UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended March 31, 2004
or

For the transition period from _______ to ________

Commission file number 1-16295

ENCORE ACQUISITION COMPANY

Registrant’s telephone number, including area code: (817) 877-9955

Not applicable
(Former name, former address and former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)

Yes x No o

      Number of shares of Common Stock, $0.01 par value, outstanding as of April 30, 2004 ....... 30,448,979

ENCORE ACQUISITION COMPANY
INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ENCORE ACQUISITION COMPANY

CONSOLIDATED BALANCE SHEETS
(in thousands except shares and per share amounts)

The accompanying notes are an integral part of these consolidated financial statements.

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ENCORE ACQUISITION COMPANY

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share amounts)
(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

2

ENCORE ACQUISITION COMPANY

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
March 31, 2004
(in thousands)
(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

3

ENCORE ACQUISITION COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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ENCORE ACQUISITION COMPANY

1. Formation of Encore

     Organized in 1998, Encore Acquisition Company (“Encore” or the “Company”), a Delaware corporation, is a growing independent energy company engaged in the acquisition, development and exploitation of North American oil and natural gas reserves. As of March 31, 2004 Encore’s oil and natural gas reserves were in four core areas: the Cedar Creek Anticline of Montana and North Dakota; the Permian Basin of West Texas and Southeastern New Mexico; the Mid Continent area, which included the Anadarko Basin of Oklahoma and the North Salt Basin of Louisiana; and the Rocky Mountains.

2. Basis of Presentation

     In the opinion of management, the accompanying unaudited consolidated financial statements of Encore include all adjustments necessary to present fairly our financial position as of March 31, 2004 and results of operations and cash flows for the three months ended March 31, 2004 and 2003. All adjustments are of a recurring nature. These interim results are not necessarily indicative of results for an entire year.

     Certain amounts and disclosures have been condensed or omitted from these consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in the Company’s 2003 Annual Report filed on Form 10-K.

     Employee stock options and restricted stock awards are accounted for at intrinsic value in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Accordingly, no compensation expense is recorded for stock options that are granted to employees or non-employee directors with an exercise price equal to or above the Company’s stock price on the date of grant. However, compensation expense is recorded for the fair value of the restricted stock granted to employees. If employee stock options and restricted stock awards were accounted for at fair value in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” the Company’s reported net income and net income per share amounts would have been adjusted to the pro forma amounts indicated below (in thousands, except per share amounts):

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3. Asset Retirement Obligations

     In August 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS 143, “Accounting for Asset Retirement Obligations,” which the Company adopted as of January 1, 2003. This statement requires the Company to record a liability in the period in which an asset retirement obligation is incurred, in an amount equal to the discounted estimated fair value of the obligation. Also, upon initial recognition of the liability, the Company must capitalize an equal amount of asset cost. Thereafter, each quarter, this liability is accreted and, if needed, adjusted up to the final cost. Accretion expense is included in ‘Other operating’ expense in the Company’s Consolidated Statements of Operations.

     The adoption of SFAS 143 on January 1, 2003 resulted in a cumulative effect of accounting change adjustment to record (i) a $4.0 million increase in the carrying values of proved properties, (ii) a $2.1 million decrease in accumulated depletion, depreciation, and amortization, (iii) a $5.2 million increase in non-current liabilities, and (iv) a gain of $0.9 million, net of tax.

     The following table shows net income and basic and diluted net income per common share as reported, as well as pro forma amounts as if the Company had adopted SFAS 143 prior to January 1, 2003 (in thousands, except per common share amounts):

     The Company’s primary asset retirement obligations relate to future plugging and abandonment expenses on our oil and natural gas properties and related facilities disposal. As of March 31, 2004, the Company had $2.8 million held in an escrow account from which funds are released only for reimbursement of plugging and abandonment expenses on our Bell Creek property. This amount is included in ‘Other assets’ in the accompanying Consolidated Balance Sheet. The following table summarizes the changes in the Company’s future abandonment liability from January 1, 2004 through March 31, 2004 (in thousands):

4. Income Taxes

     Reconciliation of income tax expense with tax at the Federal statutory rate is as follows (in thousands):

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5. Earnings Per Share (EPS)

     The following table sets forth basic and diluted EPS computations for the three months ended March 31, 2004 and 2003 (in thousands, except per share data):

     (a) There were no antidilutive options or any shares of antidilutive restricted stock outstanding for the three months ended March 31, 2004. For the quarter ended March 31, 2003 outstanding employee stock options of 240,000 were excluded from the calculation of diluted earnings per share because their effect would have been antidilutive. During the three months ended March 31, 2004, 234,856 shares of stock were issued upon exercise of employee stock options granted under the Company’s 2000 Incentive Stock Plan at a weighted average strike price of $25.76 per share. Additionally, 67,496 shares of restricted stock were granted under the Company’s 2000 Incentive Stock Plan during the three months ended March 31, 2004. For the quarter ended March 31, 2004, 6,176 shares of employee stock options and 7,366 shares of restricted stock, which were issued and outstanding at December 31, 2003, were forfeited.

6. Derivative Financial Instruments

     The following tables summarize our open commodity derivative instruments designated as hedges as of March 31, 2004:

Oil Derivative Instruments at March 31, 2004

Natural Gas Derivative Instruments at March 31, 2004

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     Encore recognizes in the consolidated statement of operations derivative fair value gains and losses related to changes in the mark-to-market value of our basis swaps and certain other commodity derivatives that are not designated for hedge accounting; ineffectiveness of our commodity futures contracts designated as hedges; and for changes in the mark-to-market value of our interest rate swap.

     In order to more effectively hedge the cash flows received on our oil production, the Company enters into financial instruments whereby the Company swaps certain per Bbl or per Mcf floating market indices for a fixed amount. These market indices are a component of the price the Company is paid on its actual production. By fixing this component of our marketing price, the Company is able to realize a net price with a more consistent differential to NYMEX. Since NYMEX is the basis of all our derivative oil hedging contracts and some of our natural gas contracts, a more consistent differential results in more effective hedges. However, management has elected not to use hedge accounting for certain of these contracts. Instead, the Company marks these contracts to market each quarter through ‘Derivative fair value (gain) loss’ in the Consolidated Statements of Operations. Thus, as these contracts do not change the Company’s overall hedged volumes, average prices presented in the tables above are exclusive of any effect of these non-hedge instruments. As of March 31, 2004, the mark-to-market value of these contracts is $0.1 million.

     The oil put contracts in place at March 31, 2004 that the Company did not designate as cash flow hedges represented 1,500 Bbls per day in the first half of 2004 and 2,500 Bbls in the second half of 2004. The Company also had natural gas put contracts not designated as hedges representing 5,000 Mcf per day for 2004. The fair value of these contracts at March 31, 2004 was $0.1 million.

Interest Rate Derivatives

     The fo