Forward-Looking Statements
This report includes "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. All statements other than statements of historical facts included in this report, including statements regarding our financial position, adequacy of resources, estimated reserve quantities, business strategies, plans, objectives and expectations for future operations and covenant compliance, are forward-looking statements. We can give no assurances that the assumptions upon which such forward-looking statements are based will prove to have been correct. Important factors that could cause actual results to differ materially from our expectations ("Cautionary Statements") are disclosed in the section entitled "Risk Factors" included in our Annual Report on Form 10-K for our most recent fiscal year, elsewhere in this report and from time to time in other filings made by us with the Securities and Exchange Commission. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified by the Cautionary Statements. General
The following discussion is intended to assist in an understanding of our financial condition and results of operations. Our consolidated financial statements and notes thereto contain detailed information that should be referred to in conjunction with the following discussion. See Item 8 "Financial Statements and Supplementary Data."
We have been engaged in the exploration, development, acquisition and production of oil and gas properties since 1950. In the past several years, our activities have been focused in the shelf and deepwater areas of the Gulf of Mexico. Production from wells in this area is characterized by high initial production rates and steep decline curves. Accordingly, we are required to make material expenditures to purchase proved oil and gas reserves and to explore for and discover reserves to replace those produced.
Disruptions in Capital Markets. The capital markets are experiencing significant disruptions, and many financial institutions have liquidity concerns, prompting government intervention to mitigate pressure on the credit markets. Our primary exposure to the current credit market crisis includes our senior secured credit facility, 9.75% senior notes due December 2010 and counterparty nonperformance risks.
Our senior secured credit facility was committed in the amount of $70 million as of December 31, 2008. Subsequent to December 31, 2008, our borrowing base redetermination was completed and reduced to $48 million due to lower commodity prices and reserves. In addition, a Monthly Commitment Reduction ("MCR") was implemented commencing June 1, 2009 in the amount of $4.33 million per month. As of August 1, 2009, we received a preliminary notice that our redetermined borrowing base would be approximately $35.0 million with the MCR increasing to approximately $4.7 million. If not extended, the senior secured credit facility matures in September 25, 2012. Should current credit market tightening be prolonged for several years, future extensions of our senior secured credit facility may contain terms that are less favorable than those of our current credit facility. The amounts which may be outstanding under our senior secured credit facility are limited by a borrowing base, which is established by our lenders and based on the value of our proved reserves using prices, costs and

other assumptions determined by our lenders. Continued disruptions in the capital markets could cause our lenders to be more restrictive in calculating our borrowing base. See Note 4 to the Consolidated Financial Statements. We have outstanding $200 million of 9.75% senior notes due in December 2010. We are actively evaluating several options for a restructuring of our balance sheet and are hopeful to achieve resolution before our 9.75% senior notes become a current liability in December 2009. No assurances can be made as to the results of these efforts. Continued disruptions in the capital markets could make it more difficult or expensive to refinance or restructure these notes when they come due.
Current market conditions also elevate the concern over counterparty risks related to our commodity derivative contracts and trade credit. At June 30, 2009, our open commodity derivative instruments were in a net receivable position with a fair value of $7.0 million. All of our commodity derivative instruments are with a major financial institution. Should the financial counterparty not perform, we may not realize the benefit of some of our derivative instruments under lower commodity prices and we could incur a loss. We sell our production to a variety of purchasers. Some of these parties may experience liquidity problems. Credit enhancements have been obtained from some parties in the way of parental guarantees or letters of credit; however, we do not have all of our trade credit enhanced through guarantees or credit support. Impairment of Oil and Gas Properties. If oil and gas prices decrease further or remain depressed for extended periods of time, we may be required to take additional writedowns of the carrying value of our oil and gas properties. We may be required to writedown the carrying value of our oil and gas properties when oil and gas prices are low or if we have substantial downward adjustments to our estimated net proved reserves, increases in our estimates of development costs or deterioration in our exploration results. Under the full-cost method which we use to account for our oil and gas properties, the net capitalized costs of our oil and gas properties may not exceed the present value, discounted at 10%, of future net cash flows from estimated net proved reserves, using period end oil and gas prices or prices as of the date of our auditor's report, plus the lower of cost or fair market value of our unproved properties. If net capitalized costs of our oil and gas properties exceed this limit, we must charge the amount of the excess to earnings. This type of charge will not affect our cash flows, but will reduce the book value of our stockholders' equity. We review the carrying value of our properties quarterly, based on prices in effect as of the end of each quarter or at the time of reporting our results. Once incurred, a writedown of oil and gas properties is not reversible at a later date, even if prices increase.

Reduced Prices for Oil and Gas Production. The United States and world economies are currently in a recession which could last through 2009 and perhaps longer. Both oil and gas prices have undergone significant decline during the second half of 2008 and into 2009 as a result of the reduced economic activity brought on by the recession. Continued lower commodity prices will reduce our cash flows from operations. To mitigate the impact of lower commodity prices on our cash flows, we have entered into crude oil and natural gas commodity derivative contracts for 2009. See Note 5 to our Consolidated Financial Statements. Depending on the length of the current recession, commodity prices may stay depressed or decline further, thereby causing a prolonged downturn, which would further reduce our cash flows from operations. This could cause us to alter our business plans including reducing or delaying our exploration and development program spending and other cost reduction initiatives.
Abandonment of the Entrada Project. In late November 2008, we and our joint working interest owner, CIECO Entrada, decided to abandon the Entrada project. Under the terms of our agreements with CIECO Entrada, Callon Entrada is responsible for its share of the costs to plug and abandon the Entrada project, which we estimate to be $46 million, $23 million net to Callon Entrada. As of June 30, 2009 the wind down of the Entrada project was substantially complete and most of the costs had been paid. In addition, prior to abandonment of the project, CIECO Entrada failed to fund two loan requests totaling $40 million under the Callon Entrada non-recourse credit agreement with CIECO Entrada. CIECO Entrada also failed to fund its working interest share of a settlement payment in the amount of $7.3 million to terminate a drilling contract for the Entrada project. Callon has paid its share of the settlement payment.
We continue to discuss with CIECO Entrada its failure to fund $40 million in loan requests and its share of a settlement payment to terminate a drilling contract. No assurances can be made regarding the outcome of these discussions. We do not believe that we have waived any of our rights under the agreements with CIECO Entrada or its parent, CIECO. The Callon Entrada Non-Recourse Credit Facility. The Callon Entrada non-recourse credit facility is a direct obligation of Callon Entrada, an indirect, wholly-owned subsidiary of Callon Petroleum Company. The Callon Entrada non-recourse credit facility is secured by a lien on the assets of Callon Entrada which generally are comprised of the Entrada Field and related equipment. Neither Callon Petroleum Company nor any other subsidiary of Callon Petroleum Company guaranteed or otherwise agreed to pay the principal or interest payments due on the Callon Entrada non-recourse credit facility, so such facility is non-recourse to Callon Petroleum Company and its other subsidiaries.
On April 2, 2009, Callon Entrada received a notice from CIECO Entrada advising Callon Entrada that certain alleged events of default occurred under the Callon Entrada non-recourse credit agreement relating to failure to pay interest when due and the breach of various other covenants related to the decision to abandon the Entrada project. The lenders under our senior secured credit facility have amended the Second Amended and Restated Credit Agreement dated September 25, 2008 to state that a default under the Callon Entrada non-recourse credit facility is not a default under their facility. In addition, this amendment eliminates a possible cross default with regard to our 9.75% senior notes due in December 2010. Accordingly, we do not believe that a default under the Callon Entrada non-recourse credit agreement will have a material negative impact on our financial position, results of operations and cash flows. See Note 1 to the Consolidated Financial Statements.

Other Events
On March 16, 2009, we were notified by the New York Stock Exchange that we had fallen below one of the NYSE's continued listing standards. We received this notification pursuant to Rule 802.01B(I) of the NYSE Listed Company Manual because our average market capitalization has been less than $75 million over a 30-day trading period and our last reported stockholder's equity was less than $75 million.
We submitted a plan with the NYSE on April 30, 2009, which demonstrated our ability to achieve compliance with Rule 802.01B(I) within an 18 month cure period. On June 12, 2009, the NYSE accepted the plan and our common stock will continue to be listed on the NYSE during the cure period, subject to ongoing monitoring and our compliance with other NYSE continued listing requirements. Liquidity and Capital Resources
Our primary sources of capital are cash flows from operations, borrowings from financial institutions and the sale of debt and equity securities. On June 30, 2009, we had cash and cash equivalents of $735,000 and $38.7 million of availability under our senior secured credit agreement. Cash provided by operating activities during the six-month period ended June 30, 2009 totaled $2.1 million, a 97% decrease when compared to the corresponding period in 2008. The decrease in liquidity is attributable to the reduction of accounts payable during the first half of 2009, lower commodity prices and lower production rates on an equivalent basis.
On September 25, 2008, we completed a $250 million second amended and restated senior secured credit agreement with Union Bank as issuing lender, which matures September 25, 2012. We received preliminary notice from Union Bank that the borrowing base and MCR, which are still under review as of August 1, 2009, are approximately $35.0 million and $4.7 million, respectively. Borrowings under the credit agreement are secured by mortgages covering our major fields excluding Entrada. As of June 30, 2009, there was $5.0 outstanding under the agreement with $38.7 million, subject to MCR, available for future borrowings. See Note 4 to the Consolidated Financial Statements.
On April 1, 2009, Diamond Offshore Drilling, Inc. ("Diamond") called on the outstanding letter of credit for CIECO Energy (US) Limited's ("CIECO") share of the settlement for the termination of the Ocean Victory drilling contract in the amount of $7.3 million. We paid our share, in the amount of $7.3 million, in March 2009. The remaining balance of the letter of credit was cancelled on April 2, 2009 by Diamond. We continue to discuss with CIECO its failure to fund the settlement for the termination of the drilling contract. The $7.3 million due from CIECO for their share of the settlement for the termination of the drilling contract is recorded as a receivable as of June 30, 2009.
Due to the uncertain economic and commodity price environment, we have designed a flexible capital spending program that will be responsive to conditions that develop during 2009. Our preliminary base capital program, including plugging and abandonment, for 2009 is $75 million, which is relatively flat with the 2008 budget of $71 million, excluding the Entrada project. The program includes $50 million for the acquisition of proved oil and gas properties with development and exploitation upside. However, depending on commodity prices and other economic conditions we experience in 2009, this base capital program may be adjusted up or down. See "Capital Expenditures" for more detail on our capital expenditure forecast for 2009.

We expect that the 2009 budget will be funded primarily from cash flows from operations, cash on hand, and borrowings under our senior secured credit facility and/or other financing. We would expect an increase in our senior secured credit facility borrowing base upon executing an acquisition. We will evaluate the level of capital spending throughout the year based on commodity prices, cash flows from operations and property acquisitions and divestitures. Inflation has not had a material impact on us and is not expected to have a material impact on us in the immediate future.
The Callon Entrada non-recourse credit facility, which has a balance of $82.4 million, is a direct obligation of Callon Entrada, an indirect, wholly-owned subsidiary of Callon Petroleum Company. The Callon Entrada non-recourse credit facility is secured by a lien on the stock of Callon Entrada and the assets of Callon Entrada which generally are comprised of the Entrada Field and related equipment. On June 1, 2009 the lease expired and reverted to the Minerals Management Service. At June 30, 2009, there was no value included on the balance sheet for the lease or related equipment. Neither Callon Petroleum Company nor any other subsidiary of Callon Petroleum Company guaranteed or otherwise agreed to pay the principal or interest payments due on the Callon Entrada non-recourse credit facility, so such facility is non-recourse to Callon Petroleum Company and its other subsidiaries. On April 2, 2009, Callon Entrada received a notice of default from CIECO Entrada advising Callon Entrada that certain events of default occurred under the non-recourse credit agreement relating to failure to pay interest when due and the breach of various other covenants related to the decision to abandon the Entrada project. This notice of default invoked CIECO's Entrada rights under the Callon Entrada non-recourse credit agreement to accelerate payment of the principal and interest due. The acceleration of payment causes the principal and interest balances under the Callon Entrada non-recourse credit agreement to be reclassified as current liabilities from long-term liabilities under U.S. generally accepted accounting principles ("GAAP"). Under GAAP, we are currently required to consolidate the financial statements and results of operations of Callon Entrada which results in Callon Entrada's non-recourse liability being reflected in a separate line item in the consolidated financial statements. See Note 1 to the Consolidated Financial Statements for more information regarding the deficiency in assets of Callon Entrada with which to repay the non-recourse credit facility.
The Indenture governing our 9.75% Senior Notes due 2010 and our senior secured credit facility contain various covenants, including restrictions on additional indebtedness and payment of cash dividends. In addition, our senior secured credit agreement contains covenants for maintenance of certain financial ratios. We were in compliance with these covenants at June 30, 2009. See Note 7 of the Consolidated Financial Statements for the year ended December 31, 2008 included in our Annual Report on Form 10-K filed March 19, 2009 for a more detailed discussion of long-term debt.

The following table describes our outstanding contractual obligations (in thousands) as of June 30, 2009:

Contractual                                           Less Than         One-Three         Four-Five          After-Five
Obligations                            Total           One Year           Years             Years              Years
Senior Secured Credit Facility       $   5,000        $        -        $    5,000        $        -        $          -
9.75% Senior Notes                     200,000                 -           200,000                 -                   -
Throughput Commitments:
Medusa Oil Pipeline                        188                56                81                31                  20


                                     $ 205,188        $       56        $  205,081        $       31        $         20

Capital Expenditures
Capital expenditures on an accrual basis were $7.7 million for the six-months ended June 30, 2009. Included in this amount was capitalized interest of approximately $1.7 million and capitalized general and administrative costs allocable directly to exploration and development projects of approximately $4.4 million. The remainder of the capital expended primarily includes the cost of seismic data, leases and plugging and abandonment costs.
Capital expenditures for the remainder of 2009 are projected to be $60.5 million and include:
• proved producing property acquisitions;

• development costs on our legacy properties;

• the cost of seismic data and leases; and

• capitalized interest and general and administrative costs.

In addition, we are projecting to spend $6.8 million for the remainder of 2009 for asset retirement obligations.
Off-Balance Sheet Arrangements
We have a 10% ownership interest in Medusa Spar LLC ("LLC"), which is a limited liability company that owns a 75% undivided ownership interest in the deepwater Spar production facilities on our Medusa Field in the Gulf of Mexico. We contributed a 15% undivided ownership interest in the production facility to the LLC in return for approximately $25 million in cash and a 10% ownership interest in the LLC. The LLC earns a tariff based upon production volume throughput from the Medusa area. We are obligated to process our share of production from the Medusa Field and any future discoveries in the area through the Spar production facilities. This arrangement allowed us to defer the cost of the Spar production facility over the life of the Medusa Field. The balance of Medusa Spar LLC is owned by Oceaneering International, Inc. and Murphy Oil Corporation. We are accounting for our 10% ownership interest in the LLC under the equity method.

Results of Operations
The following table sets forth certain unaudited operating information with
respect to the Company's oil and gas operations for the periods indicated:

                                             Three Months Ended                    Six Months Ended
                                                  June 30,                             June 30,
                                          2009                 2008              2009            2008
Net production :
Oil (MBbls)                                     263                 286             526             575
Gas (MMcf)                                    1,433               1,668           2,880           3,759
Total production (MMcfe)                      3,010               3,382           6,036           7,211
Average daily production (MMcfe)               33.1                37.2            33.3            39.6

Average sales price:
Oil (Bbls) (a)                        $       72.22         $     99.99        $  66.39        $  93.27
Gas (Mcf)                                      4.22               11.67            5.18           10.46
Total (Mcfe)                                   8.32               14.20            8.26           12.90

Oil and gas revenues:
Oil revenue                           $      18,971         $    28,554        $ 34,923        $ 53,650
Gas revenue                                   6,054              19,475          14,917          39,339

Total                                 $      25,025         $    48,029        $ 49,840        $ 92,989


Oil and gas production costs:
Lease operating expenses              $       4,656         $     4,870        $  8,695        $ 10,048

Additional per Mcfe data:
Sales price                           $        8.32         $     14.20        $   8.26        $  12.90
Lease operating expense                        1.55                1.44            1.44            1.39

Operating margin                      $        6.77         $     12.76        $   6.82        $  11.51


Depletion, depreciation and
amortization                          $        2.81         $      4.50        $   2.96        $   4.19
General and administrative (net
of management fees)                   $        1.79         $      0.87        $   1.19        $   0.78

(a) Below is a reconciliation of the average NYMEX price to the average realized sales price per barrel of oil:

Average NYMEX oil price               $       59.62         $    123.98        $  51.35        $ 110.94
Basis differential and quality
adjustments                                   (3.30 )             (4.06 )         (3.68 )         (3.95 )
Transportation                                (1.36 )             (1.34 )         (1.35 )         (1.30 )
Hedging                                       17.26              (18.59 )         20.07          (12.42 )

Average realized oil price            $       72.22         $     99.99        $  66.39        $  93.27

Comparison of Results of Operations for the Three Months Ended June 30, 2009 and the Three Months Ended June 30, 2008.
Oil and Gas Production and Revenues
Total oil and gas revenues were $25.0 million in the second quarter of 2009 compared to $48.0 million in the second quarter of 2008. Total production on an equivalent basis for the second quarter of 2009 decreased by 12% compared to the second quarter of 2008 and oil and gas prices on a Mcfe basis for the second quarter of 2009 decreased 41% compared to 2008.
Gas production during the second quarter of 2009 totaled 1.4 billion cubic feet (Bcf) and generated $6.1 million in revenues compared to 1.7 Bcf and $19.5 million in revenues during the same period in 2008. The average gas price after hedging impact for the second quarter of 2009 was $4.22 per thousand cubic feet of natural gas ("Mcf") compared to $11.67 per Mcf for the same period in 2008. Approximately 14% of the 15% decrease in 2009 production was due to a lower number of producing wells, with the remaining 1% resulting from normal and expected declines in production from our older properties. Four of our gas wells were shut-in during 2008 due to early water production and are now scheduled for plugging and abandonment. In addition, our High Island Block A-540 well was shut in during the second quarter of 2008, due to a plugged flowline, which management has determined uneconomic to repair.
Oil production during the second quarter of 2009 totaled 263,000 barrels and generated $19.0 million in revenues compared to 286,000 barrels and $28.6 million in revenues for the same period in 2008. The average oil price received after hedging impact in the second quarter of 2009 was $72.22 per barrel compared to $99.99 per barrel in the second quarter of 2008. The 8% decrease in 2009 production was attributable to normal and expected declines in production and our High Island Block A-540, described above. Lease Operating Expenses
Lease operating expenses were $4.7 million for the three-month period ended June 30, 2009, a 4% decrease when compared to the same period in 2008. The decrease was primarily due to a lower number of producing wells. Four of our gas wells were shut-in during 2008 due to early water production and are now scheduled for plugging and abandonment. In addition, our High Island Block A-540 well was shut in during the second quarter of 2008, due to a plugged flowline, which management determined uneconomic to repair. Depreciation, Depletion and Amortization Depreciation, depletion and amortization for the three-month period ended June 30, 2009 and 2008 was $8.5 million and $15.2 million, respectively. The 44% decrease was due to lower production volumes as well as a lower depletion rate resulting from the full-cost ceiling writedown which was recorded in the fourth quarter of 2008.
Accretion Expense
Accretion expense was $795,000 and $952,000 for the three-month periods ended June 30, 2009 and 2008 and represents accretion of our asset retirement obligations. See Note 9 to the Consolidated Financial Statements.

General and Administrative
General and administrative expenses, net of amounts capitalized, were $5.4 million and $2.9 million for the three-month period ended June 30, 2009 and 2008, respectively. The 83% increase was primary due to the $2.2 million of nonrecurring expenses for staffing reductions and retirements which were incurred during the second quarter of 2009. Interest Expense
Interest expense on Callon related debt obligations increased to $4.9 million during the three-month period ended June 30, 2009, compared to $4.4 million during the three-month period ended June 30, 2008. The increase is due to a larger outstanding loan balance for our senior secured credit facility. See Note 4 to the Consolidated Financial Statements for details. Callon Entrada Non- Recourse Credit Facility Interest Expense The Callon Entrada non-recourse credit facility incurred interest expense for the three-month periods ended June 30, 2009 and 2008 of $1.9 million and $321,000, respectively. The increase was due to a larger outstanding loan balance for the three-month period ended June 30, 2009 and an increase in the . . .