##### Table of Contents



Exhibit 99.1 In view of the possible
materiality of the financial condition of Torch Energy Advisors
Incorporated (Torch) to the Minimum Price commitment,
which relates to the Purchase Contract between the Trust and Torch,
Torchs financial statements are provided as an exhibit to the
Trusts annual report on Form 10-K. Upon the termination of
the Minimum Price commitment, such financial statements will not be
included in this annual filing.




---



##### Table of Contents



TORCH ENERGY ADVISORS INCORPORATEDAND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED The following should be read in conjunction with the consolidated financial statements, and the
related notes thereto, of Torch Energy Advisors Incorporated and Subsidiaries (the Company). DISCUSSION OF YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 Recently, the Company reduced the scope of its operations and its services provided to the energy
industry through reductions of its work force and through the sale of individual assets and
businesses. As discussed in more detail below, many of the services previously provided by the
Company are currently no longer provided and, if provided, are provided at significantly reduced
levels than in previous years. Revenues The Companys service activities, which included accounting and finance, oil and gas operations and
engineering, hydrocarbon marketing, acquisitions and divestitures, and various administrative
services, accounted for 69% of revenues in 2004. Revenues for such service activities are received
under various outsourcing and management contracts and are classified primarily as Service Fees or
Operating Fees. Service Fees include payments for management and administrative services, fees for
providing drilling rig crew services to third parties, certain hydrocarbon marketing activities,
and consulting services. The Company also receives fees related to oil and gas field operations,
which it classifies as Operating Fees. Operating Fees are a combination of fees paid by clients
and reimbursements received from working interest owners customarily paid to the operator of oil
and gas properties. The Companys contracts for outsourcing and management services differ from contract to contract in
how the Company is paid for its services. For certain contracts, revenues are derived from a
combination of fixed and variable fees related to the activities performed. As such, Service Fees
may fluctuate from year to year based on the level of activity of the Companys clients and in
particular the number and complexity of the clients oil and gas properties. Service Fees were $20.4 million in 2004, down 4.2% from $21.3 million in 2003. Service Fees were
$21.3 million in 2003, down 66.5% from $63.6 million in 2002 primarily due to the sale of Novistar
and the cancellation of several contracts during 2003. Included in the 2002 service fees is $3.2
million in termination fees paid as a result of customers terminating service contracts. Operating fees totaled $.4 million, down 20% from $.5 million in 2003. Operating fees totaled $.5
million, down 68.8% from $1.6 million in 2002 primarily due to the cancellation of a contract. 1




---



##### Table of Contents



TORCH ENERGY ADVISORS INCORPORATEDAND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED Until December 2004, the Companys principal oil and gas properties related to the 2001 purchase of
oil and gas properties in Louisiana and Texas by Milam Energy L.P. (Milam), a wholly-owned
partnership. These properties were sold to third parties in October and December 2004. The results
of Milam are classified as discontinued operations and the consolidated financial statements for
all periods presented have been adjusted to reflect this presentation. The Company maintains other
interests in oil and gas fields in Texas and Louisiana. Oil and gas revenues for 2004 were $6.8
million, up 580% from $1.0 million in 2003. This increase is due to the purchase of an interest in
certain oil and gas properties in Louisiana in February 2004 and the purchase of other oil and gas
interests in December 2003 and January 2004. Oil and gas revenues for 2003 were $1.0 million, down
89.1% from $9.2 million in 2002. This decrease is primarily due to the January 2003 sale of
coal-seam gas production payment properties located in Alabama, which were obtained in conjunction
with the Management Buyout in September 1996. Hedging activities mainly consist of financial swap contracts entered into for the purpose of
hedging the impact of market fluctuations on production. There was no hedging activity for 2004.
Hedging activity was a loss of $100,000 in 2003, down from a gain of $1.5 million in 2002. From time to time, the Company has sold interests in various oil and gas properties, securities,
and other assets. In October and December 2004, Milam entered into separate agreements to sell its
oil and gas properties. In October 2004, Milam sold its interest in a field for $3.6 million,
resulting in a loss of approximately $3.1 million. In December 2004, Milam sold its remaining
fields for $11.8 million resulting in a gain of approximately $1.8 million. Both the gain and loss
are included in income from discontinued operations for the year ended December 31, 2004. In
January 2003, the Company sold its assets in a coal bed methane field in Alabama for $43 million in
cash, resulting in a gain of approximately $41 million. During the year ended December 31, 2003,
the Company sold pieces of art to third parties for a total of $1,057,000, generating a gain of
$68,000. In December 2003, Torch Energy Finance Company (TEFC) and the Company sold Torch Energy
Finance Fund LPI (TEFF) to a third party for $325,000 plus the assumption of a credit facility
(see Note 14 of the Notes to Consolidated Financial Statements), resulting in a gain of
$17,487,000. In October 2002, the Company sold its interest in The Procurement Center (TPC) for
$3.45 million and 58,231 shares of Resources Connection, Inc. (RCI), valued at $798,000,
resulting in a gain of $3.45 million. In addition, the Company received a contingent payment of
$197,000 in March 2003 based on total revenues of the parent company of RCI for the year ended
December 31, 2002. In December 2003, the Company sold 58,231 RCI shares for $1,609,000, resulting
in a gain of $811,000. 2




---



##### Table of Contents



TORCH ENERGY ADVISORS INCORPORATEDAND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED Expenses The Company includes in cost of services all of the personnel costs of providing services to its
clients pursuant to its outsourcing agreements. The level of expense recorded by the Company from
year to year is subject to variability related to client activity level. Cost of services totaled
$13.5 million, $15.9 million and $48.6 million in 2004, 2003 and 2002, respectively. The decrease
in both years is due to the cancellation of several contracts in 2003 and 2002 and the sale of
Novistar at the end of 2002. General and administrative
expenses totaled $7.1 million, $13.2 million and
$18.1 million in 2004, 2003 and
2002, respectively. The 46% reduction in general and administrative costs in 2004 is due to a
reduction in workforce resulting in a reduction in salaries and benefits, performance incentives
and office rent. The 27% reduction in general and administrative costs in 2003 is directly related
to the sale of Novistar and the reduction of outsourcing services and activities of the Company,
which was primarily responsible for a significant reduction in administrative infrastructure
required by the Company. Oil and gas operating expenses for 2004 totaled $2.6 million, up 767% from $300,000 in 2003 due to
the purchase of an interest in certain oil and gas properties in Louisiana in February 2004 and the
purchase of other oil and gas interests in December 2003 and January 2004. Oil and gas operating
expenses for 2003 totaled $300,000, down 93.6% from $4.7 million in 2002 due to the January 2003
sale of coal-seam gas production payment properties located in Alabama. The Companys average oil
and gas operating expenses per Mcfe was $2.15, $1.95 and $1.59 in 2004, 2003 and 2002,
respectively. Interest expense for 2004 totaled $2.2 million, down 29.0% from $3.1 million in 2003 due to the
sale of TEFF and the assumption of a credit facility by a third party in December 2003. Interest
expense for 2003 totaled $3.1 million, down 46.6% from $5.8 million in 2002 due to the sale of
Novistar and paying off the Novistar line of credit in January 2003. Minority Interests In February 2004, the Company formed Big Energy, LLC (Big Energy). Torch E&P Company, a
wholly-owned subsidiary of the Company, owns 71.25% of Big Energy. In December 2003, the Company
formed PPM Live Oak Energy, LLC (Live Oak). Torch E&P Company owned 75% of Live Oak in 2003 and
62.5% of Live Oak in 2004. The activities of Big Energy and Live Oak subsequent to the acquisitions
are consolidated in the financial statements with the unaffiliated parties interest reflected as
minority interest. Minority interest expense for 2004 totaled $563,000. On February 18, 2000,
Novistar acquired from Oracle the Oracle Energy Upstream business, which specializes in licensing,
support and implementation of application software, including related consulting services. As part
of the purchase price, Oracle received a 21.12% interest in Novistar (see Note 11 of the Notes to
the Consolidated Financial Statements). In February 2001, 3




---



##### Table of Contents



TORCH ENERGY ADVISORS INCORPORATEDAND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED Novistar purchased software from
Accenture in exchange for a 1.7% interest in Novistar. On December 31, 2002, Novistar merged with
Paradigm Technologies, a Petroleum Place company, that provides software solutions and technology
services for the energy industry, to create P2 Energy Solutions (P2ES). As a result of the
merger, the Company acquired the interests of all historic shareholders and received a 40%
ownership interest in P2ES, resulting in the Company changing the accounting method for its
investment in Novistar to the equity method. For the year ended December 31, 2002, Novistar is
consolidated in the Companys Statement of Operations with Oracles and Accentures combined
interests reflected as minority interest, but Novistars balance sheet at December 31, 2002 is no
longer consolidated. An equity investment is recorded for the Companys investment in P2ES. On
December 20, 2003, P2ES merged with a third party, resulting in a decrease in the Companys
interest in P2ES to 21.15%. Equity in Earnings of Affiliates and Investees The Company recorded an equity loss of $2.7 million and $3.1 million for the years ended December
31, 2004 and 2003, respectively, and equity earnings of $249,000 for the year ended December 31,
2002. The equity loss in 2004 and 2003 represents the Companys loss in P2ES. Net Income The foregoing activities resulted in the following net income (amounts in thousands): 2004
    
    
    2003
    
    
    2002Income (loss) from continuing operations
before minority interest, income taxes,
extraordinary gain on extinguishment of
debt and cumulative effect of change in
accounting principle
    
    $
    (639
    )
    
    $
    47,385
    
    
    $
    592Net income
    
    $
    849
    
    
    $
    46,720
    
    
    $
    993
 4




---



##### Table of Contents



TORCH ENERGY ADVISORS INCORPORATEDAND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities was $3.5 million for the year ended December 31, 2004.
Net cash used in operating activities was $10.5 million for the year ended December 31, 2003. Net
cash provided by operating activities was $448,000 for the year ended December 31, 2002. The
Company spent $6.3 million, $1.1 million, and $2.4 million on investments in property and equipment
in 2004, 2003, and 2002, respectively. During 2004, the Company sold its oil and gas interests in
Milam generating $15.4 million in proceeds from the sale of discontinued operations. During 2003,
the Company sold its interest in coal-seam gas production payment properties located in Alabama
generating $43 million in cash. During 2002, the Company sold its interest in TPC generating $3.5
million in cash. Financing Activities On September 30, 1996, the Company recorded TACs $25.5 million Senior Subordinated Note (the
Note) payable to Torchmark as part of the purchase price for the Management
Buyout. The principal of the Note was due and payable on September 30, 2004, and it accrued
interest at 9% per annum. During 2003 and 2002, the Note was reduced by $838,000, and $500,000,
respectively, in connection with the settlement of litigation involving the Predecessor, Torchmark,
and a third party. On January 1, 2005, the Note was renegotiated resulting in five $500,000
payments for principal and accrued interest being due in 2005, $5.0 million due in 2006, $5.0
million due in 2007 and the remaining unpaid balance of principal and interest due on May 1, 2008.
As of December 31, 2004, the outstanding balance is $23.1 million, of which $21.3 million has been
classified as long-term at December 31, 2004. On February 18, 2000, Novistar executed a $10.0 million Senior Subordinated Note payable to Oracle.
The note accrued interest at 9% from February 18, 2000 to February 17, 2001; 10% from February 18,
2001 to February 17, 2002; 12% from February 18, 2002 to February 17, 2003; 15% from February 18,
2003 to February 17, 2004; and 17% from February 18, 2004 to February 17, 2005. Interest was
payable quarterly in arrears beginning on May 17, 2000. The note was due upon the earlier of: (a)
February 18, 2005, or (b) upon a Major Event. A Major Event constitutes: (a) an initial public
offering of Novistar, (b) a sale of all or substantially all of the assets of Novistar, or (c) any
transaction or series of related transactions, including, without limitation, any
reorganization, merger, or consolidation that results in the transfer of 50% or more of the
outstanding voting power of Novistar. On December 31, 2002, Novistar paid $3.2 million to Oracle to
buyout the $10 million Senior Subordinated Note payable and interest payable of $1.1 million
resulting in an extraordinary gain of $7.9 million for the year ended December 31, 2002 (see Note
11 of the Notes to Consolidated Financial Statements). Interest expense of $1.2 million related to
this Note Payable is reflected in the accompanying Statement of Operations for the year ended
December 31, 2002. 5




---



##### Table of Contents



TORCH ENERGY ADVISORS INCORPORATEDAND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED On May 17, 2001, Milam entered into an $18 million Promissory Note with a third party, which
increased to $22 million on November 18, 2003. Until the sale of the properties (see Note 11 of the
Notes to Consolidated Financial Statements), interest accrued on the indebtedness at the sum of
seven percent (7.0%) plus the three month London Inter Bank Offer Rate (LIBOR) plus a three
percent (3.0%) default rate. Monthly principal and interest payments were due based on cash flows
from certain oil and gas properties. In December 2004, proceeds from the sale of the Milam
properties were used to pay down the note and the remaining principal balance was forgiven
resulting in a gain of $5.6 million for the year ended December 31, 2004. This gain is included in
income from discontinued operations for the year ended December 31, 2004. In connection with the sale of SMGC, the Company agreed to pay the general partner $2 million on
May 1, 2002 and $1 million on December 31, 2003. The Company paid $1 million in May 2002, $1
million in December 2002, and entered into a note for the remaining $1 million that was due in May
2002 and extended to May 1, 2003. Principal plus interest was paid at the prime rate plus 7% per
annum. In March 2003, the SMGC note plus interest was paid in full. In connection with the purchase of certain assets including rigs and real property in January 2002
(see Note 11 of the Notes to Consolidated Financial Statements), the Company entered into a note
for $3,175,000 payable to the seller (Grayson Note). Principal payments on the note plus interest
on the unpaid principal balance are due monthly and the note matures in February 2007. Interest
accrues at the prime rate adjusted at the beginning of each quarter for increases or decreases
during the previous quarter (4.75% at December 31, 2004). At December 31, 2004 and 2003, the
outstanding principal balance on the Grayson Note is $1.3 million and $1.9 million, respectively. In connection with the termination of certain former employees, the Company entered into notes for
options previously granted (Option Notes). The terms of the notes vary from between 5 and 10
years commencing on the date of termination and interest accrues at the prime rate. At December 31,
2004 and 2003, the outstanding principal balance on the Option Notes is $1.6 million and $1.9
million, respectively. On February 6, 2004, Big Energy entered into a $50 million credit facility (the Big Energy
Facility) with a bank. Interest accrues on indebtedness at the banks prime rate plus .5%, but in
no event less than a per annum rate of 4.5%. The Big Energy Facility has a February 26, 2007
maturity date and contains, among other terms, provisions for the maintenance of certain financial
ratios and restrictions on additional debt. The Company was in compliance with all covenants at
December 31, 2004. The Big Energy oil and gas properties secure the Big Energy Facility. At
December 31, 2004, the outstanding balance under the Big Energy Facility is $835,000, the borrowing
base is set at $1.0 million and the weighted-average interest rate is 4.9%. 6




---



##### Table of Contents



TORCH ENERGY ADVISORS INCORPORATEDAND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED On November 9, 2000, Novistar entered into a credit facility (the Novistar Facility) with a bank.
The Novistar Facility provided a short-term loan of $17.0 million and a revolving line of credit of
up to $3.0 million. The Novistar Facility had an interest rate of LIBOR plus 1.5% if less than
$10.0 million was outstanding and an interest rate of LIBOR plus 1.875% if the outstanding balance
exceeded $10.0 million. The short-term loan under the Novistar Facility matured on November 7,
2001, and the revolving line of credit matured on March 31, 2002. The Novistar Facility was secured
by a pledge of substantially all of the assets of Novistar. In July 2001, Novistar used its $30
million revolving promissory note with TEAI to pay off the $17 million loan. Additionally, TEAI had
guaranteed the outstanding balance of the revolving line of credit. At December 31, 2002, Novistar
merged with Paradigm Technologies (see Note 11 of the Notes to Consolidated Financial Statements),
the revolving line of credit is not on the Companys books as Novistars balance sheet is no longer
consolidated. Until April 14, 2003, the Company maintained a compensating balance of $3 million as
collateral for the Novistar revolving line of credit . On August 31, 1999, the Company entered into a $50 million credit facility (the Credit
Facility) with a bank. Interest accrued on indebtedness, at the Companys option, at the banks
prime rate plus .25% or the LIBOR rate. The Credit Facility had a March 1, 2003 maturity date and
contained, among other terms, provisions for the maintenance of certain financial ratios and
restrictions on additional debt. Certain oil and gas properties secured the Credit Facility. In
January 2003, the outstanding balance under the Credit Facility was paid in full (see Note 11 of
the Notes to Consolidated Financial Statements). On July 16, 1997, TEFF entered into a $90 million Credit Facility (the TEFF Facility) with a
bank. Until March 9, 2000, ordinary interest was accrued on indebtedness, at TEFFs option, at the
banks prime rate plus 0.5% or LIBOR plus 2.0% if the loans outstanding are less than or equal to
the portfolio base; and at the banks prime rate plus 5.5% or LIBOR plus 7.0% of the portion of
loans outstanding in excess of the portfolio base. Principal and interest on the loan were repaid
from cash flow from TEFFs underlying investments. The TEFF Facility contained, among other terms,
provisions for the maintenance of certain financial ratios and restrictions on additional debt. All
security in the investments currently owned by TEFF or hereafter acquired and proceeds thereof
secured the TEFF Facility, which originally matured on December 31, 2003. Effective March 9, 2000,
TEFF amended the TEFF Facility with a bank. The amendment changed the maturity date to June 30,
2000. As a result, no additional debt could be drawn on the TEFF Facility. As the underlying
investments were sold, the proceeds were used to reduce the outstanding principal balance of the
loan. In addition, the amendment changed the
interest rate to the banks prime rate (4.0% December 31, 2003) plus 1% or LIBOR (1.5% at December
31, 2003) plus 4% regardless of the portfolio base ($0 at December 31, 2003) and changed the
allocation of gross sales proceeds between debt repayment and funds available for distribution in
the event of a sale of TEFFs investments. On December 31, 2003, TEFC and the Company sold TEFF to
a third party (see Note 12 of the Notes to Consolidated Financial Statements). 7




---



##### Table of Contents



TORCH ENERGY ADVISORS INCORPORATEDAND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED The following table lists contractual obligations of the Company by due date or expiration date: Payments Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    
    After 5Contractual Obligations
    
    Total
    
    
    1 year
    
    
    1-3 years
    
    
    4-5 years
    
    
    yearsLong Term Debt
    
    $
    27,408
    
    
    $
    3,476
    
    
    $
    9,121
    
    
    $
    14,583
    
    
    $
    228Operating Leases
    
    
    3,393
    
    
    
    634
    
    
    
    1,165
    
    
    
    977
    
    
    
    617Total Contractual Cash
Obligations
    
    $
    30,801
    
    
    $
    4,110
    
    
    $
    10,286
    
    
    $
    15,560
    
    
    $
    845
 There are no other commercial commitments at December 31, 2004. Financial Risk Management The Company, through its subsidiaries, previously offered price risk management services to
energy-related businesses (natural gas and crude oil) through a variety of financial and other
instruments including forward contracts involving physical delivery of an energy commodity, swap
agreements which require payments to (or receipt of payments from) counterparties based on the
differential between a fixed and variable price for the commodity, options contracts requiring
payments to (or receipt of payments from) counterparties based on the difference between the
options strike and market prices for the commodity and other contractual arrangements. Effective
January 1, 1999, the Company adopted mark-to-market accounting for contracts related to its price
risk management service contracts in accordance with the provisions of the Financial Accounting
Standard Boards Emerging Issues Task Force Issue No. 98-10 (EITF 98-10), Accounting for Energy
Trading and Risk Management Activities. In addition, the Company has market risk exposure in the pricing applicable to its oil and gas
production. The Company enters into financial derivative contracts for the purpose of hedging the
impact of market fluctuations on its contractual commitments and forecasted transactions related to
its oil and gas production. On January 1, 2001, the Company adopted the provisions of the
Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative
Instruments and Hedging Activities, for the accounting of its hedge transactions. In previous years, when there was significant trading and marketing activity, in order to mitigate
the risk associated with its financial and other instruments, the Company monitored and managed the
inherent market risks through a variety of techniques including periodic reporting of the
portfolios value to senior management. The Company attempted to balance its contractual portfolio
in terms of notional amounts and the timing of performance and delivery obligations. However, net
unbalanced positions could have existed or have been established based upon assessment of
anticipated market movements. The Company maintained no open positions as of December 31, 2004. 8




---



##### Table of Contents



TORCH ENERGY ADVISORS INCORPORATEDAND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
TORCH ENERGY ADVISORS INCORPORATED The counterparties to these contractual arrangements are limited to the major financial
institutions and other established companies in the petroleum industry. Although the Company is
exposed to credit loss in the event of nonperformance by these counterparties, this exposure is
managed through credit approvals, limits and monitoring procedures, and limits to the period over
which unpaid balances are allowed to accumulate. The Company has not experienced nonperformance by
counterparties to these contracts, and no material loss would be expected from any such
nonperformance. During 2004 and 2003, the risk Management activities of the Company decreased
substantially, significantly reducing the potential for credit exposure. Quantitative and Qualitative Disclosures About Market Risk Market risk is the risk that the value of the contractual portfolio will change, either favorably
or unfavorably, in response to changes in prices. The Companys major market risk is commodity
price risk related to natural gas and crude oil price risk management services and its oil and gas
production. Historically, market prices for oil and gas production and related financial derivative
contracts have been volatile and unpredictable. Pricing volatility is expected to continue. The Company did not have any open option contracts or other financial derivative contracts at
December 31, 2004. Interest Rate Risk - The Companys exposure to changes in interest rates primarily results from
short-term changes in the prime and LIBOR rates. A 10% increase in the prime and floating LIBOR
rates would have the effect of increasing interest costs to the Company by $19,000 per year. Outlook The Company continues to work toward optimization of the well servicing business and is looking at
opportunities to divest this non core business in 2005. The Company is pursuing several additional
different strategies including selling individual fields and further development. The Companys
primary business focus is directed toward making additional investments in proved oil and gas
properties and midstream assets. The Company believes that it has now structured its operations to
a size that the core business can now sustain and can be used as a platform to seek out the new
investments. 9




---



##### Table of Contents



Consolidated Financial Statements Torch Energy Advisors Incorporated and Subsidiaries
As of December 31, 2004 and 2003




---



Torch Energy Advisors Incorporated and Subsidiaries Consolidated Financial Statements As of December 31, 2004 and 2003 Contents Reports of Independent Auditors
    
    
    1Audited Financial StatementsTorch Energy Advisors Incorporated and SubsidiariesConsolidated Balance Sheets
    
    
    4Consolidated Statements of Operations
    
    
    6Consolidated Statements of Stockholders Deficit
    
    
    7Consolidated Statements of Cash Flows
    
    
    8Notes to Consolidated Financial Statements
    
    
    10




---



##### Table of Contents



Report of Independent Auditors The Board of Directors
Torch Energy Advisors Incorporated We have audited the accompanying consolidated balance sheet of Torch Energy Advisors Incorporated
and Subsidiaries (the Company) as of December 31, 2004, and the related consolidated statements
of operations, stockholders deficit, and cash flows for the year then ended. 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 audit. We did not audit the financial statements
of P2 Energy Solutions, Inc., an investment which as discussed in Note 20 to the consolidated
financial statements, is accounted for by the equity method of accounting. The investment in P2
Energy Solutions, Inc. was $9.4 million as of December 31, 2004, and the equity in its net loss
was $2.7 million for the year then ended. The financial statements of P2 Energy Solutions, Inc.
have been audited by other auditors whose report has been furnished to us, and our opinion, insofar
as it relates to the amounts included for P2 Energy Solutions, Inc., is based solely on the report
of the other auditors. We conducted our audit in accordance with auditing standards generally accepted in the United
States of America. 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 audit and the report of other auditors provide a reasonable basis
for our opinion. In our opinion, based on our audit and the report of other auditors, the financial statements
referred to above present fairly, in all material respects, the consolidated financial position of
Torch Energy Advisors Incorporated and Subsidiaries at December 31, 2004, and the consolidated
results of their operations and their cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of America. \s\ UHY Mann Frankfort
Stein & Lipp CPAs, LLP
Houston, Texas
April 11, 2005 1




---



##### Table of Contents



Report of Independent Auditors The Board of Directors
Torch Energy Advisors Incorporated We have audited the accompanying consolidated balance sheet of Torch Energy Advisors Incorporated
and Subsidiaries (the Company) as of December 31, 2003, and the related consolidated statements
of operations, stockholders deficit, and cash flows for each of the two years in the period ended
December 31, 2003. 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. The
financial statements of P2 Energy Solutions, Inc. (a corporation in which the Company has a 21.15%
interest) have been audited by other auditors whose report has been furnished to us; insofar as our
opinion on the consolidated financial statements relates to the amounts included for P2 Energy
Solutions, Inc., it is based solely on their report. We conducted our audits in accordance with auditing standards generally accepted in the United
States. 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 and the report of other auditors provide a reasonable basis for our
opinion. In our opinion, based on our audits and the report of other auditors, the financial statements
referred to above present fairly, in all material respects, the consolidated financial position of
Torch Energy Advisors Incorporated and Subsidiaries at December 31, 2003, and the consolidated
results of their operations and their cash flows for each of the two years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted in the United
States. The accompanying financial statements have been prepared assuming that the Company will continue as
a going concern. As more fully described in Note 2, the Company will need additional working
capital to service its debt. This condition raises substantial doubt about the Companys ability to
continue as a going concern (Managements plans in regard to these matters are also described in
Note 2). The financial statements do not include any adjustments to reflect the possible future
effects on the recoverability and classifications of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty. As discussed in Note 3, effective January 1, 2003, the Company changed its method of accounting for
Asset Retirement Obligations. \s\ Ernst & Young LLP
Houston, Texas
April 9, 2004
Except for discontinued operations discussed in Note 3 as of December 31, 2003 and for each of the
two years in the period ended December 31, 2003, as to which the
date is April 12, 2005 2




---



##### Table of Contents



Report of Independent Auditors The Board of Directors
P2 Energy Solutions, Inc.: We have audited the accompanying consolidated balance sheets of P2 Energy Solutions, Inc. (a
Delaware corporation) and subsidiaries as of September 30, 2004 and 2003, and the related
statements of operations, stockholders equity and comprehensive loss, and cash flows for each for
the years then ended. These consolidated financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these consolidated financial
statements based on our audit. We conducted our audits in accordance with auditing standards generally accepted in the United
States of America. 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 consideration of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Companys internal control over financial reporting.
Accordingly, we express no such opinion. 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 P2 Energy Solutions, Inc. and subsidiaries as of
December 31, 2004 and 2003, and the results of their operations and their cash flows for each of
the years then ended in conformity with accounting principles generally accepted in the United
States of America. \s\ KPMG LLP
Denver, Colorado
April 8, 2005 3




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries 
 Consolidated Balance Sheets December 312004
    
    
    2003(amounts in thousandsexcept share data)AssetsCurrent assets:Cash and cash equivalents
    
    $
    8,459
    
    
    $
    8,169Restricted cash
    
    

    173
    
    
    
    515Accounts
receivable  product marketing
    
    
    5,834
    
    
    
    5,610Accounts
receivable  joint interest billing
    
    
    325
    
    
    
    462Accounts
receivable  oil and gas and other
    
    
    4,852
    
    
    
    4,349Notes
receivable  related parties
    
    
    
    
    
    
    508Assets from price risk management
    
    
    
    
    
    
    409Prepaid drilling costs
    
    
    242
    
    
    
    571Other current assets
    
    
    1,300
    
    
    
    1,748Current assets of discontinued operations
    
    
    1,157
    
    
    
    2,549Total current assets
    
    
    22,342
    
    
    
    24,890Land
    
    
    70
    
    
    
    70Property and equipment, at cost:Oil and gas (successful efforts method)
    
    
    6,579
    
    
    
    2,058Other fixed assets
    
    
    11,092
    
    
    
    10,71317,671
    
    
    
    12,771Accumulated depreciation, depletion and amortization
    
    
    (9,603
    )
    
    
    (8,231
    )8,068
    
    
    
    4,540Notes
receivable  related parties
    
    
    794
    
    
    
    362Notes receivable
    
    
    122
    
    
    
    Equity investment
    
    
    9,359
    
    
    
    12,063Other assets
    
    
    943
    
    
    
    765Assets of discontinued operations
    
    
    500
    
    
    
    22,919Total assets
    
    $
    42,198
    
    
    $
    65,609
 4




---



##### Table of Contents



December 312004
    
    
    2003(amounts in thousandsexcept share data)Liabilities and stockholders deficitCurrent liabilities:Accounts
payable  product marketing
    
    $
    5,500
    
    
    $
    5,582Accounts payable and accrued liabilities
    
    
    12,207
    
    
    
    10,863Due to affiliates, net
    
    
    1,811
    
    
    
    2,124Notes payable to bank
    
    
    180
    
    
    
    Notes
payable - other
    
    
    1,477
    
    
    
    1,641Senior
subordinated note payable  affiliate
    
    
    1,819
    
    
    
    23,086Revenue, royalty, and production taxes payable
    
    
    2,909
    
    
    
    2,628Current liabilities of discontinued operations
    
    
    1,244
    
    
    
    22,202Total current liabilities
    
    
    27,147
    
    
    
    68,126Notes
payable  other
    
    
    2,665
    
    
    
    3,177Senior
subordinated note payable  affiliate
    
    
    21,267
    
    
    
    Other long-term liabilities
    
    
    707
    
    
    
    411Liabilities of discontinued operations
    
    
    
    
    
    
    5,022Minority interest
    
    
    1,262
    
    
    
    163Commitments and contingencies
    
    
    
    
    
    
    Stockholders deficit:Common stock, par value $1.00,
1,000 shares authorized, issued, and outstanding
    
    
    1
    
    
    
    1Additional paid-in capital
    
    
    1,999
    
    
    
    1,999Accumulated deficit
    
    
    (2,899
    )
    
    
    (3,555
    )Due from stockholder
    
    
    (9,951
    )
    
    
    (9,735
    )Total stockholders deficit
    
    
    (10,850
    )
    
    
    (11,290
    )Total liabilities and stockholders deficit
    
    $
    42,198
    
    
    $
    65,609
 See accompanying notes. 5




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries 
 Consolidated Statements of Operations Year ended December 312004
    
    
    2003
    
    
    2002(amounts in thousands)Revenues:Oil and gas revenues
    
    $
    6,761
    
    
    $
    1,011
    
    
    $
    9,150Gas plant fees
    
    
    1,139
    
    
    
    
    
    
    
    Product marketing and other trading, net
    
    
    337
    
    
    
    301
    
    
    
    (145
    )Gain (loss) from price risk management activities
    
    
    
    
    
    
    (99
    )
    
    
    1,476Service fees
    
    
    20,417
    
    
    
    21,276
    
    
    
    63,562Operating fees
    
    
    378
    
    
    
    505
    
    
    
    1,607Interest and other income
    
    
    1,006
    
    
    
    3,663
    
    
    
    3,448Gain on sale of assets and investments
    
    
    59
    
    
    
    58,871
    
    
    
    3,54830,097
    
    
    
    85,528
    
    
    
    82,646Costs and expenses:Cost of services
    
    
    13,503
    
    
    
    15,937
    
    
    
    48,599Oil and gas operating expenses
    
    
    2,576
    
    
    
    346
    
    
    
    4,693Depreciation, depletion, and amortization
    
    
    1,434
    
    
    
    1,149
    
    
    
    3,524Dry hole costs
    
    
    495
    
    
    
    459
    
    
    
    Plugging and abandonment costs
    
    
    
    
    
    
    15
    
    
    
    1,110Provision for impairment of oil & gas properties
    
    
    
    
    
    
    45
    
    
    
    Accretion expense
    
    
    104
    
    
    
    44
    
    
    
    General and administrative expenses
    
    
    7,135
    
    
    
    13,213
    
    
    
    18,148Provision for credit losses (gains)
    
    
    (450
    )
    
    
    398
    
    
    
    71Interest expense
    
    
    2,237
    
    
    
    3,071
    
    
    
    5,750Other expense
    
    
    998
    
    
    
    334
    
    
    
    408Total costs and expenses
    
    
    28,032
    
    
    
    35,011
    
    
    
    82,303Impairment and equity in earnings (losses) of
investees
    
    
    (2,704
    )
    
    
    (3,132
    )
    
    
    249Income (loss) from continuing operations before
minority interest, income taxes, extraordinary item,
and cumulative effect of change in accounting
principle
    
    
    (639
    )
    
    
    47,385
    
    
    
    592Minority interest
    
    
    (563
    )
    
    
    
    
    
    
    951Income tax benefit (provision)
    
    
    1
    
    
    
    (13
    )
    
    
    (10
    )Income (loss) from continuing operations

    
    
    (1,201
    )
    
    
    47,372
    
    
    
    1,533Income (loss) from discontinued operations
    
    
    2,050
    
    
    
    (500
    )
    
    
    (8,414
    )Extraordinary gain on extinguishment of debt
    
    
    
    
    
    
    
    
    
    
    7,874Income from continuing operations before cumulative
effect of change in accounting principle
    
    
    849
    
    
    
    46,872
    
    
    
    993Cumulative effect of change in accounting principle
    
    
    
    
    
    
    152
    
    
    
    Net income
    
    $
    849
    
    
    $
    46,720
    
    
    $
    993
 See accompanying notes. 6




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries 
 Consolidated Statements of Stockholders Deficit For the Years Ended December 31, 2004, 2003, and 2002(amounts in thousands) Accumulated
    
    
    
    
    
    
    
    
    
    
    TotalAdditional
    
    
    Other
    
    
    
    
    
    
    
    
    
    
    Stockholder'sCommon Stock
    
    
    
    
    
    
    Paid-In
    
    
    Comprehensive
    
    
    Accumulated
    
    
    Due From
    
    
    (Deficit)Shares
    
    
    Amount
    
    
    Warrants
    
    
    Capital
    
    
    Income, Net
    
    
    Deficit
    
    
    Stockholder
    
    
    EquityBalance, December 31, 2001
    
    
    1
    
    
    $
    1
    
    
    $
    116
    
    
    $
    1,999
    
    
    $
    (21
    )
    
    $
    (43,451
    )
    
    $
    (8,463
    )
    
    $
    (49,819
    )Termination of warrants to customers
    
    
    
    
    
    
    
    
    
    
    (116
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (116
    )Comprehensive income:Equity adjustment from foreign
currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21
    
    
    
    
    
    
    
    
    
    
    
    21Unrealized gain in value of
investment in equity securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    553
    
    
    
    
    
    
    
    
    
    
    
    553Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    993
    
    
    
    
    
    
    
    993Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,567Balance, December 31, 2002
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    1,999
    
    
    
    553
    
    
    
    (42,458
    )
    
    
    (8,463
    )
    
    
    (48,368
    )Dividends paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,817
    )
    
    
    
    
    
    
    (7,817
    )Advances to stockholder
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,272
    )
    
    
    (1,272
    )Comprehensive income:Unrealized gain in value of
investment in equity securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (553
    )
    
    
    
    
    
    
    
    
    
    
    (553
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    46,720
    
    
    
    
    
    
    
    46,720Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    46,167Balance, December 31, 2003
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    1,999
    
    
    
    
    
    
    
    (3,555
    )
    
    
    (9,735
    )
    
    
    (11,290
    )Dividends paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (193
    )
    
    
    
    
    
    
    (193
    )Advances to stockholder
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (216
    )
    
    
    (216
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    849
    
    
    
    
    
    
    
    849Balance, December 31,2004
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    1,999
    
    
    
    
    
    
    
    (2,899
    )
    
    
    (9,951
    )
    
    
    (10,850
    )
 See accompanying notes. 7




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries 
 Consolidated Statements of Cash Flows Year ended December 312004
    
    
    2003
    
    
    2002(amounts in thousands)Cash flows from operating activitiesNet income
    
    $
    849
    
    
    $
    46,720
    
    
    $
    993Adjustments to reconcile net income to net cash provided
by (used in) operating activities:Depreciation, depletion, and amortization
    
    
    2,322
    
    
    
    2,188
    
    
    
    10,191Impairment and equity losses (earnings) in
investees
    
    
    2,704
    
    
    
    3,132
    
    
    
    (249
    )Provision for impairment of oil & gas properties
    
    
    
    
    
    
    45
    
    
    
    1,564Accretion expense
    
    
    428
    
    
    
    276
    
    
    
    Minority interest
    
    
    563
    
    
    
    
    
    
    
    (951
    )Provision for credit losses
    
    
    (450
    )
    
    
    398
    
    
    
    71Price risk management activities
    
    
    182
    
    
    
    (659
    )
    
    
    935Gain on sale of assets and investments
    
    
    (4,381
    )
    
    
    (58,871
    )
    
    
    (3,548
    )Extraordinary gain on extinguishment of debt
    
    
    
    
    
    
    
    
    
    
    (7,874
    )Cumulative effect of change in accounting
principle
    
    
    
    
    
    
    152
    
    
    
    Other
    
    
    60
    
    
    
    (2,314
    )
    
    
    Noncash assumption of debt
    
    
    
    
    
    
    1,756
    
    
    
    Noncash forgiveness of debt
    
    
    
    
    
    
    (400
    )
    
    
    (400
    )Changes in operating assets and liabilities, net
of effects of acquisitions accounted for under
the purchase method of accounting:Accounts receivable
    
    
    507
    
    
    
    2,156
    
    
    
    11,283Due from/to affiliates
    
    
    (313
    )
    
    
    (547
    )
    
    
    672Other current assets
    
    
    2,397
    
    
    
    (2,021
    )
    
    
    (579
    )Accounts payable and accrued liabilities
    
    
    (766
    )
    
    
    (1,653
    )
    
    
    (7,285
    )Revenue, royalty, and production taxes
payable
    
    
    281
    
    
    
    968
    
    
    
    (2,380
    )Other
    
    
    (921
    )
    
    
    (1,829
    )
    
    
    (1,995
    )Net cash flows provided by (used in) operating activities
    
    
    3,462
    
    
    
    (10,503
    )
    
    
    448
 See accompanying notes. 8




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Consolidated Statements of Cash Flows (continued) Year ended December 312004
    
    
    2003
    
    
    2002(amounts in thousands)Cash flows from investing activitiesRestricted cash
    
    
    (86
    )
    
    
    (744
    )
    
    
    517Notes receivable
    
    
    (45
    )
    
    
    1,840
    
    
    
    2,971Proceeds from the sale of assets
    
    
    16,750
    
    
    
    45,493
    
    
    
    353Investment in property and equipment
    
    
    (6,349
    )
    
    
    (1,083
    )
    
    
    (2,437
    )Investment in equity investees
    
    
    
    
    
    
    
    
    
    
    (3,847
    )Proceeds from sale of investment
    
    
    
    
    
    
    
    
    
    
    3,450Purchase price adjustments on PPM Live Oak Energy
LLC
    
    
    197
    
    
    
    
    
    
    
    Payment for purchase of Torch Rig Services Onshore
(net of cash acquired) and additional rigs
    
    
    
    
    
    
    
    
    
    
    (425
    )Distributions from investments in affiliates
    
    
    
    
    
    
    
    
    
    
    452Net cash flows provided by investing activities
    
    
    10,467
    
    
    
    45,506
    
    
    
    1,034Cash flows from financing activitiesProceeds from line of credit with bank
    
    $
    1,000
    
    
    $
    
    
    
    $
    Proceeds from note payable
    
    
    2,354
    
    
    
    1,976
    
    
    
    2,204Repayment of senior subordinated note payable-
affiliate
    
    
    
    
    
    
    (338
    )
    
    
    Repayment of note payable to bank
    
    
    (165
    )
    
    
    (18,740
    )
    
    
    (461
    )Repayment of note payable
    
    
    (16,483
    )
    
    
    (4,081
    )
    
    
    (6,314
    )Contributions from minority interests
    
    
    129
    
    
    
    
    
    
    
    Distributions to minority interests
    
    
    (65
    )
    
    
    
    
    
    
    Payment of dividend
    
    
    (193
    )
    
    
    (7,817
    )
    
    
    Advances to stockholder, net
    
    
    (216
    )
    
    
    (1,272
    )
    
    
    Net cash flows used in financing activities
    
    
    (13,639
    )
    
    
    (30,272
    )
    
    
    (4,571
    )Net increase (decrease) in cash and cash equivalents
    
    
    290
    
    
    
    4,731
    
    
    
    (3,089
    )Cash and cash equivalents at beginning of year
    
    
    8,169
    
    
    
    3,438
    
    
    
    6,527Cash and cash equivalents at end of year
    
    $
    8,459
    
    
    $
    8,169
    
    
    $
    3,438Supplemental disclosures of cash flow informationCash paid during the year for:Interest
    
    $
    3,341
    
    
    $
    5,563
    
    
    $
    3,865Income taxes
    
    $
    3
    
    
    $
    14
    
    
    $
    12
 See accompanying notes. 9




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries 
 Notes to Consolidated Financial Statements December 31, 2004 1. Organization Recently, Torch Energy Advisors Incorporated and its Subsidiaries (collectively, TEAI or the
Company), has reduced the scope of its operations through the downsizing of its workforce and
through the sale of individual assets and businesses. The Company previously provided a broad range
of operational and administrative services to energy companies, often through outsourcing
arrangements. In addition, the Company provided development growth capital to independent oil and
gas companies, engaged in various hydrocarbon marketing and trading activities. The Company
continues to receive revenue from services provided to energy companies, principally drilling, and
interests it holds in oil and gas properties. Operations for the Company are headquartered in
Houston, Texas, with an operational district office in California. Until September 1996, TEAI (the Predecessor when discussing periods prior to September 30, 1996)
operated as a single business segment and was a wholly owned subsidiary of Torchmark, an insurance
and financial services holding company headquartered in Birmingham, Alabama. On September 30, 1996,
certain members of the Predecessors executive management, through the formation of Management
Holding Company (MHC) and Torch Acquisition Company (TAC), purchased TEAI from Torchmark (the
Management Buyout) (see Note 10). Torchmark retained a warrant for 10% of TACs common stock on a
fully diluted basis. The Management Buyout was recorded using the purchase method of accounting as
TEAIs executive management had no ownership in the Predecessor. During 1997, MHC was merged into
TAC. 2. Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of TEAI, including all wholly-owned and
majority-owned subsidiaries. All significant intercompany accounts and transactions have been
eliminated. 10




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Significant Subsidiaries In February 2004, the Company formed Big Energy, LLC (Big Energy), for the purpose of owning and
investing in oil and gas properties Torch E&P Company, a wholly-owned subsidiary of the Company,
owns 71.25% of Big Energy. The activities of Big Energy subsequent to the acquisition are
consolidated in the financial statements with the unaffiliated parties interest reflected as
minority interest. On December 2, 2003, the Company formed PPM Live Oak Energy, LLC (Live Oak), for the purpose of
owning and investing in oil and gas properties. Torch E&P Company owned 75% of Live Oak in 2003
and 62.5% of Live Oak in 2004. The activities of Live Oak subsequent to the acquisition are
consolidated in the financial statements with the unaffiliated parties interest reflected as a
minority interest. Effective April 2001, the Company formed Milam Energy L.P. (Milam), for the purpose of acquiring
and developing oil and gas properties. Milam Energy GP, L.L.C., served as the sole general partner
(0.1%) and TEAI served as the sole limited partner (99.9%). By December 2004, all properties owned
by Milam were sold to third parties. The results of Milam are classified as discontinued operations
and the consolidated financial statements for all periods presented have been adjusted to reflect
this presentation (see Note 3). Effective February 29, 2000, the Company formed Torch Energy TM, Inc. (TETM), to conduct energy
product marketing activities. Activities for TETM are consolidated in the Companys financial
statements. Torch Rig Services, Inc. (TRS), a wholly-owned subsidiary, was formed on June 11, 1999 for the
purpose of providing drilling rig crew services and land based workover rigs to third parties.
Activities for Torch Rig Services, Inc. are consolidated in the Companys financial statements. Torch Energy Finance Fund LPI (TEFF), a Texas limited liability partnership, was formed on
September 6, 1995. The partnership agreement was amended on July 14, 1997 for the purpose of
allowing TEFF to provide growth capital through loans and equity investments to small and mid-size
oil and gas companies for use in acquisition and exploitation opportunities. Torch Energy Finance
Company (TEFC), a wholly-owned 11




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) subsidiary, served as the sole general partner (10%) and the Company served as the sole limited
partner (90%). Activities for TEFF are consolidated in the Companys financial statements.
Investments of TEFF were carried under the equity method. In December 2003, TEFC and the Company
sold TEFF to a third party. Investees Novistar
Inc. (Novistar) was formed on April 24, 1998 and commenced
operations, effective January 1, 1999, upon the contribution by the Company of all assets and
liabilities related to the operations of Novistar, consisting primarily of software and computer
equipment. Novistar provides business process services including transaction processing,
information management, and process reengineering in three principal areas: oil and gas property
administration, information technology, and procurement and inventory management. On February 18,
2000, Novistar acquired from Oracle Corporation (Oracle) the Oracle Energy Upstream business,
which specializes in licensing, support, and implementation of application software, including
related consulting services. As part of the purchase price, Oracle received a 21.12% interest in
Novistar (see Note 11). In February 2001, Novistar purchased software from Accenture in exchange
for a 1.7% interest in Novistar. On December 31, 2002, TEAI formed a 100% owned subsidiary which purchased all of the outstanding
shares of Novistar. The subsidiary merged with Novistar (New Novistar) and eliminated all
historic shareholders of Novistar. On December 31, 2002, New Novistar merged with Paradigm
Technologies, a Petroleum Place company, that provides software solution and technology services
for the energy industry, to create P2 Energy Solutions (P2ES). As a result of the merger, the
Company received a 40% interest in P2ES, resulting in the Company changing the accounting method
for its investment to the equity method. The Companys Statement of Operations for the year ended
December 31, 2002 reflects the consolidated results of operations for Novistar. On December 19,
2003, P2ES merged with a third party, resulting in a decrease in the Companys interest in P2ES to
21.15%. Effective June 30, 1997, the Company purchased The Procurement Centre (TPC) to obtain the benefit
of TPCs experience and expertise in providing consulting and outsourcing services for the
procurement of materials and services, inventory management, logistics, and other administrative
services. The Company paid $375,000 to 12




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) obtain a 75% interest in TPC. The activities of TPC subsequent to the acquisition were consolidated
in the financial statements with the unaffiliated parties interest reflected as a minority
interest. In January 1999, the Company sold a 25% interest in TPC, resulting in the Company
changing the accounting method for its investment in TPC to the equity method. Prior activities of
TPC were not material. In October 2002, the Company sold its remaining 50% interest in TPC. The Company evaluates its loans and equity investments for impairment and, if indicated, records an
impairment as appropriate. Cash and Cash Equivalents Cash in excess of the Companys daily requirements is generally invested in short-term, highly
liquid investments with original maturities of three months or less. Such investments are carried
at cost, which approximates fair value and, for purposes of reporting cash flows, are considered to
be cash equivalents. The Company maintains its cash in bank deposits with various major financial institutions. These
accounts, at times, exceed federally insured limits. Deposits in the United States are guaranteed
by the Federal Deposit Insurance Corporation up to $100,000. The Company monitors the financial
condition of the financial institutions and has not experienced any losses on such accounts. Restricted Cash The Company had a restricted cash account, which was required by Milams May 17, 2001 promissory
note with a third party (see Note 14). The Milam note required that all proceeds related to oil and
gas properties be remitted into the restricted account. The Company was required to request
transfers from the restricted account to the operating account through specific reporting
procedures. Upon agreement with transfer requests, the third party transferred funds out of the
restricted account. The balance in the restricted
cash account, which is classified as current assets of discontinued operations (see Note 3) at
December 31, 2004 and 2003 is $690,000 and $262,000, respectively. The Company collateralizes any open letters of credit with cash (see Note 15). As of December 31,
2004 and 2003, the Company has outstanding open letters of credit collateralized by cash for
$173,000 and $515,000, respectively. 13




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Allowance for Doubtful Accounts The Company routinely assesses the recoverability of all material trade and other receivables to
determine their collectibility. The Company accrues a reserve on a receivable when, based on the
judgement of management, it is probable that a receivable will not be collected and the amount of
any reserve may be reasonably estimated. As of December 31, 2004 and 2003, the Company had an
allowance for doubtful accounts of $3.2 million and $3.8 million, respectively. Prepaid Drilling Costs At December 31, 2004, prepaid drilling costs mainly consist of cash calls for the Companys
interest in an exploratory well. At December 31, 2003, prepaid drilling costs consist of cash calls
for the Companys interests in two different exploratory wells. In March 2004, one of the wells was
determined to be a dry hole. In 2004, the Company recognized approximately $507,000 in dry hole
costs related to this well. Investment in Marketable Securities Marketable investment securities are classified in three categories: trading, available-for-sale,
or held-to-maturity. Trading securities are bought and held principally for the purpose of selling
such securities in the near term. Held-to-maturity securities are those securities in which the
Company has the ability and intent to hold the security until maturity. All other securities not
included in trading or held-to-maturity are classified as available-for-sale. The Company has no trading, available-for-sale, or held-to-maturity securities at December 31,
2004. During 2003, the Company sold available-for-sale securities which were recorded at fair
value, with unrealized gains and losses excluded from earnings, and reported as accumulated
comprehensive income, a separate component of the stockholders deficit. Realized gains and losses
for securities classified as available-for-sale were included in earnings and were derived using
the specific identification method for determining the cost of securities sold. Dividend and interest income are recognized when earned. 14




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Research and Development Expenses During 2002, all costs incurred by Novistar in developing software products were expensed as
research and development expenses in the period incurred. Software development costs incurred
subsequent to the establishment of technological feasibility were not material. For the year ended
December 31, 2002, $3.8 million of research and development expenses were included in General and
administrative expenses. Novistar is no longer being consolidated in the Companys Statement of
Operations, and as a result, there were no research and development expenses reported by the
Company for the years ended December 31, 2004 and 2003. Property and Equipment Oil and gas properties are accounted for on the successful efforts method whereby costs, including
lease acquisition and intangible drilling costs associated with exploration efforts which result in
the discovery of proved reserves and costs associated with development wells, whether or not
productive, are capitalized. Gain or loss is recognized when a property is sold or ceases to
produce and is abandoned. Capitalized costs of producing oil and gas properties are amortized using
the unit-of-production method based on units of proved reserves as estimated by independent
petroleum engineers. The Company recognizes an impairment loss when the carrying amount of a long-lived asset exceeds
the sum of the estimated undiscounted future cash flows of the asset. For each long-lived asset
determined to be impaired, an impairment loss equal to the difference between the carrying value
and the fair value of the depletable unit is recognized. The fair value of the oil and gas
properties, on a depletable unit basis, is estimated to be the present value of expected future
cash flows computed by applying estimated future oil and gas prices, as determined by management,
to estimated future production of oil and gas reserves over the economic lives of the reserves. No
impairment was recognized during the years ended December 31, 2004 and 2002. An impairment of
approximately $45,000 was recognized for the year ended December 31, 2003. Costs of acquiring undeveloped oil and gas leases are capitalized and assessed periodically to
determine whether an impairment has occurred; appropriate impairments are recorded when necessary.
No such allowance was required during the years ended December 31, 2004, 2003, and 2002. 15




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Fixed assets are depreciated on a straight-line basis over their estimated useful lives, which
range from three to ten years. Leasehold improvements, which are recorded at cost, are amortized on
a straight-line basis over their estimated useful lives or the life of the lease, whichever is
shorter. Revenue Recognition The Company recognizes revenues related to TRS as services are rendered. The Company recognizes oil and gas revenues from its interests in oil and natural gas producing
activities as the hydrocarbons are produced and sold. Marketing commissions are based on a fixed percentage of the negotiated sales price of crude oil
and natural gas and a fixed monthly fee. Marketing commissions are recognized in revenue during the
month of crude oil and natural gas production when the services are performed. In connection with the acquisition from Oracle (see Note 11), Novistar expanded its product
offerings to include consulting, licensing, support, and application hosting. Revenue recognition
for these expanded product offerings complied with the provisions of Statement of Position (SOP)
97-2, Software Revenue Recognition; SOP 98-4, Deferral of the Effective Date of Certain Provisions
of SOP 97-2; Emerging Issues Task Force Issue No. 00-3, Application of SOP 97-2, Software Revenue
Recognition to Arrangements That Include the Right to Use Software Stored on Another Entitys
Hardware; and SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to
Certain Transactions,including obtaining, as appropriate, vendor-specific objective evidence of
fair value. During 2002, revenues associated with service and operating fees were recognized ratably over the
term of the service agreements, as earned. Service level credits were recognized as a reduction of
revenue in the period in which Novistar failed to meet service levels required by its contracts.
Certain long-term service fee contracts contained multiple element arrangements relating to
consulting services and outsourcing services. The costs and revenues associated with these
consulting services were deferred and recognized on a straight-line basis over the remaining term
of the long-term service fee contract as service 16




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) fees and costs once the outsourcing services commenced. Novistar is no longer being consolidated
in the Companys Statement of Operations, and as a result, there were no consulting revenues and
costs reflected by the Company for the years ended December 31, 2004 and 2003. During the year
ended December 31, 2002, approximately $27,000 and $25,000 of consulting revenues and cost of
revenues, respectively, were deferred to be recognized over the term of the outsourcing element of
the service fee contract. Novistar recognized approximately $321,000 and $304,000 in consulting
revenues and cost of revenues, respectively, for the year ended December 31, 2002. Gas Balancing The Company uses the entitlement method for recording sales of natural gas. Under the entitlement
method of accounting, revenue is recorded based on the Companys net revenue interest in
production. Deliveries of natural gas in excess of the Companys net revenue interest are recorded
as liabilities and under-deliveries are recorded as assets. Production imbalances are recorded at the lower of the sales price in effect at the time of
production or the current market value, as allowed contractually. At December 31, 2004, the
Companys receivable for gas sales under the Companys entitled share was approximately $3,000. At
December 31, 2003, the Companys payable for gas sales over the Companys entitled share was
approximately $350,000. Accounting for Price Risk Management Activities The Company, through its subsidiaries, engaged historically in price risk management activities for
both trading and non-trading purposes. Effective January 1, 1999, the Company adopted
mark-to-market accounting for its energy trading. The Company ceased its trading activities in
2002. To conduct its trading activities, the Company used forwards, swaps, and options. Under the
mark-to-market method of accounting used to
account for trading activities, the related outstanding physical and financial instruments were
reflected at fair value, inclusive of valuation adjustments, with resulting unrealized
gains and losses recorded as Assets from price risk management activities, Other assets,
Liabilities from price risk management activities, and Other liabilities, respectively, on the
Consolidated Balance Sheets. The market prices used to value these transactions were based on
managements best estimate considering various factors including closing exchange and
over-the-counter quotations, time value, and volatility 17




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) factors. The values were adjusted to reflect the potential impact of liquidating the Companys
position in an orderly manner over a reasonable period of time under present market conditions. The Company also periodically enters into certain financial derivative contracts utilized for
non-trading purposes to hedge the impact of market price fluctuations on contractual commitments
and forecasted transactions related to its oil and gas production. On January 1, 2001, the Company
adopted the provisions of Statement of Financial Accounting Standards No. 133 (SFAS 133),
Accounting for Derivative Instruments and Hedging Activities, for the accounting of its hedge
transactions. SFAS 133 establishes accounting and reporting standards requiring that all derivative
instruments be recorded in the Consolidated Balance Sheet as either an asset or liability measured
at fair value and requires that the changes in the fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. During 2004, 2003 and 2002, the Company entered into certain over-the-counter swap contracts to
hedge the cash flow of the forecasted sale of oil and gas production. The Company did not elect to
document and designate these as hedges. Thus, the changes in the fair value of these
over-the-counter swap contracts are reflected in earnings in the consolidated statements of
operations in gain (loss) from price risk management activities for the years ended December 31,
2004, 2003 and 2002. Concentrations of Credit Risk Credit risk is the risk of loss from nonperformance by suppliers, customers, or financial
counterparties to a contract. Financial instruments which potentially subject the Company to credit
risk consist principally of trade receivables, forwards, over-the-counter options, and swaps. The
Company currently manages credit risk through informal credit policies and utilization of netting
language in its derivative contracts that may be settled with the
physical commodity. Customers not meeting the Companys credit standards are required to provide an
acceptable form of payment security. At December 31, 2004, accounts receivables and other financial
instruments were predominantly with energy related and energy trading companies in the United
States. 18




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Other Assets At December 31, 2004 and 2003, Other assets primarily consist of intangible assets which
represent the excess cost of acquired assets over the amounts assigned to tangible net assets at
acquisition. In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets
(SFAS 142), which addresses the initial recognition and measurement of intangible assets and the
subsequent accounting and measurement of goodwill and intangible assets. The Company adopted SFAS
142 on January 1, 2002 and in accordance with SFAS 142, goodwill is tested for impairment annually
in lieu of being amortized or on an interim
basis if an event or circumstance indicates that it is more likely than not that an impairment loss
has been incurred. Based on its review, no impairment of the Companys goodwill was recorded for
the years ended December 31, 2004, 2003 and 2002. Income Taxes Effective in 1997, TEAI and its subsidiaries elected to be treated as qualified Subchapter S
corporations under Section 1361 (b)(3) of the Internal Revenue Code of 1986. The effect of the
election is that TAC will file an S corporation tax return that includes TEAI and subsidiaries.
Each TAC stockholder is responsible for reporting their share of taxable income or loss and no
federal income taxes are recorded by the Company, except for a tax on excess net passive income and
certain built-in gains, if applicable. Prior to the merger of Novistar into P2ES and in conjunction
with the acquisition by Novistar of certain assets of the Oracle Energy Upstream business (see Note
11), Novistar was no longer eligible for Subchapter S corporation status. Reclassifications Certain reclassifications of prior year amounts have been made to conform with current year
presentation. 19




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting
of assets and liabilities and the disclosure of contingent assets and liabilities as of the
reporting date and the reporting of revenues and expenses during the reporting period to prepare
these consolidated financial statements in conformity with accounting principles generally accepted
in the United States. Actual results could differ from those estimates. Asset Retirement Obligations The Company adopted SFAS No. 143 Accounting for Asset Retirement Obligationson January 1, 2003,
which resulted in an increase to net oil and gas properties of $254,000 and additional liabilities
related to asset retirement obligations (ARO) of $2 million. These amounts reflect the ARO of the
company had the provisions of SFAS No. 143 been applied since inception and resulted in a non-cash
cumulative effect decrease to earnings of $152,000. In accordance with the provisions of SFAS No.
143, the Company records an abandonment liability associated with its oil and gas wells and
platforms when those assets are placed in service. Under SFAS No. 143, depletion expense is reduced
since a discounted ARO is depleted in the property balance rather than the undiscounted value
previously depleted under the old rules. The lower depletion expense under SFAS No. 143 is offset,
however, by accretion expense, which is recognized over time as the discounted liability is
accreted to its expected settlement value. Inherent in the fair value calculation of ARO are numerous assumptions and judgments, including the
ultimate settlement amounts, inflation factors, credit adjusted discount rates, timing of
settlement, and changes in the legal, regulatory, environmental and political environments. To the
extent future revisions to these assumptions impact the fair value of the existing ARO liability, a
corresponding adjustment is made to the oil and gas property
balance. 20




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) The following table is a reconciliation of the asset retirement obligation liability since adoption
(in thousands): Asset retirement obligation upon adoption on January 1, 2003
    
    $
    5,759Liabilities incurred
    
    
    212Liabilities settled
    
    
    Accretion expense
    
    
    276Revisions in estimated liabilities
    
    
    Asset retirement obligation at December 31, 2003
    
    
    6,247Liabilities incurred
    
    
    97Liabilities settled
    
    
    (5,347
    )Accretion expense
    
    
    428Revisions in estimated liabilities
    
    
    233Asset retirement obligation at December 31, 2004
    
    $
    1,658
 Liabilities incurred during 2003 relate to the acquisition of properties by Live Oak. Liabilities
incurred during 2004 relate to the acquisition of properties by Big Energy. Liabilities settled
during 2004 relate to the sale of the Milam properties. The pro forma asset retirement obligation
would have been approximately $5.5 million at January 1, 2002 had the Company adopted the
provisions of SFAS 143 on January 1, 2002. The following table shows the pro forma effect of the
implementation on the Companys net income had SFAS No. 143 been adopted by the Company on January
1, 2001 (in thousands): 2002Net income, as reported
    
    $
    993Effect on net income (loss) had SFAS No. 143 been applied
    
    $
    1,534Pro forma net income (loss)
    
    $
    2,527
 21




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. Discontinued Operations In October and December 2004, Milam entered into separate agreements to sell all of its oil and gas
properties. In October 2004, Milam sold its interest in a field for $3.6 million, resulting in a
loss of approximately $3.1 million. In December 2004, Milam sold its remaining fields for $11.8
million resulting in a gain of approximately $1.8 million. The proceeds from the sale were used to
pay down the outstanding debt balance related to these properties and the remaining principal
balance was forgiven resulting in a gain of $5.6 million for the year ended December 31, 2004 (see
Note 14). Milam was a component of the Companys oil and gas property segment, and accordingly its
results have been classified as discontinued operations and the consolidated financial statements
for all periods presented have been adjusted to reflect this presentation. Comparative balance
sheets of the discontinued operations are as follows (in thousands): December 312004
    
    
    2003Restricted cash
    
    $
    690
    
    
    $
    262Accounts receivable  oil and gas and other
    
    
    467
    
    
    
    667Prepaid drilling costs
    
    
    
    
    
    
    1,503Other current assets
    
    
    
    
    
    
    117Total current assets
    
    
    1,157
    
    
    
    2,549Oil and gas properties (successful efforts method)
    
    
    
    
    
    
    28,691Accumulated depreciation, depletion and amortization
    
    
    
    
    
    
    (7,362
    )Other assets
    
    
    500
    
    
    
    1,590Total assets
    
    $
    1,657
    
    
    $
    25,468Accounts payable and accrued liabilities
    
    $
    584
    
    
    $
    2,583Liabilities from price risk management
    
    
    
    
    
    
    227Note payable  other
    
    
    660
    
    
    
    19,392Total current liabilities
    
    
    1,244
    
    
    
    22,202Other liabilities
    
    
    
    
    
    
    5,022Total liabilities
    
    $
    1,244
    
    
    $
    27,224
 22




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. Discontinued Operations (continued) Operating results of discontinued operations are as follows (in thousands): Year Ended December 312004
    
    
    2003
    
    
    2002Oil and gas revenues
    
    $
    5,820
    
    
    $
    8,658
    
    
    $
    4,570Gain (loss) from price risk management activities
    
    
    
    
    
    
    (1,161
    )
    
    
    560Interest and other income
    
    
    13
    
    
    
    10
    
    
    
    11Loss on sale of assets
    
    
    1,259
    
    
    
    
    
    
    
    Oil and gas operating expenses
    
    
    1,923
    
    
    
    4,282
    
    
    
    4,460Depreciation, depletion and amortization
    
    
    888
    
    
    
    1,039
    
    
    
    6,667Plugging and abandonment costs
    
    
    
    
    
    
    
    
    
    
    454General and administrative expense
    
    
    456
    
    
    
    162
    
    
    
    171Dry hole costs
    
    
    2,196
    
    
    
    
    
    
    
    Accretion expense
    
    
    324
    
    
    
    232
    
    
    
    Interest expense
    
    
    2,317
    
    
    
    2,292
    
    
    
    1,803Gain on forgiveness of debt
    
    
    5,580
    
    
    
    
    
    
    
    Income (loss) from discontinued operations
    
    $
    2,050
    
    
    $
    (500
    )
    
    $
    (8,414
    )
 4. Related Party Transactions Due From Stockholder The Company has advanced approximately $9.9 million to TAC ($0.2 million in 2004, $1.3 million in
2003, and $-0- in 2002), which was used to repurchase common stock awarded to former shareholders
and a director. The related amount due from stockholder is reflected as a contra-equity account in
the accompanying Consolidated Financial Statements. Notes Receivable On January 1, 2000, the Company was issued a promissory note from one of the Companys officers for
$1.42 million. This note bears interest at 8% and has principal and interest payments due annually
through December 31, 2005. The balance on this note as of December 31, 2004 and 2003 was $794,000
and $794,000, respectively, which approximates fair value. The Company also had other outstanding
notes receivable from 23




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. Related Party Transactions (continued) other officers amounting to $114,000 at December 31, 2002. Interest accrued on these notes at 8%
with principal and interest payments are due annually through December 31, 2002. In early 2003, the
Company received the remaining $114,000 balance on these notes. Asset Management The Company provided management services relating to oil and gas operations for affiliated entities
and investees, which included Mission Resources Corporation (Mission), formerly Bellwether
Exploration Company (Bellwether), until early 2002 when the contract was cancelled. During 1999,
the principal stockholder of TAC functioned as director and from August 1999 through May 2001
served as Chief Executive Officer and Chairman of the Board of Bellwether. On October 21, 2002,
this individual resigned from the Board of Mission. As a result, Mission was no longer a related
party at December 31, 2002. In accordance with the management agreements, the Company provided
various accounting and administrative services for Mission at a fixed or variable fee. In addition,
the Company received additional compensation for services related to property or corporate
acquisitions or divestitures. The Companys total management fees received from related parties
amounted to $389,000 for the year ended December 31, 2002. In the ordinary course of business, the Company incurs amounts resulting from the payment of costs
and expenses on behalf of related parties and from charging management fees under the terms of the
respective management and administrative agreements. Such amounts are settled on a regular basis,
generally monthly. Well Operations The Company operates properties in which related parties have an ownership interest. These related
parties are charged for all customary expenses and cost reimbursements associated with such
activities on the same basis as third parties. Operators fees charged to affiliates by the Company
for the years ended December 31, 2004, 2003, and 2002 for these activities were approximately
$378,000, $380,000, and $512,000, respectively. 24




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. Related Party Transactions (continued) Oracle For the year ended December 31, 2002, Novistar paid Oracle
approximately $271,000 for rent expense and support fees for Oracle products and $99,000 for
interest on a note payable. 5. Investments In October 2002, the Company received 58,231 shares of Resources Connection, Inc. (RCI), a
Delaware incorporated publicly traded company, valued at $798,000, as proceeds for the sale of TPC
(see Note 11). In December 2003, the Company sold the 58,231 RCI shares for $1,609,000, resulting
in a gain of $811,000. 6. Notes Receivable TEFF was issued promissory notes by three entities in connection with the collateralized financing
it provided to exploration and production companies. As its source of funding for the notes, TEFF
used proceeds received from a credit facility with a bank. The banks collateral for the TEFF
outstanding loan amounts was the assigned mortgages of the oil and gas properties which TEFF had as
collateral from its notes receivable and all other assets of TEFF. Under the terms of the credit
facility, the bank reviewed on a portfolio basis the value of all collateral on the notes held by
TEFF. During 2002 and 2000, two of the entities were sold and the investment in receivables was
reduced by $6.5 million and
$21.3 million, respectively (see Note 14), as a result of proceeds received by TEFF in connection
with the mortgages it holds with the oil and gas properties. During 2001, one of the entities filed
for bankruptcy and its oil and gas properties were liquidated as part of the bankruptcy
proceedings. From the $8.8 million received from the liquidation of the oil
and gas properties, TEFF collected, as a secured creditor, $4.5 million in December 2002 and
$170,000 in March 2003. All proceeds received by TEFF in connection with the mortgages on oil and
gas properties of the three entities referred to herein have been used to satisfy a portion of the
outstanding bank credit facility. 25




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. Notes Receivable (continued) Consistent with the terms of TEFFs credit facility with the bank, notes receivable were carried at
their unpaid principal balance subject to an impairment adjustment. The impairment of the notes
receivable balance was measured on an aggregate portfolio basis. The Company suspended interest
income recognition as a result of the impairment of the notes receivable (see Note 14). In December 2003, TEFC and the Company sold TEFF to a third party for $325,000, plus the assumption
of a credit facility (see Note 14), resulting in a gain of $17,487,000. In June 2000, in connection with the sale of some of the Companys oil and gas properties, the
Company was issued a promissory note totaling $800,000. Interest accrued on this note at 10% with
principal and interest payments due monthly through June 2003. This note was settled in December
2002 for $480,000, resulting in the forgiveness of $100,000 of the note balance. 7. Fixed Assets Fixed assets consist of the following (in thousands) as of December 31: 2004
    
    
    2003Computer hardware, software, and office equipment
    
    $
    3,766
    
    
    $
    3,745Rigs and related equipment
    
    
    5,640
    
    
    
    5,586Furniture, fixtures, leasehold improvements,
art, rental equipment, and vehicles
    
    
    1,686
    
    
    
    1,38211,092
    
    
    
    10,713Less accumulated depreciation
    
    
    (7,910
    )
    
    
    (6,978
    )$
    3,182
    
    
    $
    3,735
 Depreciation expense for the years ended December 31, 2004, 2003, and 2002 amounted to $1.0
million, $1.1 million, and $3.4 million, respectively. 26




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 8. Other Assets The components of other assets are as follows (in thousands) as of December 31: 2004
    
    
    2003Goodwill
    
    $
    617
    
    
    $
    617Other
    
    
    331
    
    
    
    148948
    
    
    
    765Less accumulated amortization  other
    
    
    (5
    )
    
    
    $
    943
    
    
    $
    765
 9. Benefit Plans Effective January 1, 1996, the Company established a 401(k) retirement plan. The 401(k) retirement
plan is funded by employee and Company contributions. Employees may contribute up to 15% of their
salaries and the Company matches 50% of employee contributions up to 6%. The Companys
contributions to this plan totaled approximately $25,000, $47,000, and $518,000 for the years ended
December 31, 2004, 2003, and 2002, respectively. In addition, the Company established a
discretionary 401(k) retirement plan. During the first quarter of the year, the Company has the
option of contributing up to an
additional 3% of each employees salary for the previous year to the plan. The Company made no
contributions to the discretionary plan in 2004, 2003 and 2002. 10. Management Buyout On September 30, 1996, the Management Buyout occurred whereby certain members of the Companys
executive management purchased the Company from Torchmark for $41 million; $25.5 million in the
form of a senior subordinated note payable (see Note 14) and $15.5 million in cash. As a result of
this transaction, the Company received working and other interests in oil and gas properties. In
addition, the Company received interests in certain oil and gas properties in exchange for
consideration of up to $7 million, which is payable solely out of production and is contingent upon
the properties achieving pricing and profitability thresholds. Based upon the performance of the
properties, none of these thresholds were achieved, and no such liability was recorded at December
31, 2004. 27




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. Acquisitions and Dispositions of Assets Milam In October and December 2004, Milam entered into separate agreements to sell all of its oil and gas
properties. In October 2004, Milam sold its interest in a field for $3.6 million, resulting in a
loss of approximately $3.1 million. In December 2004, Milam sold its remaining fields for $11.8
million resulting in a gain of approximately $1.8 million. The proceeds from the sale were used to
pay down the outstanding debt balance related to these properties and the remaining principal
balance was forgiven resulting in a gain of $5.6 million (see Note 14). The results of Milam are
classified as discontinued operations and the consolidated financial statements for all periods
presented have been adjusted to reflect this presentation (see Note 3). Big Energy, LLC In February 2004, Big Energy purchased an interest in certain oil and gas properties located in
Louisiana from a third party for $2.1 million. Person Panna Maria, LLC In June 2003, the Company purchased a 4% interest in the oil and gas interests in the Person Panna
Maria, LLC (PPM) for $80,000 which currently owns a compression facility serving the properties.
In December 2003, the Company purchased an additional 80% interest in PPM for $270,000. In January
2004, the Company purchased an additional 4.5% interest in PPM for $15,000. Coal Bed Methane Field In January 2003, the Company sold its oil and gas interest in a coal bed methane field in Alabama
for $43 million in cash, resulting in a gain of approximately $41 million. Proceeds of $18.7
million were used to payoff the outstanding balance on the Credit Facility (see Note 14). In
addition, due to the sale of this field, the Senior Subordinated Note was reduced by $500,000. Art During the year ended December 31, 2004, the Company purchased two pieces of art for approximately
$238,000. During the year ended December 31, 2003, the Company sold pieces of art to third parties
for a total of $1,057,000, generating a gain of $68,000. 28




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. Acquisitions and Dispositions of Assets (continued) RCI Shares In February 2002, the Company sold its interest in certain oil and gas properties to a third party
for a total of $200,000, generating a loss of $11,000. In October 2002, the Company sold its
interest in TPC for $3.45 million and 58,231 shares of RCI, valued at $798,000, resulting in a gain
of $3.45 million. In addition, the Company received a contingent payment of $197,000 in March 2003
based on total revenues of the parent company of RCI for the year ended December 31, 2002. In
December 2003, the Company sold 58,231 RCI shares for $1,609,000, resulting in a gain of $811,000. Torch Rig Services In January 2002, the Company purchased certain assets, including rigs and real property, for
$425,000 in cash and entered into a note for $3,175,000. An intangible asset for
$478,000 was recorded for the permits, licenses, listings, approvals, and authorizations. In
addition, the Company entered into a consulting agreement with the seller whereby the Company will
pay a fee of ten semi-annual payments of $150,000 commencing on June 1, 2002. Novistar and P2ES On December 31, 2002, TEAI formed a 100% owned subsidiary which purchased all of the outstanding
Novistar stock for $.01 per share. The subsidiary merged with Novistar
(New Novistar) resulting in the acquisition of the interests of all historic shareholders of
Novistar. Petroleum Place, Inc. loaned $3.2 million to New Novistar. New Novistar used the $3.2
million loan proceeds to buy-out Oracles debt of $10 million and interest payable of $1.1 million,
resulting in an extraordinary gain of $7.9 million for the year ended December 31, 2002. The
Company then forgave $23.5 million of debt with New Novistar as uncollectible and contributed the
remaining $17 million of debt into New
Novistars capital as equity. New Novistar then merged with Paradigm Technologies to create P2ES.
As a result of the merger, the Company received a 40% interest in P2ES. 29




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. Acquisitions and Dispositions of Assets (continued) The equity investment is recorded at the historical cost of the Companys investment in Novistar.
The following provides a reconciliation of the Novistar condensed balance sheet as of December 31,
2002, prior to the close of the merger (in thousands): Current assets
    
    $
    4,919Long-term assets
    
    
    22,148Current liabilities
    
    
    (5,121
    )Long-term liabilities
    
    
    (5,177
    )$
    16,769
 On December 20, 2003, P2ES merged with a third party, resulting in a decrease in the Companys
interest in P2ES to 21.15%. 12. Other Long-Term Liabilities Other long-term liabilities at December 31, 2004 and 2003 consist of the following (amounts in
thousands): 2004
    
    
    2003Liability for plugging and abandonment costs
    
    $
    509
    
    
    $
    213Other
    
    
    198
    
    
    
    198$
    707
    
    
    $
    411
 13. Torch Energy Royalty Trust The Company serves as sponsor and operator of certain properties in which the Torch Energy Royalty
Trust (the Trust) owns a net profits interest. In connection with the formation of the Trust, the
Company entered into an oil and gas purchase contract (Purchase Contract) which expires on the
termination date of the Trust, the earliest of which is March 1, 2006. The Trust will terminate
upon the first to occur of: (a) an affirmative vote of the holders of not less than 66-2/3% of the
outstanding units to liquidate the Trust; (b) such time as the ratio of the cash amounts received
by the Trust from the net profits interests to administrative costs of the Trust is less than 1.2
to 1.0 for three consecutive quarters; (c) March 1 of any year if it is determined based on a
reserve report as of December 31 of the prior year that the present value of the estimated pre-tax 30




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 13. Torch Energy Royalty Trust (continued) future net cash flows, discounted at 10%, of proved reserves attributable to the net profits
interest is equal to or less than $25.0 million; or (d) December 31, 2012. Under the Purchase
Contract, the Company is obligated to purchase all net production attributable to the Trust
properties for indexed prices for oil and gas. Such prices are calculated monthly and are generally
based on the average spot market prices of oil and gas. The Purchase Contract also provides that
the minimum price paid by the Company for gas production is $1.70 per MMBtu, adjusted annually for
inflation (Minimum Price). When the Company pays a purchase price based on the Minimum Price, it
receives price credits (Price Credits), equal to the difference between the Index Price and the
Minimum Price, that it is entitled to deduct in determining the purchase price when the Index Price
for gas exceeds the Minimum Price. In addition, if the Index Price for gas exceeds $2.10 per MMBtu,
adjusted annually for inflation, the Company is entitled to deduct 50% of such excess (Price
Differential) in determining the purchase price. The Company has an annual option to discontinue
the Minimum Price commitment. However, if the Company discontinues the Minimum Price commitment, it
will no longer be entitled to deduct the Price Differential in calculating the purchase price and
will forfeit all accrued Price Credits. The Company has not exercised its option to discontinue the
Minimum Price commitment. The Minimum Price and sharing price in 2004, adjusted for inflation, was
$1.73 and $2.13, respectively. Total revenue recognized by the Company for the years ended December
31, 2004, 2003 and 2002 was $5.6, million, $4.4 million, and $1.0 million, respectively. Under the terms of the purchase contract defined above during the year ended December 31, 2004, the
Company purchased 4,542 MMCF of gas and 26 Mbbls of oil at an average price of $4.13 per MCF and
$34.38 per Bbl. During the year ended December 31, 2003, the Company purchased 4,698 MMCF of gas
and 24 Mbbls of oil at an average price of $3.78 per MCF and $24.94 per Bbl. During the year ended
December 31, 2002, the Company purchased 5,059 MMCF of gas and 25 Mbbls of oil at an average price
of $2.65 per MCF and $20.61 per Bbl. In December 2003, the Company purchased a contract which expired in December 2004 to limit its
exposure in 2004 to losses under the Minimum Price obligation of the Purchase Contract. A loss of
approximately $409,000 is included in revenue for the year ended December 31, 2004. 31




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. Debt Total debt at December 31, 2004 and 2003, consists of the following (amounts in thousands): 2004
    
    
    2003Senior subordinated note payable  affiliates
    
    $
    23,086
    
    
    $
    23,086Note payable  Grayson
    
    
    1,313
    
    
    
    1,948Notes Payable  options
    
    
    1,592
    
    
    
    1,941Line of credit
    
    
    835
    
    
    
    Other
    
    
    582
    
    
    
    929$
    27,408
    
    
    $
    27,904
 Senior Subordinated Note Payable  Affiliate On September 30, 1996, the Company recorded TACs $25.5 million Senior Subordinated Note (the
Note) payable to Torchmark as part of the purchase price for the Management
Buyout. The principal of the Note was due and payable on September 30, 2004, and it accrued
interest at 9% per annum. During 2003 and 2002, the Note was reduced by $838,000, and $500,000,
respectively, in connection with the settlement of litigation involving the Predecessor, Torchmark,
and a third party. As of December 31, 2004, the outstanding balance is $23.1 million, of which
$21.3 million has been classified as long-term at December 31, 2004. On January 1, 2005, the Note was renegotiated resulting in five $500,000 payments for principal and
accrued interest being due in 2005, $5.0 million due in 2006, $5.0 million due in 2007 and the
remaining unpaid balance of principal and interest due on May 1, 2008. Senior Subordinated Note Payable  Oracle On February 18, 2000, Novistar executed a $10.0 million Senior Subordinated Note payable to Oracle.
The note accrued interest at 9% from February 18, 2000 to February 17, 2001; 10% from February 18,
2001 to February 17, 2002; 12% from February 18, 2002 to February 17, 2003; 15% from February 18,
2003 to February 17, 2004; and 17% from February 18, 2004 to February 17, 2005. Interest was
payable 32




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. Debt (continued) quarterly in arrears beginning on May 17, 2000. The note was due upon the earlier of: (a) February
18, 2005, or (b) upon a Major Event. A Major Event constitutes: (a) an initial public offering of
Novistar, (b) a sale of all or substantially all of the assets of Novistar, or (c) any transaction
or series of related transactions, including, without limitation, any
reorganization, merger, or consolidation that results in the transfer of 50% or more of the
outstanding voting power of Novistar. On December 31, 2002, Novistar paid $3.2 million to Oracle to
buyout the $10 million Senior Subordinated Note payable and interest payable of $1.1 million
resulting in an extraordinary gain of $7.9 million for the year ended December 31, 2002. Interest
expense of $1.2 million related to this Note Payable is reflected in the accompanying Statement of
Operations for the year ended December 31, 2002. Promissory Note  Third Party On May 17, 2001, Milam entered into an $18 million Promissory Note with a third party, which
increased to $22 million on November 18, 2003. Until the sale of the properties (see Note 11),
interest accrued on the indebtedness at the sum of seven percent (7.0%) plus the three month London
Inter Bank Offer Rate (LIBOR) plus a three percent (3.0%) default rate. Monthly principal and
interest payments were due based on cash flows from certain oil and gas properties. In December
2004, proceeds from the sale of the Milam properties were used to pay down the note and the
remaining principal balance was forgiven resulting in a gain of $5.6 million for the year ended
December 31, 2004. This gain is included in income from discontinued operations for the year ended
December 31, 2004. Note Payable  SMGC In connection with the sale of SMGC, the Company agreed to pay the general partner $2 million on
May 1, 2002 and $1 million on December 31, 2003. The Company paid $1 million in May 2002, $1
million in December 2002, and entered into a note for the remaining $1 million that was due in May
2002 and extended to May 1, 2003. Principal plus interest was paid at the prime rate plus 7% per
annum. In March 2003, the SMGC note plus interest was paid in full. 33




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. Debt (continued) Note Payable  Grayson In connection with the purchase of certain assets including rigs and real property in January 2002
(see Note 11), the Company entered into a note for $3,175,000 payable to the seller (Grayson
Note). Principal payments on the note plus interest on the unpaid principal balance are due
monthly and the note matures in February 2007. Interest accrues at the prime rate adjusted at the
beginning of each quarter for increases or decreases
during the previous quarter (4.75% at December 31, 2004). At December 31, 2004 and 2003, the
outstanding principal balance on the Grayson Note is $1.3 million and $1.9 million, respectively. Notes Payable  Options In connection with the termination of certain former employees, the Company entered into notes for
options previously granted (Option Notes). The terms of the notes vary from between 5 and 10
years commencing on the date of termination and interest accrues at the prime rate. At December 31,
2004 and 2003, the outstanding principal balance on the Option Notes is $1.6 million and $1.9
million, respectively. Line of Credit On February 6, 2004, Big Energy entered into a $50 million credit facility (the Big Energy
Facility) with a bank. Interest accrues on indebtedness at the banks prime rate plus .5%, but in
no event less than a per annum rate of 4.5%. The Big Energy Facility has a February 26, 2007
maturity date and contains, among other terms, provisions for the maintenance of certain financial
ratios and restrictions on additional debt. The Company was in compliance with all covenants at
December 31, 2004. The Big Energy oil and gas properties secure the Big Energy Facility. At
December 31, 2004, the outstanding balance under the Big Energy Facility is $835,000, the borrowing
base is set at $1.0 million and the weighted-average interest rate is 4.9%. On November 9, 2000, Novistar entered into a credit facility (the Novistar Facility) with a bank.
The Novistar Facility provided a short-term loan of $17.0 million and a revolving line of credit of
up to $3.0 million. The Novistar Facility had an interest rate of LIBOR plus 1.5% if less than
$10.0 million was outstanding and an interest rate of LIBOR plus 1.875% if the outstanding balance
exceeded $10.0 million. The short-term 34




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. Debt (continued) loan under the Novistar Facility matured on November 7, 2001, and the revolving line of credit
matured on March 31, 2002. The Novistar Facility was secured by a pledge of substantially all of
the assets of Novistar. In July 2001, Novistar used its $30 million revolving promissory note with
TEAI to pay off the $17 million loan. Additionally, TEAI had guaranteed the outstanding balance of
the revolving line of credit. At December 31, 2002, Novistar merged with Paradigm Technologies (see
Note 11), the revolving line of credit is not on the Companys books as Novistars balance sheet is
no longer consolidated. Until April 14, 2003, the Company maintained a compensating balance of $3
million as collateral for the Novistar revolving line of credit. On August 31, 1999, the Company entered into a $50 million credit facility (the Credit Facility)
with a bank. Interest accrued on indebtedness, at the Companys option, at the banks prime rate
plus .25% or the LIBOR rate. The Credit Facility had a March 1, 2003 maturity date and contained,
among other terms, provisions for the maintenance of certain financial ratios and restrictions on
additional debt. Certain oil and gas properties secured the Credit Facility. In January 2003, the
outstanding balance under the Credit Facility was paid in full (see Note 11). On July 16, 1997, TEFF entered into a $90 million Credit Facility (the TEFF Facility) with a
bank. Until March 9, 2000, ordinary interest was accrued on indebtedness, at TEFFs option, at the
banks prime rate plus 0.5% or LIBOR plus 2.0% if the loans outstanding are less than or equal to
the portfolio base; and at the banks prime rate plus 5.5% or LIBOR plus 7.0% of the portion of
loans outstanding in excess of the portfolio base. Principal and interest on the loan were repaid
from cash flow from TEFFs underlying investments. The TEFF Facility contained, among other terms,
provisions for the maintenance of certain financial ratios and restrictions on additional debt. All
security in the investments currently owned by TEFF or hereafter acquired and proceeds thereof
secured the TEFF Facility, which originally matured on December 31, 2003. Effective March 9, 2000,
TEFF amended the TEFF Facility with a bank. The amendment changed the maturity date to June 30,
2000. As a result, no additional debt could be drawn on the TEFF Facility. As the underlying
investments were sold, the proceeds were used to reduce the outstanding principal balance of the
loan. In addition, the amendment changed the
interest rate to the banks prime rate (4.0% December 31,
2003) plus 1% or LIBOR (1.5% at December 31, 2003) plus 4% regardless of the portfolio base ($0 at December 31,
2003) and changed the allocation of gross sales proceeds between debt repayment and funds available
for distribution in the event of a sale of TEFFs investments. On December 31, 2003, TEFC and the
Company sold TEFF to a third party (see Note 11). 35




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. Debt (continued) Scheduled maturities for the next five years and thereafter as of December 31, 2004 are as follows
(in thousands): 2005
    
    $
    3,4762006
    
    
    4,6432007
    
    
    4,4782008
    
    
    14,3322009
    
    
    2512010 and thereafter
    
    
    228$
    27,408
 15. Commitments and Contingencies Litigation The Company is involved in certain litigation arising out of the normal course of business, none of
which, in the opinion of management, will have any material adverse effect on the financial
position or results of operations of the Company as a whole. Lease Obligations Rental expense for operating leases was approximately $1.0 million, $1.6 million, and $3.0 million
for the years ended December 31, 2004, 2003, and 2002, respectively. Future minimum payments under
all noncancelable leases, including amounts allocable to
affiliates, having initial terms of one year or more consisted of the following as of December 31,
2004 (amounts in thousands): Year ending December 31,2005
    
    $
    6342006
    
    
    5842007
    
    
    5812008
    
    
    4862009
    
    
    491Thereafter
    
    
    617$
    3,393
 36




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 15. Commitments and Contingencies (continued) Letters of Credit The Company has open letters of credit of approximately $173,000 at December 31, 2004, which are
fully collateralized by restricted cash balances. 16. Price Risk Management and Financial Instruments Trading Activities The Company, through its subsidiaries, previously offered price risk management services to
energy-related businesses through a variety of financial and other instruments including forward
contracts involving physical delivery of an energy commodity; swap agreements, which required
payments to (or receipt of payments from) counterparties based on the differential between a fixed
and variable price for the commodity; options contracts requiring payments to (or receipt of
payments from) counterparties based on the difference between the options strike and market prices
for the commodity; and other contractual arrangements. The Company attempted to balance its
contractual portfolio in terms of notional amounts and the timing of performance and delivery
obligations. However, net unbalanced positions could exist or were established based upon
assessment of anticipated market movements. Non-Trading Activities The Company also enters into financial swap contracts for the purpose of hedging the impact of
market fluctuations on production. At December 31, 2003, the Company was party to energy commodity
swaps covering 60,000 MMbtus of natural gas and 13,000 barrels of crude oil that extended to May of
2004 on the Milam properties. While notional amounts are used to express the volume of swaps and over-the-counter options, the
amounts potentially subject to credit risk in the event of nonperformance by the third parties are
substantially smaller. The Company does not anticipate any material impact to its financial
position or results of operations as a result of nonperformance by third parties on financial
instruments related to non-trading activities. The carrying amounts of the Companys cash and cash equivalents, receivables, other current assets,
and payables approximate the fair value at December 31, 2004 because of their short maturities. 37




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 16. Price Risk Management and Financial Instruments (continued) The carrying amounts and estimated fair values of the Companys other financial instruments,
excluding trading activities, at December 31, 2004 and 2003 were as follows: 2004
    
    
    2003Carrying
    
    
    Estimated
    
    
    Carrying
    
    
    EstimatedAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair Value(in thousands)AssetsNatural gas option
    
    $
    
    
    
    $
    
    
    
    $
    409
    
    
    $
    409LiabilitiesCrude oil swaps
    
    $
    
    
    
    $
    
    
    
    $
    116
    
    
    $
    116Natural gas swaps
    
    
    
    
    
    
    
    
    
    
    111
    
    
    
    111Current debt
    
    
    3,476
    
    
    
    3,476
    
    
    
    44,195
    
    
    
    44,195Long-term debt
    
    
    23,932
    
    
    
    23,846
    
    
    
    3,177
    
    
    
    3,177
 The Company uses the following methods and assumptions in estimating fair values: (a) energy
commodity swaps and over-the-counter options estimated fair values have been determined using
available market data and valuation methodologies and (b) the carrying amounts of the Senior
subordinated note payableaffiliate and Note payable to bank approximate fair value as the
interest rates approximate current market rates. Judgment is required in interpreting market data
and the use of different market assumptions or estimation methodologies may affect the estimated
fair value amounts. 38




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 17. Subsequent Events In January 2005, TRS received notice alleging improper abandonment work on certain properties. As a
result of this notice, contract plugging and abandonment work performed by the Company is being
investigated by the Bureau of Land Management. The Company has set up an accrual for $320,000 at
December 31, 2004 related to this investigation. In February 2005, a letter of agreement was signed by a third party and Torch E&P to sell its
interest in a certain gas property. The purchaser will assume the $1.1 million liability for
plugging and abandonment costs included in current liabilities at December 31, 2004. As a result of
this sale, the Company will no longer have an asset retirement obligation for this property;
however, the Company will retain a 3.33% overriding royalty interest. 18. SFAS 131: Disclosures about Segments of an Enterprise and Related Information Prior to January 1, 2003, the Company had four reportable segments: service activities, the capital
group, the trading and marketing group, and oil and gas properties. The service activities segment
provided technical and administrative services to energy companies, primarily through outsourcing
arrangements. The capital group segment provided growth capital to independent oil and gas
companies through TEFF, a fund formed to provide small to mid-size companies with capital for
acquisition and exploitation opportunities. The trading and marketing group segment engaged in
various hydrocarbon marketing and trading activities. The oil and gas properties segment consisted
of revenue from interests the Company held in certain oil and gas properties. The reduction of the
business activities of the Company has reduced the number of reportable segments as defined by SFAS
131. The Company had three reportable segments in 2003: service activities, the capital group and
oil and gas properties. Due to the sale of TEFF in December 2003 (see Note 2), the Company has two
reportable segments in 2004: service activities and oil and gas properties. The Companys reportable segments are strategic business units that offer different services. Each
business segment is managed separately based on the nature of the services provided to clients and
based on the different technology and marketing strategies required by each of
the segments. The accounting policies of the segments are the same as those described in the
summary of significant accounting policies (see Note 2). The Company evaluates performance based on profit or loss from operations. Intersegment fees are
accounted for as if the fees were to third parties. 39




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 18. SFAS 131: Disclosures about Segments of an Enterprise and Related Information (continued) The following tables represent reported segment profit or loss and segment assets for the years
ended December 31, 2004, 2003, and 2002 (amounts in thousands). Service
    
    
    Oil & GasActivities
    
    
    Properties
    
    
    TotalsYear ended December 31, 2004Revenues from external clients
    
    $
    20,510
    
    
    $
    7,900
    
    
    $
    28,410Intersegment revenues
    
    
    177
    
    
    
    
    
    
    
    177Gain on sale
    
    
    
    
    
    
    41
    
    
    
    41Interest revenue
    
    
    
    
    
    
    47
    
    
    
    47Interest expense
    
    
    14
    
    
    
    38
    
    
    
    52Depletion, depreciation, and
amortization
    
    
    976
    
    
    
    458
    
    
    
    1,434Equity in losses of investee
    
    
    2,704
    
    
    
    
    
    
    
    2,704Income from discontinued operations
    
    
    
    
    
    
    2,050
    
    
    
    2,050Segment profit (loss)
    
    
    (695
    )
    
    
    4,999
    
    
    
    4,304Other significant non-cash items:Segment assets
    
    
    13,552
    
    
    
    5,524
    
    
    
    19,076Equity in investee
    
    
    9,359
    
    
    
    
    
    
    
    9,359Expenditures for segment assets
    
    
    274
    
    
    
    3,919
    
    
    
    4,193
 40




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 18. SFAS 131: Disclosures about Segments of an Enterprise and Related Information (continued) Service
    
    
    Oil & GasActivities
    
    
    Properties
    
    
    TotalsYear ended December 31, 2003Revenues from external clients
    
    $
    21,073
    
    
    $
    1,011
    
    
    $
    22,084Intersegment revenues
    
    
    45
    
    
    
    
    
    
    
    45Gain (loss) on sale
    
    
    
    
    
    
    40,500
    
    
    
    40,500Interest revenue
    
    
    
    
    
    
    157
    
    
    
    157Interest expense
    
    
    113
    
    
    
    21
    
    
    
    134Depletion, depreciation, and
amortization
    
    
    1,127
    
    
    
    22
    
    
    
    1,149Equity in earnings of investees
    
    
    (3,132
    )
    
    
    
    
    
    
    (3,132
    )Loss from discontinued operations
    
    
    
    
    
    
    (500
    )
    
    
    (500
    )Segment (loss) profit
    
    
    (6,531
    )
    
    
    39,898
    
    
    
    33,367Other significant non-cash items:Segment assets
    
    
    16,971
    
    
    
    1,481
    
    
    
    18,452Equity in investees
    
    
    12,063
    
    
    
    
    
    
    
    12,063Expenditures for segment assets
    
    
    213
    
    
    
    1,125
    
    
    
    1,338
 Service
    
    
    Oil & GasActivities
    
    
    Properties
    
    
    TotalsYear ended December 31, 2002Revenues from external clients
    
    $
    62,814
    
    
    $
    9,150
    
    
    $
    71,964Intersegment revenues
    
    
    5,650
    
    
    
    
    
    
    
    5,650Gain on sale
    
    
    3,524
    
    
    
    (11
    )
    
    
    3,513Interest revenue
    
    
    
    
    
    
    104
    
    
    
    104Interest expense
    
    
    1,495
    
    
    
    902
    
    
    
    2,397Depletion, depreciation, and
amortization
    
    
    2,050
    
    
    
    110
    
    
    
    2,160Equity in earnings of investees
    
    
    249
    
    
    
    
    
    
    
    249Loss from discontinued operations
    
    
    
    
    
    
    (8,414
    )
    
    
    (8,414
    )Segment (loss) profit
    
    
    16,825
    
    
    
    (10,372
    )
    
    
    6,453Other significant non-cash items:Segment assets
    
    
    18,238
    
    
    
    1,900
    
    
    
    20,138Equity in investees
    
    
    16,769
    
    
    
    
    
    
    
    16,769Expenditures for segment assets
    
    
    124
    
    
    
    1,677
    
    
    
    1,801
 41




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 18. SFAS 131: Disclosures about Segments of an Enterprise and Related Information (continued) The following is a reconciliation of reportable segment revenues, expenditures, profit or loss,
assets, and equity in investees to the Companys consolidated totals for the years ended December
31, 2004, 2003, and 2002 (amounts in thousands): Year ended December 312004
    
    
    2003
    
    
    2002Revenues:Total revenues for reportable segments
    
    $
    28,848
    
    
    $
    62,786
    
    
    $
    81,231Other revenues
    
    
    1,436
    
    
    
    22,810
    
    
    
    7,065Elimination of intersegment revenues
    
    
    (187
    )
    
    
    (68
    )
    
    
    (5,650
    )Total consolidated revenues
    
    $
    30,097
    
    
    $
    85,528
    
    
    $
    82,646Interest expense:Total interest expense for reportable segments
    
    $
    52
    
    
    $
    134
    
    
    $
    2,397Other interest expense
    
    
    2,185
    
    
    
    2,937
    
    
    
    3,353Total interest expense
    
    $
    2,237
    
    
    $
    3,071
    
    
    $
    5,750Depletion, depreciation, and amortization:Total depletion, depreciation, and amortization
for reportable segments
    
    $
    1,434
    
    
    $
    1,149
    
    
    $
    2,160Other depletion, depreciation, and amortization
    
    
    
    
    
    
    
    
    
    
    1,364Total depletion, depreciation, and amortization
    
    $
    1,434
    
    
    $
    1,149
    
    
    $
    3,524Equity in earnings (loss) of investees:Total equity in earnings (loss) of investees for
reportable segments
    
    $
    (2,704
    )
    
    $
    (3,132
    )
    
    $
    249Other equity in earnings (loss) of investees
    
    
    
    
    
    
    
    
    
    
    Total equity in earnings (loss) of investees
    
    $
    (2,704
    )
    
    $
    (3,132
    )
    
    $
    249Profit or loss:Total profit or loss for reportable segments
    
    $
    4,304
    
    
    $
    33,367
    
    
    $
    6,453Other income (loss)
    
    
    (3,455
    )
    
    
    13,353
    
    
    
    (5,460
    )Net income
    
    $
    849
    
    
    $
    46,720
    
    
    $
    993Assets:Total assets for reportable segments
    
    $
    19,076
    
    
    $
    18,452
    
    
    $
    20,138Other assets
    
    
    23,122
    
    
    
    47,157
    
    
    
    51,095Total consolidated assets
    
    $
    42,198
    
    
    $
    65,609
    
    
    $
    71,233Equity in investees:Total equity in investees for reportable segments
    
    $
    9,359
    
    
    $
    12,063
    
    
    $
    16,769Other equity in investees
    
    
    
    
    
    
    
    
    
    
    Consolidated equity in investees
    
    $
    9,359
    
    
    $
    12,063
    
    
    $
    16,769
 42




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 18. SFAS 131: Disclosures about Segments of an Enterprise and Related Information (continued) Major Customer Revenues from one customer, Nuevo Energy Company (Nuevo), totaled $4.6 million in service fees
for the year ended December 31, 2003. Revenues from two customers, Mission and Nuevo, totaled $35
million in service and overhead fees for the year ended December 31, 2002. Four customers accounted
for 56.1% of the gross marketing revenues during the year ended December 31, 2002. 19. Supplementary Oil and Gas Data (Unaudited) Oil and Gas Producing Activities Included herein is information with respect to oil and gas acquisition, exploration, development,
and production activities, which is based on estimates of year-end oil and gas reserve quantities
and estimates of future development costs and production schedules. These reserve quantities
represent interests owned by the Company located solely within the United States. At December 31,
2004, reserve quantities and future production are primarily based upon reserve reports prepared by
the independent petroleum engineering firm of T.J. Smith & Company, Inc. and by in-house reserve
engineers. These estimates are inherently imprecise and subject to revisions from time to time. Estimates of future net cash flows from proved reserves of gas, oil, condensate, and natural gas
liquids (NGLs) were made in accordance with Financial Accounting Standards Board Statement No.
69, Disclosures about Oil and Gas Producing Activities. The estimates are based on prices in effect
at year-end. Estimated future cash inflows are reduced by estimated future development and
production costs based on year-end cost levels, assuming continuation of existing economic
conditions. Effective in 1997, the oil and gas activities of the Company fall under its S
corporation status for income tax purposes and have a zero effective income tax rate (see Note 2).
The results of these disclosures should not be construed to represent the fair market value of the
Companys oil and gas properties. A market value determination would include many additional 43




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 19. Supplementary Oil and Gas Data (Unaudited) (continued) factors including: (a) anticipated future increases or decreases in oil and gas prices and
production and development costs; (b) an allowance for return on investment; (c) the value of
additional reserves, not considered proved at the present, which may be recovered as a result of
further exploration and development activities; and (d) other business risks. Costs Incurred The following table sets forth the capitalized costs incurred in oil and gas activities for the
years ended December 31 (amounts in thousands): 2004
    
    
    2003
    
    
    2002Property acquisition
    
    $
    2,203
    
    
    $
    217
    
    
    $
    Development
    
    
    2,761
    
    
    
    985
    
    
    
    1,677Cost incurred during the year
    
    
    4,964
    
    
    
    1,202
    
    
    
    1,677Plus: asset retirement obligation costs (1)
    
    
    264
    
    
    
    466
    
    
    
    Capitalized costs incurred during the year
    
    $
    5,228
    
    
    $
    1,668
    
    
    $
    1,677
   (1)
    
    Effective January 1, 2003, the Company adopted SFAS No. 143 Asset Retirement Obligations.
The asset retirement obligation costs reflect abandonment obligations assumed during the year and
related revisions. Prior periods presentation was not changed to reflect SFAS No. 143 because the
amounts were adjusted through a one-time cumulative adjustment as described in Note 2. 44




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 19. Supplementary Oil and Gas Data (Unaudited) (continued) Capitalized Costs Relating to Oil and Gas Activities The following table sets forth the capitalized costs relating to oil and gas activities and the
associated accumulated depreciation, depletion, and amortization (amounts in thousands): December 312004
    
    
    2003
    
    
    2002Capitalized costs:Proved properties
    
    $
    5,849
    
    
    $
    30,283
    
    
    $
    29,104Asset retirement obligation costs (1)
    
    
    730
    
    
    
    466
    
    
    
    Accumulated depreciation, depletion,
and amortization
    
    
    (1,693
    )
    
    
    (8,615
    )
    
    
    (9,063
    )Net capitalized costs
    
    $
    4,886
    
    
    $
    22,134
    
    
    $
    20,041
   (1)
    
    Effective January 1, 2003, the Company adopted SFAS No. 143 Asset Retirement Obligations.
Prior year amounts do not reflect similar retirement obligation costs,as they were adjusted through a one-time
cumulative adjustment as described in Note 2. 45




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 19. Supplementary Oil and Gas Data (Unaudited) (continued) Results of Operations for Producing Activities Year ended December 312004
    
    
    2003
    
    
    2002(amounts in thousands)Revenues from oil and gas producing
activities
    
    $
    11,574
    
    
    $
    9,152
    
    
    $
    13,707Gain (loss) price risk management
activities
    
    
    
    
    
    
    (1,161
    )
    
    
    560Production costs
    
    
    (4,313
    )
    
    
    (4,533
    )
    
    
    (9,153
    )Depreciation, depletion, and amortization
    
    
    (1,281
    )
    
    
    (951
    )
    
    
    (6,666
    )Asset retirement obligation accretion (1)
    
    
    (428
    )
    
    
    (276
    )
    
    
    Results of operations from producing
activities (excluding corporate overhead
and interest costs)
    
    $
    5,552
    
    
    $
    2,231
    
    
    $
    (1,552
    )
   (1)
    
    Effective January 1, 2003, the Company adopted SFAS No. 143 Asset Retirement Obligations.
These amounts reflect current year activity only, as prior periods were adjusted through a one-time
cumulative adjustment as described in Note 2. No income tax provision is recorded for 2004, 2003 or 2002 as the Company elected subchapter S
corporation status effective January 1, 1997. 46




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 19. Supplementary Oil and Gas Data (Unaudited) (continued) Reserves The Companys estimated total proved and proved developed reserves of oil and gas for the years
ended December 31, 2004, 2003, and 2002 are as follows: 2004
    
    
    2003
    
    
    2002Oil (Mbbl)
    
    
    Gas (Mmcf)
    
    
    Oil (Mbbl)
    
    
    Gas (Mmcf)
    
    
    Oil (Mbbl)
    
    
    Gas (Mmcf)Proved reserves at
beginning of year
    
    
    1,573
    
    
    
    19,606
    
    
    
    1,477
    
    
    
    77,125
    
    
    
    2,324
    
    
    
    38,447Purchases of reserves in
place
    
    
    604
    
    
    
    393
    
    
    
    429
    
    
    
    8,404
    
    
    
    
    
    
    
    Sales of reserves
in place
    
    
    (1,065
    )
    
    
    (10,083
    )
    
    
    
    
    
    
    (65,836
    )
    
    
    
    
    
    
    Revisions of previous
estimates
    
    
    330
    
    
    
    4,378
    
    
    
    (173
    )
    
    
    650
    
    
    
    (638
    )
    
    
    41,935Extensions and
discoveries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Production
    
    
    (142
    )
    
    
    (991
    )
    
    
    (160
    )
    
    
    (737
    )
    
    
    (209
    )
    
    
    (3,257
    )Proved reserves at end
of year
    
    
    1,300
    
    
    
    13,303
    
    
    
    1,573
    
    
    
    19,606
    
    
    
    1,477
    
    
    
    77,125Proved developed
reserves:Beginning of year
    
    
    659
    
    
    
    8,535
    
    
    
    172
    
    
    
    71,195
    
    
    
    973
    
    
    
    33,377End of year
    
    
    801
    
    
    
    6,029
    
    
    
    659
    
    
    
    8,535
    
    
    
    172
    
    
    
    71,195
 47




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 19. Supplementary Oil and Gas Data (Unaudited) (continued) Discounted Future Net Cash Flows The standardized measure of discounted future net cash flows and changes therein related to proved
oil and gas reserves are shown below (amounts in thousands): Year ended December 312004
    
    
    2003
    
    
    2002Future cash inflows
    
    $
    127,209
    
    
    $
    169,126
    
    
    $
    406,085Future production costs
    
    
    (35,354
    )
    
    
    (61,760
    )
    
    
    (207,740
    )Future development costs
    
    
    (11,458
    )
    
    
    (21,895
    )
    
    
    (15,280
    )Future net inflows before income tax
    
    
    80,397
    
    
    
    85,471
    
    
    
    183,065Future income taxes
    
    
    
    
    
    
    
    
    
    
    Future net cash flows
    
    
    80,397
    
    
    
    85,471
    
    
    
    183,06510% discount factor
    
    
    (31,708
    )
    
    
    (28,860
    )
    
    
    (77,199
    )Standardized measure of discounted
future net cash flows
    
    $
    48,689
    
    
    $
    56,611
    
    
    $
    105,866
 No income tax provision is recorded for 2004, 2003, or 2002 as the Company elected subchapter S
corporation status effective January 1, 1997. 48




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 19. Supplementary Oil and Gas Data (Unaudited) (continued) The following are the principal sources of change in the standardized measure of discounted future
net cash flows (amounts in thousands): Year ended December 312004
    
    
    2003
    
    
    2002Standardized measure:Beginning of year
    
    $
    56,611
    
    
    $
    105,866
    
    
    $
    28,983Sales, net of production costs
    
    
    (7,261
    )
    
    
    (3,458
    )
    
    
    (5,114
    )Net change in prices and production
costs
    
    
    18,553
    
    
    
    6,112
    
    
    
    35,062Extensions, discoveries, and
improved recovery, net of future
production and development costs
    
    
    
    
    
    
    
    
    
    
    Changes in estimated future
development costs
    
    
    (3,394
    )
    
    
    (247
    )
    
    
    (4,074
    )Development costs incurred during
the period
    
    
    2,663
    
    
    
    985
    
    
    
    1,677Revisions of quantity estimates
    
    
    19,611
    
    
    
    (1,033
    )
    
    
    52,789Accretion of discount
    
    
    5,661
    
    
    
    10,587
    
    
    
    2,898Purchases of reserves in-place
    
    
    7,141
    
    
    
    8,889
    
    
    
    Sales of reserves in-place
    
    
    (42,859
    )
    
    
    (62,729
    )
    
    
    Changes in production rates and other
    
    
    (8,037
    )
    
    
    (8,361
    )
    
    
    (6,355
    )Standardized measure  end of year
    
    $
    48,689
    
    
    $
    56,611
    
    
    $
    105,866
 49




---



##### Table of Contents



Torch Energy Advisors Incorporated and Subsidiaries Notes to Consolidated Financial Statements (continued) 20. Investments in Significant Equity Investees The Companys 21.15% owned joint venture, P2ES, is accounted for under the equity method of
accounting. The investment in P2ES was $9.4 million and $11.8 million at December 31, 2004 and
2003, respectively. Summarized financial information for P2ES, which was audited by other auditors
and furnished to the Company, for the years ended September 30, 2004 and 2003 is as follows (in
thousands): September 302004
    
    
    2003Current assets
    
    $
    21,966
    
    
    $
    8,636Other assets
    
    
    31,868
    
    
    
    16,858$
    53,834
    
    
    $
    25,494Current liabilities
    
    $
    22,513
    
    
    $
    10,393Stockholders equity
    
    
    31,321
    
    
    
    15,101$
    53,834
    
    
    $
    25,494
 Year Ended September 302004
    
    
    2003Net sales
    
    $
    53,320
    
    
    $
    30,795Gross profit
    
    
    15,582
    
    
    
    12,559Net loss
    
    
    (15,582
    )
    
    
    (16,127
    )
 Year Ended December 312004
    
    
    2003Companys equity loss
    
    
    (2,704
    )
    
    
    (3,132
    )
 At December 31, 2004 and 2003, the Companys investment in P2ES exceeded its equity in its net
assets of P2ES at September 30, 2004 and 2003 by approximately $2.7 million and $6.0 million,
respectively, due to goodwill and timing differences. 50