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 September 30, 2007

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 incorporation or organization)		(I.R.S. Employer 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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ           Accelerated filer o           Non-accelerated filer o

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 October 31, 2007			54,238,182

 

 

ENCORE ACQUISITION COMPANY

INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006			1
Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006			2
Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2007			3
Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006			4
Notes to Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			26
Item 3. Quantitative and Qualitative Disclosures About Market Risk			41
Item 4. Controls and Procedures			41
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			42
Item 1A. Risk Factors			42
Item 6. Exhibits			42
Signature			43
Rule 13a-14(a)/15d-14(a) Certification (Principal Executive Officer)
Rule 13a-14(a)/15d-14(a) Certification (Principal Financial Officer)
Section 1350 Certification (Principal Executive Officer)
Section 1350 Certification (Principal Financial Officer)
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 Securities and Exchange Commission (“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. You can identify our forward-looking statements 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. 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 for the year ended December 31, 2006 and in our other filings with the SEC. If one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated. You should not place undue reliance on forward-looking statements. Each forward-looking statement speaks only as of the date of the particular statement. 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 OF CERTAIN TERMS

     The following are abbreviations and definitions of certain terms used in this Report. The definitions of proved developed reserves and proved reserves have been abbreviated from the applicable definitions contained in Rule 4-10(a)(2-3) 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.
	•		Council of Petroleum Accountants Societies, or 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.
	•		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.
	•		Gross Wells. The total number of wells in which we own a working interest.
	•		High-Pressure Air Injection (“HPAI”). HPAI involves utilizing compressors to force air under high pressure into previously produced oil and natural gas formations in order to displace remaining resident hydrocarbons and force them under pressure to a common lifting point for production.
	•		LIBOR. London Interbank Offered Rate.
	•		MBbls. One thousand Bbls.
	•		MBOE. One thousand BOE.
	•		Mcf. One thousand cubic feet of natural gas.
	•		Mcf/D. One Mcf per day.
	•		Net Wells. Gross wells multiplied by the percentage of the working interest owned by us.
	•		NGLs. Natural gas liquids.
	•		NYMEX. New York Mercantile Exchange.
	•		Proved Developed Reserves. Reserves that can be expected to be recovered through 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 conditions.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ENCORE ACQUISITION COMPANY

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

		September 30,				December 31,
		2007				2006
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	8,467			$	763
Accounts receivable			105,871				81,470
Inventory			19,149				18,170
Derivatives			13,533				17,349
Deferred taxes			18,851				24,978
Prepaid expenses and other			6,769				2,988
Total current assets			172,640				145,718
Properties and equipment, at cost — successful efforts method:
Proved properties, including wells and related equipment			2,740,805				2,033,914
Unproved properties			56,427				47,548
Accumulated depletion, depreciation, and amortization			(442,393	)			(364,780	)
			2,354,839				1,716,682
Other property and equipment			20,539				18,231
Accumulated depreciation			(10,041	)			(7,791	)
			10,498				10,440
Goodwill			60,606				60,606
Derivatives			25,020				40,715
Long-term receivables			47,031				19,642
Other			29,166				13,097
Total assets		$	2,699,800			$	2,006,900
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	32,913			$	18,204
Accrued liabilities:
Lease operations expense			12,265				8,582
Development capital			34,911				44,492
Interest			13,365				11,273
Production, ad valorem, and severance taxes			23,434				10,915
Oil purchases			705				11,191
Derivatives			44,002				60,448
Other			23,980				21,358
Total current liabilities			185,575				186,463
Derivatives			27,915				38,688
Future abandonment cost			28,177				19,205
Deferred taxes			294,971				282,825
Long-term debt			1,139,099				661,696
Other			1,326				1,158
Total liabilities			1,677,063				1,190,035
Commitments and contingencies (see Note 14)
Minority interest in consolidated partnership			181,412				—
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, 53,217,560 and 53,028,866 issued and outstanding, respectively			533				531
Additional paid-in capital			458,989				457,201
Treasury stock, at cost, none and 17,809 shares, respectively			—				(457	)
Retained earnings			391,980				394,917
Accumulated other comprehensive loss			(10,177	)			(35,327	)
Total stockholders’ equity			841,325				816,865
Total liabilities and stockholders’ equity		$	2,699,800			$	2,006,900

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								Nine months ended
		September 30,								September 30,
		2007				2006				2007				2006
Revenues:
Oil		$	159,295			$	99,516			$	377,514			$	268,066
Natural gas			32,439				32,177				110,548				109,050
Marketing			3,282				46,004				27,139				106,036
Total revenues			195,016				177,697				515,201				483,152
Expenses:
Production:
Lease operations			37,114				24,478				105,186				70,332
Production, ad valorem, and severance taxes			20,003				13,560				51,750				38,382
Depletion, depreciation, and amortization			49,026				27,471				136,372				82,479
Exploration			8,920				12,322				23,856				18,347
General and administrative			12,668				6,250				26,216				18,199
Marketing			4,089				48,001				27,607				105,661
Derivative fair value loss (gain)			15,786				(33,363	)			68,166				(20,263	)
Other operating			6,351				976				13,667				3,573
Total expenses			153,957				99,695				452,820				316,710
Operating income			41,059				78,002				62,381				166,442
Other income (expenses):
Interest			(23,933	)			(11,261	)			(68,040	)			(33,766	)
Other			857				463				1,889				1,012
Total other income (expenses)			(23,076	)			(10,798	)			(66,151	)			(32,754	)
Income (loss) before income taxes and minority interest			17,983				67,204				(3,770	)			133,688
Income tax provision			(8,986	)			(25,069	)			(1,490	)			(51,382	)
Minority interest in loss of consolidated partnership			2,988				—				2,988				—
Net income (loss)		$	11,985			$	42,135			$	(2,272	)		$	82,306
Net income (loss) per common share:
Basic		$	0.23			$	0.80			$	(0.04	)		$	1.60
Diluted		$	0.22			$	0.78			$	(0.04	)		$	1.57
Weighted average common shares outstanding:
Basic			53,198				52,968				53,140				51,481
Diluted			54,179				53,776				53,140				52,375

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, 2006			53,047			$	531			$	457,201				(18	)		$	(457	)		$	394,917			$	(35,327	)		$	816,865
Exercise of stock options and vesting of restricted stock			210				2				1,597				—				—				—				—				1,599
Purchase of treasury stock			—				—				—				(21	)			(546	)			—				—				(546	)
Cancellation of treasury stock			(39	)			—				(338	)			39				1,003				(665	)			—				—
Non-cash stock-based compensation			—				—				11,513				—				—				—				—				11,513
EAC’s share of ENP’s offering costs			—				—				(10,984	)			—				—				—				—				(10,984	)
Components of comprehensive income:
Net loss			—				—				—				—				—				(2,272	)			—				(2,272	)
Amortization of deferred hedge losses, net of tax of $15,041			—				—				—				—				—				—				25,150				25,150
Total comprehensive income																															22,878
Balance at September 30, 2007			53,218			$	533			$	458,989				—			$	—			$	391,980			$	(10,177	)		$	841,325

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

ENCORE ACQUISITION COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited

		Nine months ended
		September 30,
		2007				2006
Cash flows from operating activities:
Net income (loss)		$	(2,272	)		$	82,306
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depletion, depreciation, and amortization			136,372				82,479
Non-cash exploration expense			22,511				12,542
Deferred taxes			1,374				48,673
Non-cash stock-based compensation expense			12,790				6,797
Non-cash derivative			87,108				(13,013	)
Loss on disposition of assets			5,918				395
Minority interest in loss of consolidated partnership			(2,988	)			—
Other			6,055				5,644
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable			(31,064	)			11,579
Current derivatives			(15,303	)			(1,221	)
Other current assets			(1,858	)			(3,472	)
Long-term derivatives			(22,301	)			(29,097	)
Other assets			(4,428	)			(4	)
Accounts payable			4,416				(2,047	)
Other current liabilities			17,810				19,188
Other noncurrent liabilities			(496	)			13,633
Net cash provided by operating activities			213,644				234,382
Cash flows from investing activities:
Proceeds from disposition of assets			291,339				666
Purchases of other property and equipment			(2,443	)			(3,450	)
Acquisition of oil and natural gas properties			(839,945	)			(22,809	)
Development of oil and natural gas properties			(259,457	)			(241,502	)
Net advances to working interest partners			(22,644	)			(8,667	)
Other			—				(1,509	)
Net cash used in investing activities			(833,150	)			(277,271	)
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance costs			—				127,101
Proceeds from issuance of ENP common units, net of issuance costs			171,220				—
Exercise of stock options and vesting of restricted stock, net of treasury stock purchases			1,053				3,151
Proceeds from long-term debt, net of issuance costs			1,269,291				164,853
Payments on long-term debt			(805,428	)			(245,000	)
Change in cash overdrafts			10,293				(8,331	)
Payment of deferred hedge premiums			(19,219	)			—
Net cash provided by financing activities			627,210				41,774
Increase (decrease) in cash and cash equivalents			7,704				(1,115	)
Cash and cash equivalents, beginning of period			763				1,654
Cash and cash equivalents, end of period		$	8,467			$	539

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

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1. About Encore

     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, the East Texas Basin, and the Barnett Shale of northern Texas.

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”) of 9,000,000 common units, representing a 37.4 percent limited partner interest, at a price to the public of $21.00 per unit. On September 30, 2007, EAC owned approximately 61 percent of ENP’s common units, as well as all of the interests of ENP’s general partner, which is a wholly owned subsidiary of EAC. Considering the presumption of control of the general partner 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 within EAC’s operations. EAC elected not to recognize a gain on ENP’s IPO as permitted by Staff Accounting Bulletin Topic 5H, “Accounting for Sales of Stock by a Subsidiary”. See “Note 16. ENP” for additional discussion.

     In the opinion of management, the accompanying unaudited consolidated financial statements of EAC include all adjustments necessary to present fairly, in all material respects, its financial position as of September 30, 2007, results of operations for the three and nine months ended September 30, 2007 and 2006, and cash flows for the nine months ended September 30, 2007 and 2006. 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 2006 Annual Report on Form 10-K.

Variable Interest Entity

     On April 11, 2007, EAC completed the purchase of certain oil and natural gas properties and related assets in the Williston Basin of Montana and North Dakota from certain subsidiaries of Anadarko Petroleum Corporation (“Anadarko”). Prior to closing, EAC assigned all of its rights and duties under the purchase and sale agreement to Encore Operating, L.P., a Texas limited partnership and indirect wholly owned guarantor subsidiary of EAC (“Encore Operating”), which further assigned all of its rights and duties under the purchase and sale agreement to Encore Exchange, LLC, a Delaware limited liability company unaffiliated with EAC or Encore Operating (“Encore Exchange”).

     The Williston Basin acquisition was structured to qualify as the first step of 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. The Williston Basin assets were acquired by Encore Exchange as an “exchange accommodation titleholder”. Encore Exchange held the assets pursuant to a qualified exchange accommodation agreement until the second step of the like-kind exchange was completed. During the period the assets were held by Encore Exchange, Encore Operating operated the Williston Basin assets pursuant to a management agreement with Encore Exchange. The second step of the like-kind exchange was completed in July 2007 upon the completion of the disposition of certain of EAC’s Mid-Continent properties and the Williston Basin assets were transferred to EAC. See “Note 3. Acquisitions and Dispositions” for additional discussion of the Mid-Continent disposition.

     In connection with the like-kind exchange described above, EAC (through Encore Operating) loaned an amount equal to the

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

purchase price to Encore Exchange. Based on the provisions of Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 46(R), “Consolidation of Variable Interest Entities”, EAC determined that Encore Exchange was a variable interest entity for which EAC was the primary beneficiary. During the third quarter of 2007, the like-kind exchange was completed, and Encore Exchange was dissolved.

Minority Interest

     As presented in the accompanying Consolidated Balance Sheets, “Minority interest in consolidated partnership” as of September 30, 2007 of $181.4 million represents third-party ownership interests in ENP. For financial reporting purposes, the assets and liabilities of ENP are consolidated with those of EAC, with any third-party ownership interests in such amounts being presented as minority interest.

     As presented in the accompanying Consolidated Statements of Operations, “Minority interest in loss of consolidated partnership” for the three and nine months ended September 30, 2007 of $3.0 million represents the net loss 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 Cash Flows have been either combined or classified in more detail.

New Accounting Pronouncements

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

     In September 2006, the 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 expand the use of fair value measurements. SFAS 157 is prospectively effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. EAC does not expect the adoption of SFAS 157 to have a material impact on its results of operations or financial condition.

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 to measure eligible items at fair value at specified election dates, with resulting changes in fair value reported in earnings. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. EAC does not expect the adoption of SFAS 159 to have a material impact on its results of operations or financial condition.

FASB Staff Position (“FSP”) on FIN 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 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. EAC does not expect the adoption of FSP FIN 39-1 to have a material impact on its 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 to acquire oil

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

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 total purchase price for the Williston Basin assets was approximately $392.0 million, including estimated transaction costs of approximately $1.3 million. Based on currently available information, the calculation of the total purchase price and the estimated allocation to the fair value of the Williston Basin assets acquired and liabilities assumed from Anadarko are as follows as of September 30, 2007 (in thousands):

Calculation of total purchase price:
Cash paid to Anadarko		$	390,728
Estimated transaction costs			1,298
Total purchase price		$	392,026
Allocation of purchase price to the fair value of net assets acquired:
Proved properties, including wells and related equipment		$	383,741
Unproved properties			16,134
Accounts receivable			2,910
Inventory			743
Total assets acquired			403,528
Current liabilities			(7,996	)
Future abandonment cost			(3,506	)
Total liabilities assumed			(11,502	)
Fair value of net assets acquired		$	392,026

     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. 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.

     The total purchase price for the Big Horn Basin assets was approximately $393.2 million, including estimated transaction costs of approximately $1.3 million. The calculation of the total purchase price and the estimated allocation to the fair value of the Big Horn Basin assets acquired and liabilities assumed from Anadarko are as follows as of September 30, 2007 (in thousands):

Calculation of total purchase price:
Cash paid to Anadarko		$	391,943
Estimated transaction costs			1,288
Total purchase price		$	393,231
Allocation of purchase price to the fair value of net assets acquired:
Proved properties, including wells and related equipment		$	395,598
Intangibles			4,225
Accounts receivable			1,673
Total assets acquired			401,496
Current liabilities			(1,292	)
Future abandonment cost			(6,973	)
Total liabilities assumed			(8,265	)
Fair value of net assets acquired		$	393,231

     The properties and equipment amount in the Big Horn Basin purchase price allocation includes the fair value of proved leasehold costs, lease and well equipment (including flue gas reinjection facilities used to maintain reservoir pressure by

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

compressing and reinjecting the gas produced), and an oil pipeline and natural gas pipeline 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 these hydrocarbon liquids 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 and ENP financed the acquisitions of the Big Horn Basin and Williston Basin assets through borrowings under revolving credit facilities. As of December 31, 2006, estimated total proved reserves associated with the Big Horn Basin and Williston Basin acquisitions were 38,934 MBOE, 92 percent of which were oil and 90 percent of which were proved developed.

     See “Note 8. Debt” for additional discussion of EAC’s and ENP’s revolving credit facilities. See “Note 13. 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. In July 2007, additional Mid-Continent properties that were subject to preferential rights were sold. The total net proceeds were approximately $289.7 million, including estimated transactions costs of approximately $3.5 million, and EAC recorded a loss on sale of approximately $5.8 million, which is included in “Other operating expense” in the accompanying Consolidated Statements of Operations. The disposed properties included certain properties in the Anadarko and Arkoma fields of Oklahoma. EAC retained a material oil and natural gas interest in other properties in the Anadarko and Arkoma fields and remains active in those areas.

     Proceeds from the Mid-Continent disposition were used to reduce outstanding borrowings under EAC’s revolving credit facility. As of December 31, 2006, estimated total proved reserves associated with the Mid-Continent disposition were 17,416 MBOE, 92 percent of which were natural gas and 75 percent of which were proved developed.

Pro Forma

     The following unaudited pro forma condensed financial data for the three and nine months ended September 30, 2007 and 2006 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, 2006. 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 acquisitions and the Mid-Continent disposition taken place as of the dates indicated and are not intended to be a projection of future results.

		Three months ended								Nine months ended
		September 30,								September 30,
		2007				2006				2007				2006
		(in thousands, except per share amounts)
Pro forma total revenues		$	195,016			$	219,653			$	522,778			$	595,728
Pro forma net income		$	14,171			$	46,257			$	4,879			$	86,590
Pro forma net income per common share:
Basic		$	0.27			$	0.87			$	0.09			$	1.68
Diluted		$	0.26			$	0.86			$	0.09			$	1.65

Note 4. Inventory

     Inventory is comprised principally 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:

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

		September 30,				December 31,
		2007				2006
		(in thousands)
Materials and supplies		$	13,018			$	11,784
Oil in pipelines			6,131				6,386
Total inventory		$	19,149			$	18,170

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:

		September 30,				December 31,
		2007				2006
		(in thousands)
Proved leasehold costs		$	1,325,112			$	796,932
Wells and related equipment — Completed			1,373,207				1,200,938
Wells and related equipment — In process			42,486				36,044
Total proved properties		$	2,740,805			$	2,033,914

Note 6. Derivative Financial Instruments

     EAC had $48.6 million of deferred premiums payable recorded at September 30, 2007, of which $21.7 million is considered long-term and recorded in “Derivatives” in the non-current liabilities section of the accompanying Consolidated Balance Sheet and $26.9 million is considered current and recorded 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 October 2007 to January 2010. EAC recorded these amounts at their net present value at the time the contract was entered into and accretes that value up to the eventual settlement price by recording interest expense each period.

Commodity Contracts — Mark-to-Market Accounting: Previously designated as hedges

     Prior to July 2006, EAC used hedge accounting for certain of its derivative contracts, whereby the effective portion of changes in the fair value of the contract was deferred, until the hedged production occurred, in accumulated other comprehensive loss (“AOCL”) included in stockholders’ equity in the accompanying Consolidated Balance Sheets rather than recognized currently in earnings. In the third quarter of 2006, EAC elected to discontinue hedge accounting prospectively for all remaining commodity derivatives which were previously accounted for as hedges. While this change has no effect on cash flows, results of operations are affected by mark-to-market gains and losses, which fluctuate with the changes in oil and natural gas prices. The deferred loss in AOCL at the time of dedesignation is being amortized to oil and natural gas revenues over the original term of the contracts. The amortization of these amounts is included in oil and natural gas revenues with the revenues from the hedged production. All mark-to-market gains and losses from July 2006 forward are recognized in earnings through “Derivative fair value loss (gain)” in the accompanying Consolidated Statements of Operations rather than deferring such amounts in AOCL.

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

     The following tables summarize EAC’s open commodity derivative instruments as of September 30, 2007:

Oil Derivative Instruments

																																						Asset
		Daily				Average					Daily				Average					Daily				Average					Daily				Average					(Liability)
		Floor				Floor					Short Floor				Short Floor					Cap				Cap					Swap				Swap					Fair Market
Period		Volume				Price					Volume				Price					Volume				Price					Volume				Price					Value
		(Bbl)				(per Bbl)					(Bbl)				(per Bbl)					(Bbl)				(per Bbl)					(Bbl)				(per Bbl)					(in thousands)
Oct. — Dec. 2007			14,500			$	56.72					—			$	—					—			$	—					3,000			$	36.75				$	(11,847	)
Jan. — June 2008			18,500				62.84					(4,000	)			50.00					—				—					1,000				58.59					256
July — Dec. 2008			14,500				63.62					(4,000	)			50.00					—				—					—				—					6,395
Jan. — Dec. 2009			8,750				67.63					(5,000	)			50.00					—				—					1,000				68.70					11,381
Jan. — Dec. 2010			2,000				65.00					—				—					1,000				77.23					—				—					1,496
																																						$	7,681

Natural Gas Derivative Instruments

		Daily				Average					Daily				Average					Daily				Average					Daily				Average					Asset
		Floor				Floor					Short Floor				Short Floor					Cap				Cap					Swap				Swap					Fair Market
Period		Volume				Price					Volume				Price					Volume				Price					Volume				Price					Value
		(Mcf)				(per Mcf)					(Mcf)				(per Mcf)					(Mcf)				(per Mcf)					(Mcf)				(per Mcf)					(in thousands)
Oct. — Dec. 2007			36,500			$	6.85					—			$	—					2,000			$	9.85					10,000			$	4.99				$	1,562
Jan. — Dec. 2008			24,000				6.58					—				—					2,000				9.85					—				—					5,019
Jan. — Dec. 2009			4,000				7.70					—				—					2,000				9.85					—				—					992
																																						$	7,573

Commodity Contracts — Mark-to-Market Accounting: Floor Spreads

     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. EAC has entered into floor spreads with a $70 per Bbl purchased floor and a $50 per Bbl short floor for 4,000 Bbls/D in 2008 and 5,000 Bbls/D in 2009. As with EAC’s other derivative contracts, these are marked-to-market each quarter through “Derivative fair value loss (gain)” in the accompanying Consolidated Statements of Operations. In the above table, the purchased floor component of these floor spreads has been included with EAC’s other floor contracts and the short floor component is shown separately as negative volumes.

Commodity Contracts — Current Period Impact

     EAC recognized a pre-tax reduction in oil and natural gas revenues of approximately $13.4 million and $14.4 million during the three months ended September 30, 2007 and 2006, respectively, and $40.2 million and $45.7 million during the nine months ended September 30, 2007 and 2006, respectively, related to commodity derivative contracts which were previously designated as hedges. EAC also recognized derivative fair value gains and losses related to (i) changes in the market value since the date of dedesignation of derivative contracts which were previously designated as hedges, (ii) changes in the market value of certain other commodity derivatives that were never designated as hedges, (iii) settlements on derivative contracts not designated as hedges, and (iv) ineffectiveness of derivative contracts designated as hedges prior to July 2006. The following table summarizes the components of derivative fair value loss (gain) for the three and nine months ended September 30, 2007 and 2006:

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

		Three months ended								Nine months ended
		September 30,								September 30,
		2007				2006				2007				2006
						(in thousands)
Ineffectiveness on designated cash flow hedges		$	—			$	—			$	—			$	1,748
Mark-to-market loss (gain) on commodity contracts			9,686				(37,729	)			56,122				(30,639	)
Premium amortization			10,462				3,449				28,151				9,820
Settlements on commodity contracts			(4,362	)			917				(16,107	)			(1,192	)
Total derivative fair value loss (gain)		$	15,786			$	(33,363	)		$	68,166			$	(20,263	)

Commodity Contracts — Future Period Impact

     At September 30, 2007 and December 31, 2006, AOCL consisted entirely of deferred losses on commodity derivatives which were previously designated as hedges of $10.2 million and $35.3 million, respectively.

     EAC expects to reclassify the remaining $16.3 million of deferred losses associated with its dedesignated commodity contracts from AOCL to oil and natural gas revenues by June 30, 2008. EAC also expects to reclassify the remaining $6.1 million of net deferred tax assets from AOCL to income tax benefit by June 30, 2008.

Note 7. Asset Retirement Obligations

     EAC’s primary asset retirement obligations relate to future plugging and abandonment expenses on oil and natural gas properties and related facilities disposal. EAC does not include a market risk premium in its risk estimates because a reliable estimate cannot be determined. As of September 30, 2007, EAC had $6.0 million held in an escrow account from which funds are released only for reimbursement of plugging and abandonment expenses on its Bell Creek property. This amount is included in “Other assets” in the accompanying Consolidated Balance Sheets. The following table summarizes the changes in EAC’s future abandonment liability, the long-term portion of which is recorded in “Future abandonment cost” on the accompanying Consolidated Balance Sheets, for the nine months ended September 30, 2007 (in thousands):

Future abandonment liability at January 1, 2007		$	19,841
Wells drilled			89
Accretion of discount			867
Plugging and abandonment costs incurred			(497	)
Revision of estimates			(604	)
Disposition of properties			(959	)
Acquisition of properties			10,745
Future abandonment liability at September 30, 2007		$	29,482

Note 8. Debt

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

		September 30,				December 31,
		2007				2006
		(in thousands)
Revolving credit facilities		$	545,000			$	68,000
6 1/4% Senior Subordinated Notes due due April 15, 2014			150,000				150,000
6% Senior Subordinated Notes due July 15, 2015, net of unamortized discount of $4,555 and $4,892, respectively			295,445				295,108
7 1/4% Senior Subordinated Notes due December 1, 2017, net of unamortized discount of $1,346 and $1,412, respectively			148,654				148,588
Total		$	1,139,099			$	661,696

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

Revolving Credit Facilities

     Encore Acquisition Company Senior Secured Credit Agreement

     On March 7, 2007, EAC entered into a five-year amended and restated credit agreement (the “EAC Credit Agreement”) with a bank syndicate comprised of Bank of America, N.A. and other lenders, which amended and restated EAC’s Amended and Restated Credit Agreement dated as of August 19, 2004.

     The EAC Credit Agreement provides for revolving credit loans to be made to EAC from time to time and letters of credit to be issued from time to time for the account of EAC or any of its restricted subsidiaries. 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. Upon the contribution of certain assets in the Permian Basin to ENP at the closing of its IPO in September 2007, the borrowing base was reduced to $870 million. See “Note 16. ENP” for additional discussion.

     The EAC Credit Agreement matures on March 7, 2012. EAC’s obligations under the EAC Credit Agreement are secured by a first-priority security interest in EAC’s and its restricted subsidiaries’ proved oil and natural gas reserves and in the equity interests of EAC’s restricted subsidiaries. In addition, EAC’s obligations under the EAC Credit Agreement are guaranteed by its restricted subsidiaries.

     Loans under the EAC Credit Agreement are subject to varying rates of interest based on (i) the total amount outstanding in relation to the borrowing base and (ii) whether the loan is a Eurodollar loan or a base rate loan. Eurodollar loans bear interest at the Eurodollar rate plus the applicable margin indicated in the following table, and base rate loans bear interest at the base rate plus the applicable margin indicated in the following table:

		Applicable Margin for				Applicable Margin for
Ratio of Total Outstanding Borrowings to Borrowing Base		Eurodollar Loans				Base Rate Loans
Less than .50 to 1			1.000	%			0.000	%
Greater than or equal to .50 to 1 but less than .75 to 1			1.250	%			0.000	%
Greater than or equal to .75 to 1 but less than .90 to 1			1.500	%			0.250	%
Greater than or equal to .90 to 1			1.750	%			0.500	%

     The “Eurodollar rate” for any interest period (either one, two, three, or six months, as selected by EAC) is the rate per year equal to LIBOR, as published by Reuters or another source designated by Bank of America, N.A., for deposits in dollars for a similar interest period. The “base rate” is calculated as the higher of (i) the annual rate of interest announced by Bank of America, N.A. as its “prime rate” and (ii) the federal funds effective rate plus 0.5 percent.

     As of September 30, 2007, the aggregate principal amount of loans outstanding under the EAC Credit Agreement was $478.5 million and the aggregate face amount of outstanding letters of credit was $20 million, all of which related to EAC’s joint development agreement with ExxonMobil Corporation (“ExxonMobil”). See “Note 14. Commitments and Contingencies” for additional discussion of this agreement. Any outstanding letters of credit reduce the availability under the EAC Credit Agreement. Borrowings under the EAC Credit Agreement may be repaid from time to time without penalty.

     The EAC Credit Agreement contains covenants that include, among others:

	•		a prohibition against incurring debt, subject to permitted exceptions;
	•		a prohibition against paying dividends or making distributions, purchasing or redeeming capital stock, or prepaying indebtedness, subject to permitted exceptions;
	•		a restriction on creating liens on EAC’s and its restricted subsidiaries’ assets, subject to permitted exceptions;
	•		restrictions on merging and selling assets outside the ordinary course of business;
	•		restrictions on use of proceeds, investments, transactions with affiliates, or change of principal business;
	•		a provision limiting oil and natural gas hedging transactions (other than puts) to a volume not exceeding 75 percent of anticipated production from proved producing reserves;
	•		a requirement that EAC maintain a ratio of consolidated current assets to consolidated current liabilities of not less than 1.0 to 1.0; and

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

•

a requirement that EAC maintain a ratio of consolidated EBITDA (as defined in the EAC Credit Agreement) to the sum of consolidated net interest expense plus letter of credit fees of not less than 2.5 to 1.0.

     The EAC Credit Agreement contains customary events of default. If an event of default occurs and is continuing, lenders with a majority of the aggregate commitments may require Bank of America, N.A. to declare all amounts outstanding under the EAC Credit Agreement to be immediately due and payable. EAC was in compliance with all of the debt covenants under the EAC Credit Agreement as of September 30, 2007.

     EAC incurs a commitment fee on the unused portion of the EAC Credit Agreement determined based on the ratio of amounts outstanding under the EAC Credit Agreement to the borrowing base in effect on such date. The following table summarizes the calculation of the commitment fee under the EAC Credit Agreement:

		Commitment
Ratio of Total Outstanding Borrowings to Borrowing Base		Fee Percentage
Less than .50 to 1			0.250	%
Greater than or equal to .50 to 1 but less than ..75 to 1			0.300	%
Greater than or equal to .75 to 1 but less than ..90 to 1			0.375	%
Greater than or equal to .90 to 1			0.375	%

     Encore Energy Partners Operating LLC Credit Agreement

     OLLC is a party to a five-year credit agreement dated March 7, 2007 (the “OLLC Credit Agreement”) with a bank syndicate comprised of Bank of America, N.A. and other lenders. On August 22, 2007, OLLC entered into the First Amendment to the OLLC Credit Agreement, which revised certain financial covenants. The OLLC Credit Agreement provides for revolving credit loans to be made to OLLC from time to time and letters of credit to be issued from time to time for the account of OLLC or any of its restricted subsidiaries.

     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 a result of the contribution of certain assets in the Permian Basin from EAC to OLLC at the closing of ENP’s IPO in September 2007, the borrowing base was increased to $145 million.

     The OLLC Credit Agreement matures on March 7, 2012. OLLC’s obligations under the OLLC Credit Agreement are secured by a first-priority security interest in OLLC’s and its restricted subsidiaries’ proved oil and natural gas reserves and in the equity interests of OLLC and its restricted subsidiaries. In addition, OLLC’s obligations under the OLLC Credit Agreement are guaranteed by its direct parent, ENP, and OLLC’s restricted subsidiaries. EAC consolidates the debt of ENP with that of its own; however, obligations under the OLLC Credit Agreement are non-recourse to EAC and its restricted subsidiaries.

     Loans under the OLLC Credit Agreement are subject to varying rates of interest based on the same provisions as the EAC Credit Agreement.

     As of September 30, 2007, the aggregate principal amount of loans outstanding under the OLLC Credit Agreement was $66.5 million and there were no outstanding letters of credit. Any outstanding letters of credit reduce the availability under the OLLC Credit Agreement. Borrowings under the OLLC Credit Agreement may be repaid from time to time without penalty.

     The OLLC Credit Agreement contains covenants that include, among others:

	•		a prohibition against incurring debt, subject to permitted exceptions;
	•		a prohibition against paying dividends or making distributions prior to the IPO Effective Date (as defined in the OLLC Credit Agreement), purchasing or redeeming capital stock, or prepaying indebtedness, subject to permitted exceptions;
	•		a restriction on creating liens on the assets of ENP, OLLC and its restricted subsidiaries, subject to permitted exceptions;
	•		restrictions on merging and selling assets outside the ordinary course of business;
	•		restrictions on use of proceeds, investments, transactions with affiliates, or change of principal business;

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

	•		a provision limiting oil and natural gas hedging transactions (other than puts) to a volume not exceeding 75 percent of anticipated production from proved producing reserves;
	•		a requirement that OLLC maintain a ratio of consolidated current assets to consolidated current liabilities of not less than 1.0 to 1.0;
	•		a requirement that OLLC maintain a ratio of consolidated EBITDA (as defined in the OLLC Credit Agreement) to the sum of consolidated net interest expense plus letter of credit fees of not less than 1.5 to 1.0;
	•		a requirement that OLLC maintain a ratio of consolidated EBITDA (as defined in the OLLC Credit Agreement) to consolidated senior interest expense of not less than 2.5 to 1.0; and
	•		a requirement that OLLC maintain a ratio of consolidated funded debt (excluding certain related party debt) to consolidated adjusted EBITDA (as defined in the OLLC Credit Agreement) of not more than 3.5 to 1.0.

     The OLLC Credit Agreement contains customary events of default. If an event of default occurs and is continuing, lenders with a majority of the aggregate commitments may require Bank of America, N.A. to declare all amounts outstanding under the OLLC Credit Agreement to be immediately due and payable. At September 30, 2007, OLLC was in compliance with all of the debt covenants under the OLLC Credit Agreement, as amended.

     OLLC incurs a commitment fee on the unused portion of the OLLC Credit Agreement determined based on the same provisions as the EAC Credit Agreement.

Note 9. Income Taxes

     The components of the income tax provision were as follows for the nine months ended September 30, 2007 and 2006:

		Nine months ended
		September 30,
		2007				2006
		(in thousands)
Federal:
Current		$	(116	)		$	(1,361	)
Deferred			(679	)			(45,405	)
Total federal			(795	)			(46,766	)
State, net of federal benefit/expense:
Current			—				(1,348	)
Deferred			(695	)			(3,268	)
Total state			(695	)			(4,616	)
Income tax provision		$	(1,490	)		$	(51,382	)

     The following table reconciles income tax provision with income tax at the Federal statutory rate for the nine months ended September 30, 2007 and 2006:

		Nine months ended
		September 30,
		2007				2006
		(in thousands)
Income (loss) before income taxes		$	(782	)		$	133,688
Tax at statutory rate		$	274			$	(46,791	)
State income taxes, net of federal benefit/expense			19				(3,118	)
Enactment of the Texas margin tax			—				(1,389	)
Change in estimated future tax rate			(597	)			—
ENP minority interest in deferred compensation			(1,238	)			—
Permanent and other			52				(84	)
Income tax provision		$	(1,490	)		$	(51,382	)

     On January 1, 2007, EAC adopted the provisions of FIN No. 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes

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

recognized in a company’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. EAC and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. Subject to statutory exceptions that allow for a possible extension of the assessment period, EAC is no longer subject to U.S. federal, state, and local income tax examinations for years prior to 2003.

     EAC has performed its evaluation of tax positions and has determined that the adoption of FIN 48 did not have a material impact on EAC’s financial condition, results of operations, or cash flows. This evaluation is a review of the appropriate recognition threshold for each tax position recognized in EAC’s financial statements. The evaluation included, but was not limited to:

	•		a review of documentation of tax positions taken on previous returns including an assessment of whether EAC followed industry practice or the applicable requirements under the tax code;
	•		a review of open tax returns (on a jurisdiction by jurisdiction basis) as well as supporting documentation used to support those tax returns;
	•		a review of the results of past tax examinations;
	•		a review of whether tax returns have been filed in all appropriate jurisdictions;
	•		a review of existing permanent and temporary differences; and
	•		consideration of any tax planning strategies that may have been used to support realization of deferred tax assets.

Based on this evaluation, EAC did not identify any tax positions that did not meet the “highly certain positions” threshold. As a result, no additional tax expense, interest, or penalties have been accrued as a result of the review.

     EAC includes interest assessed by the taxing authorities in “Interest expense” and penalties related to income taxes in “Other expense” on its Consolidated Statements of Operations. For the nine months ended September 30, 2007 and 2006, EAC recorded only a nominal amount of interest and penalties on certain tax positions.

Note 10. Earnings Per Share (“EPS”)

     The following table reflects EPS computations for the three and nine months ended September 30, 2007 and 2006:

		Three months ended								Nine months ended
		September 30,								September 30,
		2007				2006				2007				2006
						(in thousands, except per share data)
Numerator:
Net income (loss)		$	11,985			$	42,135			$	(2,272	)		$	82,306
Denominator:
Denominator for basic EPS:
Weighted average shares outstanding			53,198				52,968				53,140				51,481
Effect of dilutive options and diluted restricted stock (a)			981				808				—				894
Denominator for diluted EPS			54,179				53,776				53,140				52,375
Net income (loss) per common share:
Basic		$	0.23			$	0.80			$	(0.04	)		$	1.60
Diluted		$	0.22			$	0.78			$	(0.04	)		$	1.57

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

Note 11. Incentive Stock Plan

     During 2000, EAC’s Board of Directors (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 September 30, 2007, there were 849,538 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, or shares subject to options or other awards that expire or are terminated 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 having Jon S. Brumley, EAC’s Chief Executive Officer and President, as its sole member. 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.

     All options that have been granted under the EAC Plan have a strike price equal to the fair market value of EAC’s common stock on the date of grant. Additionally, all options have a ten-year life and vest equally 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 compensation cost related to the EAC Plan that has been recorded in the accompanying Consolidated Statements of Operations for the nine months ended September 30, 2007 and 2006 was $7.0 million and $6.6 million, respectively. The income tax benefit related to the EAC Plan that has been recorded in the accompanying Consolidated Statements of Operations for the nine months ended September 30, 2007 and 2006 was $2.6 million and $2.4 million, respectively. During each of the nine months ended September 30, 2007 and 2006, EAC also capitalized $0.9 million 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 lease operations expense, general and administrative expense, and exploration expense based on the allocation of the respective employees’ cash compensation.

     See “Note 16. ENP” for a discussion of ENP’s unit-based compensation plan.

Stock Options

     The fair value of each option award granted during the nine months ended September 30, 2007 and 2006 was estimated on the date of grant using the 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 award. EAC uses the “simplified” method prescribed by SEC Staff Accounting Bulletin No. 107 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. The risk-free rate is based on the U.S Treasury yield curve in effect at the time of grant for periods commensurate with the expected terms of the options.

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

		Nine months ended September 30,
		2007				2006
Expected volatility			35.7	%			42.8	%
Expected dividend yield			0.0	%			0.0	%
Expected term (in years)			6.0				6.0
Risk-free interest rate			4.8	%			4.6	%

     The following table summarizes the change in the number of outstanding options and the related weighted average strike prices during the nine months ended September 30, 2007:

										Weighted
						Weighted				Average				Aggregate
		Number of				Average				Remaining				Intrinsic
		Options				Strike Price				Contractual Term				Value
		(in thousands)
Outstanding at January 1, 2007			1,337,118			$	14.44
Granted			200,059				25.73
Forfeited			(23,118	)			28.30
Exercised			(91,709	)			13.10
Outstanding at September 30, 2007			1,422,350				15.89				5.8			$	22,415
Exercisable at September 30, 2007			1,141,977				13.16				5.0				21,111

     The weighted average fair value per share of individual options granted during the nine months ended September 30, 2007 and 2006 was $11.16 and $14.96, respectively. The total intrinsic value of options exercised during the nine months ended September 30, 2007 and 2006 was $1.3 million and $2.4 million, respectively. During the nine months ended September 30, 2007 and 2006, EAC received proceeds from the exercise of stock options of $1.0 million and $2.3 million, respectively, and realized tax benefits related to stock options of $0.4 million and $0.9 million, respectively. At September 30, 2007, EAC had $1.6 million of total unrecognized compensation cost related to unvested stock options, which is expected to be recognized over a weighted average period of 2.0 years.

Restricted Stock

     During the nine months ended September 30, 2007 and 2006, EAC recognized expense related to restricted stock of $5.8 million and $5.6 million, respectively, and realized tax benefits related to restricted stock of $2.2 million and $2.1 million, respectively. A summary of the status of EAC’s unvested restricted stock outstanding as of September 30, 2007, and changes during the nine months then ended, is presented below:

						Weighted
						Average
		Number of				Grant Date
		Shares				Fair Value
Outstanding at January 1, 2007			828,619			$	26.17
Granted			342,133				25.90
Vested			(118,273	)			25.40
Forfeited			(61,145	)			26.22
Outstanding at September 30, 2007			991,334				26.17

     As of September 30, 2007, there were 819,059 shares of unvested restricted stock outstanding, dependent only on the passage of time and continued employment for vesting, 159,869 shares of which were granted during the nine months ended September 30, 2007. Additionally, as of September 30, 2007, there were 172,275 shares of unvested restricted stock outstanding that not only depend on the passage of time and continued employment, but on certain performance measures for vesting, all of which were granted during the nine months ended September 30, 2007. None of EAC’s unvested restricted stock outstanding are subject to variable accounting.

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

     As of September 30, 2007, EAC had $11.3 million of total unrecognized compensation cost related to unvested, outstanding restricted stock, which is expected to be recognized over a weighted average period of 2.7 years. During the nine months ended September 30, 2007 and 2006, there were 118,273 shares and 27,909 shares, respectively, of restricted stock that vested and employees elected to satisfy minimum tax withholding obligations related to these shares by allowing EAC to withhold 5,545 shares and 6,553 shares of common stock, respectively. These shares are treated as treasury stock by EAC until the shares are formally retired and have been reflected as such in the accompanying consolidated financial statements.

Note 12. Comprehensive Income

     Components of comprehensive income, net of related tax, are as follows:

		Three months ended								Nine months ended
		September 30,								September 30,
		2007				2006				2007				2006
		(in thousands)
Net income (loss)		$	11,985			$	42,135			$	(2,272	)		$	82,306
Amortization of deferred loss on commodity derivatives			8,596				8,894				25,150				28,448
Amortization of deferred gain on interest rate swap			—				(63	)			—				(92	)
Comprehensive income		$	20,581			$	50,966			$	22,878			$	110,662