Highlights

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

Production decreased 3.7% to 2.0 Bcfe (21.8 MMcfe/d) Revenues decreased 60.1% to $8.8 million, on a 58.5% drop in average realized commodity prices (before the effect of commodity derivatives) to $4.39 per Mcfe and a 37.8% drop in average realized commodity prices (after the effect of commodity derivatives) to $6.52 per Mcfe Net loss was $3.1 million, or $(0.15) per diluted share, compared to net income of $19.8 million, or $0.95 per diluted share, for the third quarter of 2008, a 115.8% decrease Adjusted net income (a non-GAAP measure) was $1.1 million, or $0.05 per diluted share, a 85.6% decrease EBITDAX (a non-GAAP measure) was $8.9 million, or $0.42 per diluted share, a 48.9% decrease

Third Quarter 2009 Results

Production for the third quarter of 2009 totaled 2.0 Bcfe (21.8 MMcfe/d), compared to 2.1 Bcfe (22.6 MMcfe/d) produced in the third quarter of 2008, a decrease of 3.7%. Production decreased 12.2% in the third quarter of 2009, compared to second quarter 2009 production of 2.3 Bcfe (25.1 MMcfe/d) due to decreased drilling activity and the natural decline of our tight gas fields. Third quarter 2009 production was 75% natural gas and 25% oil and NGLs, compared to 76% natural gas and 24% oil and NGLs in the third quarter of 2008.

Revenues for the third quarter of 2009 totaled $8.8 million, compared to revenues of $22 million for the third quarter of 2008. Revenues for the third 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 third quarter of 2009, before the effect of commodity derivatives, were $3.32 per Mcf, $63.49 per Bbl and $29.72 per Bbl, respectively, compared to $9.10 per Mcf, $110.61 per Bbl and $56.64 per Bbl, respectively, for the third quarter of 2008. The Company's average realized price, including the effect of commodity derivatives, was $6.52 per Mcfe for the third quarter of 2009, compared to $10.49 per Mcfe for the third quarter of 2008, a decrease of 37.8%. Of the $13.2 million decrease in revenues, approximately $12.5 million was attributable to a decrease in oil and gas prices and approximately $749,000 was attributable to a reduction in production volumes.

Net loss for the third quarter of 2009 was $3.1 million, or $(0.15) per diluted share, compared to net income of $19.8 million, or $0.95 per diluted share, for the third quarter of 2008. Net loss for the third quarter of 2009 included a pre-tax, unrealized loss on commodity derivatives of $6.4 million.

Excluding the unrealized loss on commodity derivatives and related income taxes, adjusted net income (a non-GAAP measure) for the third quarter of 2009 was $1.1 million, or $0.05 per diluted share, compared to adjusted net income of $7.6 million, or $0.36 per diluted share, for the third quarter of 2008. See "Supplemental Non-GAAP Financial and Other Measures" below for our reconciliation of adjusted net income to net income.

EBITDAX (a non-GAAP measure) for the third quarter of 2009 was $8.9 million, or $0.42 per diluted share, compared to $17.4 million, or $0.83 per diluted share, for the third 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 third quarter of 2009 were $1.9 million ($0.95 per Mcfe), compared to $1.8 million ($0.89 per Mcfe) in the third quarter of 2008. The increase in LOE per Mcfe over the prior year period was due primarily to increases in pumping and supervision, well related repairs and maintenance, compression and water hauling, certain of which are fixed costs, partially offset by lower ad valorem taxes and workover expenses.

Severance and production taxes for the third quarter of 2009 were $455,000, or 5.2% of oil and gas sales, compared to $1 million, or 4.4% of oil and gas sales, in the third quarter of 2008. The decrease in production taxes was a function of the decrease in oil and gas sales between the two periods.

Exploration expense for the third quarter of 2009 was $534,000, which resulted primarily from the expiration of leases for approximately 2,300 net acres in our Ozona Northeast and North Bald Prairie fields. We expect to re-lease substantially all of the expired acreage. We recorded no exploration expense for the third quarter of 2008.

General and administrative ("G&A") expenses for the third quarter of 2009 were $2.2 million ($1.12 per Mcfe), compared to $1.9 million ($0.92 per Mcfe) for the third quarter of 2008. The increase in G&A expenses was principally due to increased staffing and share-based compensation.

Depletion, depreciation and amortization ("DD&A") expenses for the third quarter of 2009 were $5.6 million ($2.79 per Mcfe), compared to $5 million ($2.41 per Mcfe) for the third quarter of 2008. The increase in DD&A expense was primarily attributable to an increase in capitalized costs, partially offset by a decrease in production over the prior year quarter.

Our income taxes decreased $11.8 million to a benefit of $1.4 million for the third quarter of 2009, from a provision of $10.4 million for the third quarter of 2008. The decrease in income tax provision was due to the decrease in our income before taxes. Our effective income tax rate for the third quarter of 2009 was 30.5%, compared with 34.4% for the third quarter of 2008. The decrease in the effective tax rate relates primarily to the increased impact of permanent differences between book and taxable income.

Capital Expenditures, Liquidity and Commodity Derivatives Update

Capital expenditures for drilling and development in the third quarter of 2009 totaled $2.7 million, and included the drilling of one gross (0.5 net) well in Cinco Terry that was completed during the fourth quarter of 2009 as a producer as well as deepening and recompleting wells in Cinco Terry and Ozona Northeast. Our estimated average daily net production for the month of October 2009 was 21.1 MMcfe/d.

At September 30, 2009, we had a $200 million revolving credit facility with a $100 million borrowing base, of which $36.9 million and $35.8 million were drawn at September 30, 2009 and October 31, 2009, respectively. As of September 30, 2009, our long-term debt-to-capital ratio (a non-GAAP measure) was 14%. See "Supplemental Non-GAAP Financial and Other Measures" below for our definition of "long-term debt-to-capital ratio."

As of September 30, 2009, we had the following commodity derivatives positions outstanding:

                      Volume (MMBtu)              $/MMBtu
                   -------------------     ---------------------------
 Period             Monthly     Total      Floor    Ceiling     Fixed
                   --------  ---------     ------   --------   -------
 NYMEX - Henry
  Hub

   Price
    collars 2009   180,000     540,000     $ 7.50   $ 10.50
   Price
    collars 2009   130,000     390,000     $ 8.50   $ 11.70
   Price
    swaps 2009     150,000     450,000                         $  4.50
   Price
    swaps 2010     150,000   1,800,000                         $  5.85
   Price
    swaps 2010     150,000   1,800,000                         $  6.40
 WAHA basis
  differential

   Basis
    swaps 2009     200,000     600,000                         $ (0.61)
   Basis
    swaps 2009     300,000     900,000                         $ (0.67)
   Basis
    swaps 2010     415,000   4,980,000                         $ (0.71)
   Basis
    swaps 2011     300,000   3,600,000                         $ (0.53)

Borrowing Base Increase

Effective October 30, 2009, the Company's lending group increased the Company's $100 million borrowing base to $115 million under the Company's revolving credit facility. All other terms and conditions of the credit facility remain unchanged. The credit facility is provided by The Frost National Bank, as agent, JPMorgan Chase Bank, Fortis Capital Corp. and KeyBank. The next redetermination of the borrowing base is scheduled for April 2010. The revolving credit facility matures July 31, 2011.

Management Comments

J. Ross Craft, the Company's President and Chief Executive Officer, commented, "Releasing our rigs after the first quarter of 2009 helped us reduce our long-term debt from $47.7 million at March 31, 2009 to $36.9 million at September 30, 2009. Releasing our rigs, however, also contributed to a decrease in our average daily production in 2009, as we elected not to offset the natural decline of our tight gas fields in an unfavorable natural gas price environment.