significant decreases in drilling expenditures in all three of these areas are anticipated for the remainder of fiscal 2009. The Company is currently experiencing fewer wells being drilled on its acreage elsewhere in the mid-continent area.
The industry-wide decline in drilling activity has also created downward pressure on the costs for drilling rigs, well equipment, and well services; which is expected to reduce the overall costs of drilling and completing wells. Nationwide, as lower prices continue to put downward pressure on drilling activity, and the resulting production declines occur, natural gas prices are expected to increase.
The Company historically funded capital additions, overhead costs and dividend payments primarily from operating cash flow. However, due to the sharp decrease in oil and natural gas prices and the increased expenditures for drilling in the last two years, the Company has utilized its revolving line-of-credit facility to help fund these expenditures. The Company's continued drilling activity, combined with normal delays in receiving first payments from new production and reduced product prices, could result in significantly increased borrowings under the Company's credit facility. However, the Company currently has several wells that have been recently completed which will provide significant cash flow during both the second and third quarters of fiscal 2009 as the first payments (which will cover 4 to 6 months of production) on these wells are received. The Company has availability under its restructured revolving credit facility and also is well within compliance on its debt covenants (current ratio, debt to EBITDA, tangible net worth and dividends as a percent of operating cash flow). Therefore, the Company believes the availability could be increased, if needed, by placing more of the Company's properties as security under the revolving credit facility.
RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 2008 - COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2007
Overview:
The Company recorded a first quarter 2009 net loss of $874,629, or $.10 per share, as compared to a net income of $3,480,307 or $.41 per share in the 2008 quarter.
Revenues:
Total revenues were down $2,384,101 or 17% for the 2009 quarter, primarily the result of a $2,609,430 decline in oil and natural gas sales. This sales decline was due to decreases in natural gas and oil sales prices of 37% and 40%, respectively, and a decline in oil sales volume of 18% partially offset by a 44% increase in natural gas sales volume. Gains on natural gas collar contracts resulted in a revenue increase of $129,221 compared to the 2008 quarter. The table below outlines the Company's production and average sales prices for oil and natural gas for the three month periods of fiscal 2009 and 2008:

                                 BARRELS      AVERAGE         MCF         AVERAGE        MCFE
                                   SOLD        PRICE         SOLD          PRICE         SOLD
  Three months ended 12/31/08     30,260     $ 51.80       2,313,739      $ 3.91       2,495,299
  Three months ended 12/31/07     36,721     $ 86.40       1,610,880      $ 6.24       1,831,206

Increased natural gas production is the result of continued drilling success in the southeast Oklahoma Woodford Shale area, the Fayetteville Shale area in Arkansas and the western Oklahoma Dill City area. The decrease in oil production is the result of natural decline on older wells as the Company's drilling focus is primarily for natural gas reserves. During the first quarter of fiscal 2009, the Company had several new wells that were completed and put on line, and had several more wells that were in the process of being completed. Expectations are that the production from these new wells will result in an increase in natural gas production for the second quarter of fiscal 2009 compared to the first quarter of 2009. As drilling is anticipated to continue, although at a significantly reduced rate compared to fiscal 2008, in the three core areas of the Woodford Shale, the Fayetteville Shale and the Dill City project, the Company expects additional new production to more than replace the decline in production of older wells.

Production for the last five quarters was as follows:

               Quarter ended    Barrels Sold      MCF Sold          MCFE
                 12/31/08            30,260       2,313,739       2,495,299
                  9/30/08            31,375       1,995,333       2,183,583
                  6/30/08            31,907       1,788,462       1,979,904
                  3/31/08            32,399       1,533,363       1,727,757
                 12/31/07            36,721       1,610,880       1,831,206

Gains on Natural Gas Collar Contracts:
At December 31, 2008, the Company's fair value of derivative contracts was $-0- (all of the Company's derivative contracts in place expired as of December 31, 2008); whereas at September 30, 2008, the Company's fair value of derivative contracts was an asset of $646,193. The Company recorded a gain during the fiscal 2009 first quarter of $393,007 as compared to a gain of $263,786 for the fiscal 2008 quarter. See the table under "NOTE 10: Derivatives" for a breakdown of the realized and unrealized gains and losses on derivative contracts in place during the quarters ended December 31, 2008 and 2007. Lease Operating Expenses (LOE):
LOE increased $404,242 or 30% in the 2009 quarter as compared to the 2008 quarter, while LOE per mcfe decreased in the 2009 quarter to $.70 per mcfe from $.73 per mcfe in the 2008 quarter. The total LOE increase is the result of new wells coming on line during the year. The decrease on a per mcfe basis is due to the decrease in natural gas sales prices resulting in lower "value based" fees (primarily gathering and marketing costs) which are charged as a percent of natural gas sales, combined with declining prices for field services and supplies.
Production Taxes:
Production taxes decreased $422,856 or 51% in the 2009 quarter as compared to the 2008 quarter. The decline in production tax expense is the result of qualifying for production tax credits on horizontal wells drilled in the southeast Oklahoma Woodford Shale. The state of Oklahoma offers a refund on horizontally drilled wells of nearly all production taxes paid for the first four years of production or until well payout occurs, whichever comes first. The decrease also relates to the increasing number of Arkansas Fayetteville Shale wells coming on line as compared to a year ago. Such carry a production tax rate of $.012 per mcf produced. The combined result is a decrease in the severance tax rate as a percentage of oil and natural gas sales from 6.3% in the 2008 quarter to 3.9% in the 2009 quarter. As horizontally drilled wells coming on line in the Woodford Shale (all of which qualify for the production tax credits) have become a more significant part of the Company's production, production tax expense as a percentage of oil and natural gas sales has continued to decline. Exploration Costs:
Exploration costs decreased $37,716 in the 2009 quarter as compared to the 2008 quarter. Leasehold expiration and abandonment costs were $148,018 for the 2009 quarter as compared to $214,293 for the 2008 quarter. One exploratory dry hole was drilled in the 2009 quarter at a cost of $24,247. No dry holes were drilled in the 2008 quarter; however, credits in the amount of $4,312 were recorded in the 2008 quarter on one previously drilled dry hole. Depreciation, Depletion and Amortization (DD&A):
DD&A increased $2,693,482 or 63% in the 2009 quarter. DD&A in the 2009 quarter was $2.79 per mcfe as compared to $2.32 per mcfe in the 2008 quarter. The overall increase is the result of increased production volumes in the 2009 quarter over the 2008 quarter. The increase in the DD&A rate per mcfe is due to increased costs of drilling and completing new wells during recent years. Provision for Impairment:
The provision for impairment increased $1,753,911 in the 2009 quarter as compared to the 2008 quarter. Driven by depressed oil and natural gas prices, impairment was recorded on 16 fields during the 2009 quarter in the amount of $1,875,920. Two of the fields accounted for $1,729,034 of the impairment, one field in Wheeler County, Texas consisting of one deep well (drilled in 2006 and had mechanical issues during completion which dramatically increased costs) was impaired $1,070,129 and one mature field in Beckham County, Oklahoma principally consisting of wells drilled in 2006 and prior was impaired $658,905. The Company did not incur any impairment in the three primary areas of operation (Woodford Shale area, Fayetteville Shale area and Dill City project). During the 2008 quarter, 4 fields were impaired a total of $122,009.

General and Administrative Costs (G&A):
G&A decreased $377,882 or 24% in the 2009 quarter as compared to the 2008 quarter due to decreased personnel related costs of approximately $443,000, which included a decrease in employee bonus costs of approximately $500,000 in the 2009 quarter (the result of beginning to ratably accrue for estimated 2008 annual employee bonuses during the 2008 quarter due to specific bonus performance criteria being established plus recording the full 2007 annual bonuses approved and paid during the 2008 quarter), partially offset by overall increases in several other G&A categories. Income Taxes:
The provision for income taxes for the 2009 quarter decreased $1,998,000 due to a sharp decrease in income before provision for income taxes of $6,352,936 in the 2009 quarter as compared to the 2008 quarter. The resulting effective tax rate in the 2009 quarter was 17% as compared to an effective tax rate of 34% in the 2008 quarter. The Company's utilization of excess percentage depletion (which is a permanent tax benefit) reduced taxable income a greater proportion during the 2009 quarter as compared to the 2008 quarter. This greater proportional effect in the 2009 quarter resulted in a significantly lower effective tax rate than in the 2008 quarter.
CRITICAL ACCOUNTING POLICIES
Preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. However, the accounting principles used by the Company generally do not change the Company's reported cash flows or liquidity. Generally, accounting rules do not involve a selection among alternatives, but involve a selection of the appropriate policies for applying the basic principles. Interpretation of the existing rules must be done and judgments made on how the specifics of a given rule apply to the Company.
The more significant reporting areas impacted by management's judgments and estimates are crude oil and natural gas reserve estimation, impairment of assets, oil and natural gas sales revenue accruals and provision for income tax. Management's judgments and estimates in these areas are based on information available from both internal and external sources, including engineers, geologists, consultants and historical experience in similar matters. Actual results could differ from the estimates as additional information becomes known. The oil and natural gas sales revenue accrual is particularly subject to estimates due to the Company's status as a non-operator on all of its properties. Production information obtained from well operators is substantially delayed. This causes the estimation of recent production, used in the oil and natural gas revenue accrual, to be subject to some variations. Oil and Natural Gas Reserves
Management considers the estimation of crude oil and natural gas reserves to be the most significant of its judgments and estimates. These estimates affect the unaudited standardized measure disclosures, as well as DD&A and impairment calculations. Changes in crude oil and natural gas reserve estimates affect the Company's calculation of depreciation, depletion and amortization, provision for abandonment and assessment of the need for asset impairments. On an annual basis, with a semi-annual update, the Company's consulting engineer, with assistance from Company geologists, prepares estimates of crude oil and natural gas reserves based on available geologic and seismic data, reservoir pressure data, core analysis reports, well logs, analogous reservoir performance history, production data and other available sources of engineering, geological and geophysical information. However, when significant oil and natural gas price changes occur between periods in which reserves would normally be calculated, the Company updates the reserve calculations utilizing a price deck current with the period (re-engineering is not performed, only the updated price deck is used to assess the economic lives of the wells). For instance, reserves for the quarter ended December 31, 2008 were updated due to significant changes in the prices of oil and natural gas since September 30, 2008. Both DD&A and impairment were calculated in the 2009 quarter based on these updated reserve calculations. As required by the guidelines and definitions established by the SEC, these estimates are based on current crude oil and natural gas pricing. Crude oil and natural gas prices are volatile and largely affected by worldwide production and consumption and are outside the control of management. Projected future crude oil and natural gas pricing assumptions are used by management to prepare estimates of crude oil and natural gas reserves used in formulating management's overall operating decisions in the exploration and production segment. Based on the Company's fiscal 2008 DD&A, a 10% change in the DD&A rate per mcfe would result in a corresponding $1,978,466 annual change in DD&A expense.

Successful Efforts Method of Accounting
The Company has elected to utilize the successful efforts method of accounting for its oil and natural gas exploration and development activities. Exploration expenses, including geological and geophysical costs, rentals and exploratory dry holes, are charged against income as incurred. Costs of successful wells and related production equipment and developmental dry holes are capitalized and amortized by property using the unit-of-production method as oil and natural gas is produced. The Company's exploratory wells are all on-shore and primarily located in the mid-continent area. Generally, expenditures on exploratory wells comprise less than 10% of the Company's total expenditures for oil and natural gas properties. This accounting method may yield significantly different operating results than the full cost method. Impairment of Assets
All long-lived assets, principally oil and natural gas properties, are monitored for potential impairment when circumstances indicate that the carrying value of the asset may be greater than its estimated future net cash flows. The evaluations involve significant judgment since the results are based on estimated future events, such as inflation rates, future sales prices for oil and natural gas, future production costs, estimates of future oil and natural gas reserves to be recovered and the timing thereof, the economic and regulatory climates and other factors. The Company estimates future net cash flows on its oil and natural gas properties utilizing differentially adjusted forward pricing curves for both oil and natural gas and a discount rate in line with the discount rate used by the Company's bank to evaluate its properties. The need to test a property for impairment may result from significant declines in sales prices or unfavorable adjustments to oil and natural gas reserves. A further reduction in oil and natural gas prices or a decline in reserve volumes (which are re-evaluated semi-anually) could lead to additional impairment that may be material to the Company. Any assets held for sale are reviewed for impairment when the Company approves the plan to sell. Estimates of anticipated sales prices are highly judgmental and subject to material revision in future periods. Because of the uncertainty inherent in these factors, the Company cannot predict when or if future impairment charges will be recorded. Oil and Natural Gas Sales Revenue Accrual The Company does not operate any of its oil and natural gas properties. Drilling in the last two years has resulted in adding numerous wells with significantly larger interests, thus increasing the Company's production and revenue. On many of these wells the most current available production data is gathered from the appropriate operators and oil and natural gas index prices local to each well are used to more accurately estimate the accrual of revenue on these wells. Timely obtaining production data on all other wells from the operators is not feasible; therefore, the Company utilizes past production receipts and estimated sales price information to estimate its accrual of revenue on all other wells each quarter. The oil and natural gas sales revenue accrual can be impacted by many variables including rapid production decline rates, production curtailments by operators, the shut-in of wells with mechanical problems and rapidly changing market prices for oil and natural gas. These variables could lead to an over or under accrual of oil and natural gas sales at the end of any particular quarter. Based on past history, the Company's estimated accrual has been materially accurate. Income Taxes
The estimation of the amounts of income tax to be recorded by the Company involves interpretation of complex tax laws and regulations as well as the completion of complex calculations, including the determination of the Company's percentage depletion deduction, if any. The excess percentage depletion calculation during interim periods represents a high-level estimate as the actual well-by-well calculation required cannot be performed until the end of the fiscal year. Although the Company's management believes its tax accruals are adequate, differences may occur in the future depending on the resolution of pending and new tax matters.
The above description of the Company's critical accounting policies is not intended to be an all-inclusive discussion of the uncertainties considered and estimates made by management in applying accounting principles and policies. Results may vary significantly if different policies were used or required and if new or different information becomes known to management.