<PAGE>   1
 
================================================================================
 
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
 
                                   FORM 10-K
                             ---------------------
 
(MARK ONE)
[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934 [FEE REQUIRED]
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
 
                                       OR
 
[  ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
      EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
 
        FOR THE TRANSITION PERIOD FROM                TO
 
                         COMMISSION FILE NUMBER 0-3880
 
                                TOM BROWN, INC.
             (Exact name of registrant as specified in its charter)
                             ---------------------
 
<TABLE>
        <S>                                           <C>
                       DELAWARE                                     95-1949781
           (State or other jurisdiction of                       (I.R.S. Employer
            incorporation or organization)                     Identification No.)
 
                    P. O. Box 2608
                500 Empire Plaza Bldg.
                    Midland, Texas                                    79701
           (Address of principal executive
                        offices)                                    (Zip Code)
</TABLE>
 
                             ---------------------
 
                                  915-682-9715
              (Registrant's telephone number, including area code)
 
        Securities registered pursuant to Section 12(b) of the Act: NONE
 
          Securities registered pursuant to Section 12(g) of the Act:
                          COMMON STOCK, $.10 PAR VALUE
                  CONVERTIBLE PREFERRED STOCK, $.10 PAR VALUE
                                (Title of Class)
 
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
          YES [X]                    NO  [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
 
     The aggregate market value of the Registrant's Common Stock held by
non-affiliates (based upon the last sale price of $20.125 per share as quoted on
the NASDAQ National Market System) on March 20, 1998 was approximately
$588,514,952.
 
     As of March 20, 1998, there were 29,242,979 shares of Common Stock
outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     Portions of the Registrant's definitive proxy statement for the 1998 Annual
Meeting of Stockholders to be held on May 21, 1998 are incorporated by reference
into Part III.
================================================================================
<PAGE>   2
 
                                TOM BROWN, INC.
 
                                   FORM 10-K
 
                                    CONTENTS
 
<TABLE>
<CAPTION>
                                                                              PAGE
                                                                              ----
  <S>         <C>                                                             <C>
  PART I
    Item 1.   Business....................................................      3
    Item 2.   Properties..................................................     10
    Item 3.   Legal Proceedings...........................................     13
    Item 4.   Submission of Matters to a Vote of Security Holders.........     13
  PART II
    Item 5.   Market for Registrant's Common Equity and Related                14
                Stockholder Matters.......................................
    Item 6.   Selected Financial Data.....................................     15
    Item 7.   Management's Discussion and Analysis of Financial Condition      16
                and Results of Operations.................................
    Item 8.   Financial Statements and Supplementary Data.................     20
    Item 9.   Changes in and Disagreements with Accountants on Accounting      45
                and Financial Disclosure..................................
  PART III
    Item 10.  Directors and Executive Officers of the Registrant..........     45
    Item 11.  Executive Compensation......................................     45
    Item 12.  Security Ownership of Certain Beneficial Owners and              45
                Management................................................
    Item 13.  Certain Relationships and Related Transactions..............     45
  PART IV
    Item 14.  Exhibits, Financial Statement Schedules and Reports on Form      46
                8-K.......................................................
    Signatures............................................................     48
</TABLE>
 
                                        2
<PAGE>   3
 
                                     PART I
 
ITEM 1. BUSINESS
 
GENERAL
 
     Tom Brown, Inc. (the "Company") was organized as a Nevada corporation in
1931 under the name Gold Metals Consolidated Mining Company. The name of the
Company was changed to Tom Brown Drilling Company, Inc. in 1968 and to Tom
Brown, Inc. in 1971. In April 1987, the Company changed its state of
incorporation from Nevada to Delaware. The executive offices of the Company are
located at 500 Empire Plaza, Midland, Texas 79701 and its telephone number at
that address is (915) 682-9715. Unless the context otherwise requires, all
references to the "Company" include Tom Brown, Inc. and its subsidiaries.
 
     The Company is engaged primarily in the domestic exploration for, and the
acquisition, development, production, marketing, and sale of, natural gas and
crude oil. The Company's activities are conducted principally in the Wind River
and Green River Basins of Wyoming, the Piceance Basin of Colorado, the Val Verde
Basin of west Texas and the Permian Basin of west Texas and southeastern New
Mexico, and the East Texas Basin. The Company also, to a lesser extent, conducts
exploration and development activities in other areas of the continental United
States.
 
     The Company's industry segments are (i) the exploration for, and the
acquisition, development and production of, natural gas and crude oil, and (ii)
the marketing, gathering, processing and sale of natural gas, primarily through
Wildhorse Energy Partners, L.L.C. ("Wildhorse").
 
     Except for its gas and oil leases with domestic governmental entities and
other third parties who enter into gas and oil leases or assignments with the
Company in the regular course of its business, the Company has no material
patents, licenses, franchises or concessions which it considers significant to
its gas and oil operations.
 
     The nature of the Company's business is such that it does not maintain or
require a substantial amount of products, customer orders or inventory. The
Company's gas and oil operations are not subject to renegotiations of profits or
termination of contracts at the election of the federal government.
 
     The Company has not been a party to any bankruptcy, receivership,
reorganization or similar proceeding, except in connection with reorganization
of Presidio Oil Company as described in Note 3 to Notes to Consolidated
Financial Statements.
 
BUSINESS STRATEGY
 
     The Company's business strategy is to increase shareholder value through
the acquisition and development of long-lived gas and oil reserves in areas
where the Company has industry knowledge and operations expertise. The Company's
principal investments have been in natural gas prone basins, which the Company
believes will continue to provide the opportunity to accumulate significant
long-lived gas and oil reserves at attractive prices.
 
     This strategy has enabled the Company to achieve the following:
 
  Maintain a strong balance sheet
 
     The Company emphasizes maintaining a strong balance sheet in order to
enhance its operating and financing flexibility. The Company received net
proceeds of approximately $121 million through an equity offering completed in
October 1997 and reduced long-term debt to $23 million outstanding at December
31, 1997.
 
  Achieve critical mass in core areas
 
     The Company's acreage position is approximately 3,065,000 gross (1,742,000
net) acres (including options) located primarily in the Wind River and Green
River Basins of Wyoming, the Piceance Basin of Colorado, and the Permian, Val
Verde and East Texas Basins of Texas where the Company can utilize its
 
                                        3
<PAGE>   4
 
geological and technical expertise and its control of operations for the further
development and expansion of these areas. The Company has leases, or options to
lease, approximately 2,037,000 gross (1,289,000 net) developed and undeveloped
acres in these areas.
 
  Increase reserves
 
     The Company has significantly increased its reserves over the last two
years through several acquisitions and through development drilling. The Company
replaced its production over 4.6 times during the period from January 1, 1996
through December 31, 1997. During this period, the Company's proved reserves
increased by approximately 108% to 390 billion cubic feet of natural gas
equivalents.
 
  Increase production
 
     The Company increased its net production of natural gas and oil to 106
million cubic feet equivalent ("Mmcfe") of natural gas in 1997, an increase of
approximately 207% as compared with its production in 1995.
 
  Enhance gas marketing
 
     Primarily through the formation of Wildhorse, the Company has strengthened
its ability to control and market its production by accumulating natural gas
gathering assets and increasing its marketing efforts in its core areas of
activity.
 
  Make strategic acquisitions
 
     The Company plans to continue to selectively pursue acquisitions of gas and
oil properties in its core areas of activity and, in connection therewith, the
Company from time to time will be involved in evaluations of, or discussions
with, potential acquisition candidates. The consideration for any such
acquisition might involve the payment of cash and/or the issuance of equity or
debt securities.
 
     Notwithstanding the Company's historical ability to implement the above
strategy, there can be no assurance that the Company will be able to continue to
successfully implement its strategy in the future.
 
AREAS OF ACTIVITY
 
     The following discussion focuses on areas the Company considers to be its
core areas of operations and those that offer the Company the greatest
opportunities for further exploration and development activities.
 
  Wind River, Green River, and Piceance Basins
 
     The Wind River and Green River Basins of Wyoming, and Piceance Basin of
Colorado account for a major portion of the Company's current and anticipated
exploration and development activities with approximately 65% of the Company's
proved reserves at December 31, 1997. The Company owns interests in 910
producing wells in these basins that averaged net daily production of 44 million
cubic feet of natural gas equivalent ("Mmcfe") for 1997. The Company has
approximately 1,810,000 gross (1,180,000 net) developed acres and undeveloped
acres in these basins. Additionally, the Company has options to lease
approximately 963,000 gross (548,000 net) undeveloped acres in the Wind River
Basin. The Company's interest in the leases and options to lease are subject to
the Company performing certain 3-D seismic operations and drilling certain
exploratory wells.
 
     Although the Wind River Basin has experienced limited natural gas
transportation capacity, market forces are working to correct this capacity
constraint. In January 1996, KN Energy, Inc. ("KNE") announced that it reached
an agreement to acquire an 850-mile oil pipeline owned by Amoco Pipeline
Company, which extends from Riverton, Wyoming southwest to Kansas City,
Missouri. The pipeline, renamed Pony Express, has been converted to transport
natural gas and has a capacity of 200 Mmcf per day. The Company expects Pony
Express to generate significant opportunities for Wildhorse, which has
contracted for firm transportation of 30 Mmcf of natural gas per day on this
line.
                                        4
<PAGE>   5
 
  Val Verde Basin
 
     The Val Verde Basin accounted for approximately 11% of the Company's proved
reserves at December 31, 1997. The Company holds a 50% working interest in
approximately 37,000 gross acres and 38 producing wells in this basin.
Production from this basin averaged 28 Mmcfe per day of natural gas net to the
Company's interest for 1997.
 
  Permian Basin
 
     The Permian Basin contains significant oil reserves for the Company and
accounted for approximately 4% of the Company's proved reserves as of December
31, 1997. The Company's properties in the Permian Basin are located primarily in
the Spraberry Field. The Company operates 115 wells and has approximately 32,000
net developed and undeveloped acres in this basin.
 
  East Texas Basin
 
     In January 1996 the Company began an exploration program in the Cotton
Valley Pinnacle Reef Trend of the East Texas Basin. At year-end 1997, it had
accumulated approximately 105,000 gross (58,000 net) acres in three prospect
areas containing over 40 2-D anomalies. The Company anticipates drilling an
exploratory well in the summer of 1998.
 
RECENT DEVELOPMENTS
 
  Acquisition of Sauer Drilling Company
 
     On January 7, 1998, the Company completed the acquisition of W. E. Sauer
Companies L.L.C. of Casper, Wyoming for approximately $8.1 million. The assets
purchased include five drilling rigs, tubular goods, a yard and related assets.
The Company operates the assets under the name Sauer Drilling Company and will
continue to serve the drilling needs of operators in the central Rocky Mountain
region in addition to drilling for the Company.
 
  Acquisition of the Assets of Genesis Gas and Oil, L.L.C.
 
     On October 21, 1997, the Company completed the acquisition of the assets of
Genesis Gas and Oil, L.L.C. The Genesis assets are located primarily in the
Piceance Basin of western Colorado and are principally operated by the Company.
The properties provide current net production of approximately 6 million cubic
feet of gas and 150 barrels of oil per day. The acquisition increases the
Company's acreage position in the Piceance Basin from approximately 54,000 to
86,000 net developed and 100,000 to 148,000 net undeveloped acres. The Company's
working interest has doubled from 23% to 46% in 238 producing wells and from 34%
to 68% in 500 potential development locations. The purchase price for these
assets was approximately $35.5 million.
 
  Acquisition of Gathering and Processing Assets by Wildhorse
 
     On December 19, 1997, KNE completed the acquisition of all of the assets of
Interenergy Corporation. The assets consist of gas gathering and processing
facilities located in Wyoming, Montana, North Dakota and South Dakota, as well
as a marketing division. KNE retained the marketing assets and Wildhorse
acquired the gathering and processing assets valued at $23.4 million. These
assets consist of over 300 miles of pipeline and a processing plant. The
Company, through its 45% share of Wildhorse, will benefit from the acquisition
as it develops its acreage in the Big Horn Basin.
 
  Acquisition of KN Production Company
 
     Pursuant to a letter of intent entered into in December 1995, the Company
and KNE closed certain transactions on January 31, 1996 which resulted in (i)
the Company's acquisition of all of the issued and outstanding stock of KN
Production Company ("KNPC"), a wholly owned subsidiary of KNE, and (ii)
Wildhorse being formed by the Company and KNE for the purpose of providing gas
gathering, processing, marketing, field and storage services, (collectively the
"KNPC Acquisition"). The price paid to KNE in
 
                                        5
<PAGE>   6
 
connection with the KNPC Acquisition was determined to be $36.25 million, of
which $25 million was paid in the form of 1.0 million shares of the Company's
$1.75 Convertible Preferred Stock, Series A (the "Preferred Stock") and the
remaining $11.25 million was paid in the form of 918,367 shares of the Company's
Common Stock, based on a price per share of $12.25. Additionally, the Company
dedicated a significant amount of its Rocky Mountain gas production to Wildhorse
and KNE contributed gas marketing contracts and gas storage assets located in
western Colorado. The KNPC Acquisition has been recorded under the purchase
method of accounting.
 
     As a result of the KNPC Acquisition, the Company acquired interests in 624
gross producing wells in Colorado and Wyoming, of which the Company became
operator of 308. The Company also acquired a natural gas storage facility in
western Colorado. The properties acquired by the Company included approximately
243,000 net undeveloped acres in Colorado, Wyoming, Kansas and Nebraska and
approximately 64,000 net developed acres located in Colorado and Wyoming.
 
     An integral part of the KNPC Acquisition was the formation of Wildhorse,
which is owned fifty-five percent (55%) by KNE and forty-five percent (45%) by
the Company. The business and affairs of Wildhorse are managed by KNE under the
direction of an operating team consisting of two representatives appointed by
the Company and two representatives appointed by KNE.
 
     The principal purpose of Wildhorse is to provide for services related to
natural gas, natural gas liquids and other natural gas products, including
gathering, processing and storage services, marketing services and field
services.
 
  Acquisition of Presidio Oil Company
 
     On December 23, 1996, the Company completed the acquisition of Presidio Oil
Company and its subsidiaries (the "Presidio Acquisition"), following the
issuance by the U.S. Bankruptcy Court, District of Delaware, on December 10,
1996, of an Order confirming Presidio Oil Company's reorganization under Chapter
11 of the U.S. Bankruptcy Code. The purchase price was approximately $202.6
million consisting of approximately $105 million in cash and 2.71 million shares
of the Company's Common Stock valued at $17.125 per share, plus the assumption
of certain liabilities. Such amount does not include 2.64 million shares of the
Company's Common Stock which were not issued due to the Company's ownership of
$56.15 million principal amount of Presidio Oil Company's Senior Gas Indexed
Notes (the "GINs"). The GINs were purchased in June 1995 for approximately $51
million as a strategic part of the Company's efforts to acquire Presidio Oil
Company. The Presidio Acquisition has been accounted for using the purchase
method. The cash portion of the Presidio Acquisition was funded by borrowings
under the Company's credit agreement with its bank lender. The assets acquired
consist of primarily proved oil and gas properties and approximately 865,000
gross (403,000 net) developed and undeveloped acres located primarily in
Wyoming, North Dakota, Oklahoma and Louisiana. The Wyoming properties are
concentrated in the Green River and Powder River Basins.
 
  Joint Ventures
 
     In December 1994 and December 1995, the Company and the Shoshone and
Northern Arapaho Tribes ("the Tribes") finalized the negotiations of six gas and
oil option agreements, which in addition to one option acquired earlier in 1993,
encompass approximately 663,000 gross acres (400,000 net acres) in the Wind
River Basin of Fremont County, Wyoming. The agreements, which were approved by
the Bureau of Indian Affairs, grant the Company the right to explore for and
develop gas and oil reserves on the option acreage over a ten-year period of
time once the options are exercised.
 
     In June 1996, the Company and the Tribes entered into an Exploration
License Agreement covering in excess of 300,000 gross acres in the Wind River
Basin of Wyoming. The agreement provided the Company the opportunity over the
next twelve months to enter into two Exploration Option Agreements covering a
minimum of 100,000 gross acres and a maximum of 150,000 gross acres each. The
Company has a 50% working interest in this agreement.
 
                                        6
<PAGE>   7
 
     In October 1996, the Company and Louisiana Land and Exploration Company
(now Burlington Resources Inc. ("Burlington")) announced the execution of a
letter of intent to form a joint exploration alliance in connection with the
Exploration License Agreement that the Company entered into with the Tribes. At
December 31, 1997 the Company had leases or options to lease approximately
963,000 gross (548,000 net) acres in the Wind River Basin. Upon execution of a
definitive participation agreement and receipt of tribal and regulatory agency
approval, the Company will operate the jointly held interest and have a fifty
percent (50%) working interest. Burlington will have a forty percent (40%)
working interest with the remaining ten percent (10%) being held by a third
party.
 
     In December 1996, the Company and American Exploration Company (now Louis
Dreyfus Natural Gas Corp ("LDNG")) announced the execution of a definitive
agreement to form an exploration joint venture that covers approximately 50,000
gross (40,000 net) acres of the Company's Lost Prairie and Lake Tyler Prospects
in Anderson, Cherokee and Smith Counties of east Texas located in the Cotton
Valley Pinnacle Reef Trend. In exchange for a forty percent (40%) working
interest ownership, LDNG has agreed to invest approximately $7.3 million for the
acquisition of land and a 3-D seismic survey. The Company retained the remaining
sixty percent (60%) working interest and serves as operator of the properties.
 
  Acquisition of Gathering and Processing Assets by Wildhorse
 
     In November 1996, Wildhorse completed the acquisition of the Williams Field
Services' gathering and processing assets in western Colorado and eastern Utah.
The acquired assets access existing Company production, as well as approximately
240,000 acres of undeveloped leasehold held by the Company in the Piceance
Basin. Such assets will also provide gathering to undeveloped third-party
acreage throughout the Piceance and Uinta Basins. The assets acquired include
approximately 955 miles of natural gas gathering lines, two processing plants, a
carbon dioxide treatment plant and a dew point control plant. The acquisition
has provided a significant upstream position in an area of the Rocky Mountains
that has a great potential for developing additional natural gas reserves and
deliverability.
 
MARKETS
 
     The Company's gas production has historically been sold under
month-to-month contracts with marketing companies. During 1997, there was a
significant amount of volatility in the prices received for natural gas. Monthly
closing gas prices as measured on the New York Mercantile Exchange ("NYMEX")
varied from a high of $3.99 per million British thermal unit ("Mmbtu") in
January 1997 to a low of $1.78 per Mmbtu in March 1997. Additionally, the
Company produces approximately 50% of its gas production in the Rocky Mountain
area where the price of gas varied as compared to NYMEX prices (the "Basis
Differential") from $1.25 per Mmbtu below NYMEX prices in October 1997 to $.19
per Mmbtu above NYMEX prices in January 1997.
 
     The Company markets most of its oil production with independent third-party
resellers and refiners at market ("posted") prices. These posted prices
generally reflect the prices determined by the trading of West Texas
Intermediate ("WTI") oil futures contracts on the NYMEX, with adjustments due to
Basis Differential and for the quality of oil produced.
 
     NYMEX prices for both gas and oil are influenced by seasonal demand, levels
of storage, production levels and a variety of political and economic factors
over which the Company has no control.
 
PRODUCTION VOLUMES, UNIT PRICES AND COSTS
 
     The following table sets forth certain information regarding the Company's
volumes of production sold and average prices received associated with its
production and sales of natural gas and crude oil for each of the years ended
December 31, 1997, 1996 and 1995.
 
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<PAGE>   8
 
<TABLE>
<CAPTION>
                                                                YEARS ENDED DECEMBER 31,
                                                              -----------------------------
                                                               1997       1996       1995
                                                              -------    -------    -------
<S>                                                           <C>        <C>        <C>
Production Volumes:
  Natural Gas (MMcf)........................................   31,842     16,762     10,585
  Crude Oil (MBbls).........................................    1,159        545        387
Net Average Daily
  Production Volumes:
     Natural Gas (Mcf)......................................   87,238     45,798     29,000
     Crude Oil (Bbls).......................................    3,175      1,489      1,060
Average Sales Prices:
  Natural Gas (per Mcf).....................................  $  2.25    $  1.77    $  1.31
  Crude Oil (per Bbl).......................................  $ 18.02    $ 20.45    $ 16.80
Average Production
  Cost (per Mcfe)(1)........................................  $   .62    $   .49    $   .53
</TABLE>
 
---------------
 
(1) Includes production costs and taxes on production. (Mcfe means one thousand
    cubic feet of natural gas equivalent, calculated on the basis of six barrels
    of oil to one Mcf of gas.)
 
COMPETITION
 
     The Company encounters strong competition from major oil companies and
independent operators in acquiring properties and leases for the exploration
for, and the development and production of, natural gas and crude oil.
Competition is particularly intense with respect to the acquisition of desirable
undeveloped gas and oil leases. The principal competitive factors in the
acquisition of undeveloped gas and oil leases include the availability and
quality of staff and data necessary to identify, investigate and purchase such
leases, and the financial resources necessary to acquire and develop such
leases. Many of the Company's competitors have financial resources, staffs and
facilities substantially greater than those of the Company. In addition, the
producing, processing and marketing of natural gas and crude oil is affected by
a number of factors which are beyond the control of the Company, the effect of
which cannot be accurately predicted.
 
     The principal raw materials and resources necessary for the exploration and
development of natural gas and crude oil are leasehold prospects under which gas
and oil reserves may be discovered, drilling rigs and related equipment to drill
for and produce such reserves and knowledgeable personnel to conduct all phases
of gas and oil operations. The Company must compete for such raw materials and
resources with both major oil companies and independent operators.
 
EXECUTIVE OFFICERS OF THE COMPANY
 
     The executive officers of the Company at March 20, 1998 were as follows:
 
<TABLE>
<CAPTION>
          NAME             AGE                  POSITION WITH COMPANY                  SINCE
          ----             ---                  ---------------------                  -----
<S>                        <C>   <C>                                                   <C>
Donald L. Evans..........  51    Chairman of the Board and Chief Executive Officer     1976
William R. Granberry.....  55    President, Chief Operating Officer and Director       1996
Peter R. Scherer.........  41    Executive Vice President                              1986
Clifford C. Drescher.....  45    Vice President -- Operations                          1991
Thomas E. Klauss.........  54    Vice President -- Exploration -- Southern Division    1995
Christopher E. Mullen....  37    Vice President -- Exploration -- Northern Division    1995
Richard B. Porter........  42    Vice President -- Land                                1995
Bruce R. DeBoer..........  44    Vice President and General Counsel/Secretary          1997
R. Kim Harris............  41    Controller                                            1986
B. Jack Reed.............  48    Treasurer                                             1990
</TABLE>
 
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<PAGE>   9
 
     Each executive officer is elected annually by the Company's Board of
Directors to serve at the Board's discretion.
 
EMPLOYEES
 
     At December 31, 1997, the Company had 158 employees. None of the Company's
employees are represented by labor unions or covered by any collective
bargaining agreement. The Company considers its relations with its employees to
be satisfactory.
 
REGULATION
 
  Regulation of Gas and Oil Production
 
     Gas and oil operations are subject to various types of regulation by state
and federal agencies. Legislation affecting the gas and oil industry is under
constant review for amendment or expansion. Also, numerous departments and
agencies, both federal and state, are authorized by statute to issue rules and
regulations binding on the gas and oil industry and its individual members, some
of which carry substantial penalties for failure to comply. The regulatory
burden on the gas and oil industry increases the Company's cost of doing
business and, consequently, affects its profitability.
 
  Gas Price Controls
 
     Prior to January 1993, certain natural gas sold by the Company was subject
to regulation by the Federal Energy Regulatory Commission ("FERC") under the
Natural Gas Act of 1938 and the Natural Gas Policy Act of 1978 ("NGPA"). The
NGPA prescribed maximum lawful prices for natural gas sales effective December
1, 1978. Effective January 1, 1993, natural gas prices were completely
deregulated and sales of the Company's natural gas are now made at market
prices. The majority of the Company's gas sales contracts either contain
decontrolled price provisions or already provide for market prices.
 
     In April 1992, FERC issued Order 636, a rule designed to restructure the
interstate natural gas transportation and marketing system to remove various
barriers and practices that have historically limited non-pipeline gas sellers,
including producers, from effectively competing with pipelines. The
restructuring process was implemented on a pipeline-by-pipeline basis through
negotiations in individual pipeline proceedings. Since the issuance of Order
636, FERC has issued several orders making minor modification to Order 636.
Because the restructuring requirements that emerge from the lengthy
administrative and judicial review process may be significantly different from
those currently in effect, and because implementation of the restructuring may
vary by pipeline, it is not possible to predict what, if any, effect the
restructuring resulting from Order 636 will have on the Company.
 
     When it issued Order 636, FERC recognized that in an effort to enable
non-pipeline gas sellers to compete more effectively with pipelines, it should
not allow pipelines to be penalized by their existing contracts which require
the pipelines to pay above-market prices for natural gas. FERC recognized that
it did not have authority to nullify these contracts, and instead encouraged
pipelines and producers to negotiate in good faith to terminate or amend these
contracts to conform them to market conditions. Under Order 636, a pipeline
company is permitted to pass through to certain of its customers the costs
incurred by the pipeline in terminating or amending these agreements as
transition costs. Order 636 allows customers to challenge these costs, in which
case the pipeline will be permitted to pass through costs only to the extent the
pipeline established at a FERC hearing, among other things, that the contract
was prudent at the time it was entered into, that the costs incurred in the
settlement were prudent and that the costs were incurred solely in response to
Order 636.
 
  Oil Price Controls
 
     Sales of crude oil, condensate and gas liquids by the Company are not
regulated and are made at market prices.
 
                                        9
<PAGE>   10
 
  State Regulation of Gas and Oil Production
 
     States in which the Company conducts its gas and oil activities regulate
the production and sale of natural gas and crude oil, including requirements for
obtaining drilling permits, the method of developing new fields, the spacing and
operation of wells and the prevention of waste of gas and oil resources. In
addition, most states regulate the rate of production and may establish maximum
daily production allowables for wells on a market demand or conservation basis.
 
  Environmental Regulation
 
     The Company's activities are subject to federal and state laws and
regulations governing environmental quality and pollution control. The existence
of such regulations has had no material effect on the Company's operations and
the cost of such compliance has not been material to date. However, the Company
believes that the gas and oil industry may experience increasing liabilities and
risks under the Comprehensive Environmental Response, Compensation and Liability
Act, as well as other federal, state and local environmental laws, as a result
of increased enforcement of environmental laws by various regulatory agencies.
As an "owner" or "operator" of property where hazardous materials may exist or
be present, the Company, like all others in the petroleum industry, could be
liable for fines and/or "clean-up" costs, regardless of whether the Company was
responsible for the release of any hazardous substances.
 
     Rocno Corporation, a wholly-owned subsidiary of the Company, was named as a
defendant in a Complaint filed by the United States on behalf of the
Environmental Protection Agency ("EPA") and has, along with approximately 117
other defendants, entered into a Consent Decree with the United States, pursuant
to which the defendant companies will carry out a clean-up plan. See Item 3,
Legal Proceedings.
 
  Indian Lands
 
     The Company's Muddy Ridge and Pavillion Fields are located on the Wind
River Indian Reservation. The Shoshone and Northern Arapaho Tribes regulate
certain aspects of the production and sale of natural gas and crude oil,
drilling operations, and the operation of wells and levy taxes on the production
of hydrocarbons. The Bureau of Indian Affairs and the Minerals Management
Service of the United States Department of the Interior perform certain
regulatory functions relating to operation of Indian gas and oil leases. The
Company owns interests in three leases in the Pavillion Field which were issued
pursuant to the provisions of the Act of August 21, 1916, for initial terms of
20 years each, with a preferential right by the lessee to renew the leases for
subsequent ten-year terms. The leases were renewed for ten-year terms in 1992,
effective as of June 1, 1993.
 
ITEM 2. PROPERTIES
 
GAS AND OIL PROPERTIES
 
     The principal properties of the Company consist of developed and
undeveloped gas and oil leases. Generally, the terms of developed gas and oil
leaseholds are continuing and such leases remain in force by virtue of, and so
long as, production from lands under lease is maintained. Undeveloped gas and
oil leaseholds are generally for a primary term, such as five or ten years,
subject to maintenance with the payment of specified minimum delay rentals or
extension by production.
 
TITLE TO PROPERTIES
 
     As is customary in the gas and oil industry, the Company makes only a
cursory review of title to undeveloped gas and oil leases at the time they are
acquired by the Company. However, before drilling commences, the Company causes
a thorough title search to be conducted, and any material defects in title are
remedied prior to the time actual drilling of a well on the lease begins. The
Company believes that it has good title to its gas and oil properties, some of
which are subject to immaterial encumbrances, easements and restrictions. The
gas and oil properties owned by the Company are also typically subject to
royalty and other
 
                                       10
<PAGE>   11
 
similar non-cost bearing interests customary in the industry. The Company does
not believe that any of these encumbrances or burdens materially affects the
Company's ownership or use of its properties.
 
ACREAGE
 
     The following table sets forth the gross and net acres of developed and
undeveloped gas and oil leases held by the Company at December 31, 1997.
Excluded from the table are approximately 963,000 gross (548,000 net) acres in
Wyoming under gas and oil option agreements acquired from certain Indian tribes.
 
<TABLE>
<CAPTION>
                                                        DEVELOPED             UNDEVELOPED
                                                    ------------------    --------------------
                                                     GROSS       NET        GROSS        NET
                                                    -------    -------    ---------    -------
<S>                                                 <C>        <C>        <C>          <C>
Colorado..........................................  123,870    101,015      368,336    319,348
Kansas............................................    1,920      1,560        4,081      3,887
Louisiana.........................................   12,099      3,799       17,049      5,712
Michigan..........................................      333        129          303        121
Mississippi.......................................      821        347       28,420      2,525
Montana...........................................    4,751        718      158,307     26,443
Nebraska..........................................       --         --       49,370     45,677
New Mexico........................................   17,225      6,723        2,480      1,207
North Dakota......................................      920          1        7,159        518
Oklahoma..........................................   33,997     11,080        6,461      2,300
Texas.............................................  121,631     44,193      123,302     61,487
Utah..............................................       --         --        7,684      7,684
West Virginia.....................................   73,451        973      153,584     81,497
Wyoming...........................................  155,612     60,317      628,088    404,204
Other.............................................      360         80           50         12
                                                    -------    -------    ---------    -------
          Total                                     546,990    230,935    1,554,674    962,622
                                                    =======    =======    =========    =======
</TABLE>
 
     "Gross" acres refer to the number of acres in which the Company owns a
working interest. "Net" acres refer to the sum of the fractional working
interests owned by the Company in gross acres.
 
GAS AND OIL RESERVES
 
     Estimates of the Company's gas and oil reserves at December 31, 1997, 1996
and 1995 including future net revenues and the present value of future net cash
flows, were made by Williamson Petroleum Consultants, Inc. and by Ryder Scott at
December 31, 1997 and 1996, (both are independent petroleum consultants), in
accordance with guidelines established by the Securities and Exchange Commission
(the "SEC"). Estimates of gas and oil reserves and their estimated values
require numerous engineering assumptions as to the productive capacity and
production rates of existing geological formations and require the use of
certain SEC guidelines as to assumptions regarding costs to be incurred in
developing and producing reserves and prices to be realized from the sale of
future production. Accordingly, estimates of reserves and their value are
inherently imprecise and are subject to constant revision and change and should
not be construed as representing the actual quantities of future production or
cash flows to be realized from the Company's gas and oil properties or the fair
market value of such properties.
 
     Certain additional unaudited information regarding the Company's reserves,
including the present value of future net cash flows, is set forth in Note 13 of
the Notes to Consolidated Financial Statements included herein.
 
     The Company has no gas and oil reserves or production subject to long-term
supply or similar agreements with foreign governments or authorities.
 
     Estimates of the Company's total proved gas and oil reserves have not been
filed with or included in reports to any federal authority or agency other than
the SEC.
 
                                       11
<PAGE>   12
 
PRODUCTIVE WELLS
 
     The following table sets forth the gross and net productive gas and oil
wells in which the Company owned an interest at December 31, 1997.
 
<TABLE>
<CAPTION>
                                                                    PRODUCTIVE WELLS
                                                              -----------------------------
                                                                 GROSS            NET
                                                              -----------   ---------------
                                                               GAS    OIL    GAS      OIL
                                                              -----   ---   ------   ------
<S>                                                           <C>     <C>   <C>      <C>
Colorado....................................................    442    63   203.68    31.95
Louisiana...................................................     50    38    13.29    13.93
New Mexico..................................................     35    28     7.32    12.15
North Dakota................................................      6     5     2.13     3.49
Oklahoma....................................................    128    36    31.37    10.18
Texas.......................................................    107   313    44.95   104.57
West Virginia...............................................     56    --    18.39       --
Wyoming.....................................................    434   144   143.75    39.09
Other.......................................................     17    15     4.65     1.99
                                                              -----   ---   ------   ------
          Total.............................................  1,275   642   469.53   217.35
                                                              =====   ===   ======   ======
</TABLE>
 
     A "gross" well is a well in which the Company owns a working interest.
"Net" wells refer to the sum of the fractional working interests owned by the
Company in gross wells.
 
GAS AND OIL DRILLING ACTIVITY
 
     The following table sets forth the Company's gross and net interests in
exploratory and development wells drilled during the periods indicated.
 
<TABLE>
<CAPTION>
                                                                  YEARS ENDED DECEMBER 31,
                                                          -----------------------------------------
                                                              1997          1996           1995
                                                          ------------   -----------   ------------
                      TYPE OF WELL                        GROSS   NET    GROSS   NET   GROSS   NET
                      ------------                        -----   ----   -----   ---   -----   ----
<S>                                                       <C>     <C>    <C>     <C>   <C>     <C>
Exploratory
  Gas...................................................   --       --    --     --     --       --
  Oil...................................................   --       --    --     --     --       --
  Dry...................................................    7      3.7     5     2.8     3      1.1
                                                           --     ----    --     ---    --     ----
                                                            7      3.7     5     2.8     3      1.1
Development
  Gas...................................................   72     27.7    14     3.9    34      9.7
  Oil...................................................    7      2.2    --     --      3      1.5
  Dry...................................................    3      1.1     5     1.7    10      3.9
                                                           --     ----    --     ---    --     ----
                                                           82     31.0    19     5.6    47     15.1
          Total.........................................   89     34.7    24     8.4    50     16.2
                                                           ==     ====    ==     ===    ==     ====
</TABLE>
 
     At December 31, 1997, 11 gross (6.6 net) development wells and 4 gross and
(2.6 net) exploration wells were in various stages of drilling and completion in
Texas and Wyoming.
 
     During 1997, the Company's drilling activities were conducted on a contract
basis with independent drilling contractors. At December 31, 1997, the Company
owned no drilling equipment. In January 1998, the Company acquired Sauer
Drilling Company for approximately $8.1 million. See Note 3 of the Notes to
Consolidated Financial Statements.
 
OTHER PROPERTIES
 
     The Company leases its home office facilities in Midland, Texas. The lease
covers approximately 32,000 square feet for a term of five years and expires
December 31, 2003.
 
                                       12
<PAGE>   13
 
     The Company owns a 3,200 square foot office building located on a 2.94 acre
tract in Midland, Texas. The facility is used primarily for storage of pipe and
oilfield equipment.
 
     The Company also leases office facilities in Denver, Colorado. The lease
covers approximately 38,000 square feet for a term of 5 years and expires
January 31, 2003.
 
     The Company has subleased approximately 41,000 square feet of leased office
space which was obtained through the Presidio acquisition. Both leases will
expire on March 31, 1999.
 
ITEM 3. LEGAL PROCEEDINGS
 
     The Company is a defendant in several routine legal proceedings incidental
to its business which the Company believes will not have a significant effect on
its consolidated financial position, results of operations or cash flows.
 
     In addition to routine legal proceedings incidental to the Company's
business, Rocno Corporation ("Rocno"), a wholly-owned subsidiary of the Company,
is a defendant in a Complaint filed by the United States of America which, among
other things, alleges that Rocno arranged for the disposal of "hazardous
materials" (within the meaning of the Comprehensive Environmental Response,
Compensation and Liability Act) in Waller County, Texas (the "Sheridan Superfund
Site"). In addition to Rocno, approximately 117 other companies were named as
defendants in the same matter with similar allegations by the Government of the
release by them of hazardous materials at the Sheridan Superfund Site. Effective
August 31, 1989, Rocno and thirty-six other defendants executed the Sheridan
Site Trust Agreement (the "Trust") for the purpose of creating a trust to
perform agreed upon remedial action at the Sheridan Superfund Site. In
connection with the establishment of the Trust, the parties to the Trust have
agreed to the terms of a Consent Decree entered December 3, 1991 in the United
States District Court, Southern District of Texas, Houston Division, Civil
Action No. H-91-3529, pursuant to which the defendants joining the Consent
Decree will carry out the clean-up plan prescribed by the Consent Decree. The
court has not yet approved the Consent Decree. The estimate of the total
clean-up cost is approximately $30 million. Under terms of the Trust, each party
is allocated a percentage of costs necessary to fund the Trust for clean-up
costs. Rocno's proportionate share of the estimated clean-up costs is 0.33% or
$99,000, of which $16,000 has been paid, and the remainder was accrued in the
Company's consolidated financial statements at December 31, 1997. If the
clean-up costs exceed the projected amount, Rocno will be required to pay its
pro rata share of the excess clean-up costs.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     No matters were submitted to a vote of the Company's stockholders in the
fourth quarter of the year ended December 31, 1997.
 
                                       13
<PAGE>   14
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
     The Company's Common Stock is traded in the over-the-counter market and
appears on the NASDAQ National Market System under the symbol "TMBR". The
following table sets forth the range of high and low closing quotations for each
quarterly period during the past two fiscal years as reported by NASDAQ National
Market System. The quotations are inter-dealer prices without retail mark-ups,
mark-downs or commissions and may not represent actual transactions.
 
<TABLE>
<CAPTION>
                                                              CLOSING SALE
                                                                  PRICE
                                                              -------------
                       QUARTER ENDED                          HIGH      LOW
                       -------------                          ----      ---
<S>                                                           <C>       <C>
March 31, 1996..............................................   15 3/8   12 1/8
June 30, 1996...............................................   17 7/8   12 7/8
September 30, 1996..........................................   19 1/4   14 1/4
December 31, 1996...........................................   22 3/8   16 7/8
March 31, 1997..............................................   18 1/2   18
June 30, 1997...............................................   21 9/16  20 1/4
September 30, 1997..........................................   24 7/8   24 1/2
December 31, 1997...........................................   19 3/4   17 9/16
</TABLE>
 
     On March 20, 1998 the last sale price of the Company's Common Stock, as
reported by the NASDAQ National Market System, was $20.125 per share.
 
     The transfer agent for the Company's Common Stock is Boston EquiServe,
L.P., Canton, Massachusetts.
 
     On December 31, 1997, the outstanding shares of the Company's Common Stock
(29,210,354 shares) were held by approximately 4,300 holders of record.
 
     The Company has never declared or paid any cash dividends to the holders of
Common Stock and has no present intention to pay cash dividends to the holders
of Common Stock in the future. Under the terms of the Company's Credit
Agreement, the Company is prohibited from paying cash dividends to the holders
of Common Stock without the written consent of the bank lenders. Additionally,
the Company's ability to declare and pay dividends on its Common Stock is
further restricted by the rights of the holder of the Series A Preferred Stock.
 
     On December 23, 1996, the Company completed the acquisition of Presidio Oil
Company and its subsidiaries (collectively, "Presidio"), following the issuance
by the U.S. Bankruptcy Court, District of Delaware, on December 10, 1996, of an
order confirming Presidio's reorganization under Chapter 11 of the U.S.
Bankruptcy Code. The Company issued 2,711,137 shares of its Common Stock to
creditors and shareholders of Presidio pursuant to Section 1145 of the United
States Bankruptcy Code.
 
     On March 1, 1991, the Board of Directors adopted a Rights Plan designed to
help assure that all stockholders receive fair and equal treatment in the event
of a hostile attempt to take over the Company, and to help guard against abusive
takeover tactics. The Board of Directors declared a dividend of one preferred
share purchase right (a "Right") for each outstanding share of Common Stock. The
dividend was distributed on March 15, 1991 to the shareholders of record on that
date. Each Right entitles the registered holder to purchase, for the $20 per
share exercise price, shares of Common Stock or other securities of the Company
(or, under certain circumstances, of the acquiring person) worth twice the per
share exercise price of the Right.
 
     The Rights will be exercisable only if a person or group acquires 20% or
more of the Company's Common Stock or announces a tender offer which would
result in ownership by a person or group of 20% or more of the
 
                                       14
<PAGE>   15
 
Common Stock. The date on which the above occurs is to be known as the
("Distribution Date"). The Rights will expire on March 15, 2001, unless extended
or redeemed earlier by the Company.
 
     At the time the Rights dividend was declared, the Board of Directors
further authorized the issuance of one Right with respect to each share of the
Company's Common Stock that shall become outstanding between March 15, 1991 and
the earlier of the Distribution Date or the expiration or redemption of the
Rights. Until the Distribution Date occurs, the certificates representing shares
of the Company's Common Stock also evidence the Rights. Following the
Distribution Date, the Rights will be evidenced by separate certificates.
 
     The provisions described above may tend to deter any potential unsolicited
tender offers or other efforts to obtain control of the Company that are not
approved by the Board of Directors and thereby deprive the stockholders of
opportunities to sell shares of the Company's Common Stock at prices higher than
the prevailing market price. On the other hand, these provisions will tend to
assure continuity of management and corporate policies and to induce any person
seeking control of the Company or a business combination with the Company to
negotiate on terms acceptable to the then elected Board of Directors.
 
ITEM 6. SELECTED FINANCIAL DATA
 
     The following tables set forth selected financial information for the
Company for each of the years shown.
 
     The Company's historical results of operations have been materially
affected by the substantial increase in the Company's size as a result of the
Presidio Acquisition and the KNPC Acquisition, making comparisons of individual
line items between 1997 and 1996 and 1996 and 1995 difficult. (See Note 3 to
Notes to Consolidated Financial Statements of the Company included elsewhere
herein)
 
<TABLE>
<CAPTION>
                                                           YEARS ENDED DECEMBER 31,
                                             ----------------------------------------------------
                                               1997       1996       1995       1994       1993
                                             --------   --------   --------   --------   --------
                                                   (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                          <C>        <C>        <C>        <C>        <C>
Revenues...................................  $128,737   $ 66,720   $ 41,053   $ 29,071   $ 28,708
                                             ========   ========   ========   ========   ========
Net income (loss) attributable to common
  stock....................................     6,860      6,263      5,785       (160)    (2,318)
                                             ========   ========   ========   ========   ========
Weighted average number of common shares
  outstanding(1)
  Basic....................................    25,110     21,116     16,292     15,464     11,898
                                             ========   ========   ========   ========   ========
  Diluted..................................    26,407     22,525     16,887     16,053     12,421
                                             ========   ========   ========   ========   ========
Net income (loss) per common share(1)
  Basic....................................       .27        .30        .36       (.01)      (.19)
                                             ========   ========   ========   ========   ========
  Diluted..................................       .26        .28        .34       (.01)      (.19)
                                             ========   ========   ========   ========   ========
Total assets...............................   450,926    406,374    164,174    115,092    108,084
                                             ========   ========   ========   ========   ========
Long-term debt, net of current
  maturities...............................    23,000    119,000         --         --         --
                                             ========   ========   ========   ========   ========
</TABLE>
 
---------------
 
(1) In accordance with Statement of Financial Accounting Standards ("SFAS") No.
    128 "Earnings per Share", net income per common share has been restated for
    all periods presented.
 
     The following tables set forth selected information for the Company's gas
and oil sales volumes and proved reserves for each of the years shown.
 
<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                               -----------------------------------------------
                                                1997      1996      1995      1994      1993
                                               -------   -------   -------   -------   -------
<S>                                            <C>       <C>       <C>       <C>       <C>
Volumes sold:
  Gas (Mmcf).................................   31,842    16,762    10,585     7,087     7,041
  Oil (Mbbls)................................    1,159       545       387       276       317
Proved reserves at period end:
  Gas (Mmcf).................................  347,104   359,167   163,303   180,306   130,995
  Oil (Mbbls)................................    7,227    12,306     4,068     4,522     3,300
</TABLE>
 
                                       15
<PAGE>   16
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS
 
RESULTS OF OPERATIONS
 
     The Company's historical results of operations have been materially
affected by the substantial increase in the Company's size as a result of the
Presidio Acquisition and the KNPC Acquisition, making comparisons of individual
line items between 1997 and 1996 and 1996 and 1995 difficult. (See Note 3 to
Notes to Consolidated Financial Statements of the Company included elsewhere
herein)
 
  Revenues
 
     During 1997, revenues from gas and oil production increased 127% to $92.6
million, as compared to $40.8 million in 1996. Such increase in gas and oil
revenues was the result of an increase in (i) average gas prices received by the
Company from $1.77 per Mcf to $2.25 per Mcf which increased revenues by
approximately $8.1 million, (ii) gas sales volumes of 90% which increased
revenues by approximately $33.9 million, and (iii) oil sales volumes of 113%
which increased revenues by approximately $11.1 million. A decrease in the
average oil prices from $20.45 to $18.02 reduced the revenues by approximately
$1.3. The increase in gas and oil volumes was primarily due to the Presidio
acquisition and development drilling.
 
     During 1996, revenues from gas and oil production increased 100% to $40.8
million as compared to $20.4 million in 1995. Such increase in gas and oil
revenues was the result of an increase in (i) average gas prices received by the
Company from $1.31 per Mcf to $1.77 per Mcf which increased revenues by
approximately $4.9 million, (ii) gas sales volumes of 58% which increased
revenues by approximately $10.9 million, (iii) average oil prices received from
$16.80 per barrel to $20.45 per barrel which increased revenues by approximately
$1.4 million and, (iv) oil sales volumes of 41% which increased revenues by
approximately $3.2 million. The increase in gas and oil production levels was
primarily due to the KNPC Acquisition and to a lesser extent, successful
drilling results primarily in the Val Verde Basin of west Texas.
 
     The following table reflects the Company's revenues, average prices
received for gas and oil, and amount of gas and oil production in each of the
years shown:
 
<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                                       ------------------------------
                                                         1997       1996       1995
                                                       --------    -------    -------
                                                               (IN THOUSANDS)
<S>                                                    <C>         <C>        <C>
Revenues:
  Natural gas sales..................................  $ 71,694    $29,639    $13,883
  Crude oil sales....................................    20,887     11,150      6,502
  Marketing, gathering and processing................    34,998     25,122     15,572
  Gain on sales of gas and oil properties............        --        267      4,402
  Interest income and other..........................     1,158        542        694
                                                       --------    -------    -------
          Total revenues.............................  $128,737    $66,720    $41,053
                                                       ========    =======    =======
Net income attributable to common stock..............  $  6,860    $ 6,263    $ 5,785
                                                       ========    =======    =======
</TABLE>
 
<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                                        -----------------------------
                                                         1997       1996       1995
                                                        -------    -------    -------
<S>                                                     <C>        <C>        <C>
Natural gas production sold (Mmcf)....................   31,842     16,762     10,585
Crude oil production (Mbbls)..........................    1,159        545        387
Average natural gas sales price ($/Mcf)...............  $  2.25    $  1.77    $  1.31
Average crude oil sales price ($/Bbl).................  $ 18.02    $ 20.45    $ 16.80
</TABLE>
 
     In 1997 the Company sold the majority of its properties located in North
Dakota for $11.0 million and another property located in Oklahoma for $1.6
million. No gain or loss was recorded for either sale. The Company had no
significant property sales during 1996 whereas in 1995 the Company sold all of
its properties in Arkansas, resulting in a gain of $4.1 million.
 
     Marketing, gathering and processing revenues increased 39% in 1997 as
compared to 1996 and 61% in 1996 as compared to 1995. Such increase is due to
higher gas prices and higher volumes of gas marketed due to the Company's
increased production and marketing of additional third party gas.
 
                                       16
<PAGE>   17
 
  Costs and Expenses
 
     Expenses related to gas and oil production, production taxes, and
depreciation, depletion and amortization have increased in each of the last two
years due to increased production and revenue levels resulting from successful
drilling operations as well as the KNPC and Presidio Acquisitions. On an Mcfe
basis, the Company's costs have increased during the past year as a result of
the Presidio acquisition. Costs of gas and oil production rose to $.43 per Mcfe
in 1997, as compared to $.33 per Mcfe and $.37 per Mcfe in 1996 and 1995,
respectively. Taxes on gas and oil production, which are generally calculated as
a percentage of gas and oil sales, remained at 8% of gas and oil sales in 1997
as compared to 8% and 10% of gas and oil sales during 1996 and 1995,
respectively. Such decline from 1995 to 1996 was due to the increase of natural
gas and oil produced in the Val Verde Basin in 1996 where the Company
experiences lower production tax rates as compared to its other areas of
operation.
 
     The Company's depletion, depreciation and amortization rate increased on an
Mcfe basis to $.93 per Mcfe for 1997 from $.76 per Mcfe in 1996 and $.77 per
Mcfe in 1995. The increase was the result of the costs of the Presidio
acquisition.
 
     The cost of gas sold in connection with the Company's marketing, gathering
and processing operations has increased in each of the last two years,
consistent with the increases in the associated revenues. The gross profit
percentage decreased to 15% of revenues in 1997 as compared to 18% in 1996 and
16% in 1995.
 
     Costs associated with exploration activities and impairments of leasehold
costs increased to $10.3 million in 1997 as compared to $3.8 million in 1996 and
$4.2 million in 1995. The increase was the result of an aggressive exploratory
drilling program during 1997 in which the Company began to more fully explore
for oil and gas on its large undeveloped acreage position.
 
     General and administrative expenses increased in each of the last two years
as a result of the Company's significantly higher level of operations. The
Company has benefited from the economies of scale in its growth, resulting in a
decrease in general and administrative expenses on an Mcfe of production basis
to $.24 in 1997 as compared to $.29 and $.32 per Mcfe of production in 1996 and
1995, respectively.
 
     Interest expense increased in 1997 as compared to 1996 as a result of the
debt incurred in connection with the Presidio Acquisition in December 1996. A
large portion of the debt was repaid in October 1997 with the proceeds from the
sale of 5.0 million shares of the Company's Common Stock. Interest expense
decreased in 1996 as compared to 1995 as debt was repaid in November 1995 with
the proceeds from the sale of 4.6 million shares of the Company's Common Stock.
 
     The Company incurred a current tax liability in the amount of $403,000,
$290,000 and $77,000 in 1997, 1996 and 1995, respectively, as a result of the
application of the alternate minimum tax rules as provided under the Internal
Revenue Code. The Company had not paid, prior to the year ended December 31,
1990, Federal income taxes for the past six years due to its net operating loss
carryforward. At December 31, 1997, such carryforward for tax purposes was
approximately $48.8 million.
 
     The Company reduced its net deferred tax asset to $2.6 million in 1997.
Deferred tax assets (related primarily to the Company's net operating loss and
investment tax credit carryforwards) were initially recorded in 1993 with the
adoption of SFAS No. 109, "Accounting for Income Taxes", but had been reserved
entirely by a valuation allowance until 1995. Based on additions to the
Company's gas and oil reserves and the resulting increases in anticipated future
income, the Company now expects to realize the future benefit of its net
operating loss carryforwards prior to their expiration. A valuation allowance of
approximately $5.6 million at December 31, 1997 has been provided against the
Company's net deferred tax assets based on management's estimate of the
recoverability of future tax benefits. The valuation allowance relates primarily
to the inability to use certain net operating loss and investment tax credit
carryforwards. The Company evaluated all appropriate factors to determine the
proper valuation allowance for these carryforwards, including any limitations
concerning their use, the year the carryforwards expires and the levels of
taxable income necessary for utilization. In this regard, full valuation
allowances were provided for investment tax credit carryforwards and option plan
compensation. Based on its recent operating results and its expected levels of
future earnings, the Company believes it will, more likely than not, generate
sufficient taxable income to realize the benefit attributable to the net
operating loss carryforward for which valuation allowances were not provided.
                                       17
<PAGE>   18
 
CAPITAL RESOURCES AND LIQUIDITY
 
  Growth and Acquisitions
 
     The Company's total assets have grown from $164 million at December 31,
1995 to $451 million at December 31, 1997. During this period, the Company's
proved gas and oil reserves increased from 188 Bcfe to 390 Bcfe. Most of the
growth of the Company resulted from recent acquisitions; and, to a lesser
extent, from the Company's successful exploration and development drilling.
 
     The Company continues to pursue opportunities which will add value by
increasing its reserve base and presence in significant natural gas areas, and
further developing the Company's ability to control and market the production of
natural gas. As the Company continues to evaluate potential acquisitions and
property development opportunities, it will benefit from its financing
flexibility and the leverage potential of the Company's overall capital
structure.
 
  Capital and Exploration Expenditures
 
     The Company's capital and exploration expenditures decreased to $107.9
million for the year ended December 31, 1997 as compared to capital expenditures
of $281.0 million (including $250.5 million for the KNPC and Presidio
acquisitions) and $25.2 million for the years ended December 31, 1996 and 1995,
respectively. Capital expenditures for exploratory and developmental drilling
for 1997 were approximately $42.2 million, which relates to the Company's
strategy of developing its large undeveloped acreage position. The acquisition
of the assets of Genesis Gas and Oil L.L.C. for $35.5 million was also included
in the capital expenditures for 1997. The Company anticipates capital
expenditures of approximately $103 million in 1998, $69.9 million being
allocated to exploration and development drilling. The timing of most of the
Company's capital expenditures is discretionary and there are no material
long-term commitments associated with the Company's capital expenditure plans.
Consequently, the Company is able to adjust the level of its capital
expenditures as circumstances warrant. The level of capital expenditures by the
Company will vary in future periods depending on energy market conditions and
other related economic factors.
 
     Historically, the Company has funded capital expenditures and working
capital requirements with both internally generated cash and borrowings. Net
cash flow provided by operating activities increased to $43.3 million for 1997
as compared to $26.5 million and $8.8 million.
 
  Bank Credit Facility
 
     The Company's Credit Facility provides for a $125 million revolving line of
credit with a current borrowing base of $125 million. The amount of the
borrowing base is determined by reference to the collateral value of the
Company's net proved reserves. At December 31, 1997, the aggregate outstanding
balance under the Credit Facility was $23 million, bearing interest at 6.9% per
annum, and the Company was in compliance with the covenants contained in the
Credit Facility. Borrowings under the Credit Facility are unsecured and bear
interest, at the election of the Company, at (i) the greater of the agent bank's
prime rate or the federal funds effective rate, plus 0.50% or (ii) the agent
bank's Eurodollar rate, plus a margin ranging from 0.75% to 1.00%. The Credit
Facility contains certain financial covenants which require the Company to
maintain a minimum consolidated tangible net worth as well as certain financial
ratios. See Note 4 to Notes to Consolidated Financial Statements of the Company
included elsewhere herein.
 
  Public Offering
 
     In October 1997, the Company sold 5,035,800 shares of its Common Stock in a
public offering. Net proceeds from the offering were approximately $121 million
which were used to repay a majority of the Company's outstanding debt and to
fund the acquisition of all of the assets of Genesis Gas and Oil, L.L.C.
 
  Markets and Prices
 
     Wildhorse, which was created to provide gathering, processing, marketing,
storage and field services to Rocky Mountain gas and oil producers, will
continue to pursue the construction or acquisition of gathering,
 
                                       18
<PAGE>   19
 
processing and storage areas of the Rocky Mountain region. During 1997,
Wildhorse invested approximately $40.9 million for gas gathering and processing
assets. The Company (45 percent) and KNE (55 percent) jointly own Wildhorse.
Wildhorse is operated by KNE under the direction of an operating team with equal
representation from KNE and the Company.
 
     The Company has dedicated significant amounts of its Rocky Mountain gas
production to Wildhorse for gathering, processing and marketing. KNE contributed
gas marketing contracts and storage assets in western Colorado.
 
     The Company's revenues and associated cash flows are significantly impacted
by changes in gas and oil prices. All of the Company's gas and oil production is
currently market sensitive as no amounts of the Company's future gas and oil
production have been sold at contractually specified prices. During 1997, the
average prices received for gas and oil by the Company were $2.25 per Mcf and
$18.02 per barrel, respectively, as compared to $1.77 Mcf and $20.45 per barrel
in 1996 and $1.31 per Mcf and $16.80 per barrel in 1995.
 
  Year 2000
 
     The Company utilizes software and technologies throughout its operations
that will be effected by the date change in the year 2000 (Year 2000 Issue). An
assessment of the systems that will be affected by the Year 2000 Issue is
underway. The Company does not believe the costs related to the Year 2000 Issue
will materially impact its results of operations. However, there can be no
guarantee that the systems of other companies, on which the Company's systems
rely, will be timely converted or that a failure to convert by another company
or a conversion that is incompatible with the Company's systems would not have a
material adverse effect on the Company.
 
  Forward-Looking Statements and Risk
 
     Certain statements in this report, including statements of the future
plans, objectives, and expected performance of the Company, are forward-looking
statements that are dependent on certain events, risks and uncertainties that
may be outside the Company's control which could cause actual results to differ
materially from those anticipated. Some of these include, but are not limited
to, economic and competitive conditions, inflation rates, legislative and
regulatory changes, financial market conditions, political and economic
uncertainties, future business decisions, and other uncertainties, all of which
are difficult to predict.
 
     There are numerous uncertainties inherent in estimating quantities of
proven oil and gas reserves and in projecting future rates of production and
timing of development expenditures. The total amount or timing of actual future
production may vary significantly from reserves and production estimates. The
drilling of exploratory wells can involve significant risks including those
related to timing, success rates and cost overruns. Lease and rig availability,
complex geology and other factors can affect these risks. Future oil and gas
prices also could affect results of operations and cash flows.
 
  Recent Accounting Pronouncements
 
     In June 1997, the Financial Accounting Standard Board (FASB) issued SFAS
No. 130, "Reporting Comprehensive Income", which requires the presentation of
comprehensive income in an entity's financial statements. Comprehensive income
represents all changes in equity of an entity during the reporting period,
including net income and charges made directly to equity which are excluded from
net income. This statement is not anticipated to have a material impact on the
Company's financial disclosures.
 
     In June 1997, the FASB also issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information" which establishes standards
for the way public enterprises are to report information about operating
segments in annual financial statements and requires the reporting of selected
information about operating segments in interim financial reports issued to
shareholders. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas, and major customers. SFAS No. 131
is effective for periods beginning after December 15, 1997, at which time the
Company will adopt the provision. This statement is not anticipated to have a
material impact on the Company's financial disclosures.
 
                                       19
<PAGE>   20
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Index to Consolidated Financial Statements
  Report of Independent Public Accountants..................   21
  Consolidated Balance Sheets, December 31, 1997 and 1996...   22
  Consolidated Statements of Operations, Years ended
     December 31, 1997, 1996 and 1995.......................   23
  Consolidated Statements of Changes in Stockholders'
     Equity, Years ended December 31, 1997, 1996 and 1995...   24
  Consolidated Statements of Cash Flows, Years ended
     December 31, 1997, 1996 and 1995.......................   25
  Notes to Consolidated Financial Statements................   26
</TABLE>
 
                                       20
<PAGE>   21
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Stockholders and Board of Directors
of Tom Brown, Inc.:
 
     We have audited the accompanying consolidated balance sheets of Tom Brown,
Inc. (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1996,
and the related consolidated statements of operations, changes in stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Tom Brown,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
 
                                            ARTHUR ANDERSEN LLP
 
Houston, Texas
February 25, 1998
 
                                       21
<PAGE>   22
 
                        TOM BROWN, INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                                1997        1996
                                                              --------    --------
                                                                 (IN THOUSANDS)
<S>                                                           <C>         <C>
CURRENT ASSETS:
  Cash and cash equivalents.................................  $  6,537    $ 20,504
  Accounts receivable.......................................    40,949      33,080
  Inventories...............................................       365         302
  Other.....................................................       271         889
                                                              --------    --------
          Total current assets..............................    48,122      54,775
                                                              --------    --------
PROPERTY AND EQUIPMENT, AT COST:
  Gas and oil properties, successful efforts method of
     accounting.............................................   500,561     436,879
  Other.....................................................    55,735      35,216
                                                              --------    --------
          Total property and equipment......................   556,296     472,095
  Less: Accumulated depreciation, depletion and
     amortization...........................................   160,480     124,834
                                                              --------    --------
          Net property and equipment........................   395,816     347,261
                                                              --------    --------
OTHER ASSETS:
  Deferred income taxes, net................................     2,606       2,865
  Other assets..............................................     4,382       1,473
                                                              --------    --------
          Total other assets................................     6,988       4,338
                                                              --------    --------
                                                              $450,926    $406,374
                                                              ========    ========
                       LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
  Accounts payable..........................................  $ 32,367    $ 25,033
  Accrued expenses..........................................     7,332      10,562
  Note payable -- current...................................     5,168          --
                                                              --------    --------
          Total current liabilities.........................    44,867      35,595
                                                              --------    --------
BANK DEBT...................................................    23,000     119,000
                                                              --------    --------
OTHER NON-CURRENT LIABILITIES...............................     6,661       5,643
                                                              --------    --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
  Convertible preferred stock, $.10 par value
     Authorized 2,500,000 shares; Outstanding 1,000,000
      shares with a liquidation preference of $25,000,000...       100         100
  Common Stock, $.10 par value
     Authorized 40,000,000 shares; Outstanding 29,210,354
      shares and 23,898,431 shares, respectively............     2,921       2,390
  Additional paid-in capital................................   430,502     307,631
  Accumulated deficit.......................................   (57,125)    (63,985)
                                                              --------    --------
          Total stockholders' equity........................   376,398     246,136
                                                              --------    --------
                                                              $450,926    $406,374
                                                              ========    ========
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       22
<PAGE>   23
 
                        TOM BROWN, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                     YEARS ENDED DECEMBER 31,
                                                             -----------------------------------------
                                                                1997            1996           1995
                                                             -----------     ----------     ----------
                                                             (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                          <C>             <C>            <C>
REVENUES:
  Gas and oil sales........................................   $ 92,581        $40,789        $20,385
  Marketing, gathering and processing......................     34,998         25,122         15,572
  Gain on sales of gas and oil properties..................         --            267          4,402
  Interest income and other................................      1,158            542            694
                                                              --------        -------        -------
          Total revenues...................................    128,737         66,720         41,053
                                                              --------        -------        -------
COSTS AND EXPENSES:
  Gas and oil production...................................     16,698          6,576          4,834
  Taxes on gas and oil production..........................      7,437          3,258          2,043
  Cost of gas sold.........................................     29,734         20,496         13,146
  Exploration costs........................................      8,963          3,471          3,644
  Impairments of leasehold costs...........................      1,350            331            582
  General and administrative...............................      9,411          5,786          4,184
  Depreciation, depletion and amortization.................     36,230         15,140          9,994
  Writedown of properties..................................         --             --          8,368
  Interest expense.........................................      5,920            389          1,369
                                                              --------        -------        -------
          Total costs and expenses.........................    115,743         55,447         48,164
                                                              --------        -------        -------
Income (loss) before income taxes..........................     12,994         11,273         (7,111)
 
INCOME TAX BENEFIT (PROVISION):
  Recognition of deferred tax asset........................         --             --         13,170
  Income tax expense.......................................     (4,384)        (3,338)          (274)
                                                              --------        -------        -------
Net income.................................................      8,610          7,935          5,785
Preferred stock dividends..................................     (1,750)        (1,672)            --
                                                              --------        -------        -------
Net income attributable to common stock....................   $  6,860        $ 6,263        $ 5,785
                                                              ========        =======        =======
Weighted average number of common shares outstanding:
  Basic....................................................     25,110         21,116         16,292
                                                              ========        =======        =======
  Diluted..................................................     26,407         22,525         16,887
                                                              ========        =======        =======
Net income per common share:
  Basic....................................................   $    .27        $   .30        $   .36
                                                              ========        =======        =======
  Diluted..................................................   $    .26        $   .28        $   .34
                                                              ========        =======        =======
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       23
<PAGE>   24
 
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                              ADDITIONAL                       TOTAL
                                       PREFERRED    COMMON     PAID-IN      ACCUMULATED    STOCKHOLDERS'
                                         STOCK      STOCK      CAPITAL        DEFICIT         EQUITY
                                       ---------    ------    ----------    -----------    -------------
                                                                (IN THOUSANDS)
<S>                                    <C>          <C>       <C>           <C>            <C>
Balance as of December 31, 1994......    $ --       $1,552     $177,350      $(76,033)       $102,869
  Stock options exercised............      --           6           255            --             261
  Common stock issuance..............      --         460        47,472            --          47,932
  Stock issuance costs...............      --          --          (285)           --            (285)
  Option plan compensation...........      --          --            97            --              97
  Net income.........................      --          --            --         5,785           5,785
                                         ----       ------     --------      --------        --------
Balance as of December 31, 1995......      --       2,018       224,889       (70,248)        156,659
  Stock issuance for KNPC
     Acquisition.....................     100          92        36,058            --          36,250
  Stock options exercised............      --           9           510            --             519
  Common stock issuance for Presidio
     Acquisition.....................      --         271        46,157            --          46,428
  Stock issuance costs...............      --          --            (5)           --              (5)
  Option plan compensation...........      --          --            22            --              22
  Net income.........................      --          --            --         7,935           7,935
  Preferred stock dividends..........      --          --            --        (1,672)         (1,672)
                                         ----       ------     --------      --------        --------
Balance as of December 31, 1996......     100       2,390       307,631       (63,985)        246,136
  Stock options exercised............      --          24         1,558            --           1,582
  Common stock issuance..............      --         507       121,705            --         122,212
  Stock issuance costs...............      --          --          (392)           --            (392)
  Net income.........................      --          --            --         8,610           8,610
  Preferred stock dividends..........      --          --            --        (1,750)         (1,750)
                                         ----       ------     --------      --------        --------
Balance as of December 31, 1997......    $100       $2,921     $430,502      $(57,125)       $376,398
                                         ====       ======     ========      ========        ========
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       24
<PAGE>   25
 
                        TOM BROWN, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                              ------------------------------
                                                                1997        1996      1995
                                                              ---------   --------   -------
                                                                      (IN THOUSANDS)
<S>                                                           <C>         <C>        <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income................................................  $   8,610   $  7,935   $ 5,785
  Adjustments to reconcile net income to net cash provided
    by operating activities:
    Depreciation, depletion and amortization................     36,230     15,140     9,994
    Gain on sales of assets.................................        (19)      (267)   (4,402)
    Writedown of properties.................................         --         --     8,368
    Deferred taxes..........................................        259      2,701   (13,170)
    Option plan compensation................................         --         22        97
    Exploration costs.......................................      8,963      3,471     3,644
    Impairments of leasehold costs..........................      1,350        331       582
    Changes in operating assets and liabilities:
      Decrease (increase) in accounts receivable............     (7,869)   (15,408)      990
      (Increase) decrease in inventories....................        (63)        75       886
      Decrease (increase) in other current assets...........        618        220       (12)
      Increase (decrease) in accounts payable and accrued
         expenses...........................................     (2,847)     9,919    (3,050)
      Decrease (increase) in other assets, net..............     (1,891)     2,406      (922)
                                                              ---------   --------   -------
Net cash provided by operating activities...................  $  43,341   $ 26,545   $ 8,790
                                                              ---------   --------   -------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Proceeds from sales of assets.............................  $  12,635   $    593   $ 9,044
  Investment in securities..................................         --         --   (51,093)
  KNPC and Presidio Acquisitions............................         --    (95,529)       --
  Capital and exploration expenditures......................   (102,546)   (36,293)  (27,157)
  Changes in accounts payable and accrued expenses for oil
    and gas expenditures....................................      7,498      2,364    (1,657)
                                                              ---------   --------   -------
         Net cash used in investing activities..............    (82,413)  (128,865)  (70,863)
                                                              ---------   --------   -------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from issuance of common stock....................    121,665         --    47,932
  Borrowings of long-term bank debt.........................     27,000    119,000    51,000
  Repayments of long-term bank debt.........................   (123,000)        --   (51,000)
  Preferred stock dividends.................................     (1,750)    (1,672)       --
  Proceeds from exercise of stock options...................      1,582        519       261
  Stock issuance costs......................................       (392)        (5)     (285)
                                                              ---------   --------   -------
         Net cash provided by financing activities..........     25,105    117,842    47,908
                                                              ---------   --------   -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........    (13,967)    15,522   (14,165)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR..............     20,504      4,982    19,147
                                                              ---------   --------   -------
CASH AND CASH EQUIVALENTS AT END OF YEAR....................  $   6,537   $ 20,504   $ 4,982
                                                              =========   ========   =======
Cash paid during the year for:
  Interest..................................................  $   6,027   $    136   $ 1,369
  Income taxes..............................................        429        190        77
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       25
<PAGE>   26
 
                        TOM BROWN, INC. AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
 
(1) NATURE OF OPERATIONS
 
     Tom Brown, Inc. and its wholly-owned subsidiaries ("the Company") is an
independent energy company engaged in the domestic exploration for, and the
acquisition, development, marketing, production and sale of, natural gas and
crude oil. The Company's industry segments are (i) the exploration for, and the
acquisition, development, production, and sale of, natural gas and crude oil,
and (ii) the marketing, gathering and processing of natural gas, primarily
through Wildhorse Energy Partners, L. L. C. ("Wildhorse"). All of the Company's
operations are conducted in the United States. The Company's operations are
presently focused in the Wind River and Green River Basins of Wyoming, the
Piceance Basin of Colorado, the Val Verde Basin of west Texas, the Permian Basin
of west Texas and southeastern New Mexico, and east Texas. The Company also, to
a lesser extent, conducts exploration and development activities in other areas
of the continental United States.
 
     Substantially all of the Company's production is sold under
market-sensitive contracts. The Company's revenue, profitability and future rate
of growth are substantially dependent upon the price of, and demand for, oil,
natural gas and natural gas liquids. Prices for natural gas and oil are subject
to wide fluctuation in response to relatively minor changes in their supply and
demand as well as market uncertainty and a variety of additional factors that
are beyond the control of the Company. These factors include the level of
consumer product demand, weather conditions, domestic and foreign governmental
regulations, the price and availability of alternative fuels, political
conditions in foreign countries, the foreign supply of natural gas and oil and
the price of foreign imports and overall economic conditions. The Company is
affected more by fluctuations in natural gas prices than oil prices because a
majority of its production (82 percent in 1997 on a volumetric equivalent basis)
is natural gas.
 
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Principles of Consolidation and Basis of Presentation
 
     The accompanying consolidated financial statements include the accounts of
the Company. The Company's proportionate share of assets, liabilities, revenues
and expenses associated with certain interests in gas and oil partnerships and
the Company's 45% ownership in Wildhorse are consolidated within the
accompanying financial statements. All significant intercompany accounts and
transactions have been eliminated. Certain reclassifications have been made to
amounts reported on previous years to conform to the 1997 presentation.
 
  Inventories
 
     Inventories consist of pipe and other production equipment. Inventories are
stated at the lower of cost (principally first-in, first-out) or estimated net
realizable value.
 
  Property and Equipment
 
     The Company accounts for its natural gas and crude oil exploration and
development activities under the successful effort method of accounting. Under
such method, costs of productive exploratory wells, development dry holes and
productive wells and undeveloped leases are capitalized. Gas and oil lease
acquisition costs are also capitalized. Exploration costs, including geological
and geophysical expenses and delay rentals for gas and oil leases, are charged
to expense as incurred. Exploratory drilling costs are initially capitalized,
but charged to expense if and when the well is determined not to have found
reserves in commercial quantities.
 
     Maintenance and repairs are charged to expense; renewals and betterments
are capitalized to the appropriate property and equipment accounts. Upon
retirement or disposition of assets, the costs and related
 
                                       26
<PAGE>   27
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
accumulated depreciation are removed from the accounts with the resulting gains
or losses, if any, reflected in results of operations.
 
     Unproved properties with significant acquisition costs are assessed
quarterly on a property-by-property basis and any impairment in value is charged
to expense. Unproved properties whose acquisition costs are not individually
significant are aggregated, and the portion of such costs estimated to be
nonproductive, based on historical experience, is amortized over the average
holding period. If the unproved properties are determined to be productive, the
related costs are transferred to proved gas and oil properties.
 
     During 1995, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-lived
Assets". SFAS No. 121 generally requires a separate assessment for potential
impairment of each of the Company's producing property cost centers, in contrast
to the Company's prior policy of evaluating the producing property accounts for
impairment in total. As a result, the Company recorded an $8.4 million non-cash
charge during 1995, which reduced the carrying value of certain of the Company's
non-core properties to their estimated fair values.
 
     The provision for depreciation, depletion and amortization of oil and gas
properties is calculated on a field-by-field basis using the unit-of-production
method. Included in such calculations are estimated future dismantlement,
restoration and abandonment costs, net of estimated salvage values.
 
     Other property and equipment is recorded at cost and depreciated using the
straight-line method based on estimated useful lives.
 
  Natural Gas Revenues
 
     The Company utilizes the accrual method of accounting for natural gas
revenues whereby revenues are recognized as the Company's entitlement share of
gas is produced based from its working interests in the properties. The Company
records a receivable (payable) to the extent it receives less (more) than its
proportionate share of gas revenues. At December 31, 1997, the Company had net
gas balancing liabilities of approximately $3.0 million associated with
approximately 2.7 billion cubic feet ("Bcf") of gas.
 
  Income Taxes
 
     The Company provides for income taxes using the liability method under
which deferred income taxes are recognized for the tax consequences of
"temporary differences" by applying enacted statutory tax rates applicable to
future years to differences between the financial statement carrying amounts and
the tax bases of existing assets and liabilities. The effect on deferred taxes
of a change in tax laws or tax rates is recognized in income in the period such
changes are enacted.
 
  Stock-Based Compensation
 
     The Company accounts for employee stock-based compensation using the
intrinsic value method prescribed by Accounting Principles Board (APB) Opinion
No. 25, "Accounting for Stock Issued to Employees". Accordingly, adoption of
SFAS No. 123, "Accounting for Stock-Based Compensation" in 1996 had no effect on
the Company's results of operations but proforma disclosure is made of the
effect on net income had the accounting recommended by SFAS No. 123 been
implemented (See Note 7).
 
  Use of Estimates
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements. Such estimates and assumptions also affect the reported amounts of
revenues and expenses during the reporting
 
                                       27
<PAGE>   28
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
period. Actual results could differ from those estimates. Significant estimates
with regard to these financial statements include the estimate of proved oil and
gas reserve volumes and the related present value of estimated future net
revenues to be received therefrom (see Note 13), as well as the valuation
allowance for deferred taxes (see Note 5).
 
  Net Income Per Common Share
 
     The Company has adopted SFAS No. 128, "Earnings Per Share". Under SFAS No.
128, primary earnings per share ("Primary EPS") has been replaced by basic
earnings per share ("Basic EPS"), and fully diluted earnings per share ("Fully
Diluted EPS") has been replaced by diluted earnings per share ("Diluted EPS").
Basic EPS differs from Primary EPS in that it only includes the weighted average
impact of outstanding shares of the Company's common stock (i.e., it excludes
the dilutive effect of common stock equivalents such as the Preferred Stock, as
described in Note 6, stock options, etc.). Diluted EPS is substantially similar
to Fully Diluted EPS. The provision of SFAS No. 128 resulted in the retroactive
restatement for all periods of previously reported net income per common share
figures.
 
     Basic net income per share is calculated by dividing net income
attributable to common stock by the weighted average number of common shares
outstanding during the period including the weighted average impact of the
shares of common stock issued during the year from the date of issuance.
 
     Diluted net income per share calculations also include the dilutive effect
of stock options which are convertible into common stock.
 
     The following is a reconciliation of the numerators and denominators used
in the calculation of basic and diluted net income per common share for the
years ended December 31, 1997, 1996 and 1995:
 
<TABLE>
<CAPTION>
                                         1997                          1996                          1995
                              ---------------------------   ---------------------------   ---------------------------
                               NET              PER SHARE    NET              PER SHARE    NET              PER SHARE
                              INCOME   SHARES    AMOUNT     INCOME   SHARES    AMOUNT     INCOME   SHARES    AMOUNT
                              ------   ------   ---------   ------   ------   ---------   ------   ------   ---------
                                                IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S>                           <C>      <C>      <C>         <C>      <C>      <C>         <C>      <C>      <C>
Basic EPS:
  Net Income Attributable to
    Common Stock and Share
    Amounts.................  $6,860   25,110     $.27      $6,263   21,116     $.30      $5,785   16,292     $.36
Dilutive Securities:
  Stock Options.............     --    1,297        --         --    1,409        --         --      595        --
                              ------   ------     ----      ------   ------     ----      ------   ------     ----
Diluted EPS:
  Net Income Attributable to
    Common Stock and Assumed
    Share Amounts...........  $6,860   26,407     $.26      $6,263   22,525     $.28      $5,785   16,887     $.34
                              ======   ======     ====      ======   ======     ====      ======   ======     ====
</TABLE>
 
  Consolidated Statements of Cash Flows
 
     The Company considers investments purchased with an original maturity of
three months or less to be cash equivalents. In connection with the acquisition
of Interenergy, Wildhorse assumed $11.5 million in debt, $5.2 million net to the
Company. (See notes 3 and 4.) During the year ended December 31, 1996 the
Company (i) issued 1.0 million shares of Preferred Stock and .9 million shares
of Common Stock in connection with the KNPC Acquisition (see Note 3), and (ii)
issued 2.71 million shares of the Company's Common Stock and converted its $51
million investment in Presidio GINs, purchased in June 1995, into equity
ownership, both in connection with the Presidio Acquisition (see Note 3).
Insofar as such transactions are non-cash, they are not reflected in the
Consolidated Statements of Cash Flows.
 
                                       28
<PAGE>   29
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(3) ACQUISITIONS AND DIVESTITURES
 
  Acquisition of Sauer Drilling Company
 
     In January 1998, the Company completed the acquisition of W. E. Sauer
Companies L.L.C. of Casper, Wyoming for approximately $8.1 million. The assets
purchased include five drilling rigs, tubular goods, a yard and related assets.
The Company will operate the assets under the name Sauer Drilling Company and
will continue to serve the drilling needs of operators in the central Rocky
Mountain region in addition to drilling for the Company.
 
  Acquisition of Gathering and Processing Assets by Wildhorse
 
     In December 1997, KNE completed the acquisition of all of the assets of
Interenergy Corporation, ("Interenergy"). The assets consist of gas gathering
and processing facilities located in Wyoming, Montana, North Dakota and South
Dakota, as well as a marketing division. KNE retained the marketing assets and
Wildhorse acquired the gathering and processing assets valued at $23.4 million.
The Company's share of this purchase was approximately $10.5 million. These
assets consist of over 300 miles of pipeline and a processing plant. The Company
will benefit from the acquisition as it develops its acreage in the Big Horn
Basin.
 
  Acquisition of the Assets of Genesis Gas and Oil, L.L.C.
 
     In October 1997, the Company completed the acquisition of the assets of
Genesis Gas and Oil, L.L.C. ("Genesis"). The Genesis assets are located
primarily in the Piceance Basin of western Colorado and the Green River Basin of
Wyoming and are principally operated by the Company. The properties provide
current net production of approximately 6 million cubic feet of gas and 150
barrels of oil per day. The acquisition increases the Company's acreage position
in the Piceance Basin from approximately 54,000 to 86,000 net developed and
100,000 to 148,000 net undeveloped acres. The Company's working interest has
doubled from 23% to 46% in 238 producing wells and from 34% to 68% in 500
potential development locations. The purchase price for these assets was
approximately $35.5 million.
 
  Acquisition of KN Production Company
 
     Pursuant to a letter of intent entered into in December 1995, the Company
and KN Energy, Inc. ("KNE") closed certain transactions on January 31, 1996
which resulted in (i) the Company's acquisition of all of the issued and
outstanding stock of KN Production Company ("KNPC"), a wholly owned subsidiary
of KNE, and (ii) Wildhorse being formed by the Company and KNE for the purpose
of providing gas gathering, processing, marketing, field and storage services,
(collectively the "KNPC Acquisition"). The price paid to KNE in connection with
the KNPC Acquisition was determined to be $36.25 million, of which $25 million
was paid in the form of 1.0 million shares of the Company's $1.75 Convertible
Preferred Stock, Series A (the "Preferred Stock") and the remaining $11.25
million was paid in the form of 918,367 shares of the Company's Common Stock,
based on a price per share of $12.25. The KNPC Acquisition has been recorded
under the purchase method of accounting.
 
     As a result of the KNPC Acquisition, the Company acquired interests in 624
gross producing wells in Colorado and Wyoming, of which the Company became
operator of 308. The properties acquired by the Company included approximately
243,000 net undeveloped acres in Colorado, Wyoming, Kansas and Nebraska and
approximately 64,000 net developed acres located in Colorado and Wyoming.
 
     An integral part of the KNPC Acquisition was the formation of Wildhorse,
which is owned fifty-five percent (55%) by KNE and forty-five percent (45%) by
the Company. The business and affairs of Wildhorse are managed by KNE under the
direction of an operating team consisting of two representatives appointed by
the Company and two representatives appointed by KNE. The Company dedicated a
significant amount of its Rocky Mountain gas reserves to Wildhorse and KNE
contributed substantial gas marketing contracts. The
 
                                       29
<PAGE>   30
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Company also acquired a natural gas storage facility in western Colorado that
was simultaneously transferred to Wildhorse.
 
     The principal purpose of Wildhorse is to provide for the furnishing of
services related to natural gas, natural gas liquids and other natural gas
products, including gathering, processing and storage services.
 
  Acquisition of Presidio Oil Company
 
     In December 1996, the Company completed the acquisition of Presidio Oil
Company and its subsidiaries (collectively, "Presidio"), following the issuance
by the U.S. Bankruptcy Court, District of Delaware, on December 10, 1996, of an
Order confirming Presidio' reorganization under Chapter 11 of the U.S.
Bankruptcy Code. The purchase price was approximately $206.6 million consisting
of approximately $105 million in cash and 2.71 million shares of the Company's
Common Stock valued at $17.125 per share. Such amount does not include 2.64
million shares of the Company's Common Stock which were not issued due to the
Company's ownership of $56.15 million principal amount of Presidio Senior Gas
Indexed Notes (the "GINs"). The GINs were purchased in June 1995 for
approximately $51 million as a strategic part of the Company's efforts to
acquire Presidio Oil Company. The Presidio Acquisition has been accounted for
using the purchase method of accounting. The cash portion of the Presidio
Acquisition was funded by borrowings under the Company's credit agreement with
its bank lender. The assets acquired consist primarily of proved oil and gas
properties and undeveloped acreage located in Wyoming, North Dakota, Oklahoma
and Louisiana. The Wyoming properties are concentrated in the Green River and
Powder River Basins of Wyoming.
 
  Pro Forma Information
 
     The following table presents the unaudited pro forma revenues, net income
and net income per share of the Company for the years ended December 31, 1997
and 1996 assuming that the KNPC Acquisition, the Presidio Acquisition and the
Genesis Acquisition occurred on January 1, 1996.
 
<TABLE>
<CAPTION>
                                                                     YEARS ENDED
                                                                ---------------------
                                                                  1997         1996
                                                                --------     --------
                                                                   (IN THOUSANDS,
                                                                EXCEPT FOR PER SHARE
                                                                      AMOUNTS)
<S>                                                             <C>          <C>
Revenues...................................................     $132,322     $110,214
                                                                ========     ========
Net income.................................................     $  9,712     $  9,298
                                                                ========     ========
Net income attributable to common stock....................     $  7,962     $  7,626
                                                                ========     ========
Net income per common share
  Basic....................................................     $    .32     $    .36
                                                                ========     ========
  Diluted..................................................     $    .30     $    .34
                                                                ========     ========
</TABLE>
 
  Sale of North Dakota Properties
 
     In May 1997, the Company sold the majority of its properties located in
North Dakota for $11.0 million. The properties had a net book value of $11.0
million and, accordingly, no gain was recorded on the sale. Proceeds from the
sale of these properties were used to repay a portion of the Company's
outstanding indebtedness under its Credit Facility.
 
  Sale of Arkoma Assets
 
     In September 1995, the Company sold its properties in the Arkoma Basin in
western Arkansas for $9.0 million. As a result of this sale, the Company
realized an after-tax book gain of $3.0 million. Proceeds
 
                                       30
<PAGE>   31
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
from the sale of these properties were used to repay a portion of the Company's
outstanding indebtedness under its Credit Facility.
 
(4) DEBT
 
     In December 1996, the Company entered into a bank credit agreement. The
credit agreement provided for a $125 million revolving credit facility (the
"Credit Facility") maturing in December 1999. Borrowings under the Credit
Facility are unsecured and bear interest, at the election of the Company, at a
rate equal to (i) the greater of the agent bank's prime rate or the federal
funds effective rate plus 0.50% or (ii) the agent bank's Eurodollar rate plus a
margin ranging from .75% to 1.00%. Interest on amounts outstanding under the
Credit Facility is due on the last day of each month in the case of loans
bearing interest at the prime rate or federal funds rate and, in the case of
loans bearing interest at the Eurodollar rate, interest payments are due on the
last day of each applicable interest period of one, two, three or six months, as
selected by the Company at the time of borrowing. At December 31, 1997, the
outstanding balance was $23 million at an average interest rate of 6.90%.
 
     Financial covenants of the Credit Facility require the Company to maintain
a minimum consolidated tangible net worth of not less than $289 million as of
December 31, 1997. The Company is also required to maintain a ratio of (i)
earnings before interest expense, state and federal taxes and depreciation,
depletion and amortization to (ii) consolidated fixed charges, as defined in the
credit agreement, of not less than 2.5:1. Additionally, the Company is required
to maintain a ratio of consolidated debt to consolidated total capitalization of
less than 0.45:1 and a current ratio of not less than 1.1:1. The Company was in
compliance with all financial covenants at December 31, 1997.
 
     Subsequent to December 31, 1997, the Company was out of compliance with one
of the non financial covenants of the Credit Facility. The Company received a
waiver from the lenders regarding this event of noncompliance.
 
     Standby letters of credit of approximately $3,880,000 have been issued
under two agreements. One agreement expires in April 1999 and the letter of
credit being maintained is security for performance on a long term contract
entered into by Presidio. The second letter of credit is held as security by a
surety company for two oil and gas performance bonds issued to agencies of the
U.S. Government. The bonds will remain in place until released by the government
agencies.
 
     In connection with the acquisition of gathering and processing assets of
Interenergy, Wildhorse assumed $11.5 million in debt, $5.2 million net to the
Company. At December 31, 1997, the interest rate was 8.5%. The debt was
extinguished in February 1998.
 
(5) TAXES
 
     The Company has not paid Federal income taxes due to its net operating loss
carryforward, but is required to pay alternative minimum tax ("AMT"). This tax
can be partially offset by an AMT net operating loss carryforward.
 
                                       31
<PAGE>   32
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     A U.S. Federal statutory rate applied to the Company's income (loss) before
income taxes of 35% in 1997 and 1996 and 34% in 1995 was used in the following
reconciliation of the Company's effective income tax expense:
 
<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                                       ------------------------------
                                                        1997        1996       1995
                                                       -------     ------     -------
                                                               (IN THOUSANDS)
<S>                                                    <C>         <C>        <C>
Federal income tax provision (benefit) at statutory
  rate...............................................  $ 4,548     $3,946     $(2,418)
Revision of previous tax estimates...................   (1,111)        --          --
Adjustment to valuation allowance....................     (474)      (596)      2,357
Other................................................      395       (583)         33
                                                       -------     ------     -------
                                                         3,358      2,767         (28)
AMT provisions.......................................      403        290         105
State income and franchise taxes.....................      623        281         197
                                                       -------     ------     -------
Income tax expense...................................  $ 4,384     $3,338     $   274
                                                       =======     ======     =======
</TABLE>
 
     The significant components, which give rise to the Company's deferred tax
assets (liabilities), are as follows:
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                               1997         1996
                                                              -------     --------
                                                                 (IN THOUSANDS)
<S>                                                           <C>         <C>
Net operating loss carryforwards............................  $17,072     $ 18,689
Gas and oil acquisition, exploration and development costs
  deducted for tax purposes in excess of book...............  (16,819)     (14,520)
Investment tax credit carryforwards.........................      857        2,463
Option plan compensation....................................    1,559        1,559
Other.......................................................    5,492        2,309
                                                              -------     --------
Net deferred tax asset......................................    8,161       10,500
Valuation allowance.........................................   (5,555)      (7,635)
                                                              -------     --------
Recognized net deferred tax asset...........................  $ 2,606     $  2,865
                                                              =======     ========
</TABLE>
 
     A valuation allowance of approximately $5.6 million and $7.6 million at
December 31, 1997 and 1996, respectively, has been provided against the
Company's net deferred tax assets based on management's estimate of the
recoverability of future tax benefits. The valuation allowance relates primarily
to the inability to use certain net operating loss and investment tax credit
carryforwards. The Company evaluated all appropriate factors to determine the
proper valuation allowance for these carryforwards, including any limitations
concerning their use, the year the carryforwards expires and the levels of
taxable income necessary for utilization. In this regard, full valuation
allowances were provided for investment tax credit carryforwards and option plan
compensation. Based on its recent operating results and its expected levels of
future earnings, the Company believes it will, more likely than not, generate
sufficient taxable income to realize the benefit attributable to the net
operating loss carryforward for which valuation allowances were not provided.
 
     At December 31, 1997, the Company had investment tax credit carryforwards
of approximately $.9 million and net operating loss carryforward of
approximately $48.8 million. The Company currently has no liability for deferred
Federal income taxes because of these net operating loss and investment tax
credit carryforward. Realization of the benefits of these carryforwards is
dependent upon the Company's ability to generate taxable earnings in future
periods. In addition, the availability of these carryforwards is subject to
various limitations. The remainder of the carryforwards will expire between 1998
and 2004. Additionally, the
 
                                       32
<PAGE>   33
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Company has approximately $1.7 million of statutory depletion carryforwards and
$3.7 million of AMT credit carryforwards that may be carried forward until
utilized.
 
     In 1995, the Company reversed valuation allowances associated with net
operating loss carryforwards in the amount of $13.2 million, based on 1993 and
1994 additions to the Company's oil and gas reserves and resulting increases in
anticipated future income.
 
(6) STOCKHOLDERS EQUITY
 
  Common Stock
 
     The Company's Common Stock is $.10 par value per share. There are
40,000,000 authorized shares of Common Stock of which 29,210,354 shares and
23,898,431 shares were outstanding as of December 31, 1997 and 1996,
respectively.
 
     In October 1997, the Company sold 5,035,800 shares of Common Stock in a
public offering. The net proceeds of such offering were approximately $121.0
million and were used to repay a majority of the Company's outstanding long-term
debt and to fund the acquisition of all of the assets of Genesis Gas and Oil,
L.L.C. (See Note 3).
 
     The Company issued 918,367 shares of Common Stock in January 1996 in
connection with the KNPC Acquisition and 2.71 million shares of Common Stock in
December 1996 in connection with the Presidio Acquisition (See Note 3).
 
  Rights Plan
 
     On March 1, 1991, the Board of Directors adopted a Rights Plan designed to
help assure that all stockholders receive fair and equal treatment in the event
of a hostile attempt to take over the Company, and to help guard against abusive
takeover tactics. The Board of Directors declared a dividend of one preferred
share purchase right (a "Right") for each outstanding share of Common Stock. The
dividend was distributed on March 15, 1991 to the shareholders of record on that
date. Each Right entitles the registered holder to purchase, for the $20 per
share exercise price, shares of Common Stock or other securities of the Company
(or, under certain circumstances, of the acquiring person) worth twice the per
share exercise price of the Right.
 
     The Rights will be exercisable only if a person or group acquires 20% or
more of the Company's Common Stock or announces a tender offer which would
result in ownership by a person or group of 20% or more of the Common Stock. The
date on which the above occurs is to be known as the ("Distribution Date"). The
Rights will expire on March 15, 2001, unless extended or redeemed earlier by the
Company.
 
     At the time the Rights dividend was declared, the Board of Directors
further authorized the issuance of one Right with respect to each share of the
Company's Common Stock that shall become outstanding between March 15, 1991 and
the earlier of the Distribution Date or the expiration or redemption of the
Rights. Until the Distribution Date occurs, the certificates representing shares
of the Company's Common Stock also evidence the Rights. Following the
Distribution Date, the Rights will be evidenced by separate certificates.
 
     The provisions described above may tend to deter any potential unsolicited
tender offers or other efforts to obtain control of the Company that are not
approved by the Board of Directors and thereby deprive the stockholders of
opportunities to sell shares of the Company's Common Stock at prices higher than
the prevailing market price. On the other hand, these provisions will tend to
assure continuity of management and corporate policies and to induce any person
seeking control of the Company or a business combination with the Company to
negotiate on terms acceptable to the then elected Board of Directors.
 
                                       33
<PAGE>   34
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Preferred Stock
 
     In January 1996, in connection with the KNPC acquisition, (see Note 3) the
Company issued 1,000,000 shares of its $1.75 Convertible Preferred Stock, Series
A (the "Preferred Stock"). There are 2,500,000 shares of Preferred Stock
authorized.
 
     As the holder of the Preferred Stock, KNE is entitled to receive cumulative
dividends at the annual rate of $1.75 per share, payable in cash quarterly on
the fifteenth day of March, June, September and December in each year. If full
cumulative dividends on the Preferred Stock have not been declared and paid or
set apart for payment, the Company may not declare or pay or set apart for
payment any dividends or make any other distributions on, or make any payment on
account of the purchase, redemption or retirement of, the Company's Common
Stock, or any other stock of the Company ranking junior to the Preferred Stock
as to payment of dividends or distribution of assets on liquidation, dissolution
or winding up of the Company (other than, in the case of dividends or
distributions, dividends or distributions paid in shares of Common Stock or such
other junior ranking stock).
 
     The Company has the option, at any time beginning on or after March 15,
2001, to redeem all or any part of the outstanding shares of Preferred Stock at
the redemption price of $25.00 per share, plus an amount equal to all accrued
and unpaid dividends on such shares of Preferred Stock to the date of
redemption.
 
     Upon the occurrence of a change of control of the Company, KNE, as the
holder of the Preferred Stock, has the right to cause the Preferred Stock to be
redeemed by the Company, in whole or in part, at the redemption price of $25.50
per share, plus all accrued and unpaid dividends. Generally, for purposes of the
Preferred Stock, a change of control is any situation in which a majority of the
Board of Directors of the Company changes within a period of twelve months or a
new person or group of persons becomes in control of the Company, within the
meaning of rules of the Securities and Exchange Commission.
 
     Each share of the Preferred Stock is convertible at the option of the
holder thereof, at any time and from time to time prior to the redemption of
such share, into fully paid and nonassessable shares of Common Stock of the
Company at the initial conversion rate of 1.666 shares of Common Stock for each
share of Preferred Stock, subject to customary adjustments.
 
     The Preferred Stock is exchangeable, in whole or in part, at the option of
the Company on any dividend payment date at any time on or after March 15, 1999,
and prior to March 15, 2001, for shares of Common Stock at the exchange rate of
1.666 shares of Common Stock for each share of Preferred Stock; provided that
(i) on or prior to the date of exchange, the Company shall have declared and
paid or set apart for payment to the holders of Preferred Stock all accumulated
and unpaid dividends to the date of exchange, and (ii) the current market price
of the Common Stock is above $18.375 (the "Threshold Price"). The exchange rate
is subject to adjustment in the same manner and under the same circumstances as
the conversion rate is subject to adjustment, and the Threshold Price is also
subject to adjustment in the same manner and under the same circumstances.
 
     Upon the dissolution, liquidation or winding up of the Company, whether
voluntary or involuntary, the holders of the Preferred Stock are entitled to
receive out of the assets of the Company available for distribution to
stockholders, the amount of $25.00 per share plus an amount equal to all
dividends on such shares (whether or not earned or declared) accrued and unpaid
thereon to the date of final distribution, before any payment or distribution
may be made on the Common Stock or on any class of stock ranking junior to the
Preferred Stock with respect to distributions upon dissolution, liquidation or
winding up.
 
     If at any time dividends payable on the Preferred Stock are in arrears and
unpaid in an amount equal to or exceeding the amount of dividends payable
thereon for four quarterly dividend periods, the total number of Directors on
the Company's Board of Directors will be limited to a maximum of nine and the
holders of the outstanding Preferred Stock will have the exclusive right, voting
separately as a class without regard to series,
 
                                       34
<PAGE>   35
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
to designate a special class of two Directors of the Company (the "Special
Directors") at the next annual or special meeting of stockholders of the Company
irrespective of whether such meeting otherwise would involve the election of
directors, and the membership of the Board of Directors of the Company shall be
increased by the number of the Special Directors so designated. Such right of
the holders of Preferred Stock to designate Special Directors continues until
all dividends accumulated and payable on the Preferred Stock have been paid in
full, at which time such right to designate Special Directors terminates,
subject to re-vesting in the event of a subsequent dividend payment arrearage.
 
     In exercising the right to designate Special Directors or when otherwise
granted voting rights by operation of law, each share of Preferred Stock shall
be entitled to one vote, except as described below.
 
     For so long as KNE owns 80% or more of the voting power of the securities
of the Company issued pursuant to the KNPC Acquisition, KNE has the right to
elect a special class of two Directors to the Board of Directors of the Company,
and for so long as KNE owns securities of the Company issued pursuant to the
KNPC Acquisition possessing less than 80% of the voting power of the securities
of the Company issued pursuant to the KNPC Acquisition, but more than 30% of
such voting power, KNE has the right to elect a special class of one Director to
the Board of Directors of the Company.
 
     The holders of the Preferred Stock are entitled to vote on all matters upon
which holders of the Company's Common Stock have the right to vote. In such
voting, each share of Preferred Stock is entitled to a number of votes per share
equivalent to the number of shares of Common Stock issuable upon conversion of
the Preferred Stock and shall vote together with the holders of the outstanding
shares of the Company's Common Stock as if a part of that class.
 
(7) BENEFIT PLANS
 
  1989 Plan
 
     On September 28, 1990, shareholders approved the Company's 1989 Stock
Option Plan (the "1989 Plan"). The aggregate number of shares of Common Stock
that may be issued under the 1989 Plan is 2,000,000 shares.
 
     The exercise price of the options granted to employees and directors prior
to 1991, which was originally set at $5.25 per share, was reduced effective
September 4, 1991 to $4.00 per share, the market value at that date. The options
expire ten years from the date of grant.
 
  1993 Plan
 
     In May 1990 and March 1992, the Board of Directors adopted the 1990 Phantom
Stock Option Plan and the 1992 Phantom Stock Option Plan for Non-employee
Directors (the "Phantom Plans").
 
     In February 1993, the Board of Directors adopted the Company's 1993 Stock
Option Plan (the "1993 Plan"). The 1993 Plan provides for issuance of options to
certain employees and directors to purchase shares of Common Stock. The
aggregate number of shares of Common Stock that may be issued under the 1993
Plan is 1,200,000 shares. The exercise price, vesting and duration of the
options may vary and will be determined at the time of issuance. Also, in
connection with the 1993 Plan, employees and directors who were granted units
pursuant to the Phantom Plans surrendered those units for a like number of
options under the 1993 Plan at the surrendered units' exercise prices.
 
                                       35
<PAGE>   36
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     A summary of the status of the plans described above, as of the dates
indicated, and the changes during the years then ended, is presented in the
table and narrative below:
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                         ---------------------------------------------------
                                              1997              1996              1995
                                         ---------------   ---------------   ---------------
                                                   WTD.              WTD.              WTD.
                                         SHARES    AVG.    SHARES    AVG.    SHARES    AVG.
                                         UNDER    EXER.    UNDER    EXER.    UNDER    EXER.
                                         OPTION   PRICE    OPTION   PRICE    OPTION   PRICE
                                         ------   ------   ------   ------   ------   ------
                                                        (SHARES IN THOUSANDS)
<S>                                      <C>      <C>      <C>      <C>      <C>      <C>
Outstanding, beginning of year.........  2,110    $11.06   1,525    $ 8.72   1,120    $ 6.51
Granted................................    307     19.12     673     15.70     470     12.96
Exercised..............................   (244)     5.54     (88)     5.89     (60)     4.41
Forfeited..............................     --        --      --        --      (5)     3.86
                                         -----             -----             -----
Outstanding, end of year...............  2,173     12.84   2,110     11.06   1,525      8.72
                                         =====             =====             =====
Exercisable, end of year...............  1,501     10.77   1,457      8.99   1,309      8.28
                                         =====             =====             =====
Available for grant, end of year.......    741                31               429
                                         =====             =====             =====
</TABLE>
 
     The weighted average fair value of options granted during the years ended
December 31, 1997, 1996, and 1995 was $10.35, $9.19, and $6.71, respectively.
 
The following table summarizes information about stock options outstanding at
December 31, 1997:
 
<TABLE>
<CAPTION>
                                           OPTIONS OUTSTANDING              OPTIONS EXERCISABLE
                                  -------------------------------------   -----------------------
                                  NO. OF SHS.    WTD. AVG.                NO. OF SHS.
            RANGE OF                 UNDER       REMAINING    WTD. AVG.      UNDER      WTD. AVG.
            EXERCISE              OUTSTANDING   CONTRACTUAL   EXERCISE    EXERCISABLE   EXERCISE
             PRICES                 OPTIONS        LIFE         PRICE       OPTIONS       PRICE
            --------              -----------   -----------   ---------   -----------   ---------
                                                       (SHARES IN THOUSANDS)
<S>                               <C>           <C>           <C>         <C>           <C>
$ 3.810-7.620...................       491         4.71        $ 4.33          491       $ 4.33
 11.125-13.320..................       479         7.74         12.17          445        12.13
 14.687-21.653..................     1,203         8.55         16.59          565        15.30
                                     -----                                   -----
                                     2,173         7.50         12.84        1,501        10.77
                                     =====                                   =====
</TABLE>
 
     The Company accounts for its stock-based compensation using the intrinsic
value method prescribed by APB Opinion No. 25 and related interpretations, under
which no compensation cost has been recognized for the stock option plans.
Alternatively, if compensation costs for these plans had been determined in
accordance
 
                                       36
<PAGE>   37
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
with SFAS No. 123, the Company's net income and net income per share would
approximate the following pro forma amounts:
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                           --------------------------------
                                                             1997        1996        1995
                                                           --------    --------    --------
                                                           (IN THOUSANDS, EXCEPT PER SHARE
                                                                       AMOUNTS)
<S>                                                        <C>         <C>         <C>
Net Income
  As Reported............................................   $6,860      $6,263      $5,785
  Pro Forma..............................................    4,708       4,729       5,105
Basic Net Income per Common Share:
  As Reported............................................   $ 0.27      $ 0.30      $ 0.36
  Pro Forma..............................................     0.19        0.22        0.31
Diluted Net Income per Common Share:
  As Reported............................................   $ 0.26      $ 0.28      $ 0.34
  Pro Forma..............................................     0.18        0.21        0.30
</TABLE>
 
     The fair value of each option is estimated as of the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1997, 1996, and 1995 respectively: (i) risk-free
interest rates of 6.20, 6.35 and 7.59 percent; (ii) expected lives of seven
years, (iii) expected volatility of 40.9 and 45.4, and 46.9 percent, and (iv) no
dividend yields. The pro forma amounts shown above may not be representative of
future results because the SFAS No. 123 method of accounting has not been
applied to options granted prior to January 1, 1995.
 
  Profit Sharing, ESOP and KSOP Plans
 
     Effective April 1, 1985, the Company adopted a profit sharing plan (the
"Profit Sharing Plan") for the benefit of all employees. Under the Profit
Sharing Plan, the Company could contribute to a trust either stock or cash in
such amounts as the Company deemed advisable. The Company contributed $30,000
for 1995 to the Profit Sharing Plan.
 
     Effective April 1, 1986, the Company adopted an employee stock ownership
plan (the "ESOP") for the benefit of all employees. Under the ESOP, the Company
could contribute cash or the Company's Common Stock to a trust in such amounts
as the Company deemed advisable. The Company contributed $30,000 to the trust
for 1995, for the purchase by the trust of 2,110 shares of Common Stock.
 
     Effective April 1, 1990, the Profit Sharing Plan was amended to provide for
voluntary employee contributions under Section 401(k) of the Internal Revenue
Code of 1986, as amended. The Profit Sharing Plan was further amended to provide
employees with the ability to give direct investment instructions to the Profit
Sharing Trustee for amounts held for their benefit.
 
     Effective January 1, 1996 the Company adopted the KSOP which is a merger of
the ESOP and the Profit Sharing Plan which contains 401(k) profit sharing plan
and employer stock ownership plan provisions for the benefit of those persons
who qualify as participants. The Company contributed $100,000 to the KSOP for
1997 and 1996 respectively.
 
(8) FAIR VALUE OF FINANCIAL INSTRUMENTS
 
     The following methods and assumptions were used to estimate the fair value
of financial instruments. The carrying values of trade receivables and trade
payables included in the accompanying Consolidated Balance Sheets approximated
market value at December 31, 1997 and 1996.
 
                                       37
<PAGE>   38
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Cash and Cash Equivalents
 
     The carrying amounts approximated fair value due to the short maturity of
these instruments.
 
  Debt
 
     The carrying value approximates fair value because the interest rate is
variable and is reflective of current market conditions.
 
  Letters of Credit
 
     The letters of credit reflect fair values as a condition of the underlying
purpose and are subject to fees competitively determined in the market place.
 
(9) RELATED PARTIES AND SIGNIFICANT CUSTOMERS
 
     Certain of the Company's officers and directors participate (either
individually or indirectly through various entities) with the Company and other
unrelated investors in the drilling, development and operation of gas and oil
properties. Related party transactions are non-interest bearing and are settled
in the normal course of business with terms which, in management's opinion, are
similar to those with other joint owners.
 
     The Company has engaged from time to time two law firms, one of whose
partner serves as a director and one of whose partner served as an officer
through May 1997. The amounts paid to each of these firms for the years ended
December 31, 1997, 1996 and 1995 were approximately $189,000, and $110,000;
$56,000 and $268,000; and $103,000 and $159,000, respectively. The Company also
paid approximately $32,000, $74,000 and $35,000 during the years ended December
31, 1997, 1996 and 1995, respectively, to a consulting firm that has a partner
who serves as a director of the Company.
 
     The Company participates in exploration activity with a partnership, one of
whose partners is a director of the Company. During the years ended December 31,
1997, 1996, and 1995 the Company billed $960,000, $239,000 and $153,000,
respectively to such partnership for their share of certain leasehold costs.
 
     In addition, certain officers and directors of the Company are directors of
a former subsidiary. The Company and the former subsidiary make available to
each other certain personnel, office services and records with each party being
reimbursed for costs and expenses incurred in connection therewith. During the
years ended December 31, 1997, 1996 and 1995, the Company charged the former
subsidiary approximately $80,000, $75,000 and $70,000, respectively, for such
services. The former subsidiary performs drilling services on certain wells
operated by the Company and charged approximately $11,000, $42,000 and $934,000
for such services during the years ended December 31, 1997, 1996 and 1995,
respectively. In management's opinion, the above described transactions and
services were provided on the same terms as could be obtained from non-related
sources.
 
     Gas and oil sales to Conoco, Inc. accounted for 28% of gas and oil sales
and marketing, gathering and processing revenues for the year ended December 31,
1997. For the years ended 1996 and 1995, gas and oil sales to three purchasers,
Coastal Oil and Gas, Conoco, Inc. and KN Gas Marketing, Inc. accounted for 15%,
14% and 13% and 14%, 25% and 12%, respectively. Because there are numerous other
parties available to purchase the Company's production, the Company believes the
loss of these purchasers would not materially affect its ability to sell natural
gas or crude oil.
 
  Concentration of Credit Risk
 
     The Company's revenues are derived principally from uncollateralized sales
to customers in the oil and gas industry. The concentration of credit risk in a
single industry affects the Company's overall exposure to
 
                                       38
<PAGE>   39
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
credit risk because customers may be similarly affected by changes in economic
and other conditions. The Company has not experienced significant credit losses
on such receivables.
 
(10) SEGMENT INFORMATION
 
     The Company operates in two reportable segments: (i) gas and oil
exploration and development and (ii) marketing, gathering and processing. The
segment results are presented in the following schedule:
 
<TABLE>
<CAPTION>
                                      GAS & OIL      MARKETING,
                                    EXPLORATION &    GATHERING &    INTERCOMPANY
                                     DEVELOPMENT     PROCESSING     SALES & OTHER     TOTAL
                                    -------------    -----------    -------------    --------
                                                         (IN THOUSANDS)
<S>                                 <C>              <C>            <C>              <C>
Year ended December 31, 1997
  Assets..........................    $394,762         $57,628         $(1,464)      $450,926
  Revenues........................      93,716          41,853          (6,832)       128,737
  Income before taxes.............       9,703           3,291              --         12,994
  Capital expenditures............      90,643          17,213              --        107,856
  Depreciation and amortization...      35,229           1,001              --         36,230
Year ended December 31, 1996
  Assets..........................    $383,697         $24,923         $(2,246)      $406,374
  Revenues........................      41,598          29,476          (4,354)        66,720
  Income before taxes.............       7,417           3,856              --         11,273
  Capital expenditures............     256,054          24,550              --        280,604
  Depreciation and amortization...      13,762           1,378              --         15,140
Year ended December 31, 1995
  Assets..........................    $157,928         $ 6,246         $    --       $164,174
  Revenues........................      25,385          19,696          (4,028)        41,053
  Income (loss) before taxes......      (9,060)          1,949              --         (7,111)
  Capital expenditures............      24,809           1,203              --         26,012
  Depreciation and amortization...       9,785             209              --          9,994
</TABLE>
 
(11) COMMITMENTS AND CONTINGENCIES
 
     The Company's operations are subject to numerous Federal and state
government regulations that may give rise to claims against the Company. In
addition, the Company is a defendant in various lawsuits generally incidental to
its business. The Company does not believe that the ultimate resolution of such
litigation will have a material adverse effect on the Company's financial
position or results of operations.
 
                                       39
<PAGE>   40
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Lease Commitments
 
     At December 31, 1997, the Company had long-term leases covering certain of
its facilities and equipment. The minimum rental commitments under
non-cancelable operating leases with lease terms in excess of one year are as
follows:
 
<TABLE>
<CAPTION>
                        YEARS ENDING                              COMMITMENT
                        DECEMBER 31,                                AMOUNT
                        ------------                            --------------
                                                                (IN THOUSANDS)
<S>                                                             <C>
1998........................................................        $1,059
1999........................................................           964
2000........................................................           874
2001........................................................           872
2002........................................................           858
Thereafter..................................................           293
                                                                    ------
                                                                    $4,920
                                                                    ======
</TABLE>
 
     Total rental expense incurred for the years ended December 31, 1997, 1996
and 1995 was approximately $741,000, $394,000 and $262,000, respectively, all of
which represented minimum rentals under non-cancelable operating leases.
 
  Firm Transportation Commitments
 
     As of December 31, 1997, Wildhorse had entered into several contracts for
firm transportation on interstate pipelines. Based upon current rates and using
the Company's forty-five percent (45%) ownership in Wildhorse, the Company's
obligation for such firm transportation for the next five years and thereafter
is as follows:
 
<TABLE>
<CAPTION>
                        YEARS ENDING                              COMMITMENT
                        DECEMBER 31                                 AMOUNT
                        ------------                            --------------
                                                                (IN THOUSANDS)
<S>                                                             <C>
1998........................................................       $ 4,114
1999........................................................         4,114
2000........................................................         4,114
2001........................................................         3,760
2002........................................................         2,873
Thereafter..................................................         2,644
                                                                   -------
                                                                   $21,619
                                                                   =======
</TABLE>
 
     On January 23, 1998 KN Energy filed for a rate increase on their Pony
Express pipeline. The requested increase would raise the rate from approximately
$.45 to $.76. Should the rate increase be approved by F.E.R.C., the commitment
amount from firm transportation would increase by approximately $8.2 million net
to the Company. F.E.R.C. has currently stated that a rate increase, if allowed,
will not become effective until August 1, 1998.
 
  Environmental Matters
 
     A wholly owned subsidiary of the Company is a party to an environmental
cleanup proceeding. The subsidiary's share of the estimated cleanup costs was
accrued in the consolidated financial statements at December 31, 1997. Based on
the amount of remediation costs estimated for this site and the Company's de
minimis contribution, if any, the Company believes that the outcome of this
proceeding will not have a material adverse effect on its financial position or
results of operations.
 
                                       40
<PAGE>   41
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(12) QUARTERLY FINANCIAL DATA (UNAUDITED)
 
<TABLE>
<CAPTION>
                                               FIRST    SECOND     THIRD    FOURTH
                                              QUARTER   QUARTER   QUARTER   QUARTER    TOTAL
                                              -------   -------   -------   -------   --------
                                                  (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                           <C>       <C>       <C>       <C>       <C>
Year ended December 31, 1997
  Revenues..................................  $36,350   $26,888   $27,659   $37,840   $128,737
  Gross profit(1)...........................   23,351    15,211    14,742    20,406   $ 73,710
  Net income (loss) attributable to common
     stock..................................    6,015       252      (338)      931   $  6,860
  Net income (loss) per common share(2)(3)
     Basic..................................      .25       .01      (.01)      .03   $    .27
     Diluted................................      .24       .01      (.01)      .03   $    .26
Year ended December 31, 1996
  Revenues..................................  $13,205   $14,071   $14,773   $24,671   $ 66,720
  Gross profit(1)...........................    7,300     7,999     6,407    13,875   $ 35,581
  Net income attributable to common stock...      870     1,012       122     4,259   $  6,263
  Net income per common share(2)(3)
     Basic..................................      .04       .05       .01       .20   $    .30
     Diluted................................      .04       .05       .01       .19   $    .28
</TABLE>
 
---------------
 
(1) Gross Profit is computed as the excess of gas and oil revenues over
    operating expenses. Operating expenses are those associated directly with
    gas and oil and marketing, gathering and processing revenues and include
    lease operations, gas and oil related taxes cost of gas sold and other
    expenses.
 
(2) The sum of the individual quarterly net income (loss) per share may not
    agree with year-to-date net income (loss) per share as each period's
    computation is based on the weighted average number of common shares
    outstanding during the period.
 
(3) Net income per common share has been restated in accordance with SFAS No.
    128. (See Note 2.)
 
(13) SUPPLEMENTAL INFORMATION RELATED TO GAS AND OIL ACTIVITIES (UNAUDITED)
 
     The following tables set forth certain historical costs and operating
information related to the Company's gas and oil producing activities:
 
  Capitalized Costs and Costs Incurred
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                    ---------------------------------
                                                      1997        1996        1995
                                                    ---------   ---------   ---------
                                                             (IN THOUSANDS)
<S>                                                 <C>         <C>         <C>
Capitalized costs
  Proved gas and oil properties...................  $ 456,093   $ 392,192   $ 184,424
  Unproved gas and oil properties.................     44,468      44,687       2,200
                                                    ---------   ---------   ---------
  Total gas and oil properties....................    500,561     436,879     186,624
  Less: Accumulated depreciation, depletion and
     amortization.................................   (151,544)   (118,635)   (105,442)
                                                    ---------   ---------   ---------
          Net capitalized costs...................  $ 349,017   $ 318,244   $  81,182
                                                    =========   =========   =========
</TABLE>
 
                                       41
<PAGE>   42
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                           YEARS ENDED DECEMBER 31,
                                                         ----------------------------
                                                          1997       1996      1995
                                                         -------   --------   -------
                                                                (IN THOUSANDS)
<S>                                                      <C>       <C>        <C>
Costs incurred
  Proved property acquisition costs....................  $35,540   $194,869   $    44
  Unproved property acquisition costs..................    6,128     42,877       657
  Exploration costs....................................   11,777      3,471     3,144
  Development costs....................................   33,731     13,177    21,747
                                                         -------   --------   -------
          Total........................................  $87,176   $254,394   $25,592
                                                         =======   ========   =======
</TABLE>
 
  Gas and Oil Reserve Information (Unaudited)
 
     The following summarizes the policies used by the Company in preparing the
accompanying gas and oil reserve disclosures, Standardized Measure of Discounted
Future Net Cash Flows Relating to Proved Gas and Oil Reserves and reconciliation
of such standardized measure between years.
 
     Estimates of proved and proved developed reserves at December 31, 1997,
1996 and 1995 were principally prepared by independent petroleum consultants.
Proved reserves are estimated quantities of natural gas and crude oil which
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. Proved developed reserves are proved reserves that can be
recovered through existing wells with existing equipment and operating methods.
All of the Company's gas and oil reserves are located in the United States.
 
     The standardized measure of discounted future net cash flows from
production of proved reserves was developed as follows:
 
          1. Estimates are made of quantities of proved reserves and the future
     periods during which they are expected to be produced based on year end
     economic conditions.
 
          2. The estimated future cash flows from proved reserves were
     determined based on year-end prices, except in those instances where fixed
     and determinable price escalations are included in existing contracts.
 
          3. The future cash flows are reduced by estimated production costs and
     costs to develop and produce the proved reserves, all based on year end
     economic conditions and by the estimated effect of future income taxes
     based on the then-enacted tax law, the Company's tax basis in its proved
     gas and oil properties and the effect of net operating loss, investment tax
     credit and other carryforwards.
 
     The standardized measure of discounted future net cash flows does not
purport to present, nor should it be interpreted to present, the fair value of
the Company's gas and oil reserves. An estimate of fair value would also take
into account, among other things, the recovery of reserves not presently
classified as proved, anticipated future changes in prices and costs and a
discount factor more representative of the time value of money and the risks
inherent in reserve estimates.
 
                                       42
<PAGE>   43
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Quantities of Gas and Oil Reserves (Unaudited)
 
     The following table presents estimates of the Company's net proved and
proved developed natural gas and oil reserves (including natural gas liquids).
 
<TABLE>
<CAPTION>
                                                              RESERVE QUANTITIES
                                                              -------------------
                                                                GAS         OIL
                                                              (MMCF)       (MBLS)
                                                              -------      ------
<S>                                                           <C>          <C>
Proved reserves:
Estimated reserves at December 31, 1994.....................  180,306       4,522
  Revisions of previous estimates...........................  (11,071)       (476)
  Extensions and discoveries................................   12,065         455
  Sales of minerals in place................................   (7,412)        (46)
  Production................................................  (10,585)       (387)
                                                              -------      ------
Estimated reserves at December 31, 1995.....................  163,303       4,068
  Revisions of previous estimates...........................   10,249        (471)
  Purchase of minerals in place.............................  174,185       6,278
  Extensions and discoveries................................   28,192       2,976
  Production................................................  (16,762)       (545)
                                                              -------      ------
Estimated reserves at December 31, 1996.....................  359,167      12,306
  Revisions of previous estimates...........................  (41,299)     (2,763)
  Purchase of minerals in place.............................   23,341         268
  Extensions and discoveries................................   38,487         189
  Sales of minerals in place................................     (750)     (1,614)
  Production................................................  (31,842)     (1,159)
                                                              -------      ------
Estimated reserves at December 31, 1997.....................  347,104       7,227
                                                              =======      ======
Proved developed reserves:
  December 31, 1994.........................................  114,061       2,877
  December 31, 1995.........................................  109,267       2,862
  December 31, 1996.........................................  257,241       8,994
  December 31, 1997.........................................  258,756       5,749
</TABLE>
 
 Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Gas
 and Oil Reserves (Unaudited)
 
<TABLE>
<CAPTION>
                                                                      DECEMBER 31,
                                                           -----------------------------------
                                                             1997          1996         1995
                                                           ---------    ----------    --------
                                                                     (IN THOUSANDS)
<S>                                                        <C>          <C>           <C>
Future cash flows........................................  $ 805,645    $1,523,845    $308,965
Future production costs..................................   (225,488)     (380,453)    (86,735)
Future development costs.................................    (50,839)      (62,124)    (13,344)
                                                           ---------    ----------    --------
Future net cash flows before tax.........................    529,318     1,081,268     208,886
Future income taxes......................................    (77,277)     (265,260)    (31,016)
                                                           ---------    ----------    --------
Future net cash flows after tax..........................    452,041       816,008     177,870
Annual discount at 10%...................................   (186,867)     (349,795)    (74,523)
                                                           ---------    ----------    --------
Standardized measure at discounted future net cash
  flows..................................................  $ 265,174    $  466,213    $103,347
                                                           =========    ==========    ========
Discounted future net cash flows before income taxes.....  $ 300,814    $  608,746    $114,586
                                                           =========    ==========    ========
</TABLE>
 
                                       43
<PAGE>   44
                        TOM BROWN, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Natural gas and oil prices have declined significantly since December 31,
1997. Accordingly, the discounted future net cash flows shown above would be
substantially lower if the standardized measure were calculated using prices in
effect at the end of the first quarter.
 
 Changes in Standardized Measure of Discounted Future Net Cash Flows (Unaudited)
 
<TABLE>
<CAPTION>
                                                                YEARS ENDED DECEMBER 31,
                                                           ----------------------------------
                                                             1997         1996         1995
                                                           ---------    ---------    --------
                                                                     (IN THOUSANDS)
<S>                                                        <C>          <C>          <C>
Gas and oil sales, net of production costs...............  $ (68,446)   $ (30,955)   $(13,509)
Net changes in anticipated prices and production cost....   (267,369)     129,492     (10,077)
Extensions and discoveries, less related costs...........     28,816       81,675      10,803
Changes in estimated future development costs............     21,347       (1,985)      2,254
Previously estimated development costs incurred..........        315          428       4,152
Net change in income taxes...............................    106,893     (131,293)      1,872
Purchase of minerals in place............................     16,059      288,643          --
Sales of minerals in place...............................    (11,534)         (37)     (6,133)
Accretion of discount....................................     60,875       11,458      12,494
Revision of quantity estimates...........................    (49,263)      16,993      (8,337)
Changes in production rates and other....................    (38,732)      (1,553)     (2,002)
                                                           ---------    ---------    --------
Change in Standardized Measure...........................  $(201,039)   $ 362,866    $ (8,483)
                                                           =========    =========    ========
</TABLE>
 
                                       44
<PAGE>   45
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE
 
     None.
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     Certain information regarding Directors of the Company will be included in
the Company's definitive proxy statement to be filed with the Securities and
Exchange Commission not later than 120 days after the end of the Company's
fiscal year covered by this Form 10-K and such information is incorporated by
reference to the Company's definitive proxy statement. Information concerning
the Executive Officers of the Company appears under Item I of this Annual Report
on Form 10-K.
 
ITEM 11. EXECUTIVE COMPENSATION
 
     Certain information regarding compensation of executive officers of the
Company will be included in the Company's definitive proxy statement to be filed
with the Securities and Exchange Commission not later than 120 days after the
end of the Company's fiscal year covered by this Form 10-K and such information
is incorporated by reference to the Company's definitive proxy statement.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     Certain information regarding security ownership of certain beneficial
owners and management will be included in the Company's definitive proxy
statement to be filed with the Securities and Exchange Commission not later than
120 days after the end of the Company's fiscal year covered by this Form 10-K
and such information is incorporated by reference to the Company's definitive
proxy statement.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     Certain information regarding transactions with management and other
related parties will be included in the Company's definitive proxy statement to
be filed with the Securities and Exchange Commission not later than 120 days
after the end of the Company's fiscal year covered by this Form 10-K and such
information is incorporated by reference to the Company's definitive proxy
statement.
 
                                       45
<PAGE>   46
 
                                    PART IV
 
ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
         FORM 8-K
 
     (1) See Index to Consolidated Financial Statements under Item 8 of this
Annual Report on Form 10-K.
 
     (2) None
 
     (3) Exhibits:
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
         (2.1)           -- Exchange Agreement dated August 5, 1996 by and among
                            Presidio Oil Company, Presidio Exploration, Inc.,
                            Presidio West Virginia, Inc., Palisade Oil, Inc. and the
                            Registrant (Incorporated by reference to Exhibit No. 2.1
                            in the Registrant's Quarterly Report on Form 10-Q for the
                            six months ended June 30, 1996).
         (2.2)           -- First Amendment to Exchange Agreement dated August 20,
                            1996 by and among Presidio Oil Company, Presidio
                            Exploration, Inc., Presidio West Virginia, Inc., Palisade
                            Oil, Inc. and the Registrant (Incorporated by reference
                            to Exhibit No. 2.2 in the Registrant's Form 8-K Report
                            dated December 23, 1996 and filed with the Securities and
                            Exchange Commission on January 6, 1997).
         (2.3)           -- Second Amendment to Exchange Agreement dated September 5,
                            1996 by and among Presidio Oil Company, Presidio
                            Exploration, Inc., Presidio West Virginia, Inc., Palisade
                            Oil, Inc. and the Registrant (Incorporated by reference
                            to Exhibit No. 2.3 in the Registrant's Form 8-K Report
                            dated December 23, 1996 and filed with the Securities and
                            Exchange Commission on January 6, 1997).
         (2.4)           -- Third Amendment to Exchange Agreement dated November 20,
                            1996 by and among Presidio Oil Company, Presidio
                            Exploration, Inc., Presidio West Virginia, Inc., Palisade
                            Oil, Inc. and the Registrant (Incorporated by reference
                            to Exhibit No. 2.4 in the Registrant's Form 8-K Report
                            dated December 23, 1996 and filed with the Securities and
                            Exchange Commission on January 6, 1997).
         (3.1)           -- Certificate of Incorporation, as amended, of the
                            Registrant (Incorporated by reference to Exhibit No. 4 in
                            the Registrant's Form 10-Q Report for the quarterly
                            period ended June 30, 1996 and filed with the Securities
                            and Exchange Commission on August 14, 1996).
         (3.2)           -- Bylaws of the Registrant (Incorporated by reference to
                            Exhibit No. 3.2 in the Registrant's Form 8-B Registration
                            Statement dated July 15, 1987 and filed with the
                            Securities and Exchange Commission on July 17, 1987).
         (4.1)           -- Rights Agreement dated as of March 5, 1991 between the
                            Registrant and The First National Bank of Boston,
                            successor in interest to American Stock Transfer & Trust
                            Company (Incorporated by reference to Exhibit No. 4(a) in
                            the Registrant's Form 8-K Report dated March 12, 1991 and
                            filed with the Securities and Exchange Commission on
                            March 15, 1991).
        (10.1)           -- Wind River Gathering Company Joint Venture Agreement
                            between Retex Gathering Company, Inc. and KN Gas
                            Gathering, Inc. dated March 18, 1991 (Incorporated by
                            reference to Exhibit No. 10.5 in the Registrant's Form
                            S-1 Registration Statement dated May 3, 1993 and filed
                            with the Securities and Exchange Commission on May 4,
                            1993).
</TABLE>
 
                                       46
<PAGE>   47
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
        (10.2)           -- Agreement and Plan of Reorganization, dated January 31,
                            1996, by and among the Registrant, TBI Acquisition, Inc.,
                            KN Production Company and KN Energy, Inc. (Incorporated
                            by reference to Exhibit No. 10.1 in the Registrant's Form
                            8-K Report dated January 31, 1996 and filed with the
                            Securities and Exchange Commission on February 15, 1996).
        (10.3)           -- Limited Liability Company Agreement, dated January 31,
                            1996, of Wildhorse Energy Partners, LLC, between the
                            Registrant and KN Energy, Inc. (Incorporated by reference
                            to Exhibit No. 10.2 in the Registrant's Form 8-K Report
                            dated January 31, 1996 and filed with the Securities and
                            Exchange Commission on February 15, 1996).
        (10.4)           -- Registration Rights Agreement, dated January 31, 1996,
                            between the Registrant and KN Energy, Inc. (Incorporated
                            by reference to Exhibit No. 10.4 in the Registrant's Form
                            8-K Report dated January 31, 1996 and filed with the
                            Securities and Exchange Commission on February 15, 1996).
        (10.5)           -- Credit Agreement, dated as of December 23, 1996, among
                            the Registrant, The Chase Manhattan Bank and the other
                            lenders parties thereto. (Incorporated by reference to
                            Exhibit 10.8 in the Registrant's Form 10-K Report dated
                            March 24, 1997 and filed with the Securities and Exchange
                            Commission on March 27, 1997).
        (10.6)*          -- Purchase and Sale Agreement between Genesis Gas and Oil,
                            L.L.C. and TBI Production Company, dated October 1, 1997)
                         Executive Compensation Plans and Arrangements (Exhibits 10.7
                            through 10.10):
        (10.7)           -- 1989 Stock Option Plan (Incorporated by reference to
                            Exhibit No. 10.17 in the Registrant's Form S-1
                            Registration Statement dated February 14, 1990 and filed
                            with the Securities and Exchange Commission on February
                            13, 1990).
        (10.8)           -- Tom Brown, Inc. KSOP Plan (Incorporated by reference to
                            Exhibit 10.19 in the Registrants' Form 10-K Report dated
                            March 24, 1997 and filed with the Securities and Exchange
                            Commission on March 27, 1997).
        (10.9)           -- Second Amended and Restated Employment Agreement dated
                            January 1, 1997 between the Registrant and Donald L.
                            Evans (Incorporated by reference to Exhibit 10.15 in the
                            Registrants' Form 10-K Report dated March 24, 1997 and
                            filed with the Securities and Exchange Commission on
                            March 27, 1997).
        (10.10)          -- 1993 Stock Option Plan (Incorporated by reference to
                            Exhibit 10.25 in the Registrant's Form 10-K Report dated
                            March 26, 1993 and filed with the Securities and Exchange
                            Commission on March 31, 1993).
        (21.1)*          -- Subsidiaries of the Registrant.
        (23.1)*          -- Consent of Arthur Andersen LLP.
        (23.2)*          -- Consent of Williamson Petroleum Consultants, Inc.
        (23.3)*          -- Consent of Ryder Scott Company.
        (27.1)*          -- Financial Data Schedule
</TABLE>
 
---------------
 
* Filed herewith
 
     (4) Reports on Form 8-K:
 
     The Company filed a Report on Form 8-K on October 10, 1997 for its purchase
of the assets of Genesis Gas and Oil, L.L.C.
 
                                       47
<PAGE>   48
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
 
                                            TOM BROWN, INC.
 
                                            By:     /s/ DONALD L. EVANS
                                              ----------------------------------
                                                       Donald L. Evans
                                              Chairman of the Board of Directors
                                                 and Chief Executive Officer
 
Date: March 26, 1998
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
                      SIGNATURE                                     TITLE                    DATE
                      ---------                                     -----                    ----
<C>                                                    <S>                              <C>
 
                 /s/ DONALD L. EVANS                   Chairman of the Board and Chief  March 26, 1998
-----------------------------------------------------    Executive Officer
                   Donald L. Evans
 
                  /s/ R. KIM HARRIS                    Controller and Principal         March 26, 1998
-----------------------------------------------------    Financial Officer
                    R. Kim Harris
 
              /s/ WILLIAM R. GRANBERRY                 President, Chief Operating       March 26, 1998
-----------------------------------------------------    Officer and Director
                William R. Granberry
 
                 /s/ THOMAS C. BROWN                   Director                         March 26, 1998
-----------------------------------------------------
                   Thomas C. Brown
 
             /s/ EDWARD W. LEBARON, JR.                Director                         March 26, 1998
-----------------------------------------------------
               Edward W. LeBaron, Jr.
 
                  /s/ HENRY GROPPE                     Director                         March 26, 1998
-----------------------------------------------------
                    Henry Groppe
 
             /s/ ROBERT H. WHILDEN, JR.                Director                         March 26, 1998
-----------------------------------------------------
               Robert H. Whilden, Jr.
 
                /s/ JAMES B. WALLACE                   Director                         March 26, 1998
-----------------------------------------------------
                  James B. Wallace
 
               /s/ DAVID M. CARMICHAEL                 Director                         March 26, 1998
-----------------------------------------------------
                 David M. Carmichael
 
                 /s/ CLYDE MCKENZIE                    Director                         March 26, 1998
-----------------------------------------------------
                   Clyde McKenzie
</TABLE>
 
                                       48
<PAGE>   49
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
   EXHIBIT
     NO.                                EXHIBIT
  ---------                             -------
  <C>         <S>
 
     10.6     -- Purchase and Sale Agreement between Genesis Gas and Oil,
                 L.L.C. and TBI Production Company, dated October 1, 1997.
     21.1     -- Subsidiaries of the Registrant.
     23.1     -- Consent of Arthur Andersen LLP.
     23.2     -- Consent of Williamson Petroleum Consultants, Inc.
     23.3     -- Consent of Ryder Scott Company.
     27.1     -- Financial Data Schedule.
</TABLE>