UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2008

or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

ENCORE ACQUISITION COMPANY

(Exact name of registrant as specified in its charter)

Delaware		75-2759650
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
777 Main Street, Suite 1400, Fort Worth, Texas		76102
(Address of principal executive offices)		(Zip Code)

(817) 877-9955
(Registrant’s telephone number, including area code)

Not applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Number of shares of common stock, $0.01 par value, outstanding as of May 2, 2008                                                                  53,295,415

 

 

ENCORE ACQUISITION COMPANY

INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2008 and December 31, 2007			1
Consolidated Statements of Operations for the three months ended March 31, 2008 and 2007			2
Consolidated Statement of Stockholders’ Equity for the three months ended March 31, 2008			3
Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2007			4
Notes to Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
Item 3. Quantitative and Qualitative Disclosures About Market Risk			42
Item 4. Controls and Procedures			42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			43
Item 1A. Risk Factors			43
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			43
Item 6. Exhibits			43
Signature			45
Form of Stock Option Agreement - Nonqualified
Form of Stock Option Agreement - Incentive
Form of Restricted Stock Award - Executive
Amendment No.1 to Second Amended and Restated Agreement
Rule 13a-14(a)/15d-14(a) Certification
Rule 13a-14(a)/15d-14(a) Certification
Section 1350 Certification
Section 1350 Certification
Statement showing Computation of Ratios of Earnings to Fixed Charges

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

     Certain information included in this Quarterly Report on Form 10-Q (the “Report”) and other materials filed with the SEC, or in other written or oral statements made or to be made by us, other than statements of historical fact, are forward-looking statements as defined by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements give our current expectations or forecasts of future events. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “may,” “will,” “could,” “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “should,” “predict,” “potential,” “pursue,” “target,” “continue,” and other words and terms of similar meaning. Readers are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date of this Report. Our actual results may differ significantly from the results discussed in the forward-looking statements. Such statements involve risks and uncertainties, including, but not limited to, the matters discussed in “Item 1A. Risk Factors” in our Annual Report on Form 10-K and in our other filings with the SEC. If one or more of these risks or uncertainties materialize (or the consequences of such a development changes), or should underlying assumptions prove incorrect, actual outcomes may vary materially from those forecasted or indicated. We undertake no responsibility to update forward-looking statements for changes related to these or any other factors that may occur subsequent to this filing for any reason.

ENCORE ACQUISITION COMPANY

GLOSSARY

     The following are abbreviations and definitions of certain terms used in this Report. The definitions of proved developed reserves, proved reserves, and proved undeveloped reserves have been abbreviated from the applicable definitions contained in Rule 4-10(a)(2-4) of Regulation S-X.

	•		Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil or other liquid hydrocarbons.
	•		Bbl/D. One Bbl per day.
	•		BOE. One barrel of oil equivalent, calculated by converting natural gas to oil equivalent barrels at a ratio of six Mcf of natural gas to one Bbl of oil.
	•		BOE/D. One BOE per day.
	•		Completion. The installation of permanent equipment for the production of oil or natural gas.
	•		Council of Petroleum Accountants Societies (“COPAS”). A professional organization of oil and gas accountants that maintains consistency in accounting procedures and interpretations, including the procedures that are part of most joint operating agreements. These procedures establish a drilling rate and an overhead rate to reimburse the operator of a well for overhead costs, such as accounting and engineering.
	•		Delay Rentals. Fees paid to the lessor of an oil and natural gas lease during the primary term of the lease prior to the commencement of production from a well.
	•		Development Well. A well drilled within the proved area of an oil or natural gas reservoir to the depth of a stratigraphic horizon known to be productive.
	•		Dry Hole. A well found to be incapable of producing hydrocarbons in sufficient quantities such that proceeds from the sale of such production would exceed LOE and production taxes.
	•		EAC. Encore Acquisition Company, a Delaware corporation, together with its subsidiaries.
	•		ENP. Encore Energy Partners LP, a publicly traded Delaware limited partnership, together with its subsidiaries.
	•		Exploratory Well. A well drilled to find and produce oil or natural gas in an unproved area, to find a new reservoir in a field previously producing oil or natural gas in another reservoir, or to extend a known reservoir.
	•		Field. An area consisting of a single reservoir or multiple reservoirs, all grouped on or related to the same individual geological structural feature and/or stratigraphic condition.
	•		Gross Acres or Gross Wells. The total acres or wells, as the case may be, in which we own a working interest.
	•		Lease Operations Expense (“LOE”). All direct and allocated indirect costs of producing oil and natural gas after completion of drilling. Such costs include labor, superintendence, supplies, repairs, maintenance, and direct overhead charges.
	•		LIBOR. London Interbank Offered Rate.
	•		MBbl. One thousand Bbls.
	•		MBOE. One thousand BOE.
	•		MBOE/D. One thousand BOE per day.
	•		Mcf. One thousand cubic feet, used in reference to natural gas.
	•		Mcf/D. One Mcf per day.
	•		MMcf. One million cubic feet, used in reference to natural gas.
	•		Natural Gas Liquids (“NGLs”). The combination of ethane, propane, butane, and natural gasolines that when removed from natural gas become liquid under various levels of higher pressure and lower temperature.
	•		Net Acres or Net Wells. Gross acres or wells, as the case may be, multiplied by the working interest percentage owned by us.
	•		Net Profits Interest (“NPI”). An interest that entitles the owner to a specified share of net profits from production of hydrocarbons.
	•		NYMEX. New York Mercantile Exchange.
	•		Oil. Crude oil, condensate, and NGLs.
	•		Operator. The entity responsible for the exploration, exploitation, and production of an oil or natural gas well or lease.
	•		Production Margin. Oil and natural gas revenues less LOE and production, ad valorem, and severance taxes.
	•		Productive Wells. Producing wells and wells capable of production, including natural gas wells awaiting pipeline connections to commence deliveries and oil wells awaiting connection to production facilities.
	•		Proved Developed Reserves. Proved reserves that can be expected to be recovered from existing wells with existing equipment and operating methods.
	•		Proved Reserves. The estimated quantities of oil, natural gas, and NGLs that geological and engineering data demonstrate with reasonable certainty are recoverable in future years from known reservoirs under existing economic and operating

ENCORE ACQUISITION COMPANY

			conditions.
	•		Proved Undeveloped Reserves. Proved reserves that are expected to be recovered from new wells drilled to known reservoirs on acreage yet to be drilled for which the existence and recoverability of such reserves can be estimated with reasonable certainty, or from existing wells where a relatively major expenditure is required to establish production, including unrealized production response from enhanced recovery techniques that have been proved effective by actual tests in the area and in the same reservoir.
	•		SEC. The United States Securities and Exchange Commission.
	•		Secondary Recovery. Enhanced recovery of oil or natural gas from a reservoir beyond the oil or natural gas that can be recovered by normal flowing and pumping operations. Secondary recovery techniques involve maintaining or enhancing reservoir pressure by injecting water, gas, or other substances into the formation. The purpose of secondary recovery is to maintain reservoir pressure and to displace hydrocarbons toward the wellbore. The most common secondary recovery techniques are gas injection and waterflooding.
	•		Successful Well. A well capable of producing oil and/or natural gas in commercial quantities.
	•		Tertiary Recovery. An enhanced recovery operation that normally occurs after waterflooding in which chemicals or natural gases are used as the injectant.
	•		Undeveloped Acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil or natural gas regardless of whether such acreage contains proved reserves.
	•		Waterflood. A secondary recovery operation in which water is injected into the producing formation in order to maintain reservoir pressure and force oil toward and into the producing wells.
	•		Working Interest. An interest in an oil or natural gas lease that gives the owner the right to drill for and produce oil and natural gas on the leased acreage and requires the owner to pay a share of the LOE and development costs.
	•		Workover. Operations on a producing well to restore or increase production.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ENCORE ACQUISITION COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)

		March 31,				December 31,
		2008				2007
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	205			$	1,704
Accounts receivable, net of allowance for doubtful accounts of $6,045			152,017				134,880
Inventory			30,736				16,257
Derivatives			10,259				9,722
Deferred taxes			29,316				20,420
Other			9,507				5,527
Total current assets			232,040				188,510
Properties and equipment, at cost — successful efforts method:
Proved properties, including wells and related equipment			2,963,795				2,845,776
Unproved properties			73,220				63,352
Accumulated depletion, depreciation, and amortization			(537,130	)			(489,004	)
			2,499,885				2,420,124
Other property and equipment			22,005				21,750
Accumulated depreciation			(10,914	)			(10,733	)
			11,091				11,017
Goodwill			60,606				60,606
Derivatives			25,606				34,579
Long-term receivables			50,363				40,945
Other			28,244				28,780
Total assets		$	2,907,835			$	2,784,561
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	17,835			$	21,548
Accrued liabilities:
Lease operations expense			17,771				15,057
Development capital			51,181				48,359
Interest			12,758				12,795
Production, ad valorem, and severance taxes			31,630				24,694
Oil and natural gas purchases			11,496				8,721
Derivatives			74,084				39,337
Oil and natural gas revenues payable			14,624				13,076
Other			16,704				21,143
Total current liabilities			248,083				204,730
Derivatives			57,335				47,091
Future abandonment cost, net of current portion			28,912				27,371
Deferred taxes			335,207				312,914
Long-term debt			1,174,377				1,120,236
Other			1,520				1,530
Total liabilities			1,845,434				1,713,872
Commitments and contingencies (see Note 16)
Minority interest in consolidated partnership			119,068				122,534
Stockholders’ equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued and outstanding			—				—
Common stock, $.01 par value, 144,000,000 shares authorized, 52,326,023 and 53,303,464 issued and outstanding, respectively			524				534
Additional paid-in capital			531,348				538,620
Treasury stock, at cost, 28,193 and 17,690 shares, respectively			(954	)			(590	)
Retained earnings			414,493				411,377
Accumulated other comprehensive loss			(2,078	)			(1,786	)
Total stockholders’ equity			943,333				948,155
Total liabilities and stockholders’ equity		$	2,907,835			$	2,784,561

The accompanying notes are an integral part of these consolidated financial statements.

ENCORE ACQUISITION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)

		Three months ended
		March 31,
		2008				2007
Revenues:
Oil		$	220,534			$	82,623
Natural gas			48,312				32,978
Marketing			4,056				14,941
Total revenues			272,902				130,542
Expenses:
Production:
Lease operations			40,350				30,520
Production, ad valorem, and severance taxes			27,452				12,515
Depletion, depreciation, and amortization			49,543				35,028
Exploration			5,488				11,521
General and administrative			9,687				7,360
Marketing			3,782				15,011
Derivative fair value loss			65,138				45,614
Other operating			2,506				2,565
Total expenses			203,946				160,134
Operating income (loss)			68,956				(29,592	)
Other income (expenses):
Interest			(19,760	)			(16,287	)
Other			851				431
Total other income (expenses)			(18,909	)			(15,856	)
Income (loss) before income taxes and minority interest			50,047				(45,448	)
Income tax benefit (provision)			(18,733	)			16,019
Minority interest in income of consolidated partnership			(94	)			—
Net income (loss)		$	31,220			$	(29,429	)
Net income (loss) per common share:
Basic		$	0.59			$	(0.55	)
Diluted		$	0.58			$	(0.55	)
Weighted average common shares outstanding:
Basic			52,799				53,077
Diluted			53,869				53,077

The accompanying notes are an integral part of these consolidated financial statements.

ENCORE ACQUISITION COMPANY
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands)
(unaudited)

		Issued																								Accumulated
		Shares of								Additional				Shares of												Other				Total
		Common				Common				Paid-in				Treasury				Treasury				Retained				Comprehensive				Stockholders’
		Stock				Stock				Capital				Stock				Stock				Earnings				Loss				Equity
Balance at December 31, 2007			53,321			$	534			$	538,620				(18	)		$	(590	)		$	411,377			$	(1,786	)		$	948,155
Exercise of stock options and vesting of restricted stock			225				2				1,636				—				—				—				—				1,638
Repurchase and retirement of common stock			(1,174	)			(12	)			(11,679	)			—				—				(27,427	)			—				(39,118	)
Purchase of treasury stock			—				—				—				(28	)			(954	)			—				—				(954	)
Cancellation of treasury stock			(18	)			—				(179	)			18				590				(411	)			—				—
Non-cash equity-based compensation			—				—				2,950				—				—				—				—				2,950
ENP distributions to MIU holders			—				—				—				—				—				(266	)			—				(266	)
Components of comprehensive income:
Net income			—				—				—				—				—				31,220				—				31,220
Change in deferred hedge loss on interest rate swaps, net of tax of $397			—				—				—				—				—				—				(1,171	)			(1,171	)
Amortization of deferred loss on commodity derivative contracts, net of tax of $549			—				—				—				—				—				—				879				879
Total comprehensive income																															30,928
Balance at March 31, 2008			52,354			$	524			$	531,348				(28	)		$	(954	)		$	414,493			$	(2,078	)		$	943,333

The accompanying notes are an integral part of these consolidated financial statements.

ENCORE ACQUISITION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

		Three months ended
		March 31,
		2008				2007
Cash flows from operating activities:
Net income (loss)		$	31,220			$	(29,429	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depletion, depreciation, and amortization			49,543				35,028
Non-cash exploration expense			3,656				9,665
Deferred taxes			14,623				(15,899	)
Non-cash equity-based compensation expense			2,896				3,070
Non-cash derivative loss			62,176				53,610
Loss (gain) on disposition of assets			(23	)			226
Minority interest in income of consolidated partnership			94				—
Other			2,376				821
Changes in operating assets and liabilities, net of effects from acquisition:
Accounts receivable			(16,753	)			146
Current derivatives			(670	)			(14,732	)
Other current assets			(18,459	)			(3,685	)
Long-term derivatives			(1,196	)			(18,084	)
Other assets			(67	)			(683	)
Accounts payable			(6,303	)			(2,056	)
Other current liabilities			8,953				(2,890	)
Other noncurrent liabilities			(339	)			(49	)
Net cash provided by operating activities			131,727				15,059
Cash flows from investing activities:
Proceeds from disposition of assets			184				1,214
Purchases of other property and equipment			(1,054	)			(606	)
Acquisition of oil and natural gas properties			(30,780	)			(438,568	)
Development of oil and natural gas properties			(97,802	)			(101,924	)
Net advances to working interest partners			(8,972	)			(13,382	)
Net cash used in investing activities			(138,424	)			(553,266	)
Cash flows from financing activities:
Repurchase of common stock			(39,118	)			—
Exercise of stock options and vesting of restricted stock, net of treasury stock purchases			684				60
Proceeds from long-term debt, net of issuance costs			357,274				606,778
Payments on long-term debt			(303,500	)			(75,027	)
Payment of commodity derivative contract premiums			(8,534	)			(5,350	)
ENP distributions to holders of MIUs and public units			(4,198	)			—
Change in cash overdrafts			2,590				11,609
Net cash provided by financing activities			5,198				538,070
Decrease in cash and cash equivalents			(1,499	)			(137	)
Cash and cash equivalents, beginning of period			1,704				763
Cash and cash equivalents, end of period		$	205			$	626

The accompanying notes are an integral part of these consolidated financial statements.

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1. About EAC

     EAC is engaged in the acquisition and development of oil and natural gas reserves from onshore fields in the United States. Since 1998, EAC has acquired producing properties with proven reserves and leasehold acreage and grown the production and proven reserves by drilling, exploring, reengineering or expanding existing waterflood projects, and applying tertiary recovery techniques. EAC’s properties — and oil and natural gas reserves — are located in four core areas:

	•		the Cedar Creek Anticline (“CCA”) in the Williston Basin of Montana and North Dakota;
	•		the Permian Basin of West Texas and southeastern New Mexico;
	•		the Rockies, which includes non-CCA assets in the Williston, Big Horn, and Powder River Basins of Wyoming, Montana, and North Dakota, and the Paradox Basin of southeastern Utah; and
	•		the Mid-Continent area, which includes the Arkoma and Anadarko Basins of Oklahoma, the North Louisiana Salt Basin, and the East Texas Basin.

Note 2. Basis of Presentation

     EAC’s consolidated financial statements include the accounts of wholly owned and majority-owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.

     In February 2007, EAC formed ENP to acquire, exploit, and develop oil and natural gas properties and to acquire, own, and operate related assets. In September 2007, ENP completed its initial public offering (“IPO”). As of March 31, 2008 and December 31, 2007, EAC owned approximately 67.3 percent and 58.0 percent, respectively, of ENP’s common units, as well as all of the interests of Encore Energy Partners GP LLC (“GP LLC”), a Delaware limited liability company and ENP’s general partner, which is an indirect wholly owned non-guarantor subsidiary of EAC. Considering the presumption of control of GP LLC in accordance with Emerging Issues Task Force Issue No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights”, the financial position, results of operations, and cash flows of ENP are consolidated with those of EAC. EAC elected to account for gains on ENP’s issuance of common units as capital transactions as permitted by Staff Accounting Bulletin (“SAB”) Topic 5H, “Accounting for Sales of Stock by a Subsidiary”. See “Note 18. ENP” for additional discussion.

     In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments necessary to present fairly, in all material respects, its financial position as of March 31, 2008, and results of operations and cash flows for the three months ended March 31, 2008 and 2007. All adjustments are of a normal recurring nature. These interim results are not necessarily indicative of results for an entire year.

     Certain amounts and disclosures have been condensed or omitted from these consolidated financial statements pursuant to the rules and regulations of the SEC. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in EAC’s 2007 Annual Report on Form 10-K.

Minority Interest

     As presented in the accompanying Consolidated Balance Sheets, “Minority interest in consolidated partnership” as of March 31, 2008 and December 31, 2007 of $119.1 million and $122.5 million, respectively, represents third-party ownership interests in ENP. As presented in the accompanying Consolidated Statements of Operations, “Minority interest in income of consolidated partnership” for the three months ended March 31, 2008 of $0.1 million represents the net income of ENP attributable to third-party owners.

Reclassifications

     Certain amounts in prior periods have been reclassified to conform to the current period presentation. In particular, certain amounts on the accompanying Consolidated Statements of Operations and Consolidated Statements of Cash Flows have been either combined or classified in more detail.

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

New Accounting Pronouncements

Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”)

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS 157. SFAS 157 standardizes the definition of fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures related to the use of fair value measures in financial statements. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, but does not require any new fair value measurements. SFAS 157 is prospectively effective for financial assets and liabilities for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, the FASB issued FASB Staff Position (“FSP”) 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”), which delays the effective date of SFAS 157 for one year for nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). EAC elected a partial deferral of SFAS 157 for all instruments within the scope of FSP 157-2, including but not limited to, its asset retirement obligations and goodwill. EAC will continue to evaluate the impact of SFAS 157 on these instruments during the deferral period. The adoption of SFAS 157 on January 1, 2008, as it relates to financial assets and liabilities, did not have a material impact on EAC’s results of operations or financial condition. See “Note 7. Fair Values of Financial Assets and Liabilities” for additional discussion.

SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115” (“SFAS 159”)

     In February 2007, the FASB issued SFAS 159. SFAS 159 permits entities to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis. SFAS 159 allows entities an irrevocable option to measure eligible items at fair value at specified election dates, with resulting changes in fair value reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. EAC did not elect the fair value option for eligible instruments and therefore, the adoption of SFAS 159 on January 1, 2008 did not have a material impact on EAC’s results of operations or financial condition.

FSP Interpretation 39-1, “Amendment of FASB Interpretation No. 39” (“FSP FIN 39-1”)

     In April 2007, the FASB issued FSP FIN 39-1. FSP FIN 39-1 amends FASB Interpretation (“FIN”) No. 39, “Offsetting of Amounts Related to Certain Contracts” (“FIN 39”), to permit a reporting entity that is party to a master netting arrangement to offset the fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments that have been offset under the same master netting arrangement in accordance with FIN 39. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007. The adoption of FSP FIN 39-1 on January 1, 2008 did not have an impact on EAC’s results of operations or financial condition. EAC will assess the impact of electing the fair value option for any newly acquired eligible instruments. Electing the fair value option for such instruments could have a material impact on EAC’s future results of operations or financial condition.

SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”)

     In December 2007, the FASB issued SFAS 141R. SFAS 141R is a revision of SFAS No. 141, “Business Combinations” (“SFAS 141”). SFAS 141R amends SFAS 141 by requiring an acquirer to recognize: (i) the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at fair value as of the acquisition date, (ii) a gain attributable to any “negative goodwill” in a bargain purchase, and (iii) an expense related to acquisition costs. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008. EAC does not expect the adoption of SFAS 141R to have a material impact on its current results of operations or financial condition. However, future results of operations or financial condition may be materially affected if a significant acquisition is consummated subsequent to the effective date.

SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment to ARB No. 51” (“SFAS 160”)

     In December 2007, the FASB issued SFAS 160. SFAS 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements” to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. EAC expects

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

the adoption of SFAS 160 to have a material impact on how it accounts for and discloses the noncontrolling interest in ENP. “Minority interest in consolidated partnership” in EAC’s Consolidated Balance Sheets will be reflected as a component of stockholders’ equity and “Minority interest in income of consolidated partnership” in EAC’s Consolidated Statements of Operations will be moved to below net income.

SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (“SFAS 161”)

     In March 2008, the FASB issued SFAS 161. SFAS 161 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” to require enhanced disclosures about an entity’s derivative and hedging activities and thereby improve the transparency of financial reporting. SFAS 161 is effective for fiscal years beginning on or after November 15, 2008 with early application permitted. The adoption of SFAS 161 is not expected to impact EAC’s results of operations or financial condition.

Note 3. Acquisitions and Dispositions

Acquisitions

     On January 23, 2007, EAC entered into a purchase and sale agreement with certain subsidiaries of Anadarko Petroleum Corporation (“Anadarko”) to acquire oil and natural gas properties and related assets in the Williston Basin of Montana and North Dakota. The closing of the Williston Basin acquisition occurred on April 11, 2007 after which time the operations have been included with those of EAC. The Williston Basin acquisition was treated as a reverse like-kind exchange under Section 1031 of the Internal Revenue Code of 1986, as amended, and I.R.S. Revenue Procedure 2000-37 with the Mid-Continent disposition discussed below.

     The total purchase price for the Williston Basin assets was approximately $392.1 million, including transaction costs of approximately $1.3 million. The calculation of the total purchase price and the allocation to the fair value of the Williston Basin assets acquired and liabilities assumed from Anadarko are as follows (in thousands):

Calculation of total purchase price:
Cash paid to Anadarko		$	390,728
Transaction costs			1,333
Total purchase price		$	392,061
Allocation of purchase price to the fair value of net assets acquired:
Proved properties, including wells and related equipment		$	383,909
Unproved properties			16,134
Accounts receivable			3,008
Inventory			805
Total assets acquired			403,856
Current liabilities			8,289
Future abandonment cost and assumed liabilities			3,506
Total liabilities assumed			11,795
Fair value of net assets acquired		$	392,061

     On January 16, 2007, EAC entered into a purchase and sale agreement with certain subsidiaries of Anadarko to acquire oil and natural gas properties and related assets in the Big Horn Basin of Wyoming and Montana, which included oil and natural gas properties and related assets in or near the Elk Basin field in Park County, Wyoming and Carbon County, Montana and oil and natural gas properties and related assets in the Gooseberry field in Park County, Wyoming. Prior to closing, EAC assigned the rights and duties under the purchase and sale agreement relating to the Elk Basin assets to Encore Energy Partners Operating LLC (“OLLC”), a Delaware limited liability company and wholly owned subsidiary of ENP, and the rights and duties under the purchase and sale agreement relating to the Gooseberry assets to Encore Operating, L.P. (“Encore Operating”), a Texas limited partnership and indirect wholly owned guarantor subsidiary of EAC. The closing of the Big Horn Basin acquisition occurred on March 7, 2007 after which time the operations have been included with those of EAC.

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

     The total purchase price for the Big Horn Basin assets was approximately $393.6 million, including transaction costs of approximately $1.3 million. The calculation of the total purchase price and the allocation to the fair value of the Big Horn Basin assets acquired and liabilities assumed from Anadarko are as follows (in thousands):

Calculation of total purchase price:
Cash paid to Anadarko		$	392,289
Transaction costs			1,288
Total purchase price		$	393,577
Allocation of purchase price to the fair value of net assets acquired:
Proved properties, including wells and related equipment		$	395,606
Intangibles			4,225
Accounts receivable			1,673
Other property and equipment			346
Total assets acquired			401,850
Current liabilities			1,300
Future abandonment cost and assumed liabilities			6,973
Total liabilities assumed			8,273
Fair value of net assets acquired		$	393,577

     Proved properties include the fair value of proved leasehold costs, lease and well equipment (including flue gas reinjection facilities used to maintain reservoir pressure by compressing and reinjecting the gas produced), and pipelines used primarily to transport production from the acquired fields. NGLs are produced as a byproduct of the flue gas tertiary recovery project and are sold at market prices. The revenues generated by NGLs are included in “Oil revenues” in the accompanying Consolidated Statements of Operations. Third-party revenues and expenses related to the pipelines are included in “Marketing revenues” and “Marketing expenses”, respectively, in the accompanying Consolidated Statements of Operations.

     EAC financed the acquisitions of the Gooseberry field and Williston Basin assets through borrowings under its revolving credit facility. ENP financed the acquisition of the Elk Basin assets through a $93.7 million contribution from EAC, $120 million of borrowings under a subordinated credit agreement with EAP Operating, LLC, a Delaware corporation and direct wholly owned subsidiary of EAC, and borrowings under its revolving credit facility. See “Note 9. Long-Term Debt” for additional discussion of EAC’s and ENP’s revolving credit facilities. See “Note 15. Financial Statements of Subsidiary Guarantors” for a discussion of EAC’s guarantor and non-guarantor subsidiaries.

Dispositions

     On June 29, 2007, EAC completed the sale of certain oil and natural gas properties in the Mid-Continent area and in July 2007, additional Mid-Continent properties that were subject to preferential rights were sold. EAC received total net proceeds of approximately $294.8 million, after deducting transaction costs of approximately $3.6 million, and recorded a loss on sale of approximately $7.4 million. The disposed properties included certain properties in the Anadarko and Arkoma basins of Oklahoma. EAC retained material oil and natural gas interests in other properties in these basins and remains active in those areas. Proceeds from the Mid-Continent disposition were used to reduce outstanding borrowings under EAC’s revolving credit facility.

Pro Forma

     The following unaudited pro forma condensed financial data was derived from the historical financial statements of EAC and from the accounting records of Anadarko to give effect to the Big Horn Basin and Williston Basin asset acquisitions and the Mid-Continent disposition as if they had occurred on January 1, 2007. The unaudited pro forma condensed financial information has been included for comparative purposes only and is not necessarily indicative of the results that might have occurred had the Big Horn Basin and Williston Basin asset acquisitions and the Mid-Continent disposition taken place as of the date indicated and are not intended to be a projection of future results.

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

		Three months ended
		March 31, 2007
		(in thousands, except per
		share amounts)
Pro forma total revenues		$	155,579
Pro forma net loss		$	(30,646	)
Pro forma net loss per common share:
Basic		$	(0.58	)
Diluted		$	(0.58	)

Note 4. Inventory

     Inventory is composed of materials and supplies and oil in pipelines, which are stated at the lower of cost (determined on an average basis) or market. Oil produced at the lease which resides unsold in pipelines is carried at an amount equal to its operating costs to produce. Oil in pipelines purchased from third parties is carried at average purchase price. EAC’s inventory consisted of the following as of the dates indicated:

		March 31,				December 31,
		2008				2007
		(in thousands)
Materials and supplies		$	12,800			$	11,567
Oil in pipelines			17,936				4,690
Total inventory		$	30,736			$	16,257

Note 5. Proved Properties

     Amounts shown in the accompanying Consolidated Balance Sheets as “Proved properties” include leasehold costs and wells and related equipment, both completed and in process, and consisted of the following as of the dates indicated:

		March 31,				December 31,
		2008				2007
		(in thousands)
Proved leasehold costs		$	1,363,008			$	1,346,516
Wells and related equipment — Completed			1,480,436				1,408,512
Wells and related equipment — In process			120,351				90,748
Total proved properties		$	2,963,795			$	2,845,776

Note 6. Derivative Financial Instruments

     As of March 31, 2008, EAC had $70.6 million of deferred premiums payable of which $30.7 million is long-term and included in “Derivatives” in the non-current liabilities section of the accompanying Consolidated Balance Sheet and $39.9 million is current and included in “Derivatives” in the current liabilities section of the accompanying Consolidated Balance Sheet. The premiums relate to various oil and natural gas floor contracts and are payable on a monthly basis from April 2008 to January 2010. EAC recorded these premiums at their net present value at the time the contracts were entered into and accretes that value up to the eventual settlement price by recording interest expense each period.

Commodity Derivative Contracts — Mark-to-Market Accounting

     In order to partially finance the cost of premiums on certain purchased floors, EAC may sell floors with a strike price below the strike price of the purchased floor. Together the two floors, known as a floor spread or put spread, have a lower premium cost than a traditional floor contract but provide price protection only down to the strike price of the short floor. As with EAC’s other commodity derivative contracts, these are marked-to-market each quarter through “Derivative fair value loss” in the accompanying Consolidated Statements of Operations. In the following table, the purchased floor component of these floor

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

spreads has been included with EAC’s other floor contracts and the short floor component is shown separately as negative volumes.

     The following tables summarize EAC’s open commodity derivative contracts as of March 31, 2008:

Oil Derivative Contracts

		Daily				Average					Daily				Average					Daily				Average					Daily				Average
		Floor				Floor					Short Floor				Short Floor					Cap				Cap					Swap				Swap
Period		Volume				Price					Volume				Price					Volume				Price					Volume				Price
		(Bbls)				(per Bbl)					(Bbls)				(per Bbl)					(Bbls)				(per Bbl)					(Bbls)				(per Bbl)
April — June 2008
			19,880			$	83.77					—			$	—					2,440			$	101.99					—			$	—
			6,000				71.67					—				—					2,000				96.65					—				—
			9,500				61.32					—				—					—				—					—				—
			3,000				56.67					(4,000	)			50.00					—				—					1,000				58.59
Second Half 2008
			14,880				83.36					—				—					2,440				101.99					5,000				91.56
			6,000				71.67					—				—					2,000				96.65					—				—
			5,500				62.27					—				—					—				—					—				—
			3,000				56.67					(4,000	)			50.00					—				—					—				—
2009
			13,380				80.00					—				—					440				97.75					2,000				90.46
			2,250				74.11					—				—					—				—					3,000				89.22
			—				—					(5,000	)			50.00					—				—					1,000				68.70
2010
			880				80.00					—				—					440				93.80					—				—
			2,000				75.00					—				—					1,000				77.23					—				—
2011
			1,880				80.00					—				—					1,440				95.41					—				—
			1,000				70.00					—				—					—				—					—				—

Natural Gas Derivative Contracts

		Daily				Average					Daily				Average					Daily				Average					Daily				Average
		Floor				Floor					Short Floor				Short Floor					Cap				Cap					Swap				Swap
Period		Volume				Price					Volume				Price					Volume				Price					Volume				Price
		(Mcf)				(per Mcf)					(Mcf)				(per Mcf)					(Mcf)				(per Mcf)					(Mcf)				(per Mcf)
April — Dec. 2008
			6,300			$	8.18					—			$	—					6,300			$	9.52					5,000			$	8.14
			11,300				7.38					—				—					7,500				8.35					5,000				7.47
			20,000				6.35					—				—					—				—					—				—
2009
			3,800				8.20					—				—					3,800				9.83					—				—
			3,800				7.20					—				—					—				—					—				—
2010
			3,800				8.20					—				—					3,800				9.58					—				—
			3,800				7.20					—				—					—				—					—				—

Interest Rate Swaps

     In the first quarter of 2008, as a result of the increase in debt levels, ENP entered into interest rate swaps whereby it swapped $100 million of floating rate debt on its revolving credit facility to a weighted average fixed rate of 3.06 percent and an expected margin of 1.25 percent. These interest rate swaps were designated as cash flow hedges. The following table summarizes ENP’s open interest rate swaps as of March 31, 2008:

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

		Notional				Fixed				Floating
Term		Amount				Rate				Rate
		(in thousands)
March 2008-January 2011		$	50,000				3.1610	%		1 month LIBOR
March 2008-January 2011			25,000				2.9650	%		1 month LIBOR
March 2008-January 2011			25,000				2.9613	%		1 month LIBOR

     During the three months ended March 31, 2008, settlements of interest rate swaps reduced ENP’s interest expense by approximately $18,000.

Current Period Impact

     As a result of commodity derivative contracts that were previously designated as hedges, EAC recognized a pre-tax reduction in oil and natural gas revenues of approximately $1.4 million and $13.4 million during the three months ended March 31, 2008 and 2007, respectively. EAC also recognized derivative fair value gains and losses related to (i) changes in the market value of commodity derivative contracts, (ii) settlements on commodity derivative contracts, (iii) premium amortization, and (iv) changes in fair value of interest rate swaps prior to designation. The following table summarizes the components of derivative fair value loss for the periods indicated:

		Three months ended March 31,
		2008				2007
		(in thousands)
Mark-to-market loss on commodity derivative contracts		$	46,779			$	47,445
Premium amortization			15,513				6,364
Change in fair value of interest rate swaps prior to designation			(381	)			—
Settlements on commodity derivative contracts			3,227				(8,195	)
Total derivative fair value loss		$	65,138			$	45,614

Accumulated Other Comprehensive Loss (“AOCL”)

     At March 31, 2008, AOCL consisted of deferred losses, net of tax, on commodity derivative contracts that were previously designated as hedges of $0.9 million and deferred losses, net of tax, on interest rate swaps, which are designated as hedges, of $1.2 million. At December 31, 2007, AOCL consisted entirely of deferred losses, net of tax, on commodity derivative contracts that were previously designated as hedges of $1.8 million.

     EAC expects to reclassify the remaining $1.4 million of deferred losses associated with its dedesignated commodity derivative contracts from AOCL to oil and natural gas revenues by June 30, 2008. EAC also expects to reclassify the remaining $0.5 million of income taxes associated with its dedesignated commodity derivative contracts from AOCL to income tax benefit by June 30, 2008. EAC expects to reclassify $0.5 million of deferred losses associated with ENP’s interest rate swaps from AOCL to interest expense during the twelve months ending March 31, 2009. EAC also expects to reclassify $0.1 million of income taxes associated with ENP’s interest rate swaps from AOCL to income tax benefit during the twelve months ending March 31, 2009.

Note 7. Fair Values of Financial Assets and Liabilities

     As discussed in “Note 2. Basis of Presentation”, effective January 1, 2008, EAC adopted SFAS 157, which, among other things, requires enhanced disclosures about assets and liabilities carried at fair value.

     As defined in SFAS 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). EAC utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. EAC primarily applies the market and income approaches for recurring fair value measurements and utilizes the best available information. Accordingly, EAC utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. EAC has reviewed its recurring transactions and found that its markets and instruments are fairly liquid and

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

has established that EAC is able to transact at the mid-point of the bid/ask spread. EAC is able to classify fair value balances based on the observability of those inputs.

     SFAS 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy defined by SFAS 157 are as follows:

	•		Level 1 — Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
	•		Level 2 — Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.
	•		Level 3 — Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value. EAC performs an analysis of all instruments subject to SFAS 157 and includes in Level 3 all of those whose fair value is based on significant unobservable inputs.

     The carrying values of Cash and cash equivalents, Accounts receivable, net, Long-term receivables, outstanding borrowings under revolving credit facilities (included in Long-term debt), Accounts payable, and Accrued liabilities included in the accompanying Consolidated Balance Sheets approximated fair value at March 31, 2008. These assets and liabilities are not presented in the following tables.

     The following table sets forth by level within the fair value hierarchy EAC’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2008. As required by SFAS 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. EAC’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.

						Fair Value Measurements at Reporting Date Using
						Quoted Prices
						in Active				Significant
						Markets for				Other				Significant
						Identical				Observable				Unobservable
						Assets				Inputs				Inputs
Description		March 31, 2008				(Level 1)				(Level 2)				(Level 3)
		(in thousands)
Oil derivative contracts — swaps		$	(30,444	)		$	—			$	(30,444	)		$	—
Oil derivative contracts — floors and caps			15,685				—				—				15,685
Natural gas derivative contracts — swaps			(5,279	)			—				(5,279	)			—
Natural gas derivative contracts — floors and caps			(3,740	)			—				—				(3,740	)
Interest rate swaps			(1,186	)			—				(1,186	)			—
Total		$	(24,964	)		$	—			$	(36,909	)		$	11,945

     The following table provides a reconciliation of the fair value of EAC’s financial assets and liabilities that were accounted for at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2008:

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

		Fair Value Measurements Using Significant
		Unobservable Inputs (Level 3)
						Natural Gas
		Oil Derivative				Derivative
		Contracts —				Contracts —
		Floors and Caps				Floors and Caps				Total
		(in thousands)
Balance at January 1, 2008		$	16,647			$	7,081			$	23,728
Total gains (losses):
Included in earnings			(2,158	)			(11,491	)			(13,649	)
Purchases, issuances, and settlements			1,196				670				1,866
Balance at March 31, 2008		$	15,685			$	(3,740	)		$	11,945
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date		$	(2,158	)		$	(11,491	)		$	(13,649	)

     EAC does not use hedge accounting for its commodity derivative contracts, therefore, all gains and losses on its Level 3 financial assets and liabilities are included in “Derivative fair value loss” on the accompanying Consolidated Statements of Operations.

     The following methods and assumptions were used to estimate the fair values of the financial assets and liabilities in the above tables that are accounted for at fair value on a recurring basis. As per the requirements under SFAS 157, all fair values reflected in the table above and on the accompanying Consolidated Balance Sheet have been adjusted for non-performance risk. The adjustment to fair value related to non-performance risk as of March 31, 2008 was a reduction of the net liability value of approximately $0.3 million.

     Level 1 Fair Value Measurements

     As of March 31, 2008, EAC did not have any assets or liabilities measured under the Level 1 fair value hierarchy.

     Level 2 Fair Value Measurements

     Oil and natural gas derivative contracts — swaps. The fair values of the oil and natural gas derivative contracts were estimated using a combined income and market-based valuation methodology based upon forward commodity prices. Forward curves were obtained from independent pricing services reflecting broker market quotes.

     Interest rate swaps. The fair values of the interest rate swaps were estimated using a combined income and market-based valuation methodology based upon forward interest rate yield curves and credit. The curves were obtained from independent pricing services reflecting broker market quotes.

     Level 3 Fair Value Measurements

     Oil and natural gas derivative contracts — floors and caps. The fair values of the oil and natural gas derivative contracts were estimated using pricing models and discounted cash flow methodologies based on inputs that are not readily available in public markets and, accordingly, these floors and caps have been categorized as Level 3 within the valuation hierarchy.

Note 8. Asset Retirement Obligations

     EAC’s asset retirement obligations relate to future plugging and abandonment expenses on oil and natural gas properties and related facilities disposal. As of March 31, 2008 and December 31, 2007, EAC had $7.5 million and $6.7 million, respectively, held in escrow from which funds are released only for reimbursement of plugging and abandonment expenses on its Bell Creek property, which is included in other long-term assets in the accompanying Consolidated Balance Sheets. The following table summarizes the changes in asset retirement obligations for the three months ended March 31, 2008 (in thousands):

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

Future abandonment liability at January 1, 2008		$	28,079
Wells drilled			45
Acquisition of properties			13
Accretion of discount			343
Plugging and abandonment costs incurred			(335	)
Revision of previous estimates			1,558
Future abandonment liability at March 31, 2008		$	29,703

     As of March 31, 2008, $28.9 million of EAC’s asset retirement obligations is long-term and recorded in “Future abandonment cost, net of current portion” and $0.8 million is current and included in “Other current liabilities” on the accompanying Consolidated Balance Sheets.

Note 9. Long-Term Debt

     EAC’s long-term debt consisted of the following as of the dates indicated:

		March 31,				December 31,
		2008				2007
		(in thousands)
Revolving credit facilities		$	580,000			$	526,000
6.25% Senior Subordinated Notes due April 15, 2014			150,000				150,000
6.0% Senior Subordinated Notes due July 15, 2015, net of unamortized discount of $4,322 and $4,440, respectively			295,678				295,560
7.25% Senior Subordinated Notes due December 1, 2017, net of unamortized discount of $1,301 and $1,324, respectively			148,699				148,676
Total		$	1,174,377			$	1,120,236

Revolving Credit Facilities

     Encore Acquisition Company Senior Secured Credit Agreement

     EAC is party to a five-year amended and restated credit agreement dated March 7, 2007 (as amended, the “EAC Credit Agreement”). The aggregate amount of the commitments of the lenders under the EAC Credit Agreement is $1.25 billion. Availability under the EAC Credit Agreement is subject to a borrowing base, which is redetermined semi-annually and upon requested special redeterminations. As of March 31, 2008, the borrowing base was $870 million.

     As of March 31, 2008, there were $415 million of outstanding borrowings and $435 million of borrowing capacity under the EAC Credit Agreement. As of March 31, 2008, there were $20 million of outstanding letters of credit, all of which related to EAC’s joint development agreement with ExxonMobil Corporation (“ExxonMobil”). See “Note 16. Commitments and Contingencies” for additional discussion of this agreement.

     Effective February 7, 2008, EAC amended the EAC Credit Agreement to, among other things, provide that certain negative covenants in the EAC Credit Agreement restricting hedge transactions do not apply to any oil and natural gas hedge transaction that is a floor or put transaction not requiring any future payments or delivery by EAC or any of its restricted subsidiaries.

     As of March 31, 2008, EAC was in compliance with all covenants of the EAC Credit Agreement.

     Encore Energy Partners Operating LLC Credit Agreement

     OLLC is a party to a five-year credit agreement dated March 7, 2007 (as amended, the “OLLC Credit Agreement”). The aggregate amount of the commitments of the lenders under the OLLC Credit Agreement is $300 million. Availability under the OLLC Credit Agreement is subject to a borrowing base, which is redetermined semi-annually and upon requested special redeterminations. As of March 31, 2008, the borrowing base was $240 million.

     As of March 31, 2008, there were $165 million of outstanding borrowings and $74.9 million of borrowing capacity under the OLLC Credit Agreement. As of March 31, 2008, there were $0.1 million of outstanding letters of credit.

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

     As of March 31, 2008, OLLC was in compliance with all covenants of the OLLC Credit Agreement.

Note 10. Stockholders’ Equity

     In December 2007, EAC announced that its Board of Directors (the “Board”) had approved a new share repurchase program authorizing the purchase of up to $50 million of EAC’s common stock. As of March 31, 2008, EAC had repurchased and retired 1,174,691 shares of its outstanding common stock for approximately $39.1 million, or an average price of $33.30 per share, under the share repurchase program.

Note 11. Income Taxes

     The components of EAC’s income tax benefit (provision) were as follows for the periods indicated:

		Three months ended
		March 31,
		2008				2007
		(in thousands)
Federal:
Current		$	(3,544	)		$	120
Deferred			(13,804	)			15,750
Total federal			(17,348	)			15,870
State, net of federal benefit/expense:
Current			(566	)			—
Deferred			(819	)			149
Total state			(1,385	)			149
Income tax benefit (provision)		$	(18,733	)		$	16,019

     The following table reconciles EAC’s income tax benefit (provision) with income tax at the Federal statutory rate for the periods indicated:

		Three months ended
		March 31,
		2008				2007
		(in thousands)
Income (loss) before income taxes, net of minority interest		$	49,953			$	(45,448	)
Income tax at the Federal statutory rate		$	(17,484	)		$	15,907
State income taxes, net of federal benefit/expense			(1,328	)			1,124
Change in estimated future state tax rate			—				(972	)
Nondeductible deferred compensation			(263	)			—
Permanent and other			342				(40	)
Income tax benefit (provision)		$	(18,733	)		$	16,019

     At March 31, 2008 and 2007, EAC had net operating loss (“NOL”) carryforwards related to federal and state income taxes of $14.0 million and $26.0 million, respectively, which are available to offset future regular taxable income, if any. At March 31, 2008, EAC also had alternative minimum tax (“AMT”) credits of $2.7 million, which are available to reduce future regular tax liabilities in excess of AMT. EAC believes it is more likely than not that these NOL carryforwards will offset future taxable income prior to their expiration. The AMT credits have no expiration. Therefore, a valuation allowance against these deferred tax assets is not considered necessary.

     EAC has no tax positions that do not meet the “highly certain positions” threshold prescribed by FIN No. 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109”. As a result, no additional tax expense, interest, or penalties have been accrued. EAC includes interest assessed by taxing authorities in “Interest expense” and penalties

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

related to income taxes in “Other expense” on its Consolidated Statements of Operations. For the three months ended March 31, 2008 and 2007, EAC recorded only a nominal amount of interest and penalties on certain tax positions.

Note 12. Earnings Per Share (“EPS”)

     The following table reflects EAC’s EPS computations for the periods indicated:

		Three months ended
		March 31,
		2008 (b)				2007
		(in thousands, except per share data)
Numerator:
Net income (loss)		$	31,220			$	(29,429	)
Denominator:
Denominator for basic EPS:
Weighted average shares outstanding			52,799				53,077
Effect of dilutive options and restricted stock (a)			1,070				—
Denominator for diluted EPS			53,869				53,077
Net income (loss) per common share:
Basic		$	0.59			$	(0.55	)
Diluted		$	0.58			$	(0.55	)

Note 13. Incentive Stock Plans

     During 2000, the Board and stockholders approved the 2000 Incentive Stock Plan (the “EAC Plan”). The EAC Plan was amended and restated effective March 18, 2004. The purpose of the EAC Plan is to attract, motivate, and retain selected employees of EAC and to provide EAC with the ability to provide incentives more directly linked to the profitability of the business and increases in shareholder value. All directors and full-time regular employees of EAC and its subsidiaries and affiliates are eligible to be granted awards under the EAC Plan. The total number of shares of common stock reserved for issuance pursuant to the EAC Plan is 4,500,000. As of March 31, 2008, there were 454,721 shares available for issuance under the EAC Plan. Shares delivered or withheld for payment of the exercise price of an option, shares withheld for payment of tax withholding, shares subject to options or other awards that expire or are forfeited, and restricted shares that are forfeited will again become available for issuance under the EAC Plan. The EAC Plan provides for the granting of cash awards, incentive stock options, non-qualified stock options, restricted stock, and stock appreciation rights at the discretion of the Compensation Committee of the Board. The Board also has a Restricted Stock Award Committee whose sole member is Jon S. Brumley, EAC’s Chief Executive Officer and President. The Restricted Stock Award Committee may grant up to 25,000 shares of restricted stock on an annual basis to non-executive employees at its discretion.

     The EAC Plan contains the following individual limits:

	•		an employee may not be granted awards covering or relating to more than 225,000 shares of common stock in any calendar year;
	•		a non-employee director may not be granted awards covering or relating to more than 15,000 shares of common stock in any calendar year; and
	•		an employee may not receive awards consisting of cash (including cash awards that are granted as performance awards) in respect of any calendar year having a value determined on the grant date in excess of $1.0 million.

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

     All options granted under the EAC Plan have a strike price equal to the fair market value of EAC’s common stock on the grant date. Additionally, all options have a ten-year life and vest over a three-year period. Restricted stock granted under the EAC Plan vests over varying periods from one to five years, subject to performance-based vesting for certain members of senior management.

     The non-cash stock-based compensation expense related to the EAC Plan recorded in the accompanying Consolidated Statements of Operations for the three months ended March 31, 2008 and 2007 was $1.8 million and $3.1 million, respectively. The income tax benefit of the non-cash stock-based compensation cost related to the EAC Plan recorded in the accompanying Consolidated Statements of Operations for the three months ended March 31, 2008 and 2007 was $0.7 million and $1.1 million, respectively. During the three months ended March 31, 2008 and 2007, EAC also capitalized $0.4 million and $0.3 million, respectively, of non-cash stock-based compensation cost as a component of “Properties and equipment” in the accompanying Consolidated Balance Sheets. Non-cash stock-based compensation expense has been allocated to LOE and general and administrative (“G&A”) expense based on the allocation of the respective employees’ cash compensation.

     See “Note 18. ENP” for a discussion of ENP’s unit-based compensation plan.

Stock Options

     The fair value of options granted during the three months ended March 31, 2008 and 2007 was estimated on the grant date using a Black-Scholes option valuation model based on the assumptions noted in the following table. The expected volatility is based on the historical volatility of EAC’s common stock for a period of time commensurate with the expected term of the options. For options granted prior to January 1, 2008, EAC used the “simplified” method prescribed by SAB No. 107, “Valuation of Share-Based Payment Arrangements for Public Companies” to estimate the expected term of the options, which is calculated as the average midpoint between each vesting date and the life of the option. For options granted subsequent to December 31, 2007, EAC determined the expected life of the options based on an analysis of historical exercise and forfeiture behavior as well as expectations about future behavior. The risk-free interest rate is based on the U.S Treasury yield curve in effect at the grant date for a period of time commensurate with the expected term of the options.

		Three months ended March 31,
		2008				2007
Expected volatility			33.7	%			35.7	%
Expected dividend yield			0.0	%			0.0	%
Expected term (in years)			6.25				6.00
Risk-free interest rate			3.0	%			4.8	%

     The following table summarizes the changes in the number of EAC’s outstanding options and the related weighted average strike prices during the three months ended March 31, 2008:

										Weighted
						Weighted				Average				Aggregate
		Number of				Average				Remaining				Intrinsic
		Options				Strike Price				Contractual Term				Value
														(in thousands)
Outstanding at January 1, 2008			1,381,782			$	16.03
Granted			176,170				33.76
Forfeited or expired			(11,264	)			30.61
Exercised			(12,857	)			22.35
Outstanding at March 31, 2008			1,533,831				17.90				5.8			$	34,322
Exercisable at March 31, 2008			1,209,774				14.54				4.9				31,134

     The weighted average fair value per share of options granted during the three months ended March 31, 2008 and 2007 was $13.15 and $11.16, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2008 and 2007 was $0.2 million and $0.3 million, respectively. During the three months ended March 31, 2008 and 2007, EAC received proceeds from the exercise of stock options of $0.3 million and $0.4 million, respectively, and realized tax benefits related to stock options of $0.7 million and $0.2 million, respectively. At March 31, 2008, EAC had $2.4 million of total

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

unrecognized compensation cost related to unvested stock options, which is expected to be recognized over a weighted average period of 2.5 years.

Restricted Stock

     During the three months ended March 31, 2008 and 2007, EAC recognized expense related to restricted stock of $1.5 million and $2.6 million, respectively, and realized tax benefits related to restricted stock of $0.5 million and $1.0 million, respectively. The following table summarizes the changes in the number of EAC’s unvested restricted stock awards and their related weighted average grant date fair value for the three months ended March 31, 2008:

						Weighted
						Average
		Number of				Grant Date
		Shares				Fair Value
Outstanding at January 1, 2008			918,338			$	27.07
Granted			266,042				33.76
Vested			(212,586	)			26.32
Forfeited			(26,161	)			28.89
Outstanding at March 31, 2008			945,633				29.07