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 June 30, 2008

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, 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):

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 August 1, 2008		53,323,951

 

 

ENCORE ACQUISITION COMPANY

INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2008 and December 31, 2007			1
Consolidated Statements of Operations for the three and six months ended June 30, 2008 and 2007			2
Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2008			3
Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2007			4
Notes to Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			32
Item 3. Quantitative and Qualitative Disclosures About Market Risk			49
Item 4. Controls and Procedures			49
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			50
Item 1A. Risk Factors			50
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			50
Item 4. Submission of Matters to a Vote of Security Holders			50
Item 5. Other Information			51
Item 6. Exhibits			51
Signature			52
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 (Loss) to Fixed Charges
Second Amendment to Amended and Restated Credit Agreement

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 2007 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 expected. 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.
	•		Dry Gas. Natural gas comprised of over 90 percent methane and suitable for use by customers of local gas distribution companies.
	•		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 an entity owns 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.
	•		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 an entity.
	•		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.
	•		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 conditions.
	•		Proved Undeveloped Reserves. Proved reserves that are expected to be recovered from new wells drilled to known reservoirs

ENCORE ACQUISITION COMPANY

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.

	•		Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil and/or natural gas that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs.
	•		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 production 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)

		June 30,				December 31,
		2008				2007
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	1,594			$	1,704
Accounts receivable, net of allowance for doubtful accounts of $6,045			185,054				134,880
Inventory			26,582				16,257
Derivatives			3,301				9,722
Deferred taxes			84,242				20,420
Other			4,882				5,527
Total current assets			305,655				188,510
Properties and equipment, at cost — successful efforts method:
Proved properties, including wells and related equipment			3,106,417				2,845,776
Unproved properties			85,757				63,352
Accumulated depletion, depreciation, and amortization			(586,900	)			(489,004	)
			2,605,274				2,420,124
Other property and equipment			22,357				21,750
Accumulated depreciation			(11,369	)			(10,733	)
			10,988				11,017
Goodwill			60,606				60,606
Derivatives			10,863				34,579
Long-term receivables			64,850				40,945
Other			29,040				28,780
Total assets		$	3,087,276			$	2,784,561
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	30,177			$	21,548
Accrued liabilities:
Lease operations expense			18,216				15,057
Development capital			61,025				48,359
Interest			12,078				12,795
Production, ad valorem, and severance taxes			42,712				24,694
Marketing			8,331				8,721
Derivatives			198,142				39,337
Oil and natural gas revenues payable			16,628				13,076
Other			27,512				21,143
Total current liabilities			414,821				204,730
Derivatives			133,318				47,091
Future abandonment cost, net of current portion			28,895				27,371
Deferred taxes			350,292				312,914
Long-term debt			1,141,519				1,120,236
Other			1,538				1,530
Total liabilities			2,070,383				1,713,872
Commitments and contingencies (see Note 16)
Minority interest in consolidated partnership			101,034				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, 52,357,211 and 53,303,464 issued and outstanding, respectively			525				534
Additional paid-in capital			537,779				538,620
Treasury stock, at cost, none and 17,690 shares, respectively			—				(590	)
Retained earnings			377,138				411,377
Accumulated other comprehensive income (loss)			417				(1,786	)
Total stockholders’ equity			915,859				948,155
Total liabilities and stockholders’ equity		$	3,087,276			$	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								Six months ended
		June 30,								June 30,
		2008				2007				2008				2007
Revenues:
Oil		$	286,924			$	135,596			$	507,458			$	218,219
Natural gas			67,889				45,131				116,201				78,109
Marketing			2,521				8,916				6,577				23,857
Total revenues			357,334				189,643				630,236				320,185
Expenses:
Production:
Lease operations			40,697				37,552				81,047				68,072
Production, ad valorem, and severance taxes			35,043				19,232				62,495				31,747
Depletion, depreciation, and amortization			51,026				52,318				100,569				87,346
Exploration			11,593				3,415				17,081				14,936
General and administrative			11,559				6,188				21,246				13,548
Marketing			3,725				8,507				7,507				23,518
Derivative fair value loss			256,390				6,766				321,528				52,380
Other operating			3,226				4,751				5,732				7,316
Total expenses			413,259				138,729				617,205				298,863
Operating income (loss)			(55,925	)			50,914				13,031				21,322
Other income (expenses):
Interest			(16,785	)			(27,820	)			(36,545	)			(44,107	)
Other			686				601				1,537				1,032
Total other expenses			(16,099	)			(27,219	)			(35,008	)			(43,075	)
Income (loss) before income taxes and minority interest			(72,024	)			23,695				(21,977	)			(21,753	)
Income tax benefit (provision)			21,322				(8,524	)			2,589				7,496
Minority interest in loss of consolidated partnership			14,982				—				14,888				—
Net income (loss)		$	(35,720	)		$	15,171			$	(4,500	)		$	(14,257	)
Net income (loss) per common share:
Basic		$	(0.68	)		$	0.29			$	(0.09	)		$	(0.27	)
Diluted		$	(0.68	)		$	0.28			$	(0.09	)		$	(0.27	)
Weighted average common shares outstanding:
Basic			52,344				53,143				52,571				53,111
Diluted			52,344				54,020				52,571				53,111

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				Income (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			256				3				1,325				—				—				—				—				1,328
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			(46	)			—				(465	)			46				1,544				(1,079	)			—				—
Non-cash equity-based compensation			—				—				6,535				—				—				—				—				6,535
ENP distributions to holders of management incentive units			—				—				—				—				—				(1,233	)			—				(1,233	)
Adjustment to reflect gain on issuance of ENP common units			—				—				3,458				—				—				—				—				3,458
Other			—				—				(15	)			—				—				—				—				(15	)
Components of comprehensive loss:
Net loss			—				—				—				—				—				(4,500	)			—				(4,500	)
Change in deferred hedge gain on interest rate swaps, net of tax of $253			—				—				—				—				—				—				417				417
Amortization of deferred loss on commodity derivative contracts, net of tax of $1,071			—				—				—				—				—				—				1,786				1,786
Total comprehensive loss																															(2,297	)
Balance at June 30, 2008			52,357			$	525			$	537,779				—			$	—			$	377,138			$	417			$	915,859

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

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

		Six months ended
		June 30,
		2008				2007
Cash flows from operating activities:
Net loss		$	(4,500	)		$	(14,257	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depletion, depreciation, and amortization			100,569				87,346
Non-cash exploration expense			15,545				13,870
Deferred taxes			(26,756	)			(7,745	)
Non-cash equity-based compensation expense			6,205				5,480
Non-cash derivative loss			300,370				65,038
Loss (gain) on disposition of assets			(79	)			2,282
Minority interest in loss of consolidated partnership			(14,888	)			—
Other			6,619				2,589
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable			(47,301	)			(42,735	)
Current derivatives			(670	)			(15,303	)
Other current assets			(9,680	)			(8,554	)
Long-term derivatives			(1,196	)			(19,828	)
Other assets			(1,033	)			(2,200	)
Accounts payable			4,208				4,468
Other current liabilities			25,825				11,127
Other noncurrent liabilities			(923	)			(253	)
Net cash provided by operating activities			352,315				81,325
Cash flows from investing activities:
Proceeds from disposition of assets			631				291,454
Purchases of other property and equipment			(1,622	)			(1,614	)
Acquisition of oil and natural gas properties			(49,280	)			(779,576	)
Development of oil and natural gas properties			(233,225	)			(187,227	)
Net advances to working interest partners			(22,907	)			(24,158	)
Net cash used in investing activities			(306,403	)			(701,121	)
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			374				497
Proceeds from long-term debt, net of issuance costs			618,339				1,120,019
Payments on long-term debt			(598,500	)			(492,500	)
ENP distributions to holders of management incentive units and public units			(11,168	)			—
Payment of commodity derivative contract premiums			(20,583	)			(12,185	)
Change in cash overdrafts			4,634				8,140
Net cash provided by (used in) financing activities			(46,022	)			623,971
Increase (decrease) in cash and cash equivalents			(110	)			4,175
Cash and cash equivalents, beginning of period			1,704				763
Cash and cash equivalents, end of period		$	1,594			$	4,938

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 June 30, 2008 and December 31, 2007, EAC owned approximately 66.7 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, EAC’s financial position as of June 30, 2008, results of operations for the three and six months ended June 30, 2008 and 2007, and cash flows for the six months ended June 30, 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 June 30, 2008 and December 31, 2007 of $101.0 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 loss of consolidated partnership” for the three and six months ended June 30, 2008 of $15.0 million and $14.9 million, respectively, 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 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, which standardizes the definition of fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), 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 was 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 delayed 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 indefinite lived assets. 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, which permits entities to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis. SFAS 159 also 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 was 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 an impact on EAC’s results of operations or financial condition. In the future, 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.

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

     In April 2007, the FASB issued FSP FIN 39-1, which 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 was 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.

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

     In December 2007, the FASB issued SFAS 141R, which replaces SFAS No. 141, “Business Combinations”. SFAS 141R establishes principles and requirements for the reporting entity in a business combination, including: (1) recognition and measurement in the financial statements of the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (2) recognition and measurement of goodwill acquired in the business combination or a gain from a bargain purchase; and (3) determination of the information to be disclosed to enable financial statement users to evaluate the nature and financial effects of the business combination. SFAS 141R is prospectively effective for business combinations consummated in fiscal years beginning on or after December 15, 2008 with early application prohibited. EAC is evaluating the impact SFAS 141R will have on its results of operations and financial condition and the reporting of future acquisitions in the consolidated financial statements.

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, which 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

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

deconsolidation of a subsidiary. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. SFAS 160 clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest and the disclosure of consolidated net income attributable to the parent and to the noncontrolling interest on the face of the consolidated statement of operations. EAC does not expect the adoption of SFAS 160 to have a material impact on its results of operations or financial condition.

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, which amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), to require enhanced disclosures about (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations; and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for fiscal years beginning on or after November 15, 2008, with early application encouraged. The adoption of SFAS 161 will require additional disclosures regarding EAC’s derivative instruments; however, it will not impact EAC’s results of operations or financial condition.

SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”)

     In May 2008, the FASB issued SFAS 162, which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP. SFAS 162 moves the hierarchy of GAAP sources for nongovernmental entities from the auditing literature to the accounting literature. With some modifications and additions, the hierarchy from the American Institute of Certified Public Accountants Statement on Auditing Standards No. 69, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles” has been carried forward to SFAS 162. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles”. The adoption of SFAS 162 will not impact EAC’s results of operations or financial condition.

FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP 03-6-1”)

     In June 2008, the FASB issued FSP 03-6-1, which addresses whether instruments granted in equity-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation for computing basic earnings per share (“EPS”) under the two-class method described in paragraphs 60 and 61 of SFAS No. 128, “Earnings per Share”. FSP 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years, with early application prohibited. FSP 03-6-1 requires all prior-period EPS data to be adjusted retrospectively (including interim financial statements, summaries of earnings, and selected financial data). EAC is currently evaluating the effect the adoption of FSP 03-6-1 will have on its EPS calculations.

Note 3. Acquisitions and Dispositions

Acquisitions

     In January 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 in April 2007. The Williston Basin acquisition was treated as a reverse like-kind exchange under Section 1031 of the Internal Revenue Code of 1986, as amended, (the “Code”) 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.

     Also in January 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

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

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 in March 2007. The total purchase price for the Big Horn Basin assets was approximately $393.6 million, including transaction costs of approximately $1.3 million.

     EAC financed the acquisitions of the Gooseberry assets 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 limited liability company and direct wholly owned guarantor subsidiary of EAC, and borrowings under its revolving credit facility.

Dispositions

     In June 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 asset disposition were used to reduce outstanding borrowings under EAC’s revolving credit facility.

Pro Formas

     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 asset disposition as if they had each 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 asset disposition taken place as of the date indicated and are not intended to be a projection of future results.

		Three months ended				Six months ended
		June 30, 2007
		(in thousands, except per share amounts)
Pro forma total revenues		$	172,187			$	327,766
Pro forma net income (loss)		$	14,899			$	(15,739	)
Pro forma net income (loss) per common share:
Basic		$	0.28			$	(0.30	)
Diluted		$	0.28			$	(0.30	)

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:

		June 30,				December 31,
		2008				2007
		(in thousands)
Materials and supplies		$	12,020			$	11,567
Oil in pipelines			14,562				4,690
Total inventory		$	26,582			$	16,257

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

Note 5. Proved Properties

     Amounts shown in the accompanying Consolidated Balance Sheets as “Proved properties, including wells and related equipment” consisted of the following as of the dates indicated:

		June 30,				December 31,
		2008				2007
		(in thousands)
Proved leasehold costs		$	1,370,663			$	1,346,516
Wells and related equipment — Completed			1,590,353				1,408,512
Wells and related equipment — In process			145,401				90,748
Total proved properties		$	3,106,417			$	2,845,776

Note 6. Derivative Financial Instruments

     As of June 30, 2008, EAC had $58.1 million of deferred premiums payable of which $21.1 million was long-term and included in “Derivatives” in the non-current liabilities section of the accompanying Consolidated Balance Sheet and $37.0 million was 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 July 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

     From time to time, EAC sells floors with a strike price below the strike price of the purchased floors in order to partially finance the premiums paid on the purchased floors. 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.

     The following tables summarize EAC’s open commodity derivative contracts as of June 30, 2008:

Oil Derivative Contracts

		Average				Weighted					Average				Weighted					Average				Weighted					Average				Weighted
		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)
July — Dec. 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					—				—					—				—					—				—

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

Natural Gas Derivative Contracts

		Average				Weighted					Average				Weighted					Average				Weighted					Average				Weighted
		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)
July — 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 June 30, 2008:

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

     During each of the three and six months ended June 30, 2008, settlements of interest rate swaps increased EAC’s consolidated interest expense by approximately $0.1 million.

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 June 30, 2008 and 2007, respectively, and $2.9 million and $26.8 million during the six months ended June 30, 2008 and 2007, respectively. EAC also recognized derivative fair value gains and losses related to (1) changes in the market value of derivative contracts, (2) settlements on commodity derivative contracts, and (3) premium amortization. The following table summarizes the components of derivative fair value loss for the periods indicated:

		Three months ended								Six months ended
		June 30,								June 30,
		2008				2007				2008				2007
						(in thousands)
Mark-to-market loss (gain) on derivative contracts		$	220,586			$	(1,008	)		$	266,984			$	46,437
Premium amortization			17,293				11,324				32,806				17,688
Settlements on commodity derivative contracts			18,511				(3,550	)			21,738				(11,745	)
Total derivative fair value loss		$	256,390			$	6,766			$	321,528			$	52,380

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

Accumulated Other Comprehensive Income (“AOCI”)

     At June 30, 2008, AOCI consisted entirely of deferred gains, net of tax, on ENP’s interest rate swaps that are designated as hedges of $0.4 million. At December 31, 2007, AOCI 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 $0.1 million of deferred gains associated with ENP’s interest rate swaps from AOCI to offset interest expense during the twelve months ending June 30, 2009. EAC also expects to reclassify $0.1 million of income taxes associated with ENP’s interest rate swaps from AOCI to income tax benefit during the twelve months ending June 30, 2009.

Note 7. Fair Values of Financial Assets and Liabilities

     As discussed in “Note 2. Basis of Presentation”, EAC adopted SFAS 157 on January 1, 2008, as it relates to financial assets and liabilities. SFAS 157 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 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) and the lowest priority to unobservable inputs (Level 3). 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, other than quoted prices within Level 1, are 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 are unobservable as of the reporting date. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.

     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 June 30, 2008. 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 the financial assets and liabilities and their placement within the fair value hierarchy levels.

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

						Fair Value Measurements at Reporting Date Using
						Quoted Prices in
						Active Markets for				Significant Other				Significant
						Identical Assets				Observable Inputs				Unobservable Inputs
Description		June 30, 2008				(Level 1)				(Level 2)				(Level 3)
		(in thousands)
Oil derivative contracts — swaps		$	(159,105	)		$	—			$	(159,105	)		$	—
Oil derivative contracts — floors and caps			(77,330	)			—				—				(77,330	)
Natural gas derivative contracts — swaps			(8,730	)			—				(8,730	)			—
Natural gas derivative contracts — floors and caps			(15,378	)			—				—				(15,378	)
Interest rate swaps			1,350				—				1,350				—
Total		$	(259,193	)		$	—			$	(166,485	)		$	(92,708	)

     The following table summarizes the changes in the fair value of EAC’s Level 3 financial assets and liabilities for the six months ended June 30, 2008:

		Fair Value Measurements Using Significant
		Unobservable Inputs (Level 3)
		Oil Derivative				Natural Gas
		Contracts —				Derivative 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			(105,870	)			(24,674	)			(130,544	)
Purchases, issuances, and settlements			11,893				2,215				14,108
Balance at June 30, 2008		$	(77,330	)		$	(15,378	)		$	(92,708	)
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		$	(105,870	)		$	(24,674	)		$	(130,544	)

     Since EAC does not use hedge accounting for its commodity derivative contracts, all gains and losses on its Level 3 financial assets and liabilities are included in “Derivative fair value loss” in the accompanying Consolidated Statements of Operations. All fair values reflected in the table above and in the accompanying Consolidated Balance Sheet have been adjusted for non-performance risk. The adjustment to fair value related to non-performance risk as of June 30, 2008 was a reduction of the net liability value of approximately $3.3 million.

     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.

     Level 2 Fair Value Measurements

     Oil and natural gas derivative contracts — swaps. Fair values 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. Fair values 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. Fair values were estimated using pricing models and discounted cash flow methodologies based on inputs that are not readily available in public markets.

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

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 June 30, 2008 and December 31, 2007, EAC had $8.5 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 properties, which is included in other long-term assets in the accompanying Consolidated Balance Sheets. The following table summarizes the changes in EAC’s asset retirement obligations for the six months ended June 30, 2008 (in thousands):

Future abandonment liability at January 1, 2008		$	28,079
Wells drilled			162
Acquisition of properties			81
Accretion of discount			667
Plugging and abandonment costs incurred			(891	)
Revision of previous estimates			1,717
Future abandonment liability at June 30, 2008		$	29,815

     As of June 30, 2008, $28.9 million of EAC’s asset retirement obligations was long-term and recorded in “Future abandonment cost, net of current portion” and $0.9 million was 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:

		June 30,				December 31,
		2008				2007
		(in thousands)
Revolving credit facilities		$	547,000			$	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 $4,204 and $4,440, respectively			295,796				295,560
7.25% Senior Subordinated Notes due December 1, 2017, net of unamortized discount of $1,277 and $1,324, respectively			148,723				148,676
Total		$	1,141,519			$	1,120,236

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”). 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. Effective May 22, 2008, EAC amended the EAC Credit Agreement to, among other things, increase the margins applicable to the ratio of total outstanding borrowings to borrowing base, as noted in the table below, and increase the borrowing base to $1.1 billion.

     The following table represents the applicable margin for Eurodollar and base rate loans under the EAC Credit Agreement, as amended:

		Applicable Margin for				Applicable Margin for
Ratio of Total Outstanding Borrowings to Borrowing Base		Eurodollar Loans				Base Rate Loans
Less than .50 to 1			1.250	%			0.000	%
Greater than or equal to .50 to 1 but less than .75 to 1			1.500	%			0.250	%
Greater than or equal to .75 to 1 but less than .90 to 1			1.750	%			0.500	%
Greater than or equal to .90 to 1			2.000	%			0.750	%

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

     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 June 30, 2008, the borrowing base was $1.1 billion and there were $396 million of outstanding borrowings and $704 million of borrowing capacity under the EAC Credit Agreement. As of June 30, 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 June 30, 2008, the borrowing base was $240 million and there were $151 million of outstanding borrowings, $0.1 million of outstanding letters of credit, and $88.9 million of borrowing capacity under the OLLC Credit Agreement. As of June 30, 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”) approved a share repurchase program authorizing EAC to repurchase up to $50 million of its common stock. As of June 30, 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 were as follows for the periods indicated:

		Six months ended
		June 30,
		2008				2007
		(in thousands)
Federal:
Current		$	(20,110	)		$	(249	)
Deferred			22,877				7,747
Total federal			2,767				7,498
State, net of federal benefit:
Current			(4,057	)			—
Deferred			3,879				(2	)
Total state			(178	)			(2	)
Income tax benefit		$	2,589			$	7,496

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

		Six months ended
		June 30,
		2008				2007
		(in thousands)
Loss before income taxes, net of minority interest		$	(7,089	)		$	(21,753	)
Income tax at the Federal statutory rate		$	2,481			$	7,614
State income taxes, net of federal benefit			165				519
Change in estimated future state tax rate			—				(542	)
Nondeductible deferred compensation expense			20				—
Permanent and other			(77	)			(95	)
Income tax benefit		$	2,589			$	7,496

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

     At June 30, 2008, EAC had net operating loss (“NOL”) carryforwards related to federal and state income taxes of $13.3 million, which are available to offset future regular taxable income, if any. At June 30, 2008, EAC also had alternative minimum tax (“AMT”) credits of $2.2 million, which are available to reduce future regular tax liabilities in excess of AMT. EAC believes it is more likely than not that the 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 related to income taxes in “Other expense” on its Consolidated Statements of Operations. For the six months ended June 30, 2008 and 2007, EAC recorded only a nominal amount of interest and penalties on certain tax positions.

Note 12. EPS

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

		Three months ended								Six months ended
		June 30,								June 30,
		2008 (c)				2007				2008 (c)				2007
		(in thousands, except per share data)
Numerator:
Net income (loss)		$	(35,720	)		$	15,171			$	(4,500	)		$	(14,257	)
Denominator:
Denominator for basic EPS:
Weighted average shares outstanding			52,344				53,143				52,571				53,111
Effect of dilutive options (a)			—				427				—				—
Effect of dilutive restricted stock (b)			—				450				—				—
Denominator for diluted EPS			52,344				54,020				52,571				53,111
Net income (loss) per common share:
Basic		$	(0.68	)		$	0.29			$	(0.09	)		$	(0.27	)
Diluted		$	(0.68	)		$	0.28			$	(0.09	)		$	(0.27	)

Note 13. Incentive Stock Plans

     In May 2008, EAC’s stockholders approved the 2008 Incentive Stock Plan (the “2008 Plan”). No additional awards will be granted under EAC’s 2000 Incentive Stock Plan (the “2000 Plan”) and any previously granted awards currently outstanding under the 2000 Plan will remain outstanding in accordance with their terms. The purpose of the 2008 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 2008 Plan. The total number of shares of common stock reserved for issuance pursuant to the 2008 Plan is 2,400,000. No more than 1,600,000 shares of EAC’s common stock will be available for grants of “full value” stock awards, such as restricted stock or stock units. As of June 30, 2008, there were

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

2,389,000 shares available for issuance under the 2008 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 2008 Plan. The 2008 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 2008 Plan contains the following individual limits:

	•		an employee may not be granted awards covering or relating to more than 300,000 shares of common stock during any calendar year;
	•		a non-employee director may not be granted awards covering or relating to more than 20,000 shares of common stock during 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 $5.0 million.

     In May 2008, the Board approved certain amendments to the 2000 Plan to ensure compliance with Section 409A of the Code. In particular, the 2000 Plan was amended to allow for the exemption of options from the requirements of Section 409A of the Code by requiring that, upon a change-in-control, options granted or that vest on or after January 1, 2005 be valued at their fair market value as of the date they are cashed out, rather than the highest price per share paid in the 60 days prior to the change-in-control. The amendments to the 2000 Plan did not require stockholder approval under its terms, applicable laws, or the rules of the New York Stock Exchange.

     All options have a strike price equal to the fair market value of EAC’s common stock on the grant date, have a ten-year life, and vest over a three-year period. Restricted stock awards vest 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 recorded in the accompanying Consolidated Statements of Operations for the six months ended June 30, 2008 and 2007 was $4.1 million and $5.5 million, respectively. The income tax benefit of the non-cash stock-based compensation expense recorded in the accompanying Consolidated Statements of Operations for the six months ended June 30, 2008 and 2007 was $1.5 million and $2.0 million, respectively. During the six months ended June 30, 2008 and 2007, EAC also capitalized $1.0 million and $0.7 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 six months ended June 30, 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 was 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.

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

		Six months ended June 30,
		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	%