Highlights

Highlights for the first quarter of 2009 (compared to first quarter of 2008) include:

    * Production increased 28% to 2.5 Bcfe (28.1 MMcfe/d)   * Production was 70% natural gas and 30% oil and NGLs, compared to 84%    natural gas and 16% oil and NGLs in the first quarter of 2008   * Revenues decreased 47% to $10.1 million, on a 59% drop in average    realized commodity prices (before the effect of commodity    derivatives) to $3.98 per Mcfe and a 46% drop in average realized    commodity prices (after the effect of commodity derivatives) to    $5.24 per Mcfe   * Net income decreased 69% to $868,000, or $0.04 per diluted share   * Adjusted net (loss) income (a non-GAAP measure) decreased 109% to a    loss of $548,000, or $0.03 per diluted share   * EBITDAX (a non-GAAP measure) decreased 45% to $8.3 million, or $0.40    per diluted share 

First Quarter 2009 Results

Production for the first quarter of 2009 totaled 2.5 Bcfe (28.1 MMcfe/d), compared to 2.0 Bcfe (21.7 MMcfe/d) produced in the first quarter of 2008, an increase of 28%. First quarter of 2009 production was 70% natural gas and 30% oil and NGLs, compared to 84% natural gas and 16% oil and NGLs in the first quarter of 2008.

Revenues for the first quarter of 2009 totaled $10.1 million, compared to revenues of $19 million for the first quarter of 2008. Revenues for the first quarter of 2009 were negatively impacted by a sharp decline in realized commodity prices over the prior year quarter. Average realized natural gas, oil and NGL prices for the first quarter of 2009, before the effect of commodity derivatives, were $3.73 per Mcf, $34.37 per Bbl and $20.99 per Bbl, respectively, versus $8.93 per Mcf, $97.91 per Bbl and $50.95 per Bbl, respectively, for the first quarter of 2008. The Company's average realized price, including the effect of commodity derivatives, was $5.24 per Mcfe for the first quarter of 2009, compared to $9.64 per Mcfe for the first quarter of 2008, a decrease of 46%. Of the $8.9 million decrease in revenues, approximately $11.3 million was attributable to a decrease in oil and gas prices, which was partially offset by approximately $2.4 million attributable to an increase in production from Cinco Terry.

Net income for the first quarter of 2009 was $868,000, or $0.04 per diluted share, compared to net income of $2.8 million, or $0.13 per diluted share, for the first quarter of 2008. Net income for the first quarter of 2009 included a pre-tax, unrealized gain on commodity derivatives of $2.1 million. Excluding the unrealized gain on commodity derivatives and related income taxes, adjusted net (loss) income (a non-GAAP measure) for the first quarter of 2009 was a loss of $548,000, or $0.03 per diluted share, compared to adjusted net income of $5.9 million, or $0.29 per diluted share, for the first quarter of 2008. See "Supplemental Non-GAAP Financial and Other Measures" below for our reconciliation of adjusted net (loss) income to net income.

In addition to lower realized commodity prices, net income and adjusted net income for the first quarter of 2009 were negatively impacted by an increase in our effective income tax rate to 63.7% for the three months ended March 31, 2009, as described in more detail below.

EBITDAX (a non-GAAP measure) for the first quarter of 2009 was $8.3 million, or $0.40 per diluted share, compared to $15.2 million, or $0.73 per diluted share, for the first quarter of 2008. See "Supplemental Non-GAAP Financial and Other Measures" below for our reconciliation of EBITDAX to net income.

Lease operating expenses ("LOE") for the first quarter of 2009 were $2.4 million ($0.94 per Mcfe), compared to $1.4 million ($0.71 per Mcfe) in the first quarter of 2008. The increase in LOE over the prior year period was primarily a result of increased activities in our Cinco Terry field. Initial compression was installed in Cinco Terry during the first quarter of 2008 and has increased as a result of additional facilities required to compress and treat the natural gas produced from Cinco Terry. Compression and treating costs also included higher repair and maintenance costs attributable to the compression and treating facilities in both Cinco Terry and Ozona Northeast. In addition, the increase in LOE during the three months ended March 31, 2009 was partially attributable to a rise in estimated ad valorem taxes and actual well-related repair and maintenance costs. We do not expect the level of LOE for the balance of 2009 to differ materially from the first quarter of 2009.

Severance and production taxes for first quarter of 2009 were $430,000, or 4.3% of oil and gas sales, compared to $753,000, or 4.0% of oil and gas sales, in the first quarter of 2008.

General and administrative ("G&A") expenses for the first quarter of 2009 were $2.8 million ($1.11 per Mcfe), compared to $1.9 million ($0.98 per Mcfe) in the first quarter of 2008. Higher G&A expenses in the first quarter of 2009 were due to higher share-based compensation resulting from timing of payment of 2009 annual director fees, as well as higher salaries and related employee benefit costs attributable to our increase in staff from the prior year period. Except for $377,000 in non-cash, share-based compensation expense for 2009 annual director fees incurred in the first quarter of 2009, we do not expect the level of G&A expenses for the balance of 2009 to differ materially from the first quarter of 2009.

Depletion, depreciation and amortization ("DD&A") expenses for the first quarter of 2009 were $6.9 million ($2.74 per Mcfe), compared to $5.2 million ($2.64 per Mcfe) for the prior year quarter. The increase in DD&A expenses was primarily due to increased production and higher capital costs, partially offset by an increase in our estimated proved reserves at December 31, 2008.

Our income tax provision was $1.5 million for the three months ended March 31, 2009 and 2008. Our effective income tax rate for the three months ended March 31, 2009 was 63.7%, compared with 35% for the three months ended March 31, 2008. The increase in the effective rate resulted primarily from a change in our estimated income tax expenses for the year ended December 31, 2008, along with an increased impact of permanent differences between book and taxable income and increased effective state income tax rates. We expect the effective income tax rate to be approximately 39% for the remainder of 2009.

Capital Expenditures and Drilling Operations

Capital expenditures for drilling and development in the first quarter of 2009 totaled $13.2 million, and included the completion of 10 gross (five net) wells that were waiting on completion at December 31, 2008. During the first quarter of 2009, we drilled a total of 13 (6.5 net) wells in Cinco Terry, four (two net) of which were completed as producers, seven (3.5 net) of which were in various stages of completion at March 31, 2009 and two (one net) of which were non-productive. Our estimated average daily net production for the month of April 2009 was 25.7 MMcfe/d. Production for the month of April 2009 was negatively impacted by partial curtailment over approximately four days in Ozona Northeast due to scheduled maintenance at a downstream NGL fractionation facility.

As previously announced, due to the continued weakness in commodity prices, we did not extend the contracts for our two remaining drilling rigs after March 31, 2009, and we released these rigs during the first week of April 2009. We currently expect that our capital expenditures for the year ending December 31, 2009 could range from $15 million to $25 million. We intend to fund our 2009 capital expenditures with internally-generated cash flow, with any excess cash flow applied to debt, working capital obligations or strategic acquisitions. Our capital expenditure budget is subject to change depending upon a number of factors, including economic and industry conditions at the time of drilling, prevailing and anticipated prices for oil and gas, the results of our development and exploration efforts, the availability of sufficient capital resources to us and other participants for drilling prospects, our financial results, the availability of leases on reasonable terms and our ability to obtain permits for the drilling locations.

Recent Acreage Acquisition

In April 2009, we acquired an additional 2,702 gross (1,396 net) acres of leasehold interests adjacent to our Cinco Terry field in Crockett County, Texas through The University of Texas System's April lease sale process. We believe the acreage is prospective for Ellenburger and Canyon Sands production. This purchase, plus additional purchases made during the first quarter of 2009, expands our Cinco Terry project to a total of 50,226 gross (20,994 net) acres.

Liquidity and Commodity Derivatives Update

We have a $200 million revolving credit facility with a $100 million borrowing base, of which $47.7 million and $47 million were drawn at March 31, 2009 and April 30, 2009, respectively. As previously announced, our borrowing base was reaffirmed on April 1, 2009 based on our 2008 year-end estimated proved reserves of 211.1 Bcfe.