Summary of STONE ENERGY CORP

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Form 10-Q and the information referenced herein contain statements that constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The words "plan," "expect," "project," "estimate," "assume," "believe," "anticipate," "intend," "budget," "forecast," "predict" and other similar expressions are intended to identify forward-looking statements. These statements appear in a number of places and include statements regarding our plans, beliefs or current expectations, including the plans, beliefs and expectations of our officers and directors. We use the terms "Stone," "Stone Energy," "Company," "we," "us" and "our" to refer to Stone Energy Corporation.
When considering any forward-looking statement, you should keep in mind the risk factors that could cause our actual results to differ materially from those contained in any forward-looking statement. Important factors that could cause actual results to differ materially from those in the forward-looking statements herein include the timing and extent of changes in commodity prices for oil and gas, operating risks and other risk factors as described in our Annual Report on Form 10-K. Furthermore, the assumptions that support our forward-looking statements are based upon information that is currently available and is subject to change. We specifically disclaim all responsibility to publicly update any information contained in a forward-looking statement or any forward-looking statement in its entirety and therefore disclaim any resulting liability for potentially related damages. All forward-looking statements attributable to Stone Energy Corporation are expressly qualified in their entirety by this cautionary statement.
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") contained in this Form 10-Q should be read in conjunction with the MD&A contained in our Annual Report on Form 10-K for the year ended December 31, 2007.
Overview
Stone Energy Corporation is an independent oil and gas company engaged in the acquisition, exploration, exploitation, development and operation of oil and gas properties located primarily in the Gulf of Mexico. Prior to June 29, 2007, we also had significant operations in the Rocky Mountain Region. We are also engaged in an exploratory joint venture in Bohai Bay, China. Our business strategy is to increase reserves, production and cash flow through the acquisition, exploitation and development of mature properties in the Gulf Coast Basin and exploring opportunities in the deep water environment of the Gulf of Mexico, Rocky Mountain Region, Appalachia, Bohai Bay, China and other potential areas. Throughout this document, reference to our "Gulf Coast Basin" properties includes our onshore, shelf, deep shelf and deep water properties. Reference to our "Rocky Mountain Region" includes our properties in several Rocky Mountain Basins and the Williston Basin.
Acquisition
On August 28, 2008, we completed the acquisition of Bois d'Arc Energy, Inc. ("Bois d'Arc") in a cash and stock transaction totaling approximately $1.7 billion. Bois d'Arc was an independent exploration company engaged in the discovery and production of oil and natural gas in the Gulf of Mexico. The primary factors considered by management in making the acquisition included the belief that the merger would position the combined company as one of the largest independent Gulf of Mexico-focused exploration and production companies, with a solid production base, a strong portfolio for continued development of proved and probable reserves, and an extensive inventory of exploration opportunities. At the time of the transaction, management expected the merger would be accretive to our stockholders during 2008 and 2009 with respect to earnings per share, reserves and production. Pursuant to the terms and conditions of the agreement and plan of merger, Stone paid total merger consideration of approximately $935 million in cash and issued approximately 11.3 million common shares, valued at $63.52 per share. The per share value of the Stone common shares issued was calculated as the average of Stone's closing share price for the two days prior to through the two days after the merger announcement date of April 30, 2008. The cash component of the merger consideration was funded with approximately $510 million of cash on hand and $425 million of borrowings from our amended and restated bank credit facility. The revenues and expenses associated with Bois d'Arc have been included in Stone's Condensed Consolidated Financial Statements since August 28, 2008, the date the acquisition closed. The subsequent shut-ins from Hurricanes Gustav and Ike minimized the effects of the Bois d'Arc revenues on third quarter 2008 results. Amended Credit Facility
In connection with the acquisition of Bois d'Arc on August 28, 2008, we entered into an amended and restated revolving credit facility, maturing on July 1, 2011, through a syndicated bank group. The new facility has an initial borrowing base of $700 million. See Bank Credit Facilitybelow for additional information regarding the amended and restated credit facility. Hurricanes
Hurricanes Gustav and Ike caused significant disruption in our operations for the quarter resulting in production deferrals approximating 7.1 Bcfe and significant damage to our offshore facilities. Although we are still quantifying the financial impact of the damage we anticipate it will exceed our insurance coverage limits.

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Critical Accounting Policies
Our Annual Report on Form 10-K describes the accounting policies that we believe are critical to the reporting of our financial position and operating results and that require management's most difficult, subjective or complex judgments. Our most significant estimates are:
• remaining proved oil and gas reserves volumes and the timing of their production;

• estimated costs to develop and produce proved oil and gas reserves;

• accruals of exploration costs, development costs, operating costs and production revenue;

• timing and future costs to abandon our oil and gas properties;

• the effectiveness and estimated fair value of derivative positions;

• classification of unevaluated property costs;

• capitalized general and administrative costs and interest;

• insurance recoveries related to hurricanes;

• estimates of fair value in business combinations;

• goodwill impairment testing and measurement;

• current income taxes; and

• contingencies.

This Quarterly Report on Form 10-Q should be read together with the discussion contained in our Annual Report on Form 10-K regarding these critical accounting policies.
Other Factors Affecting Our Business and Financial Results In addition to the matters discussed above, our business, financial condition and results of operations are affected by a number of other factors. This Quarterly Report on Form 10-Q should be read in conjunction with the discussion in our Annual Report on Form 10-K regarding these other risk factors. Known Trends and Uncertainties
International Operations. Included in unevaluated oil and gas property costs at September 30, 2008 are $12.1 million of remaining capital expenditures related to our properties in Bohai Bay, China. Under full cost accounting, investments in individual countries represent separate cost centers for computation of depreciation, depletion and amortization as well as for full cost ceiling test evaluations. During the fourth quarter of 2007, this investment was deemed to be impaired in the amount of $8.2 million. During the three and nine-month periods ended September 30, 2008, this investment was deemed to be impaired in the amount of $8.8 million and $18.9 million, respectively. This is our sole investment in the Peoples Republic of China. It is possible that future evaluations of this project could result in additional impairment charges to income on our income statement.
Credit Crisis. During the quarter ended September 30, 2008, world financial markets experienced a severe reduction in the availability of credit. Although we have not been severely impacted by this condition in the short-term, it is difficult to predict its impact on us in future quarters. Possible negative impacts could include a decrease in the availability of borrowings under our credit facility, an increased counterparty credit risk on our derivatives contracts and the requirement by contractual counterparties of us to post collateral guaranteeing performance.
Goodwill. The acquisition of Bois d' Arc resulted in the recording of goodwill on our balance sheet in the amount of $337.9 million. Generally accepted accounting principles require that we periodically test goodwill for impairment. If we were to determine that goodwill is impaired this would result in a charge on our income statement in future periods.
Lease Operating Expenses. Although we have not completely quantified the damage caused by Hurricanes Gustav and Ike, we expect that lease operating expenses will increase in the coming quarters as repairs are initiated.
Declining Commodity Prices. We have experienced a significant decline in oil and natural gas prices in the last several months. If this trend were to continue it could increase the likelihood of goodwill impairments and write-downs of oil and gas properties, reduce the available borrowings under our credit facility and severely impact our cash flows used to fund operations and capital expenditures.

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Liquidity and Capital Resources
Cash Flow and Working Capital. Net cash flow provided by operating activities totaled $487.2 million during the nine months ended September 30, 2008 compared to $374.3 million in the comparable period in 2007. Based on our outlook of commodity prices and our estimated production, we expect to fund our 2008 capital expenditures with cash flow provided by operating activities.
Net cash flow used in investing activities totaled $1.2 billion during the nine months ended September 30, 2008, which primarily represents cash used in the acquisition of Bois d'Arc and our investment in oil and natural gas properties. Net cash flow provided by investing activities totaled $377.2 million during the first nine months of 2007, which primarily represents proceeds received from the sale of substantially all of our Rocky Mountain Region properties offset by our investment in oil and gas properties.
Net cash flow provided by financing activities totaled $431.3 million for the nine months ended September 30, 2008, which primarily represents borrowings under our bank credit facility in conjunction with the acquisition of Bois d'Arc and proceeds from the exercise of stock options and vesting of restricted stock. Net cash flow used in financing activities totaled $394.9 million for the nine months ended September 30, 2007, which primarily represents the redemption of our senior floating rate notes and repayments of borrowings under our bank credit facility.
We had working capital at September 30, 2008 of $109.3 million. We believe that our working capital balance should be viewed in conjunction with the availability of borrowings under our bank credit facility when measuring liquidity. "Liquidity" is defined as the ability to obtain cash quickly either through the conversion of assets or incurrence of liabilities. See "Bank Credit Facility".
Capital Expenditures. Third quarter 2008 additions to oil and gas property costs of $2.1 billion included $29.4 million of lease acquisition costs, $1.9 billion of property acquisition costs, $4.3 million of capitalized salaries, general and administrative expenses (inclusive of incentive compensation) and $7.0 million of capitalized interest. Year-to-date 2008 additions to oil and gas property costs of $2.3 billion included $69.1 million of lease acquisition costs, $1.9 billion of property acquisition costs, $14.2 million of capitalized salaries, general and administrative expenses (inclusive of incentive compensation) and $15.7 million of capitalized interest. These investments were financed by cash flow from operating activities, borrowings under our bank credit facility and the issuance of common stock.
Our 2008 capital expenditures budget, which excludes acquisitions, asset retirement costs and capitalized interest, salaries, general and administrative expenses, was approximately $395 million prior to the Bois d'Arc acquisition. After adjusting for the Bois d'Arc acquisition and the impact of the hurricanes, we now expect 2008 capital expenditures to be approximately $425 to $450 million. To the extent that 2008 cash flow from operating activities exceeds our estimated 2008 capital expenditures, we may repurchase shares of common stock or invest in the money markets. If cash flow from operating activities during 2008 is not sufficient to fund estimated 2008 capital expenditures, we believe that our bank credit facility will provide us with adequate liquidity. See "Bank Credit Facility."
Bank Credit Facility. At September 30, 2008, we had $425 million of outstanding borrowings under our bank credit facility and letters of credit totaling $46.1 million had been issued under the facility. On August 28, 2008, we entered into an amended and restated revolving credit facility totaling $700 million, maturing on July 1, 2011, through a syndicated bank group. The new facility has an initial borrowing base of $700 million and replaces the previous $300 million facility. At September 30, 2008, the weighted average interest rate under the credit facility was approximately 5.5%. As of November 3, 2008, after accounting for the $46.1 million of letters of credit, we had $228.9 million of borrowings available under the new credit facility. The facility is required to be guaranteed by all of our material direct and indirect subsidiaries. As of August 28, 2008 the facility is guaranteed by Stone Energy Offshore, L.L.C. ("Stone Offshore"), a wholly owned subsidiary of Stone.
The borrowing base under the credit facility is redetermined semi-annually, in May and November, by the lenders taking into consideration the estimated value of our oil and gas properties and those of our direct and indirect material subsidiaries in accordance with the lenders' customary practices for oil and gas loans. In addition, we and the lenders each have discretion at any time, but not more than two additional times in any calendar year, to have the borrowing base redetermined. The bank group is currently conducting its scheduled November review of the borrowing base.
The credit facility is collateralized by substantially all of Stone's and Stone Offshore's assets. Stone and Stone Offshore are required to mortgage, and grant a security interest in, their oil and gas reserves representing at least 80% of the discounted present value of the future consolidated net income of Stone, Stone Offshore and their material subsidiaries' oil and gas reserves reviewed in determining the borrowing base. At Stone's option, loans under the credit facility will bear interest at a rate based on the adjusted London Interbank Offering Rate plus an applicable margin, or a rate based on the prime rate or Federal funds rate plus an applicable margin. The credit facility provides for optional and mandatory prepayments, affirmative and negative covenants, and interest coverage ratio and leverage ratio maintenance covenants.
Share Repurchase Program. On September 24, 2007, our Board of Directors authorized a share repurchase program for an aggregate amount of up to $100 million. The shares may be repurchased from time to time in the open market or through privately

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negotiated transactions. The repurchase program is subject to business and market conditions, and may be suspended or discontinued at any time. Through September 30, 2008, 100,000 shares had been repurchased under this program at a total cost of $4.2 million.
Contractual Obligations and Other Commitments In June 2008, management approved a commitment to purchase $46 million of long-lead items, mainly tubular goods, to allow for the efficient execution of our drilling program in late 2008 and early 2009. We have paid out approximately $19.5 million to date on these long-lead items, leaving a remaining commitment of $26.5 million. After the closing of the merger with Bois d'Arc, we currently have rig commitments totaling approximately $34.6 million due within six months or less.
Results of Operations
The following tables set forth certain information with respect to our oil and gas operations.

                                                  Three Months Ended
                                                    September 30,
                                                2008             2007           Variance         % Change
Production:
Oil (MBbls)                                         943            1,313             (370 )            (28 %)
Natural gas (MMcf)                                6,213           10,801           (4,588 )            (42 %)
Oil and natural gas (MMcfe)                      11,871           18,679           (6,808 )            (36 %)
Revenue data (in thousands) (a):
Oil revenue                                   $ 100,726        $ 100,759        $     (33 )              -
Natural gas revenue                              66,584           77,653          (11,069 )            (14 %)

Total oil and natural gas revenue             $ 167,310        $ 178,412        $ (11,102 )             (6 %)
Average prices (a):
Oil (per Bbl)                                 $  106.81        $   76.74        $   30.07               39 %
Natural gas (per Mcf)                             10.72             7.19             3.53               49 %
Oil and natural gas (per Mcfe)                    14.09             9.55             4.54               48 %
Expenses (per Mcfe):
Lease operating expenses                      $    3.38        $    2.11        $    1.27               60 %
Salaries, general and administrative
expenses (b)                                       0.88             0.42             0.46              110 %
DD&A expense on oil and gas properties             4.30             3.76             0.54               14 %

(a) Includes the cash settlement of effective hedging contracts.

(b) Exclusive of incentive compensation expense.

                                                  Nine Months Ended
                                                    September 30,
                                                2008             2007           Variance         % change
Production:
Oil (MBbls)                                       3,647            4,691           (1,044 )            (22 %)
Natural gas (MMcf)                               24,631           34,109           (9,478 )            (28 %)
Oil and natural gas (MMcfe)                      46,513           62,255          (15,742 )            (25 %)
Revenue data (in thousands) (a):
Oil revenue                                   $ 380,002        $ 305,516        $  74,486               24 %
Natural gas revenue                             253,503          246,120            7,383                3 %

Total oil and natural gas revenue             $ 633,505        $ 551,636        $  81,869               15 %
Average prices (a):
Oil (per Bbl)                                 $  104.20        $   65.13        $   39.07               60 %
Natural gas (per Mcf)                             10.29             7.22             3.07               43 %
Oil and natural gas (per Mcfe)                    13.62             8.86             4.76               54 %
Expenses (per Mcfe):
Lease operating expenses                      $    2.26        $    2.11        $    0.15                7 %
Salaries, general and administrative
expenses (b)                                       0.69             0.41             0.28               68 %
DD&A expense on oil and gas properties             3.95             3.67             0.28                8 %

(a) Includes the cash settlement of effective hedging contracts.

(b) Exclusive of incentive compensation expense.

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During the third quarter of 2008, net income totaled $34.1 million, or $1.04 per share, compared to $34.1 million, or $1.23 per share for the third quarter of 2007. For the nine months ended September 30, 2008, net income totaled $179.2 million, or $6.02 per share, compared to $116.5 million, or $4.21 per share, during the comparable 2007 period. All per share amounts are on a diluted basis. On August 28, 2008, we completed the acquisition of Bois d'Arc. The revenues and expenses associated with Bois d'Arc have been included in Stone's Condensed Consolidated Financial Statements since August 28, 2008.
We follow the full cost method of accounting for oil and gas properties. During the third quarter of 2008, we recognized a ceiling test write-down of our oil and gas properties in China totaling $8.8 million ($5.7 million after taxes). During the nine months ended September 30, 2008, we recognized a ceiling test write-down of our oil and gas properties in China totaling $18.9 million ($12.3 million after taxes). The write-down did not impact our cash flow from operations but did reduce net income and stockholders' equity.
Included in the nine month 2007 net income is a $55.7 million gain ($36.3 million net of tax) on the sale of our Rocky Mountain Region properties, representing the excess of the proceeds from the sale over the carrying value of the oil and gas properties and other assets sold and transaction costs.
The variance in the three and nine-month periods' results was also due to the following components:
Production. During the third quarter of 2008, total production volumes decreased 36% to 11.9 Bcfe compared to 18.7 Bcfe produced during the third quarter of 2007. Oil production during the third quarter of 2008 totaled approximately 943,000 barrels compared to 1,313,000 barrels produced during the third quarter of 2007, while natural gas production totaled 6.2 Bcf during the third quarter of 2008 compared to 10.8 Bcf produced during the third quarter of 2007. Year-to-date 2008 production totaled 3,647,000 barrels of oil and 24.6 Bcf of natural gas compared to 4,691,000 barrels of oil and 34.1 Bcf of natural gas produced during the comparable 2007 period.
Production rates were negatively impacted during the third quarter of 2008 by Gulf Coast shut-ins due to Hurricanes Gustav and Ike, amounting to volumes of approximately 7.1 Bcfe (77 MMcfe per day). Production rates were negatively impacted during the third quarter of 2007 by extended Gulf Coast shut-ins due to Hurricanes Katrina and Rita, amounting to volumes of approximately 0.9 Bcfe (10 MMcfe per day). Without the effects of hurricane production deferrals, production volumes decreased approximately 0.6 Bcfe for the third quarter of 2008 compared to the comparable 2007 quarter. Slightly offsetting this decrease was production associated with the Bois d'Arc acquisition, which closed on August 28, 2008, totaling approximately 0.6 Bcfe through September 30, 2008. Production deferrals due to hurricanes for the nine months ended September 30, 2008 and 2007, amounted to 7.1 Bcfe (26 MMcfe per day) and 3.1 Bcfe (17 MMcfe per day), respectively. Without the effect of production deferrals, year-to-date 2008 production volumes decreased approximately 11.8 Bcfe from year-to-date 2007 production volumes. The decrease was primarily the result of the sale of substantially all of our Rocky Mountain Region properties on June 29, 2007 and the divestiture of non-core Gulf of Mexico properties in the first quarter of 2008. Rocky Mountain Region production was 6.6 Bcfe for the nine months ended September 30, 2007.
Prices. Prices realized during the third quarter of 2008 averaged $106.81 per Bbl of oil and $10.72 per Mcf of natural gas, or 48% higher, on an Mcfe basis, than third quarter 2007 average realized prices of $76.74 per Bbl of oil and $7.19 per Mcf of natural gas. Average realized prices during the first nine months of 2008 were $104.20 per Bbl of oil and $10.29 per Mcf of natural gas compared to $65.13 per Bbl of oil and $7.22 per Mcf of natural gas realized during the first nine months of 2007. All unit pricing amounts include the cash settlement of effective hedging contracts.
We enter into various hedging contracts in order to reduce our exposure to the possibility of declining oil and gas prices. Our effective hedging transactions decreased our average realized natural gas price by $0.07 per Mcf and decreased our average realized oil price by $16.89 per Bbl in the third quarter of 2008. During the third quarter of 2007, our effective hedging transactions increased our average realized natural gas price by $0.68 per Mcf and decreased our average realized oil price by $0.09 per Bbl. Effective hedging transactions for the first nine months of 2008 decreased our average realized oil price by $11.50 per Bbl and had no impact on average realized natural gas prices. Natural gas prices realized during the first nine months of 2007 were increased by $0.25 per Mcf and oil prices were increased by $0.21 per Bbl as a result of effective hedging transactions.
Income. Third quarter 2008 oil and natural gas revenue totaled $167.3 million, compared to third quarter 2007 oil and natural gas revenue of $178.4 million. The decrease is attributable to a 36% decrease in production volumes slightly offset by a 48% increase in average realized prices on a gas equivalent basis. Year-to-date 2008 oil and natural gas revenue totaled $633.5 million compared to $551.6 million during the comparable 2007 period. The increase was due to a 54% increase in average realized prices on a gas equivalent basis, partially offset by a 25% decline in production volumes. Oil and natural gas revenue related to the properties acquired from Bois d'Arc totaled $4.4 million from August 28, 2008 through September 30, 2008. We sold substantially all of our Rocky Mountain Region properties on June 29, 2007. Rocky Mountain Region oil and natural gas revenue amounted to $47.1 million for the nine months ended September 30, 2007.
Interest income totaled $2.3 million during the third quarter of 2008 compared to $5.3 million during the comparable quarter of 2007 and $10.6 million during the nine months ended September 30, 2008 compared to $6.9 million during the comparable 2007 period. The increase in interest income for the nine months ended September 30, 2008 is the result of an increase in our cash balances

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during the 2008 periods after the sale of substantially all of our Rocky Mountain Region properties in June 2007. During the third quarter of 2008, interest income decreased as a result of a decrease in our cash balances after the acquisition of Bois d'Arc.
During the quarter ended September 30, 2008, as a result of extended shut-ins of production after Hurricanes Gustav and Ike, our September 2008 crude oil and natural gas production levels were below the volumes that we had hedged. Consequently, some of our crude oil and natural gas hedges for the month of September 2008 were deemed to be ineffective. Net derivative income for the quarter ended September 30, 2008, totaled $5.0 million, consisting of $0.7 million of cash settlements on the ineffective derivative contracts, $5.3 million of changes in the fair market value of the ineffective portion of . . .