Oil
and Natural Gas Properties Investments in oil and
natural gas properties are accounted for using the full-cost method of accounting.
All costs directly associated with the acquisition, exploration and development
of oil and natural gas properties are capitalized. Such costs include lease acquisitions,
seismic surveys, and drilling and completion equipment. The Company proportionally
consolidates its interests in oil and natural gas properties. The Company capitalized
compensation costs for employees working directly on exploration activities of
$1.4 million, $1.7 million and $2.1 million in 2003, 2004 and 2005, respectively.
Maintenance and repairs are expensed as incurred. Oil
and natural gas properties are amortized based on the unit-of-production method
using estimates of proved reserve quantities. Investments in unproved properties
are not amortized until proved reserves associated with the projects can be determined
or until they are impaired. Unevaluated properties are evaluated periodically
for impairment on a property-by-property basis. If the results of an assessment
indicate that the properties are impaired, the amount of impairment is added to
the proved oil and natural gas property costs to be amortized. The amortizable
base includes estimated future development costs and, dismantlement, restoration
and abandonment costs, net of estimated salvage values. The depletion rate per
Mcfe for 2003, 2004 and 2005 was $1.55, $1.86 and $2.22, respectively. Dispositions
of oil and natural gas properties are accounted for as adjustments to capitalized
costs with no gain or loss recognized, unless such adjustments would significantly
alter the relationship between capitalized costs and proved reserves.
Effective February 1, 2005, the Company sold to a private company its interest
in the Patterson Prospect Area in St. Mary Parish, Louisiana, including the Shadyside
#1 well and any anticipated follow-up wells, for approximately $9.0 million. The
Company’s average daily production from the Shadyside #1 during the fourth quarter
2004 was approximately 970 Mcfe per day. Proceeds from the sale were used in the
2005 Barnett Shale and Gulf Coast drilling program and for general corporate purposes.
In April 2005, the Company acquired assets in the Barnett
Shale for approximately $4.1 million. This acquisition consisted of approximately
600 net acres and working interests in 14 existing gross wells (7.3 net) with
an estimated 5.4 Bcfe of proved reserves, based upon the Company’s internal estimates.
All of the interests in the wells acquired related to wells in which the Company
already had an interest. The consideration paid for this acquisition was approximately
$2.3 million in cash and 112,697 shares of the Company’s common stock. The
net capitalized costs of proved oil and natural gas properties are subject to
a “ceiling test” which limits such costs to the estimated present value, discounted
at a 10% interest rate, of future net revenues from proved reserves, based on
current economic and operating conditions. If net capitalized costs exceed this
limit, the excess is charged to operations through depreciation, depletion and
amortization. Depreciation of other property and equipment
is provided using the straight-line method based on estimated useful lives ranging
from five to 10 years. Loss on Early Extinguishment of
Long-Term Debt On July 21, 2005, the Company entered
into the Second Lien Credit Facility (see Note 7) and used a portion of the net
proceeds from that facility to redeem the balances outstanding under the Senior
Subordinated Notes ($29.6 million), and the Senior Subordinated Secured Notes
($22.5 million). In connection with the repayment of this indebtedness, the Company
recorded a loss of $3.7 million on the early extinguishment of debt in its 2005
third quarter primarily attributable to the write-off of deferred loan costs and
unamortized debt discount which totaled $3.4 million of the total loss incurred.
Oil and Natural Gas Reserve Estimates The
process of estimating quantities of proved reserves is inherently uncertain, and
the reserve data included in this document are estimates prepared by Ryder Scott
Company, DeGolyer and MacNaughton and Fairchild & Wells, Inc., independent petroleum
engineers. Reserve engineering is a subjective process of estimating underground
accumulations of hydrocarbons that cannot be measured in an exact manner. The
process relies on interpretation of available geologic, geophysical, engineering
and production data. The extent, quality and reliability of this data can vary.
The process also requires certain economic assumptions regarding drilling and
operating expense, capital expenditures, taxes and availability of funds. The
SEC mandates some of these assumptions such as oil and natural gas prices and
the present value discount rate. Proved reserve estimates
prepared by others may be substantially higher or lower than the Company’s estimates.
Because these estimates depend on many assumptions, all of which may differ from
actual results, reserve quantities actually recovered | 
