1996 ANNUAL REPORT 

Letter to Stockholders: A Strategy for the 21st Century

The annual letter to our stockholders traditionally focuses on the Company’s progress during the year, and for 1996 we have a number of outstanding accomplishments to report.

Thanks largely to the dedicated efforts of our employees, we achieved increases of 47% in proved reserves, 74% in production, 158% in cash flows from operating activities, and 159% in net income per share. We also experienced a 149% increase in the year-end price of the Company’s common stock, ranking 20th in stock price performance out of the approximately 2,900 companies listed on the NYSE.

We more than doubled the Company’s acreage position in the AWP Olmos Field in South Texas--an area where the Company drilled 124 wells in 1996 and increased production by 227%. In addition, we more than quadrupled our leasehold acreage in the Texas Austin Chalk trend--where the Company is pursuing a highly successful horizontal drilling program. We also continued to pursue exploration opportunities in other parts of the United States, along with several international initiatives.

To provide working capital for these activities, we completed a successful offering of $115 million of 6.25% Convertible Subordinated Notes due 2006.

We can all be proud of this list of achievements, but we realize that our stockholders--which include virtually all of our employees--are now focusing on the future.

Although the beginning of the new millennium is just a few years away, our goal is to build a Company that enters the 21st century with much larger quantities of oil and gas reserves than it holds today. By the end of the year 2000, we intend to have reserves equal to one trillion cubic feet of natural gas equivalent, almost four times the Company’s proved reserves base at the end of 1996.

Accomplishing this goal will require reserves growth of about 40% per year, and our track record gives us confidence that we can meet those expectations. Over the last five years, the Company’s proved reserves have grown at a compounded annual rate of 40%.

We have other reasons for confidence as well. Entering 1997, the Company holds the largest inventory of undrilled leasehold acreage in its history. Our plans for the year include drilling 178 wells, compared to 153 wells in 1996 and 76 wells in 1995.

We also have the working capital needed to implement our 1997 drilling program. At year end, we had over $77 million in cash and cash equivalents on our balance sheet, having generated over $37 million during the year in net cash from operating activities. As our production increases, we can anticipate significant additional growth in cash generated from our oil and gas operations.

Finally, our teams of professionals have the skill and experience in applying an array of advanced technologies that provide us with a competitive advantage in each of our focus areas. Over the last three years, they have been able to add reserves at an average discovery cost of $0.57 per Mcfe, achieving our current goal of adding reserves through drilling for $0.65 per Mcfe or less.

Reaching our reserves goal of one trillion cubic feet of natural gas equivalent by the end of the year 2000 would create considerable additional value for our stockholders as the increased reserves lead to increased production. In the absence of major declines in oil and gas prices, higher production rates should contribute to strong gross margins from oil and gas sales, as production costs; depreciation, depletion, and amortization (DD&A); and general and administrative expenses (G&A) remain low or continue to decline on a per-unit-of-production basis. In 1996, we achieved production costs of $0.43 per Mcfe, DD&A of $0.85 per Mcfe, and G&A expenses (net of supervision fees) of $0.10 per Mcfe—compared to $0.59, $0.82, and $0.15 per Mcfe, respectively, just two years ago.

The combination of increases in production with strong gross margins per unit of production should lead to increases in cash flows from operating activities, net income, and net income per share.

Our policy is to reinvest these cash flows in additional reserves growth in order to generate even higher cash flows and earnings over time.

Our belief that these achievements will be reflected in the price of our common stock was confirmed in 1996 when increases in cash flows and net income per share were accompanied by comparable increases in our year-end stock price.

With this performance, 1996 turned out to be one of the most exciting years in the Company’s history. Now we are committed to making sure that the dawn of the next millennium is also the dawn of an even brighter future for the Company and all of its stakeholders.

With our strategy for the 21st century in place, we are eagerly anticipating the future.



A. Earl Swift
March 10, 1997

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