The following discussion is intended to assist you in understanding our business and results of operations together with our present financial condition. This section should be read in conjunction with Item 6, "Selected Financial Data" and our consolidated financial statements and the accompanying notes included elsewhere in this Form 10-K.
Statements in our discussion may be forward-looking. These forward-looking statements involve risks and uncertainties. We caution that a number of factors could cause future production, revenues and expenses to differ materially from our expectations. See "Disclosures Regarding Forward-Looking Statements" at the beginning of this Annual Report and "Risk Factors" in Item 1A for additional discussion of some of these factors and risks. Overview of Our Business
We are an independent oil and gas company engaged in the exploration, development and acquisition of oil and gas properties, primarily in the Southwestern, Appalachian and Gulf Coast regions of the United States. We operate in one segment. We have a single company-wide management team that administers all properties as a whole rather than by discrete operating segments. We track only basic operational data by area. We do not maintain complete separate financial statement information by area. We measure financial performance as a single enterprise and not on an area-by-area basis.
Our strategy is to increase reserves and production through internally generated drilling projects coupled with complementary acquisitions. Our revenues, profitability and future growth depend substantially on prevailing prices for oil and gas and on our ability to find, develop and acquire oil and gas reserves that are economically recoverable. We use the successful efforts method of accounting for our oil and gas activities. Our corporate headquarters are in Fort Worth, Texas.
Industry Environment
We operate entirely within the United States, a mature region for the exploration and production of oil and gas. Although new discoveries of oil and gas occur in the United States, because it is a mature region, the size and frequency of these discoveries is generally declining, while finding and development costs are increasing. We believe that there remain areas of the United States, such as the Appalachian Basin and certain areas in our Southwest and Gulf Coast Areas that are underexplored or have not been fully explored and developed with the benefit of newly available exploration and production reservoir enhancement technology. Examples of such technology include advanced 3-D seismic processing, hydraulic reservoir fracture stimulation, advances in well logging and analysis, horizontal drilling and completion techniques, secondary and tertiary recovery practices, and automated remote well monitoring and control devices.
Oil and gas are commodities. The price that we receive for the natural gas we produce is largely a function of market supply and demand. Demand for natural gas in the United States increased dramatically during this decade; however, the current economic slowdown has reduced this demand over the second half of 2008 and is continuing into 2009. Demand is impacted by general economic conditions, weather and other seasonal conditions, including hurricanes and tropical storms. Over or under supply of natural gas can result in substantial price volatility. Historically, commodity prices have been volatile and we expect the volatility to continue in the future. Factors impacting the future supply balance are the growth in domestic gas production and the increase in the United States LNG import capacity. Significant LNG capacity increases have been announced which may allow for more LNG imports resulting in increased price volatility. A substantial or extended decline in oil and gas prices or poor drilling results could have a material adverse effect on our financial position, results of operations, cash flows, quantities of oil and gas reserves that may be economically produced and our ability to access capital markets.
Realized oil and gas average prices increased from 2007 to 2008. As a result of narrowing excess worldwide capacity, weakness in the dollar, and continuing tension in the Middle East, oil reached a record price of $147.00 per Bbl in July 2008. However, rising crude oil supplies, the tightened credit markets and lower demand in the slowing U.S and global economies have caused recent oil prices to decline. Oil prices are expected to remain volatile. Although our average realized price (including all derivative settlements) received for oil and gas was $8.58 per mcfe in the year ended December 31, 2008, prices were bolstered by record oil prices in the first half of the year. In fourth quarter 2008, our average realized price (including all derivative settlements) declined to $6.86 per mcfe. In a trend that began in the fourth quarter of 2008 and has continued into 2009, the industry has experienced deteriorating basis differentials in the Midcontinent and West Texas areas primarily caused by an over-supply of gas in these regions.

Capital Budget for 2009
Our capital budget for 2009 is currently set at $700.0 million, excluding acquisitions. The 2009 capital budget is less than the 2008 capital spending levels due to lower expected operating cash flows resulting from declining oil and gas prices. For 2009, we expect our cash flow to fund our capital budget. As has been our historical practice, we will periodically review our capital expenditures throughout the year and adjust the budget based on commodity prices and drilling success.
Source of Our Revenues
We derive our revenues from the sale of oil and gas that is produced from our properties. Revenues are a function of the volume produced, the prevailing market price at the time of sale, quality, Btu content and transportation costs to market. Production volumes and the price of oil and gas are the primary factors affecting our revenues. To achieve more predictable cash flows and to reduce our exposure to downward price fluctuations, we use derivative instruments to hedge future sales prices on a significant portion of our gas and oil production. During 2008 and 2006, the use of derivative instruments prevented us from realizing the full benefit of upward price movements and may do so in future periods. Our average realized price calculations (including all derivative settlements) include both the effects of the settlement of derivative contracts that are accounted for as hedges and the settlement of derivative contracts that are not accounted for as hedges. Principal Components of Our Cost Structure
• Direct Operating Expenses. These are day-to-day costs incurred to bring hydrocarbons out of the ground and to the market together with the daily costs incurred to maintain our producing properties. Such costs also include maintenance, repairs and workovers expenses related to our oil and gas properties. These costs are expected to moderate in 2009 as we expect industry demand for these services to decline. Direct operating expenses also include stock-based compensation expense (non-cash) associated with equity grants of stock appreciation rights (SARs) and the amortization of restricted stock grants as part of employee compensation.

• Production and Ad Valorem Taxes. Production taxes are paid on produced oil and gas based on a percentage of market prices (not hedged prices) or at fixed rates established by federal, state or local taxing authorities. Ad valorem taxes are taxes generally based on reserve values at the end of each year.

• Exploration Expense. These are geological and geophysical costs, including payroll and benefits for the geological and geophysical staff, seismic costs, delay rentals and the costs of unsuccessful exploratory dry holes. Exploration expense includes stock-based compensation expense (non-cash) associated with equity grants of SARs and the amortization of restricted stock grants as part of employee compensation.

• General and Administrative Expense. These costs include overhead, including payroll and benefits for our corporate staff, costs of maintaining our headquarters, costs of managing our production and development operations, franchise taxes, audit and other professional fees and legal compliance are included in general and administrative expense. General and administrative expense includes stock-based compensation expense (non-cash) associated with equity grants of SARs and the amortization of restricted stock grants as part of employee compensation.

• Abandonment and impairment of unproved properties. This category includes unproved property impairment and costs associated with lease expirations.

• Interest. We typically finance a portion of our working capital requirements and acquisitions with borrowings under our bank credit facility and with our longer-term debt securities. As a result, we incur substantial interest expense that is affected by both fluctuations in interest rates and our financing decisions. We will likely continue to incur significant interest expense as we continue to grow. We expect our 2009 capital budget to be funded primarily with internal cash flow.

• Depreciation, Depletion and Amortization. This includes the systematic expensing of the capitalized costs incurred to acquire, explore and develop gas and oil. As a successful efforts company, we capitalize all costs associated with our acquisition and development efforts and all successful exploration efforts, and apportion these costs to each unit of production through depreciation, depletion and amortization expense. This expense also includes the systematic, monthly accretion of the future abandonment costs of tangible assets such as wells, service assets, pipelines, and other facilities.

• Income Taxes. We are subject to state and federal income taxes but are currently not in a tax paying position for regular federal income taxes, primarily due to the current deductibility of intangible drilling costs ("IDC"). We do pay some state income taxes where our IDC deductions do not exceed our taxable income or where state income taxes are determined on another basis. Currently, substantially all of our federal taxes are deferred; however, at some point, we anticipate using all of our net operating loss carryforwards and we will recognize current income tax expense and continue to recognize current tax expense as long as we are generating taxable income.

Management's Discussion and Analysis of Income and Operations Overview of 2008 Results
During 2008, we achieved the following results:
• Achieved 21% production growth and 19% reserve growth;

• Drilled 490 net wells with a 98% success rate;

• Continued expansion of emerging plays;

• Posted record financial results and maintained a strong balance sheet;

• Completed acquisitions of properties containing 95.6 Bcfe of proved reserves; and

• Completed $68.2 million of asset sales.

Our 2008 performance reflects another year of successfully executing our strategy of growth through drilling supplemented by complementary acquisitions. The business of exploring for, developing, and acquiring oil and gas is highly competitive and capital intensive. As in any commodity business, the costs associated with finding, acquiring, extracting, and financing our operations are critical to profitability and long-term value creation for stockholders. Generating meaningful growth while containing costs presents an ongoing challenge. During the recent period of historically high oil and gas prices, drilling service and operating costs generally increased due to increased competition for goods and services. Prices for oil and gas dramatically declined in the last half of 2008 and we are presently experiencing reductions in service costs which vary by region. We faced other challenges in 2008 including attracting and retaining qualified personnel, consummating and integrating acquisitions, accessing the capital markets to fund our growth on sufficiently favorable terms and introducing new oil and gas extraction technologies into new regions and projects such as the Pennsylvania Marcellus Shale. We have continued to expand and improve the technical staff through the hiring of additional experienced professionals. Our inventory of exploration and development prospects continues to be strong, providing new growth opportunities, greater diversification of technical risk and better efficiency.
Total revenues increased 53% in 2008 over the same period of 2007. This increase is due to higher production and higher realized oil and gas prices. Our 2008 production growth is due to the continued success of our drilling program and to acquisitions completed in 2006 and 2007. Average realized prices (including all derivative settlements) were 7% higher in 2008, although realized prices declined sharply in the last half of 2008. As discussed in Item 1A of this report, significant changes in oil and gas prices can have a material impact on our balance sheet and our results of operations, including the fair value of our derivatives.
All of our expenses have increased on both an absolute and per mcfe basis when compared to 2007, due to higher overall industry costs, higher compensation expense resulting from additional employees, increased salaries and higher levels of activity. While overall costs were higher, the rate of inflation experienced in our industry has moderated for some goods and services as commodity prices weakened. The availability of goods and services continues to be mixed, based on region and service company expertise. We continue to experience competition for technical and experienced personnel and overall compensation inflation in our industry has moderated. It is difficult for us to forecast price trends, supply, service or personnel availability, any of which, if changed in an adverse manner, would significantly impact both operating costs and capital expenditures. As we continue to have Marcellus wells shut-in waiting on pipeline and processing facilities and we continue to expand our Marcellus operating team to meet the needs of this developing asset, we expect to see continued upward pressure on our cost structure. The initial phase of the pipeline and processing infrastructure was completed in fourth quarter 2008 with additional expansions set for 2009 and later.

Oil and Gas Sales, Production and Realized Price Calculations Our oil and gas sales vary from year to year as a result of changes in realized commodity prices and production volumes. Hedges included in oil and gas sales reflect settlements on those derivatives that qualify for hedge accounting. Cash settlement of derivative contracts that are not accounted for as hedges are included in the income statement caption called "Derivative fair value income (loss)." Oil and gas sales increased 42% from 2007 due to a 21% increase in production and a 17% increase in realized prices. Oil and gas sales in 2007 increased 44% from 2006 due to a 22% increase in production and an 18% increase in realized prices. The following table illustrates the primary components of oil and gas sales for each of the last three years (in thousands):

                                         2008           2007          2006
            Oil and Gas Sales
            Oil wellhead              $   298,482     $ 226,686     $ 189,516
            Oil hedges realized           (72,135 )     (23,755 )     (45,265 )

            Total oil revenue         $   226,347     $ 202,931     $ 144,251


            Gas wellhead              $   923,160     $ 585,538     $ 466,099
            Gas hedges realized             8,561        27,916       (47,916 )

            Total gas revenue         $   931,721     $ 613,454     $ 418,183


            Total NGL revenue         $    68,492     $  46,152     $  36,705


            Combined wellhead         $ 1,290,134     $ 858,376     $ 692,320
            Combined hedges               (63,574 )       4,161       (93,181 )

            Total oil and gas sales   $ 1,226,560     $ 862,537     $ 599,139

Our production continues to grow through drilling success as we place new wells into production and through additions from acquisitions, partially offset by the natural decline of our oil and gas wells and asset sales. For 2008, our production volumes increased 18% in our Appalachia Area, increased 22% in our Southwest Area and increased 61% in our Gulf Coast Area. For 2007, our production volumes increased 15% in our Appalachia Area, increased 28% in our Southwest Area and declined 17% in our Gulf Coast Area. For 2006, our production volumes increased 10% in our Appalachia Area, increased 29% in our Southwest Area and declined 36% in our Gulf Coast Area. Our production for each of the last three years is set forth in the following table:

                                      2008              2007              2006
       Production
       Crude oil (bbls)               3,084,529         3,359,668        3,039,150
       NGLs (bbls)                    1,385,701         1,114,730        1,091,785
       Natural gas (mcf)            114,323,436        89,594,626       70,712,770
       Total (mcfe) (a)             141,144,816       116,441,014       95,498,380

       Average daily production
       Crude oil (bbls)                   8,428             9,205            8,326
       NGLs (bbls)                        3,786             3,054            2,991
       Natural gas (mcf)                312,359           245,465          193,734
       Total (mcfe) (a)                 385,642           319,016          261,639

(a) Oil and NGLs are converted to mcfe at the rate of one barrel equals six mcf.

Our average realized price (including all derivative settlements) received for oil and gas during 2008 was $8.58 per mcfe compared to $8.02 per mcfe in 2007 and $6.80 per mcfe in 2006. Our average realized price (including all derivative settlements) calculation includes all cash settlements for derivatives, whether or not they qualify for hedge accounting. Average price calculations for each of the last three years is shown below:

                                                             2008             2007             2006
Average Prices
Average sales prices (wellhead):
Crude oil (per bbl)                                       $  96.77          $ 67.47          $ 62.36
NGLs (per bbl)                                            $  49.43          $ 41.40          $ 33.62
Natural gas (per mcf)                                     $   8.07          $  6.54          $  6.59
Total (per mcfe) (a)                                      $   9.14          $  7.37          $  7.25

Average realized prices (including derivatives that
qualify for hedge accounting):
Crude oil (per bbl)                                       $  73.38          $ 60.40          $ 47.46
NGLs (per bbl)                                            $  49.43          $ 41.40          $ 33.62
Natural gas (per mcf)                                     $   8.15          $  6.85          $  5.91
Total (per mcfe) (a)                                      $   8.69          $  7.41          $  6.27

Average realized prices (including all derivative
settlements):
Crude oil (per bbl)                                       $  68.20          $ 60.16          $ 47.46
NGLs (per bbl)                                            $  49.43          $ 41.40          $ 33.62
Natural gas (per mcf)                                     $   8.15          $  7.66          $  6.62
Total (per mcfe) (a)                                      $   8.58          $  8.02          $  6.80

Average NYMEX prices (b):
Crude oil (per bbl)                                       $ 100.47          $ 72.34          $ 66.22
Natural gas (per mcf)                                     $   8.91          $  6.92          $  7.26

(a) Oil and NGLs are converted at the rate of one barrel equals six mcf.

(b) Based on average of bid week prompt month prices.

Derivative fair value income (loss) increased to a gain of $70.1 million in 2008 compared to a loss of $7.8 million in 2007 and a gain of $142.4 million in 2006. Some of our derivatives do not qualify for hedge accounting but are, to a degree, an economic offset to our commodity price exposure. These contracts are accounted for using the mark-to-market accounting method whereby all realized and unrealized gains and losses related to these contracts are included in "Derivative fair value income (loss)" in the revenue section of our statement of operations. Mark-to-market accounting treatment creates volatility in our revenues as gains and losses from derivatives are included in total revenues and are not included in our balance sheet in "Accumulated other comprehensive income
(loss)." As commodity prices increase or decrease, such changes will have an opposite effect on the mark-to-market value of our derivatives. Because oil and gas prices declined dramatically in the last half of 2008, our derivatives became comparatively more valuable. However, we expect these gains will be offset by lower wellhead revenues in the future. We have also entered into basis swap agreements to limit volatility caused by changing differentials between index and regional prices received. Basis swaps do not qualify for hedge accounting purposes and are marked to market. Hedge ineffectiveness, also included in "Derivative fair value income (loss)," is associated with our hedging contracts that qualify for hedge accounting under SFAS No. 133. The following table presents information about the components of derivative fair value income (loss) for each of the years in the three-year period ended December 31, 2008 (in thousands):

                                                          2008             2007             2006
Change in fair value of derivatives that do not
qualify for hedge accounting (a)                        $  83,867        $ (78,769 )      $  86,491
Realized (loss) gain on settlements - gas (b) (c)          (1,383 )         71,098           49,939
Realized loss on settlements - oil (b) (c)                (15,431 )           (244 )              -
Hedge ineffectiveness - realized (c)                        1,386              968                -
- unrealized (a)                                            1,696             (820 )          5,965

Derivative fair value income (loss)                     $  70,135        $  (7,767 )      $ 142,395

(a) These amounts are unrealized and are not included in average sales price calculations.

(b) These amounts represent realized gains and losses on settled derivatives that do not qualify for hedge accounting.

(c) These settlements are included in average realized price calculations (including all derivative settlements).

Other revenue increased in 2008 to $21.7 million compared to $5.0 million in 2007 and $856,000 in 2006. The 2008 period includes a $20.2 million gain on the sale of assets and a loss from equity method investments of $218,000. The 2007 period includes income from equity method investments of $974,000 and other miscellaneous income. The 2006 period includes income from equity method investments of $548,000.
Our costs have increased as we continue to grow. We believe some of our expense fluctuations are best analyzed on a unit-of-production, or per mcfe, basis. The following presents information about certain of our expenses on a per mcfe basis for 2008, 2007 and 2006.

                                         Year Ended                                              Year Ended
                       2008          2007         Change       % Change        2007          2006         Change        % Change
Direct operating
expense              $ 1.01        $ 0.92        $ 0.09            10 %      $ 0.92        $ 0.85        $  0.07             8 %
Production and
ad valorem tax
expense                0.39          0.36          0.03             8 %        0.36          0.38          (0.02 )           5 %
General and
administrative
expense                0.65          0.60          0.05             8 %        0.60          0.52           0.08            15 %
Interest expense       0.71          0.67          0.04             6 %        0.67          0.58           0.09            15 %
Depletion,
depreciation and
amortization
expense                2.12          1.89          0.23            12 %        1.89          1.62           0.27            17 %

Direct operating expense was $142.4 million in 2008 compared to $107.5 million in 2007 and $81.3 million in 2006 due to higher oilfield service costs and higher volumes. Our operating expenses are increasing as we add new wells from development and acquisitions and maintain production from our existing properties. We incurred $9.9 million of workover costs in 2008 compared to $7.1 million in 2007 and $3.5 million in 2006. On a per mcfe basis, direct operating expenses for 2008 increased $0.09 or 10% from the same period of 2007 with the increase consisting primarily of higher workover costs ($0.01 per mcfe), higher personnel and related costs ($0.02 per mcfe) along with higher equipment leasing costs ($0.02 per mcfe) and higher overall industry costs. On a per mcfe basis, direct operating expenses for 2007 increased $0.07 or 8% from the same period of 2006 with the increase consisting primarily of higher workover costs ($0.02 per mcfe), higher water disposal costs ($0.02 per mcfe), higher well services and equipment costs ($0.04 per mcfe) and a $0.01 per mcfe increase in stock-based compensation. Stock-based compensation expense represents the amortization of our grants of restricted stock and SARs as part of employee compensation. The following table summarizes direct operating expenses per mcfe for 2008, 2007 and 2006:

                                                       Year Ended                                        Year Ended
                                                                              %                                                 %
                                       2008        2007       Change       Change        2007        2006       Change        Change
Lease operating expense               $ 0.92      $ 0.84      $  0.08           10 %    $ 0.84      $ 0.80      $  0.04             5 %
Workovers                               0.07        0.06         0.01           17 %      0.06        0.04         0.02            50 %
Stock-based compensation (non-cash)     0.02        0.02            -            - %      0.02        0.01         0.01           100 %

Total direct operating expenses       $ 1.01      $ 0.92      $  0.09           10 %    $ 0.92      $ 0.85      $  0.07             8 %

Production and ad valorem taxes are paid based on market prices and not hedged prices. These costs were $55.2 million in 2008 compared to $42.4 million in 2007 and $36.4 million in 2006. On a per mcfe basis, production and ad valorem taxes increased to $0.39 in 2008 from $0.36 in the same period of 2007, primarily due to a 24% increase in pre-hedge prices. On a per mcfe basis, . . .