 |   | $ | 12,471,581 |   | 72 | % |

 

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* Not meaningful

 

Lease operating expenses for the nine months ended September 30,2004 increased 107% compared to the same period of 2003.  Current year results were impacted by thedrilling of 38 wells since the third quarter of 2003 as well as increasedproduction of 62% over 2003, the Miller merger, acquisitions of properties fromthird parties, increased costs at O’Connor Ranch, as well as salt waterdisposal costs at the Thibodeaux well for the first half of the year. Thesecost increases have lead to an increase in lease operating expenses to $0.41per Mcfe for the nine months ended September 30, 2004 from $0.32 per Mcfein the comparable prior year period.

 

Severance and ad valoremtaxes for the nine months ended September 30, 2004 increased 96% over2003.  Severance tax expense for thefirst nine months of 2004 of $2.8 million was 111% higher than the comparableprior year period as a result of higher revenue. Our severance tax expense islevied on our oil and gas revenue dollars (excluding hedging and derivativeimpact), so if commodity prices remain high, we expect to continue to incurhigher severance tax expense.  For thenine months ended September 30, 2004, severance tax expense wasapproximately 6.0% of revenue subject to severance taxes compared to 4.8% ofrevenue subject to severance taxes

 

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for the comparable 2003period. The increase in tax as a percent of revenue was due primarily to ashift in our revenue stream to properties with higher severance tax rates. Advalorem costs increased 26% from $274,405 in the first nine months of 2003 to$345,502 in the first nine months of 2004. On an equivalent basis, severance and ad valorem taxes averaged $0.35per Mcfe and $0.29 per Mcfe for the nine months ended September 30, 2004and 2003, respectively.

 

Depletion, depreciation,and amortization (“DD&A”) and accretion expense for the nine months ended September 30,2004 totaled $15.5 million compared to $9.3 million for the same period in2003.  Depletion on our oil and naturalgas properties increased 72% for the first nine months of 2004 compared to thesame period of 2003. Depletion expense on a unit of production basis for thenine months ended September 30, 2004 was $1.71 per Mcfe, compared to a2003 rate of $1.60 per Mcfe for the same period.  The increase in depletion expense was dueprimarily to the higher production levels in the first nine months of 2004 ascompared to the same period of 2003.  Depreciationof furniture and fixtures for the nine months ended September 30, 2004decreased 42% compared to the prior year. In the first quarter of 2003, wemoved offices resulting in accelerated depreciation of leasehold costsassociated with our prior office building lease.  We recorded accretion expense associatedwith our asset retirement obligation for the nine months ended September 30,2004 with an increase of 79% over the comparable 2003 period due to the newobligations incurred for the acquisition, merger and new wells drilled sincethen.

 

Total G&A for thenine months ended September 30, 2004 was $7.1 million, an increase of 73%compared to the comparable prior year total of $4.1 million.  G&A costs include deferred compensationrelated to repriced options, deferred compensation related to restricted stockgrants and other G&A costs. A FIN44 charge of $1.3 million was incurred for the nine months ended September 30,2004 compared to no charge in the comparable prior year period.Amortization related to restricted stock awards granted over the past threeyears totaled $354,600 and $270,043, respectively, for the nine months ended September 30,2004 and 2003. Other G&A for the nine months ended September 30, 2004,which does not include the deferred compensation expenses discussed above,totaled $5.5 million, a 42% increase from the comparable 2003 period total of$3.8 million.  The increase in otherG&A was attributable to higher salaries and benefits, due in part to higherstaffing levels, as well as higher legal and professional fees and higherinvestor relation costs.  In addition, weincurred costs associated with the Miller acquisition of approximately$233,000. For the nine months ended September 30, 2004 and 2003, overheadreimbursement fees reduced G&A costs by $179,762 and $87,033,respectively.  Capitalized G&A costsfurther reduced other G&A by $1.6 million and $1.2 million, respectively,for the nine months ended September 30, 2004 and 2003.  Other G&A on a unit of production basisfor the nine months ended September 30, 2004 was $0.62 per Mcfe comparedto $0.70 per Mcfe for the comparable 2003 period.

 

Included in other income (expense) was interestexpense of $241,887 for the nine months ended September 30, 2004 comparedto $470,086 in the same 2003 period. Interest expense, including facility fees, was $620,005 for the firstnine months of 2004 on weighted average debt of $19.8 million compared tointerest expense of $659,783 on weighted average debt of approximately $21.4million for the first nine months of 2003. Capitalized interest for the nine months ended September 30, 2004totaled $378,118 compared to $189,697 in the same prior year period.  At September 30, 2004, our unprovedproperty balance was $9.1 million compared to $5.0 million at December 31,2003 and $7.6 million at September 30, 2003, resulting in the highercapitalized interest for the 2004 period. We also reported deferred loan costs of $106,332 during the first ninemonths of 2004.  We amended our creditfacility after the Miller merger resulting in loan costs of $425,364 that willbe amortized over a three-year period ending December 31, 2006.

 

An income tax provision was recorded for the ninemonths ended September 30, 2004 and 2003 of $5.4 million and $2.3 million,respectively. The increase is primarily due to the increase in pre-tax income.As of December 31, 2003, we had estimated cumulative NOL carryforwards forfederal income tax purposes of approximately $50.1 million, including $17.4million of NOL carryforwards acquired in the Miller merger, that begin toexpire in 2012.  Currently, we do notanticipate making federal tax payments in 2004.

 

Upon adoption of SFAS No. 143on January 1, 2003, we recorded a cumulative effect of a change inaccounting principal of $357,825 (net of income taxes of $192,675) to recognizetransition amounts for asset retirement obligations, asset retirement costs andaccumulated depletion.

 

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For the nine months endedSeptember 30, 2004, we had net income of $9.8 million, or $0.76 basicearnings per share and $0.73 diluted earnings per share, as compared to netincome of $3.8 million, or $0.40 basic and $0.39 diluted earnings per share inthe comparable 2003 period.  Basicweighted average shares outstanding increased from approximately 9.5 millionfor the nine months ended September 30, 2003 to 12.9 million in thecomparable 2004 period.  The increase inshares outstanding was due primarily to the issuance of stock for theacquisition of Miller in December 2003 as well as the exercise of stockoptions, the exercise of warrants and the vesting and issuance of restrictedstock during 2003 and the first nine months 2004.

 

**Liquidity**

 

Our primary ongoingsource of capital is the cash flow generated from our operating activitiessupplemented by borrowings under our credit facility.  Net cash generated from operating activitiesis a function of production volumes, commodity prices, which are inherentlyvolatile and unpredictable, operating efficiency and capital spending.  Our business, as with other extractiveindustries, is a depleting one in which each gas equivalent unit produced mustbe replaced or we, and a critical source of our future liquidity, will shrink.Our overall production decline is approximately 25% per year.  Less predictable than production declines fromour proved reserves is the impact of constantly changing oil and natural gasprices on cash flows and, therefore capital budgets.  We attempt to mitigate the price risk withour hedging program. Reserves and production volumes are influenced, in part,by the amount of future capital expenditures. In turn, capital expenditures areinfluenced by many factors including drilling results, oil and gas prices,industry conditions, prices, availability of goods and services and the extentto which oil and gas properties are acquired.

 

Some significant changesto working capital may also affect our liquidity in the short term. Theincrease in accrued capital expenditures at September 30, 2004 accountsfor most of the increase in accrued liabilities at September 30, 2004.These accruals represent liabilities incurred from the increase in exploratoryand development activities in the third quarter of 2004 and will requirepayment as soon as we receive invoices from our vendors. Therefore, we expectour short-term cash outflows for the fourth quarter to increase as theseliabilities come due. At September 30, 2004, we had 12 wells in variousstages of drilling and completion.

 

Our liability related tocommodity derivatives has increased to $2.3 million, as commodity pricesincreased, contributing to the working capital reduction. The derivativefinancial instrument liability represents the amount by which strip commodityprices exceed the price caps on our contracts. Should commodity pricesdecrease, the liability will decline, and the unrealized losses on the incomestatement and in other comprehensive income will reduce or could possiblyresult in gains. Since hedges and derivatives are settled out of the receiptsfrom the sale of production, we anticipate having adequate cash inflows tosettle any hedge payments when they come due while maintaining revenue near thederivative price.

 

After considering theimpact of these working capital changes and our forecasts of future results ofoperations, we believe that cash flows from operating activities, assupplemented by borrowings on our line of credit, combined with our ability tocontrol the timing of the majority of our future exploration and developmentrequirements will provide us with the flexibility and liquidity to meet ourplanned capital requirements for 2004. In addition, our revolving creditfacility has $23.0 million available for general corporate purposes, includingexploratory and developmental drilling and acquisitions of oil and gasproperties.

 

*NetCash Provided By Operating Activities*

 

Cash flows provided byoperating activities were $34.4 million for the nine months ended September 30,2004 compared to $16.3 million for the nine months ended September 30,2003.  The significant increase in cashflows provided by operating activities for the nine months ended September 30,2004 compared to 2003 was primarily due to higher oil and gas productionrevenue partially offset by higher operating expense.  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 toreduce the volatility realized on commodity prices, we enter into derivativeinstruments.  Due to the inflatedcommodity pricing for crude oil, the impact related to the derivatives to thefirst nine months of 2004 has been

 

33

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negative, as the priceshave exceeded the highs we expected. We have realized the benefit of these highprices on our crude oil production, but also realized the negative impact from$410,713 of cash settlements on our crude oil derivatives. We have alsorealized $222,000 of cash settlements on our natural gas hedges. Overall, oiland gas production revenue increased with a 62% increase in production and a17% increase in the average price received for our production.

 

*NetCash Used In Investing Activities*

 

We reinvest a substantial portion of our cashflows in our drilling, acquisition, land and geophysical activities.  As a result, we used $36.0 million ininvesting activities during the first nine months of 2004.  Capital expenditures of $32.9 million wereattributable to the drilling of 30 gross wells, 23 of which were successful,including 2, which were being tested at quarter end. Leasehold acquisitions,including seismic data and other geological and geophysical expenditurestotaled $2.6 million and acquisition costs totaled $0.1 million for the ninemonths ended September 30, 2004. The remaining capital expenditures were associated with computerhardware and office equipment.  Proceedsfrom the sale of oil and gas properties totaled $45,000 during the first ninemonths of 2004.  During the nine monthsended September 30, 2003, we used $25.2 million in investingactivities.  Capital expenditures of$25.5 million for the nine months ended September 30, 2003, were partiallyoffset by $330,096 in proceeds from the sale of interests in certain oil andgas properties, including the sale of our interest in the Essex I and Essex IIjoint ventures.

 

We currently anticipatecapital expenditures in 2004 to be approximately $52 million.  Approximately $43.3 million is allocated toour expected drilling and production activities; $4.3 million is allocated toland and seismic activities; and $4.6 million relates to capitalized interestand G&A and other.  We plan to fundthese expenditures from expected cash flow from operations plus someincremental borrowings.  We have not explicitlybudgeted for acquisitions; however, we have spent considerable effort evaluatingacquisition opportunities during 2004 and expect to continue. We have signed aPurchase and Sale Agreement with Contango to purchase onshore South Texasproperties for approximately $50 million (before purchase price adjustments).We expect to fund this acquisition and any others that may occur in the nearterm through traditional oil and gas reserve-based bank debt, and the issuanceof common stock and, if required, through additional debt and equityfinancings.  We currently have $23.0million of unused borrowing capacity under our credit facility.

 

*NetCash Provided By Financing Activities*

 

Cash flows provided byfinancing activities totaled $2.7 million for the nine months ended September 30,2004. Net borrowings of $1.0 million under our current credit facility as wellas deferred loan costs of $0.4 million associated with amending that facilityafter the Miller merger were partially offset by $2.2 million in proceeds fromthe issuance of common stock related to stock options and warrants exercised inthe first nine months of 2004. Cash flows provided by financing activitiestotaled $9.6 million for the nine months ended September 30, 2003, andincluded borrowings of $10.7 million and payments of $1.2 million under ourcredit facility as well as $84,603 in proceeds from the issuance of commonstock.

 

Due to our activeexploration, development and acquisition activities, we have experienced andexpect to continue to experience substantial working capital requirements.  We intend to fund our 2004 capitalexpenditures, commitments and working capital requirements through cash flowsfrom operations, and to the extent necessary, other financing activities.  The projected 2004 cash flows from operationsand borrowing supplements from our line of credit are estimated to besufficient to fund our budgeted exploration and development program.  We believe we will be able to generate capitalresources and liquidity sufficient to fund our capital expenditures and meetsuch financial obligations as they come due.

 

*Contractual Cash Obligations*

 

In July 2004, weexpanded our corporate office space and increased our lease obligation for ahalf floor within our current office building. This increases our totalobligation from $4.1 million to $5.8 million over the same

 

34

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lease term. There were noother material changes, outside the ordinary course of our business, in othercontractual obligations since December 31, 2003.

 

**Capital Resources**

 

Our primary needs for cash are for exploration,development and acquisition of oil and gas properties, and the repayment ofprincipal and interest on outstanding debt. We attempt to fund our exploration and development activities primarilyfrom internally generated cash flows and any shortfalls are supplemented by borrowings under our credit facility. Weroutinely adjust capital expenditures in response to changes in oil and naturalgas prices, drilling and acquisition costs, and cash flow. We typically havefunded acquisitions from borrowings under our credit facility and cash flowfrom operations.  We have historicallyutilized net cash provided by operating activities, debt and equity as capitalresources to obtain necessary funding for all of our cash needs.

 

During 2003 and 2004, the rise in our stock pricecontributed to significant exercise of warrants and stock options, from whichwe have realized increased cash flows from financing activities. During November andDecember of 2003, we issued 375,000 shares of common stock in connectionwith the exercise of warrants that resulted in proceeds to us of approximately$2.0 million.  As of December 31,2003, 45,000 of the warrants were outstanding. On March 2, 2004, Mr. Elias, our Chairman and Chief ExecutiveOfficer, exercised the remaining warrants for 45,000 shares of common stock,which resulted in  proceeds to us ofapproximately $241,000. Increased activity in stock option and warrantexercises has also resulted in proceeds to us of approximately $1.9 million forthe nine months ended September 30, 2004. We typically do not rely onproceeds from the exercise of warrants and stock options to sustain ourbusiness as they are unpredictable events.

 

We had cash and cash equivalents at September 30,2004 of $2.5 million consisting primarily of short-term money marketinvestments, as compared to $1.3 million at December 31, 2003.  Working capital was ($240,810) million as of September 30,2004, as compared to $0.9 million at December 31, 2003.  Available borrowing capacity under ourfacility was $23.0 million at September 30, 2004 and we had $150 millionremaining under our shelf registration statement (see discussion below).

 

In the event such capitalresources are not available to us, our drilling and other activities may becurtailed, which may adversely affect our ability to replace our reserves andproduction streams.

 

*Credit Facility*

 

In March 2004, buteffective December 31, 2003, the Company entered into a new amended andrestated credit facility (the “Credit Facility”) which permits borrowings up tothe lesser of (i) the borrowing base or (ii) $100 million.  Borrowings under the Credit Facility bearinterest at a rate equal to prime plus 0.50% or LIBOR plus 2.25%.  As of September 30, 2004, $22.0 millionin borrowings were outstanding under the Credit Facility and our interest ratewas 4.06%.  The Credit Facility matures December 31,2006 and is secured by substantially all of the Company’s assets.

 

Effective June 2004,the borrowing base under the Credit Facility was increased to $45.0 millionfrom $40.0 million as a result  of theacquisition of properties in the Miller merger and our drilling activitiessince the last redetermination. Effective November 1, 2004, the CreditFacility’s borrowing base was increased from $45.0 million to $48.0 million.

 

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

•                  TheEBITDAX to Interest Expense ratio requires that the ratio of(a) ourconsolidated EBITDAX (defined as EBITDA plus similar non-cash items 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.

 

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•                  TheWorking Capital ratio requires that the amount of our consolidated currentassets less our consolidated current liabilities, as defined in the agreement,be at least $1.0 million.

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

 

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

 

*Shelf Registration Statement*

 

Wefiled a $150 million shelf registration statement with the SEC, which becameeffective in May 2004. Under the shelf registration statement, we mayissue, from time to time, any combination of debt securities, preferred stock,common stock or warrants for debt securities or equity securities in one ormore offerings to those persons who agree to purchase our securities. At September 30,2004, we had $150 million remaining for issuance under the shelf registration.Our ability to utilize our shelf registration statement for the purpose ofissuing, from time to time, any combination of debt securities, preferredstock, common stock or warrants for debt securities or equity securities willdepend upon, among other things, market conditions and the existence ofinvestors who wish to purchase our securities at prices acceptable to us.

 

*Off Balance Sheet Arrangements*

 

We currently do not have any off balance sheet arrangements.

 

**Risk Management Activities –Derivatives & Hedging**

 

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

 

All of these price-riskmanagement transactions are considered derivative instruments and accounted forin accordance with SFAS No. 133, *“Accountingfor Derivative Instruments and Hedging Activities”*. These derivativeinstruments are intended to hedge our price risk and may be considered hedgesfor economic purposes, but certain of these transactions may not qualify forspecial cash flow hedge accounting. Therefore, depending on the type oftransaction and the circumstances, different accounting treatment may apply tothe timing and location of the income statement impact, but all derivatives arerecorded on the balance sheet at fair value. The following table providesadditional information regarding the Company’s various derivative and hedgingtransactions that were recorded at fair value on the balance sheet as of September 30,2004.

 
| Fair  value of contracts outstanding at December 31, 2003                           |   | $          | 120,801    |   |
|------------------------------------------------------------------------------------------|--------|------------|------------|--------|
| Contracts  realized or otherwise settled during the period                               |   | (37,688    | )          |
| Fair  value of new contracts when entered into during 2004                               |   | (1,930,329 | )          |
| Changes  in fair values attributable to changes in valuation techniques and  assumptions |   | —     |       |
| Other  changes in fair values                                                            |   | (429,747   | )          |
| Fair  values of contracts outstanding at September 30, 2004                         |   | $          | (2,276,963 | )      |

 

36

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The following table details the fair value of ourcommodity-based derivative and hedging contracts by year of maturity andvaluation methodology as of September 30, 2004.

 
| ** **                                          | ** ** | **Fair Value of Contracts at September 30, 2004** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------|------------|
| **Source of Fair Value**                            | ** ** | **Maturity  less than 1  year**                        | ** ** | **Maturity  1-3 years** | ** ** | **Maturity  4-5 years** | ** ** | **Maturity in  excess of 5  years** | ** ** | **Total fair  value** | ** ** |
| Prices  actively quoted                             |       | —                                                 |       | — |   | — |   | — |   | — |   |
| Prices  provided by other external sources          |       | (2,159,880                                             | )          | (117,083 | ) | — |   | — |   | (2,276,963 | ) |
| Prices  based on models and other valuation methods |       | —                                                 |       | — |   | — |   | — |   | — |   |
| Total                                               |       | $                                                      | (2,159,880 | ) | $ | (117,083 | ) | $ | — |   | $ | — |   | $ | (2,276,963 | ) |
|                                                     |            |                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Tax Matters**

 

At December 31,2003, we had estimated cumulative NOL carryforwards for federal income taxpurposes of approximately $50.1 million, including $17.4 million of NOL’sacquired in the Miller merger, that will begin to expire in 2012.  We currently anticipate that all of these NOL’swill be utilized in connection with federal income taxes payable in thefuture.  Our ability to fully utilize theNOL’s assumes that certain items, primarily intangible drilling costs, havebeen written off for tax purposes in the current year.  However, we have not made a finaldetermination if an election will be made to capitalize all or part of theseitems for tax purposes in the future.

 

**Recently Issued Accounting Pronouncements**

 

In March 2004, the FASB issued an exposure draftentitled “*Share-Based Payment, an Amendmentof FASB Statement No. 123 and 95*.”  This proposed statement addresses theaccounting for share-based payment transactions in which an enterprise receivesemployee services in exchange for (a) equity instruments of the enterpriseor (b) liabilities that are based on the fair value of the enterprise’sequity instruments or that may be settled by the issuance of such equityinstruments.  The proposed statementwould eliminate the ability to account for share-based compensationtransactions using APB Opinion No. 25, “*Accountingfor Stock Issued to Employees*”, and generally would require insteadthat such transactions be accounted for using a fair-value-based method. TheFASB continued deliberations throughout the third quarter and expects to issuea final statement in the fourth quarter of 2004. As proposed, this statementwould be effective for the Company on January 1, 2005.  We are currently evaluating the impact thatmay result from adoption of this proposed statement.

 

In September 2004, the SEC issued SAB No. 106regarding the application of SFAS No. 143 by oil and gas producingentities that follow the full cost accounting method. SAB No. 106,effective in the fourth quarter of 2004, states that after adoption of SFAS No. 143,the future cash outflows associated with settling asset retirement obligationsthat have been accrued on the balance sheet should be excluded from the presentvalue of estimated future net cash flows used for the full cost ceiling testcalculation. It also confirms that the estimated dismantlement and abandonment costs,net of estimated salvage values, should be included in amortizable base used incomputing unit-of-production depletion. This standard will also requirecompanies to disclose in the accounting impact of SFAS No. 143 on theiroil and gas producing activities, including the calculation of the ceiling testand depreciation, depletion and amortization. The Company currently does notexpect the adoption of SAB No. 106 in the fourth quarter of 2004 to haveany material impact on its financial statements, nor does it expect adoption tohave a material effect on the results of the ceiling test calculation.

 

37

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***ITEM 3.  QUALITATIVE AND QUANTITATIVE DISCLOSURESABOUT MARKET RISK***

 

We are exposed to market risk from changes in interestrates and commodity prices.  We use acredit facility, which has a floating interest rate, to finance a portion ofour operations. We are not subject to fair value risk resulting from changes inour floating interest rates.  The use offloating rate debt instruments provides a benefit due to downward interest ratemovements but does not limit us to exposure from future increases in interestrates.  Based on the September 30,2004 outstanding borrowings and a floating interest rate of 4.06%, a 10% changein interest rates would result in an increase or decrease of interest expenseof approximately $85,300 on an annual basis.

 

In the normal course of business we enter into hedgingtransactions, including commodity price collars, swaps and floors to mitigateour exposure to commodity price movements, but not for trading or speculativepurposes.   During 2003, due to theinstability of prices and to achieve a more predictable cash flow, we put inplace two natural gas collars for a portion of our 2004 production. During thefirst nine months of 2004, we put in place five additional natural gas collarsand two crude oil collars covering 2004 and 2005 production. Please refer toNote 8 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 following is a list of contractsoutstanding during the nine months ended September 30, 2004

 
| **Transaction Date** | ** ** | **Transaction  Type** | ** **   | ** ** | **Beginning** | ** ** | **Ending** | ** ** | **Price  Per Unit** | ** ** | **Volumes  Per Day** | ** ** |
|----------------------|------------|-----------------------|--------------|------------|---------------|------------|------------|------------|---------------------|------------|----------------------|------------|
| ***Natural Gas:***   |       |                  |         |       |          |       |       |       |                |       |                 |       |
| 12/03                |       | Natural Gas Collar    | (1)          |       | 01/01/04      |       | 03/31/04   |       | $4.50-$7.05         |       | 5,000                |       |
| 08/03                |       | Natural Gas Collar    | (1) (2) |       | 04/01/04      |       | 09/30/04   |       | $4.50-$6.00         |       | 10,000               |       |
|                 |       |                  |         |       |          |       |       |       |                |       |                 |       |
|                 |       |                  |         |       | 01/01/04      |       | 03/31/04   |       |                |       |                 |       |
| 08/03                |       | Natural Gas Collar    | (1) (2) |       | 10/01/04      |       | 12/31/04   |       | $4.50-$7.00         |       | 10,000               |       |
| 02/04                |       | Natural Gas Collar    | (1)          |       | 04/01/04      |       | 09/30/04   |       | $4.50-$6.20         |       | 5,000                |       |
| 03/04                |       | Natural Gas Collar    | (1)          |       | 10/01/04      |       | 12/31/04   |       | $4.50-$7.25         |       | 5,000                |       |
| 05/04                |       | Natural Gas Collar    | (1)          |       | 01/01/05      |       | 03/31/05   |       | $5.00-$10.39        |       | 10,000               |       |
| 07/04                |       | Natural Gas Collar    | (1)          |       | 04/01/05      |       | 06/30/05   |       | $5.00-$7.53         |       | 10,000               |       |
| 07/04                |       | Natural Gas Collar    | (1)          |       | 07/01/05      |       | 09/30/05   |       | $5.00-$7.67         |       | 10,000               |       |
|                 |       |                  |         |       |          |       |       |       |                |       |                 |       |
| ***Crude Oil:***     |       |                  |         |       |          |       |       |       |                |       |                 |       |
| 03/04                |       | Crude Oil Collar      | (3)          |       | 04/01/04      |       | 12/31/04   |       | $30.00-$35.50       |       | 400                  |       |
| 05/04(08/04)         |       | Crude Oil Collar      | (3) (4) |       | 01/01/05      |       | 12/31/05   |       | $35.00-$40.00       |       | 200/290              |       |

 

----

(1)                TheCompany’s current hedging activities for natural gas were entered into on a perMMbtu delivered price basis, using the Houston Ship Channel Index, withsettlement for each calendar month occurring five business days following theexpiration date.

(2)                Thiscontract was entered into at a cost of $686,250.

(3)                Hedgeaccounting is not applied to the Company’s collars on crude oil, which wereentered into on a per barrel delivered price basis, using the West TexasIntermediate Index, with settlement for each calendar month occurring fivebusiness days following the expiration date. The change in fair value isreflected in net revenue for the nine months ended September 30, 2004.

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

 

  At September 30,2004, the fair value of the outstanding hedges was a liability of approximately$2.3 million. A 10% change in the commodity price per unit, as long as theprice is either above the ceiling or below the floor price would cause the fairvalue total of the hedge to increase or decrease by approximately $217,400.

 

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

#####  

We maintain disclosure controls and procedures thatare designed to provide reasonable assurance that information required to bedisclosed by us in the reports that we file or submit to the Securities andExchange Commission under the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized and reported within the time periods specifiedby the Commission's rules and forms, and that information is accumulated andcommunicated to our management, including our Chief Executive Officer and ourChief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure. 

 

In March 2005, we discovered an error in a spreadsheetapplication, which was designed to eliminate intercompany balances. As a resultof the error, amounts accumulated in the property account for one subsidiarywere also included as an accrued capital expenditure by another subsidiary andinadvertently not eliminated in consolidation. This caused property balances tobe overstated.  This error in theproperty balance also impacted our computation of depletion expense andtherefore operating expenses, operating income, income tax expense, net incomeand earnings per share.  As a result ofthe error, we are restating our September 30, 2004 financial statements andother disclosures, as reflected in this Amendment No. 1 to our Form 10-Q forthe quarterly period ended September 30, 2004. The error arose as a result of a change in accounting processes thatoccurred during the second quarter of 2004 and therefore prior year resultswere not affected and second quarter 2004 results were not materiallyaffected.  In January 2005, weeffectively corrected the problem by re-instituting the accounting process wehad used prior to the second quarter of 2004. Management has concluded, based on the circumstances involving thespreadsheet error discussed above, that as of December 31, 2004, a materialweakness in internal control over financial reporting existed with respect tothe design of the Company’s controls over the elimination of intercompanybalances and transactions.  

 

In light of our decision to restate the financialstatements and the identification of a material weakness, we carried out anevaluation in accordance with Exchange Act Rules 13a-15 and 15d-15 and underthe supervision and with the participation of management, including our ChiefExecutive Officer and our 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 our Chief Financial Officer concluded that, due tothe material weakness discussed above, our disclosure controls and procedureswere not effective as of September 30, 2004. 

** **

There has been no change in our internal controls overfinancial reporting that occurred during the three months ended September 30,2004 that has materially affected, or is reasonably likely to materiallyaffect, our internal controls over financial reporting.

38

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**PART II - OTHER INFORMATION**

 

**Item 1 - Legal Proceedings**

 

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

 

During the secondquarter of 2004, the Company received notice that its franchise tax returns forthe State of Texas would be audited for the tax years 1999 through 2002. Afterreviewing documents submitted, the agent representing the Office of theComptroller of the State of Texas proposed adjustments to the calculation thatwould result in an increased franchise tax liability.  The agent maintained that transfers by theparent company to its subsidiaries that the Company classified as intercompanyloans should instead be classified 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.

 

During the third quarter the agent reduced theproposed franchise tax deficiency adjustment to the Company and itssubsidiaries to an aggregate of $467,000. The Company intends to continue tovigorously contest this proposed franchise tax assessment through appropriateadministrative levels in the Comptroller’s Office.   The next step in the administrative processis a hearing at the Comptroller’s Office scheduled for November 2004.  Should the Company’s administrative appealsprove unsuccessful, the Company plans to seek further appellate relief throughavailable judicial means.  Due to itsintention to continue to vigorously contest the proposed adjustments, theCompany has not recognized any provision for the additional franchise taxes thatwould result from the proposed deficiency.

 
| **Item 2 – Unregistered Sale of Equity Securities  and Use of Proceeds** | None   |
|-------------------------------------------------------------------------------|--------|
| **Item 3 - Defaults Upon Senior Securities**                                  | None   |
| **Item 4 - Submission of Matters to a Vote of  Security Holders**             | None   |
| **Item 5 - Other Information**                                                | None   |
|                                                                          |   |
| **Item 6 - Exhibits**                                                         |   |

 

The following exhibits are filed as partof this report:

 

# **INDEX TO EXHIBITS**

 
| **Exhibit No.** |   |
|----------------------|--------|
| 2.1                  | — |   | Amended and Restated  Combination Agreement by and among (i) Edge Group II Limited  Partnership, (ii) Gulfedge Limited Partnership, (iii) Edge Group  Partnership, (iv) Edge Petroleum Corporation, (v) Edge  Mergeco, Inc. and (vi) the Company, dated as of January 13,  1997 (Incorporated by reference from exhibit 2.1 to the Company’s  Registration Statement on Form S-4 (Registration No. 333-17269)). |
|                 |   |   |   |   |
| 2.2                  | — |   | Agreement and Plan of  Merger dated as of May 28, 2003 among Edge Petroleum Corporation, Edge  Delaware Sub Inc. and Miller Exploration Company (Miller”) (Incorporated by  reference from Annex A to the Joint Proxy Statement/Prospectus contained in  the Company’s Registration Statement on Form S-4/A filed on  October 31, 2003 (Registration No. 333-106484)). |

 

39

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| 2.3    | — |   | Asset Purchase  Agreement dated as of October 7, 2004 by and among Contango Step, L.P.,  Contango Oil and Gas Company, Edge Petroleum Exploration Company and Edge  Petroleum Corporation (Incorporated by reference from exhibit 2.1 to the  Company’s Form 8-K filed on October 12, 2004).                                                                                                                                                                                                                                   |
|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |
| 3.1    | — |   | Restated Certificate of  Incorporation of the Company (Incorporated by reference from exhibit 3.1 to  the Company’s Registration Statement on Form S-1/A filed on  February 5, 1997 (Registration No. 333-17267)).                                                                                                                                                                                                                                                                                                             |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |
| 3.2    | — |   | Certificate of  Amendment to the Restated Certificate of Incorporation of the Company  (Incorporated by reference from exhibit 3.1 to the Company’s Registration  Statement on Form S-1/A filed on February 5, 1997 (Registration  No. 333-17267)).                                                                                                                                                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |
| 3.3    | — |   | 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).                                                                                                                                                                                                                                                                                                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |
| 3.4    | — |   | 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).                                                                                                                                                                                                                                                                                                               |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |
| 3.5    | — |   | 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 by and between Edge  Petroleum Corporation, Edge Petroleum Exploration Company, Edge Petroleum  Operating Company, Inc., Miller Oil Corporation, and Miller Exploration  Company, as borrowers, and Union Bank of California, N.A., a national banking  association, as Agent for itself and as lender. (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    | — |   | Registration Rights  Agreement by and among Edge, Guardian Energy Management Corp., Kelly E.  Miller and the Debra A. Miller Trust, dated December 4, 2003  (Incorporated by reference from exhibit 4.2 of the Company’s Registration  Statement on Form S-3 filed on February 3, 2004 (Registration  No. 333-112462)).                                                                                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |
| 4.3    | — |   | Securities Purchase  Agreement between Miller and Guardian Energy Management Corp., dated  July 11, 2000 (Incorporated by reference from exhibit 10.1 to Miller’s  Current Report on Form 8-K, filed on July 25, 2000).                                                                                                                                                                                                                                                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |
| 4.4    | — |   | Warrant between Miller  and Guardian Energy Management Corp., dated July 11, 2000, exercisable  for 900,000 shares of Miller’s common stock (as adjusted for the one for ten  reverse stock split of Miller effected October 11, 2002 and as adjusted  pursuant to the Agreement and Plan of Merger by and among the Company, Edge  Delaware Sub Inc. and Miller) (incorporated by reference from  Exhibit 4.3 to Miller’s Current Report on Form 8-K filed on July 25,  2000).                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |
| 4.5    | — |   | Miller Exploration  Company Stock Option and Restricted Stock Plan of 1997 (Incorporated by  reference from exhibit 10.1(a) to Miller’s Annual Report on Form 10-K  for the year ended December 31, 1997 (File No. 000-23431)).                                                                                                                                                                                                                                                                                           |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |
| 4.6    | — |   | 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’s Registration  Statement on Form S-8 filed on April 11, 2001 (Registration  No. 333-58678)).                                                                                                                                                                                                                                                               |

 

40

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| 4.7          | — |   | 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’s Registration  Statement on Form S-8 filed on April 11, 2001 (Registration  No. 333-58678)).                                                              |
|--------------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 4.8          | — |   | Form of Miller  Stock Option Agreement (Incorporated by reference from exhibit  10.1(b) to Miller’s Annual Report on Form 10-K for the year ended  December 31, 1997 (File No. 000-23431)).                                                                                                                         |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 10.1         | — |   | Joint Venture Agreement  between Edge Joint Venture II and Essex Royalty Limited Partnership II, dated  as of May 10, 1994 (Incorporated by reference from exhibit 10.2 to the  Company’s Registration Statement on Form S-4 (Registration No. 333-17269)).                                                                   |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 10.2         | — |   | Joint Venture Agreement  between Edge Joint Venture II and Essex Royalty Limited Partnership, dated as  of April 11, 1992 (Incorporated by reference from exhibit 10.3 to the  Company’s Registration Statement on Form S-4 (Registration No. 333-17269)).                                                                    |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 10.3         | — |   | Amendment dated  August 21, 2000 to the Joint Venture Agreement between Edge Joint  Venture II and Essex Royalty Limited Partnership II, dated as of May 10,  1994. (Incorporated by reference from exhibit 10.3 to the Company’s Annual  Report on Form 10-K/A for the year ended December 31, 2002).                   |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 10.4         | — |   | Amendment dated  August 21, 2000 to the Joint Venture Agreement between Edge Joint  Venture II and Essex Royalty Limited Partnership, dated as of April 11,  1992. (Incorporated by reference from exhibit 10.2 to the Company’s Annual  Report on Form 10-K/A for the year ended December 31, 2002).                    |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 10.5         | — |   | Letter Agreement  between Edge Petroleum Corporation and Essex Royalty Limited Partnership,  dated as of July 30, 2002. (Incorporated by reference from exhibit 10.4  to the Company’s Annual Report on Form 10-K/A for the year ended  December 31, 2002).                                                                   |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 10.6         | — |   | 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)).                                                                                                            |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 10.7         | — |   | 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)).                                                                                                                           |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 10.8         | — |   | 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).                                                                                                 |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| +10.9        | — |   | Incentive Plan of Edge  Petroleum Corporation as Amended and Restated Effective as of June 1,  2004.                                                                                                                                                                                                                                         |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 10.10        | — |   | 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). |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| 10.11        | — |   | 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). |
|         |   |   |                                                                                                                                                                                                                                                                                                                                              |   |
| +10.12  | — |   | Form of Director’s  Restricted Stock Award Agreement under the Incentive Plan of Edge Petroleum  Corporation.                                                                                                                                                                                                                           |

 

41

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| 10.13  | — |   | Severance Agreements by  and between Edge Petroleum Corporation and the Officers of the Company named  herein. (Incorporated by reference from exhibit 10.4 to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999). |
|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                            |   |
| 10.14  | — |   | 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). |
|   |   |   |                                                                                                                                                                                                                                                                            |   |   |
| 10.15  | — |   | 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)).                            |
|   |   |   |                                                                                                                                                                                                                                                                            |   |
| 10.16  | — |   | 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)).             |
|   |   |   |                                                                                                                                                                                                                                                                            |   |
| *31.1  | — |   | Certification by John  W. Elias, Chief Executive Officer, pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                      |
|   |   |   |                                                                                                                                                                                                                                                                            |   |
| *31.2  | — |   | Certification by  Michael G. Long, Chief Financial Officer, pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                    |
|   |   |   |                                                                                                                                                                                                                                                                            |   |
| *32.1  | — |   | Certification by John  W. Elias, Chief Executive Officer, pursuant to 18 USC Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                     |
|   |   |   |                                                                                                                                                                                                                                                                            |   |
| *32.2  | — |   | Certification by  Michael G. Long, Chief Financial Officer, pursuant to 18 USC  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                  |
|        |        |        |                                                                                                                                                                                                                                                                                 |  |  |

 

----

* Filed herewith.

+ Previously filed.

 

42

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## **SIGNATURES**

 

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

 

 
|                                              | EDGE PETROLEUM  CORPORATION, |
|---------------------------------------------------|------------------------------|
|                                              | A DELAWARE CORPORATION       |
|                                              | (REGISTRANT)                 |
|                                              |                         |   |
|                                              |                         |   |
| Date      March 16, 2005 |                         | /s/ John W.  Elias |   |
|                                              | John W. Elias                |   |
|                                              | Chief Executive Officer  and |   |
|                                              | Chairman of the  Board       |   |
|                                              |                         |   |
|                                              |                         |   |
| Date      March 16, 2005 |                         | /s/ Michael G.  Long |   |
|                                              | Michael G. Long              |   |
|                                              | Senior Vice  President and   |   |
|                                              | Chief Financial  Officer     |   |

 

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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  dated as of October 7, 2004 by and among Contango Step, L.P., Contango  Oil and Gas Company, Edge Petroleum Exploration Company and Edge Petroleum  Corporation (Incorporated by reference from exhibit 2.1 to the Company’s  Form 8-K filed on October 12, 2004). |
|                 |   |   |   |
| 3.1                  | — |   | Restated Certificate of  Incorporation of the Company (Incorporated by reference from exhibit 3.1 to  the Company’s Registration Statement on Form S-1/A filed on  February 5, 1997 (Registration No. 333-17267)). |
|                 |   |   |   |
| 3.2                  | — |   | Certificate of Amendment  to the Restated Certificate of Incorporation of the Company (Incorporated by  reference from exhibit 3.1 to the Company’s Registration Statement on  Form S-1/A filed on February 5, 1997 (Registration No. 333-17267)). |
|                 |   |   |   |
| 3.3                  | — |   | 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). |
|                 |   |   |   |
| 3.4                  | — |   | 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). |
|                 |   |   |   |
| 3.5                  | — |   | 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 by and between Edge  Petroleum Corporation, Edge Petroleum Exploration Company, Edge Petroleum  Operating Company, Inc., Miller Oil Corporation, and Miller Exploration  Company, as borrowers, and Union Bank of California, N.A., a national banking  association, as Agent for itself and as lender. (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                  | — |   | Registration Rights  Agreement by and among Edge, Guardian Energy Management Corp., Kelly E.  Miller and the Debra A. Miller Trust, dated December 4, 2003  (Incorporated by reference from exhibit 4.2 of the Company’s Registration  Statement on Form S-3 filed on February 3, 2004 (Registration  No. 333-112462)). |
|                 |   |   |   |
| 4.3                  | — |   | Securities Purchase  Agreement between Miller and Guardian Energy Management Corp., dated  July 11, 2000 (Incorporated by reference from exhibit 10.1 to Miller’s  Current Report on Form 8-K, filed on July 25, 2000). |
|                 |   |   |   |
| 4.4                  | — |   | Warrant between Miller  and Guardian Energy Management Corp., dated July 11, 2000, exercisable  for 900,000 shares of Miller’s common stock (as adjusted for the one for ten  reverse stock split of |

 

44

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|   |   |   | Miller effected  October 11, 2002 and as adjusted pursuant to the Agreement and Plan of  Merger by and among the Company, Edge Delaware Sub Inc. and Miller)  (incorporated by reference from Exhibit 4.3 to Miller’s Current Report  on Form 8-K filed on July 25, 2000).                             |
|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 4.5    | — |   | Miller Exploration  Company Stock Option and Restricted Stock Plan of 1997 (Incorporated by  reference from exhibit 10.1(a) to Miller’s Annual Report on Form 10-K  for the year ended December 31, 1997 (File No. 000-23431)).                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 4.6    | — |   | 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’s Registration  Statement on Form S-8 filed on April 11, 2001 (Registration  No. 333-58678)).                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 4.7    | — |   | 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’s Registration  Statement on Form S-8 filed on April 11, 2001 (Registration  No. 333-58678)).                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 4.8    | — |   | Form of Miller  Stock Option Agreement (Incorporated by reference from exhibit  10.1(b) to Miller’s Annual Report on Form 10-K for the year ended  December 31, 1997 (File No. 000-23431)).                                                                                                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 10.1   | — |   | Joint Venture Agreement  between Edge Joint Venture II and Essex Royalty Limited Partnership II, dated  as of May 10, 1994 (Incorporated by reference from exhibit 10.2 to the  Company’s Registration Statement on Form S-4 (Registration No. 333-17269)).                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 10.2   | — |   | Joint Venture Agreement  between Edge Joint Venture II and Essex Royalty Limited Partnership, dated as  of April 11, 1992 (Incorporated by reference from exhibit 10.3 to the  Company’s Registration Statement on Form S-4 (Registration No. 333-17269)).                                                  |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 10.3   | — |   | Amendment dated  August 21, 2000 to the Joint Venture Agreement between Edge Joint  Venture II and Essex Royalty Limited Partnership II, dated as of May 10,  1994. (Incorporated by reference from exhibit 10.3 to the Company’s Annual  Report on Form 10-K/A for the year ended December 31, 2002). |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 10.4   | — |   | Amendment dated  August 21, 2000 to the Joint Venture Agreement between Edge Joint  Venture II and Essex Royalty Limited Partnership, dated as of April 11,  1992. (Incorporated by reference from exhibit 10.2 to the Company’s Annual  Report on Form 10-K/A for the year ended December 31, 2002).  |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 10.5   | — |   | Letter Agreement  between Edge Petroleum Corporation and Essex Royalty Limited Partnership,  dated as of July 30, 2002. (Incorporated by reference from exhibit 10.4  to the Company’s Annual Report on Form 10-K/A for the year ended  December 31, 2002).                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 10.6   | — |   | 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)).                                                                                          |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 10.7   | — |   | 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)).                                                                                                         |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| 10.8   | — |   | 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).                                                                               |
|   |   |   |                                                                                                                                                                                                                                                                                                                            |
| +10.9  | — |   | Incentive Plan of Edge  Petroleum Corporation as Amended and Restated Effective as of June 1,  2004.                                                                                                                                                                                                                       |

 

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| 10.10        | — |   | 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).  |
|--------------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.11        | — |   | 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). |
|         |   |   |                                                                                                                                                                                                                                                                                                                                               |
| +10.12  | — |   | Form of Director’s  Restricted Stock Award Agreement under the Incentive Plan of Edge Petroleum  Corporation.                                                                                                                                                                                                                            |
|         |   |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.13        | — |   | Severance Agreements by  and between Edge Petroleum Corporation and the Officers of the Company named  herein. (Incorporated by reference from exhibit 10.4 to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999).                                                                    |
|         |   |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.14        | — |   | 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).                                                                    |
|         |   |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.15        | — |   | 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)).                                                                                               |
|         |   |   |                                                                                                                                                                                                                                                                                                                                               |
| 10.16        | — |   | 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)).                                                                                |
|         |   |   |                                                                                                                                                                                                                                                                                                                                               |
| *31.1        | — |   | Certification by John  W. Elias, Chief Executive Officer, pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                         |
|         |   |   |                                                                                                                                                                                                                                                                                                                                               |
| *31.2        | — |   | Certification by  Michael G. Long, Chief Financial Officer, pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                       |
|         |   |   |                                                                                                                                                                                                                                                                                                                                               |
| *32.1        | — |   | Certification by John  W. Elias, Chief Executive Officer, pursuant to 18 USC Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                        |
|         |   |   |                                                                                                                                                                                                                                                                                                                                               |
| *32.2        | — |   | Certification by  Michael G. Long, Chief Financial Officer, pursuant to 18 USC  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                     |

 

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* Filed herewith.

+ Previously filed.

 

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