e10vq
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
     
For the Quarterly Period Ended June 30, 2006   Commission File Number 001-14039
CALLON PETROLEUM COMPANY
(Exact name of registrant as specified in its charter)
     
Delaware   64-0844345
     
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
200 North Canal Street
Natchez, Mississippi 39120
(Address of principal executive offices)(Zip code)
(601) 442-1601
(Registrant’s telephone number,
including area code)
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 þ No o 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definitions of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o 
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No þ 
As of August 4, 2006, there were 20,646,573 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.
 
 

 


Table of Contents

CALLON PETROLEUM COMPANY
TABLE OF CONTENTS
         
    Page No.  
Part I. Financial Information
       
 
       
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    23  
 Certification of CEO and CFO Pursuant to Section 302
 Certification of CEO and CFO Pursuant to Section 906

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Callon Petroleum Company
Consolidated Balance Sheets
(In thousands, except share data)
                 
    June 30,     December 31,  
    2006     2005  
    (Unaudited)     (Note 1)  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 1,046     $ 2,565  
Accounts receivable
    27,461       33,195  
Deferred tax asset
    9,768       26,770  
Restricted investments
    4,200       4,110  
Fair market value of derivatives
    4,382       889  
Other current assets
    1,755       1,998  
 
           
Total current assets
    48,612       69,527  
 
           
 
               
Oil and gas properties, full-cost accounting method:
               
Evaluated properties
    1,010,963       937,698  
Less accumulated depreciation, depletion and amortization
    (568,026 )     (539,399 )
 
           
 
    442,937       398,299  
 
               
Unevaluated properties excluded from amortization
    58,987       49,065  
 
           
Total oil and gas properties
    501,924       447,364  
 
           
 
               
Other property and equipment, net
    1,741       1,605  
Long-term gas balancing receivable
    660       403  
Restricted investments-long-term
    1,896       1,858  
Investment in Medusa Spar LLC
    12,510       11,389  
Other assets, net
    1,962       1,630  
 
           
Total assets
  $ 569,305     $ 533,776  
 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable and accrued liabilities
  $ 35,845     $ 39,323  
Fair market value of derivatives
    1,119       1,247  
Undistributed oil and gas revenues
    1,294       721  
Asset retirement obligations-current
    22,783       21,660  
Current maturities of long-term debt
    229       263  
 
           
Total current liabilities
    61,270       63,214  
 
           
 
               
Long-term debt
    196,641       188,813  
Asset retirement obligations-long-term
    25,833       16,613  
Deferred tax liability
    28,044       31,633  
Accrued liabilities to be refinanced
          5,000  
Other long-term liabilities
    774       455  
 
           
Total liabilities
    312,562       305,728  
 
           
Stockholders’ equity:
               
Preferred Stock, $.01 par value, 2,500,000 shares authorized;
           
Common Stock, $.01 par value, 30,000,000 shares authorized; 20,578,205 and 19,357,138 shares outstanding at June 30, 2006 and December 31, 2005, respectively
    206       194  
Capital in excess of par value
    218,345       220,360  
Unearned compensation restricted stock
          (3,334 )
Other comprehensive income
    1,963       (331 )
Retained earnings
    36,229       11,159  
 
           
Total stockholders’ equity
    256,743       228,048  
 
           
Total liabilities and stockholders’ equity
  $ 569,305     $ 533,776  
 
           
The accompanying notes are an integral part of these financial statements.

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Callon Petroleum Company
Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share amounts)
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2006     2005     2006     2005  
Operating revenues:
                               
Oil and gas sales
  $ 47,057     $ 41,668     $ 92,638     $ 84,680  
 
                       
 
                               
Operating expenses:
                               
Lease operating expenses
    7,365       6,197       13,270       12,733  
Depreciation, depletion and amortization
    14,791       13,671       28,627       29,079  
General and administrative
    1,924       2,801       3,650       4,495  
Accretion expense
    1,331       770       2,750       1,631  
Derivative expense
    30       533       120       912  
 
                       
Total operating expenses
    25,441       23,972       48,417       48,850  
 
                       
 
                               
Income from operations
    21,616       17,696       44,221       35,830  
 
                       
 
                               
Other (income) expenses:
                               
Interest expense
    4,128       4,265       8,276       8,834  
Other (income)
    (670 )     (96 )     (1,000 )     (298 )
 
                       
Total other (income) expenses
    3,458       4,169       7,276       8,536  
 
                       
 
                               
Income before income taxes
    18,158       13,527       36,945       27,294  
Income tax expense
    6,294       4,735       12,844       9,553  
 
                       
 
                               
Income before Medusa Spar LLC
    11,864       8,792       24,101       17,741  
Income from Medusa Spar LLC net of tax
    439       519       969       1,045  
 
                       
 
                               
Net income
    12,303       9,311       25,070       18,786  
Preferred stock dividends
                      318  
 
                       
Net income available to common shares
  $ 12,303     $ 9,311     $ 25,070     $ 18,468  
 
                       
 
                               
Net income per common share:
                               
Basic
  $ 0.61     $ 0.52     $ 1.26     $ 1.04  
 
                       
Diluted
  $ 0.57     $ 0.46     $ 1.17     $ 0.92  
 
                       
 
                               
Shares used in computing net income:
                               
Basic
    20,314       17,736       19,855       17,703  
 
                       
Diluted
    21,448       20,345       21,388       20,511  
 
                       
The accompanying notes are an integral part of these financial statements.

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Callon Petroleum Company
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
                 
    Six Months Ended  
    June 30,     June 30,  
    2006     2005  
Cash flows from operating activities:
               
Net income
  $ 25,070     $ 18,786  
Adjustments to reconcile net income to cash provided by operating activities:
               
Depreciation, depletion and amortization
    28,996       29,403  
Accretion expense
    2,750       1,631  
Amortization of deferred financing costs
    1,106       998  
Non-cash derivative expense
    120       912  
Income from investment in Medusa Spar LLC
    (969 )     (1,045 )
Deferred income tax expense
    12,844       9,553  
Non-cash charge related to compensation plans
    267       1,600  
Excess tax benefits from share-based payment arrangements
    (1,304 )      
Changes in current assets and liabilities:
               
Accounts receivable
    1,282       (1,669 )
Other current assets
    243       (1,072 )
Current liabilities
    5,579       (5,132 )
Change in gas balancing receivable
    (257 )     54  
Change in gas balancing payable
    103       (118 )
Change in other long-term liabilities
    216       (7 )
Change in other assets, net
    (704 )     (341 )
 
           
Cash provided by operating activities
    75,342       53,553  
 
           
 
               
Cash flows from investing activities:
               
Capital expenditures
    (80,015 )     (32,566 )
Distribution from Medusa Spar LLC
    370       266  
 
           
Cash used by investing activities
    (79,645 )     (32,300 )
 
           
 
Cash flows from financing activities:
               
Change in accrued liabilities to be refinanced
    (5,000 )      
Increase in debt
    39,000       7,000  
Payments on debt
    (32,000 )     (12,000 )
Issuance of common stock
          2  
Equity issued related to employee stock plans
    (381 )     (154 )
Excess tax benefits from share-based payment arrangements
    1,304        
Capital leases
    (139 )     (326 )
Cash dividends on preferred stock
          (318 )
 
           
Cash provided (used) by financing activities
    2,784       (5,796 )
 
           
 
Net increase (decrease) in cash and cash equivalents
    (1,519 )     15,457  
Cash and cash equivalents:
               
Balance, beginning of period
    2,565       3,266  
 
           
Balance, end of period
  $ 1,046     $ 18,723  
 
           
The accompanying notes are an integral part of these financial statements.

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CALLON PETROLEUM COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2006
1.   General
 
    The financial information presented as of any date other than December 31 has been prepared from the books and records of Callon Petroleum Company (the “Company” or “Callon”) without audit. Financial information as of December 31, 2005 has been derived from the audited financial statements of the Company, but does not include all disclosures required by U.S. generally accepted accounting principles. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the financial information for the periods indicated, have been included. For further information regarding the Company’s accounting policies, refer to the Consolidated Financial Statements and related notes for the year ended December 31, 2005 included in the Company’s Annual Report on Form 10-K filed March 15, 2006. The results of operations for the three-month and six-month periods ended June 30, 2006 are not necessarily indicative of future financial results.
 
2.   Stock-Based Compensation
 
    The Company has various stock plans (“Plans”) under which employees of the Company and its subsidiaries and non-employee members of the Board of Directors of the Company have been or may be granted certain equity compensation. The Company has compensatory stock option plans in place whereby participants have been or may be granted rights to purchase shares of common stock of Callon. For further discussion of the Company’s Plans, refer to Note 11 of the Consolidated Financial Statements for the year ended December 31, 2005 included in the Company’s Annual Report on Form 10-K filed March 15, 2006.
 
    On March 9, 2006, the Board of Directors of the Company approved the 2006 Stock Incentive Plan (“2006 Plan”). The 2006 Plan was approved by the shareholders at the May 4, 2006 annual meeting. Pursuant to the 2006 Plan, 500,000 shares of common stock shall be reserved for issuance upon exercise of stock options, restricted stock or other stock-based awards.
 
    Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standard No. 123 (revised 2004), (“SFAS 123R”) “Share-Based Payment,” utilizing the modified prospective approach. Prior to the adoption of SFAS 123R we accounted for stock option grants in accordance with Accounting Principals Board Opinion No. 25, “Accounting for Stock Issued to Employees” (the intrinsic value method) and, accordingly, recognized no compensation expense for stock option grants.

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    Under the modified prospective approach, SFAS 123R applies to new awards, unvested awards as of January 1, 2006 and awards that were outstanding on January 1, 2006 that are subsequently modified, repurchased or cancelled. Under the modified prospective approach, compensation cost recognized in 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of Statement of Financial Accounting Standard No. 123 (“SFAS 123”) “Accounting for Stock-Based Compensation,” and compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. Prior periods were not restated to reflect the impact of adopting the new standard.
 
    As a result of most of the Company’s stock-based compensation being in the form of restricted stock, the impact of the adoption of SFAS 123R on income before taxes, net income and basic and diluted earnings per share for the three-month and six-month periods ended June 30, 2006 was immaterial.
 
    SFAS 123R requires the cash flows from tax benefits resulting from tax deductions in excess of compensation cost recognized for stock options exercised (excess tax benefits) to be classified as financing cash flows. The $1.3 million of excess tax benefits classified as a financing cash inflow for the six-month period ended June 30, 2006 would have been classified as an operating cash flow had the Company not adopted SFAS 123R. There were no cash proceeds from the exercise of stock options for the six months ended June 30, 2006 due to the fact that all options were exercised through net-share settlements.
 
    For the three-month period ended June 30, 2006, we recorded stock-based compensation expense of $234,000, of which $125,000 was included in general and administrative expenses and $109,000 was capitalized to oil and gas properties. For the six-month period ended June 30, 2006, we recorded stock-based compensation expense of $468,000, of which $250,000 was included in general and administrative expenses and $218,000 was capitalized to oil and gas properties. Shares available for future stock option or restricted stock grants to employees and directors under existing plans were 1,423,300 at June 30, 2006.

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    The following table illustrates the effect on operating results and per share information had the Company accounted for stock-based compensation in accordance with SFAS 123 for the three-month and six-month periods ended June 30, 2005 (in thousands, except per share amounts):
                 
    Three Months Ended     Six Months Ended  
    June 30, 2005     June 30, 2005  
             
Net income available to common-as reported
  $ 9,311     $ 18,468  
Add: Stock-based compensation expense included in net income as reported, net of tax
    770       962  
Deduct: Total stock-based compensation expense under fair value based method, net of tax
    (833 )     (1,063 )
 
           
Net income available to common-pro forma
  $ 9,248     $ 18,367  
 
           
 
               
Net income per share available to common:
               
Basic-as reported
  $ 0.52     $ 1.04  
Basic-pro forma
  $ 0.52     $ 1.04  
 
               
Diluted-as reported
  $ 0.46     $ 0.92  
Diluted-pro forma
  $ 0.45     $ 0.91  
    Stock Options
 
    The Company uses the Black-Scholes option pricing model to estimate the fair value of stock-based awards with the following weighted-average assumptions for the indicated periods.
                                 
    Three Months Ended   Six Months Ended
    June 30,   June 30,
    2006   2005   2006   2005
                 
Dividend yield
                       
Expected volatility
          38.2 %     38.9 %     39.4 %
Risk-free interest rate
          4.1 %     4.6 %     4.2 %
Expected life of option (in years)
          5       5       4  
Weighted-average grant-date fair value
          5.34       7.72       5.59  
Forfeiture rate
                7.5 %      
    The assumptions above are based on multiple factors, including historical exercise patterns of employees with respect to exercise and post-vesting employment termination behaviors, expected future exercising patterns and the historical volatility of our stock price. There were no stock options granted during the three months ended June 30, 2006.

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    At June 30, 2006, there was $266,000 of unrecognized compensation cost related to unvested stock options, which is expected to be recognized over a weighted-average period of 2.5 years.
 
    The following table represents stock option activity for the six months ended June 30, 2006:
                         
                    Weighted-Average
    Number of   Weighted-Average   Remaining
    Shares   Exercise Price   Contract Life
     
Outstanding options at beginning of period
    1,205,558     $ 10.11          
Granted
    15,000       18.69          
Exercised
    (411,833 )     10.55          
Forfeited
                   
     
 
                       
Outstanding options at end of period
    808,725       10.05     4.27 Yrs.
     
 
                       
Outstanding exercisable at end of period
    763,725     $ 9.60     3.97 Yrs.
     
    The aggregate intrinsic value of options outstanding was $7.5 million and the aggregate intrinsic value of options exercisable was $7.4 million. Total intrinsic value of options exercised was $3.7 million for the six months ended June 30, 2006.
 
    The following table summarizes our nonvested stock option activity for the six months ended June 30, 2006:
                 
    Number of   Weighted-Average
    Shares   Exercise Price
     
Nonvested stock options at beginning of period
    39,000     $ 16.94  
Granted
    15,000       18.69  
Vested
    (9,000 )     16.71  
Forfeited
           
     
 
               
Nonvested stock options at end of period
    45,000     $ 17.57  
     

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    Restricted Stock
 
    The Plans allow for the issuance of restricted stock awards. The unearned stock-based compensation related to these awards is being amortized to compensation expense over the vesting period, which ends in the third quarter of 2009. The compensation expense for these awards was determined based on the market price of our stock at the date of grant applied to the total numbers of shares that were anticipated to fully vest. As of June 30, 2006, we had unearned stock-based compensation of $2.9 million associated with these awards.
 
    The following table represents unvested restricted stock activity for the six months ended June 30, 2006:
                 
    Number of   Weighted-Average
    Shares   Grant Price
     
Outstanding shares at beginning of period
    272,000     $ 13.66  
Granted
           
Vested
           
Forfeited
           
     
 
               
Outstanding shares at end of period
    272,000     $ 13.66  
     
3.   Per Share Amounts
 
    Basic net income per common share was computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted net income per common share was determined on a weighted average basis using common shares issued and outstanding adjusted for the effect of common stock equivalents computed using the treasury stock method. In addition, an adjustment was included in 2005 for the effect of the convertible preferred stock.

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    A reconciliation of the basic and diluted earnings per share computation is as follows (in thousands, except per share amounts):
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2006     2005     2006     2005  
(a) Net income available to common shares
  $ 12,303     $ 9,311     $ 25,070     $ 18,468  
Preferred dividends assuming conversion of preferred stock (if dilutive)
                      318  
 
                       
(b) Income available to common shares assuming conversion of preferred stock (if dilutive)
  $ 12,303     $ 9,311     $ 25,070     $ 18,786  
 
                       
 
                               
(c) Weighted average shares outstanding
    20,314       17,736       19,855       17,703  
Dilutive impact of stock options
    247       284       294       299  
Dilutive impact of warrants
    775       1,177       1,133       1,222  
Dilutive impact of restricted stock
    112       44       106       57  
Convertible preferred stock (if dilutive)
          1,104             1,230  
 
                       
(d) Total diluted shares
    21,448       20,345       21,388       20,511  
 
                       
 
                               
Basic income per share (a¸c)
  $ 0.61     $ 0.52     $ 1.26     $ 1.04  
Diluted income per share (b¸d)
  $ 0.57     $ 0.46     $ 1.17     $ 0.92  
 
                               
Stock options and warrants excluded due to the exercise price being greater than the stock price (in thousands)
    15       40       15       30  
4.   Derivatives
 
    The Company periodically uses derivative financial instruments to manage oil and gas price risk. Settlements of gains and losses on commodity price contracts are generally based upon the difference between the contract price or prices specified in the derivative instrument and a NYMEX price or other cash or futures index price.
 
    The Company’s derivative contracts that are accounted for as cash flow hedges under Statement of Financial Accounting Standards No. 133 (“SFAS No. 133”), “Accounting for Derivative Instruments and Hedging Activities,” are recorded at fair market value and the changes in fair value are recorded through other comprehensive income (loss), net of tax, in stockholders’ equity. The cash settlements on these contracts are recorded as an increase or decrease in oil and gas sales. The changes in fair value related to ineffective derivative contracts are recognized as derivative expense (income). The cash settlements on these contacts are also recorded within derivative expense (income).

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    Cash settlements on effective cash flow hedges during the three-month period ended June 30, 2006 resulted in an increase in oil and gas sales of $1.8 million compared to a reduction of oil and gas sales of $1.8 million for the same period in 2005. The six-month periods ended June 30, 2006 and 2005 resulted in an increase in oil and gas sales of $2.5 million and a reduction of oil and gas sales of $4.6 million, respectively.
 
    The Company recognized derivative expense of $30,000 and $533,000 for the three-month periods ended June 30, 2006 and 2005, respectively, and derivative expense of $120,000 and $912,000 for the six-month periods ended June 30, 2006 and 2005, respectively, relating to the amortization of derivative contract premiums.
 
    As of June 30, 2006, the fair value of the outstanding gas derivative contracts was a current asset of $4.4 million and the fair value of the outstanding oil derivative contracts was a current liability of $1.1 million and a long-term liability of $214,000.
 
    Listed in the table below are the outstanding derivative contracts as of June 30, 2006:
     Collars
                                 
                Average   Average    
    Volumes per   Quantity   Floor   Ceiling    
Product   Month   Type   Price   Price   Period
Oil
    30,000     Bbls   $ 60.00     $ 77.10     07/06—12/06
Oil
    30,000     Bbls   $ 60.00     $ 81.75     07/06—12/06
Oil
    25,000     Bbls   $ 65.00     $ 83.30     01/07—12/07
 
                               
Natural Gas
    100,000     MMBtu   $ 8.00     $ 10.30     07/06—09/06
Natural Gas
    600,000     MMBtu   $ 8.00     $ 9.30     07/06—12/06

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5.   Long-Term Debt
    Long-term debt consisted of the following at:
                 
    June 30,     December 31,  
    2006     2005  
    (In thousands)  
Senior Secured Credit Facility
               
(matures July 31, 2007)
  $ 7,000     $  
9.75% Senior Notes (due 2010), net of discount
    188,874       187,941  
Capital lease
    996       1,135  
 
           
Total debt
    196,870       189,076  
Less current portion:
               
Capital lease
    229       263  
 
           
Long-term debt
  $ 196,641     $ 188,813  
 
           
    On June 15, 2004, the Company closed on a three-year senior secured credit facility underwritten by Union Bank of California, N.A. The credit facility had an initial borrowing base of $60 million, which was increased to $70 million in the second quarter of 2005. The borrowing base is reviewed and redetermined semi-annually and can be increased to a maximum of $175 million. Borrowings under the credit facility are secured by mortgages covering the Company’s five largest fields. As of June 30, 2006, there was $7 million outstanding under the facility with a weighted average interest rate of 7.1% and $63 million available for future borrowings.
6.   Comprehensive Income
    A summary of the Company’s comprehensive income (loss) is detailed below (in thousands):
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2006     2005     2006     2005  
Net income
  $ 12,303     $ 9,311     $ 25,070     $ 18,786  
Other comprehensive income (loss):
                               
Change in fair value of derivatives
    1,019       1,856       2,294       (2,993 )
 
                       
Total comprehensive income
  $ 13,322     $ 11,167     $ 27,364     $ 15,793  
 
                       

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7.   Asset Retirement Obligations
    The following table summarizes the activity for the Company’s asset retirement obligation for the six-month period ended June 30, 2006:
         
    Six Months Ended  
    June 30, 2006  
Asset retirement obligation at beginning of period
  $ 38,273  
Accretion expense
    2,750  
Liabilities incurred
    1,109  
Liabilities settled
    (4,834 )
Revisions to estimate
    11,318  
 
     
Asset retirement obligation at end of period
    48,616  
Less: current asset retirement obligation
    (22,783 )
 
     
Long-term asset retirement obligation
  $ 25,833  
 
     
    The upward revisions to estimate were primarily due to a sharp increase in industry service cost for the Gulf of Mexico region experienced in the first quarter of 2006, principally as a result of the weather patterns during the second half of 2005.
 
    Assets, primarily U.S. Government securities, of approximately $6.1 million at June 30, 2006, are recorded as restricted investments. These assets are held in abandonment trusts dedicated to pay future abandonment costs for several of the Company’s oil and gas properties.
8.   Accounting Pronouncements
    In June 2006, the Financial Accounting Standards Board released interpretation No. 48, Accounting for Uncertainty in Income Taxes, (“FIN 48”). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position must meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The effective date for FIN 48 is fiscal years beginning after December 15, 2006. The Company is currently reviewing the provisions of FIN 48 and has not yet determined the impact of adoption.

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    Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
    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
 
    Our revenues, profitability, future growth and the carrying value of our oil and gas properties are substantially dependent on prevailing prices of oil and gas, our ability to find, develop and acquire additional oil and gas reserves that are economically recoverable and our ability to develop existing proved undeveloped reserves. Our ability to maintain or increase our borrowing capacity and to obtain additional capital on attractive terms is also influenced by oil and gas prices. Prices for oil and gas are subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and gas, market uncertainty and a variety of additional factors beyond our control. These factors include weather conditions in the United States, the condition of the United States economy, the actions of the Organization of Petroleum Exporting Countries, governmental regulations, political stability in the Middle East and elsewhere, the foreign supply of oil and gas, the price of foreign imports and the availability of alternate fuel sources. Any substantial and extended decline in the price of oil or gas would have an adverse effect on the carrying value of our proved reserves, borrowing capacity, revenues, profitability and cash flows from operations. We use derivative financial instruments for price protection purposes on a limited amount of our future production, but do not use derivative financial instruments for trading purposes.
 
    The following discussion is intended to assist in an understanding of our historical financial position and results of operations. Our historical financial statements and notes thereto included elsewhere in this quarterly report contain detailed information that should be referred to in conjunction with the following discussion.

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    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, 2006, we had net cash and cash equivalents of $1 million and $63 million of availability under our senior secured credit facility. Cash provided from operating activities during the six-month period ended June 30, 2006 totaled $75 million, a 40% increase when compared to 2005. The increase was primarily attributable to oil and gas prices. Net capital expenditures from the cash flow statement for the six-month period ended June 30, 2006 totaled $80 million.
 
    Production of our reserves during 2006, without weather-related downtime, is projected to be higher than 2005 due to 10 new discoveries scheduled to commence initial production during 2006 and are expected to offset traditional declines from our current producing properties. Given the current pricing environment for oil and natural gas and the higher production volumes, our cash provided by operating activities for 2006 is expected to exceed 2005.
 
    Our capital expenditure plans for 2006, including capitalized interest and general and administrative expenses, will require $150 million of funding. We expect that cash flow generated from operations during 2006 and current availability under our senior secured credit facility, if necessary, will provide the capital necessary to fund these planned capital expenditures as well as our asset retirement obligations which are expected to be approximately $30 million. See the Capital Expenditures section below for a more detailed discussion of our capital expenditures for 2006.
 
    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 facility contains covenants for maintenance of certain financial ratios. We were in compliance with these covenants at June 30, 2006. See Note 5 of the Consolidated Financial Statements for the year ended December 31, 2005 included in our Annual Report on Form 10-K filed March 15, 2006 for a more detailed discussion of long-term debt.
 
    The lenders for our senior secured credit facility have approved in principle a three-year maturity date extension to July 31, 2010. The closing of the transaction is subject to the drafting of a restated and amended credit facility which is expected to occur in August 2006.
 
    The following table describes our outstanding contractual obligations (in thousands) as of June 30, 2006:
                                         
          Less Than     One-Three     Four-Five     After-Five  
Contractual Obligations   Total     One Year     Years     Years     Years  
 
Senior Secured Credit Facility
  $ 7,000     $     $ 7,000     $     $  
9.75% Senior Notes
    200,000                   200,000        
Capital Lease (future minimum payments)
    1,477       383       514       448       132  
Throughput Commitments:
                                       
Medusa Spar LLC
    10,708       3,528       5,160       2,020        
Medusa Oil Pipeline
    503       155       159       107       82  
 
                             
 
  $ 219,688     $ 4,066     $ 12,833     $ 202,575     $ 214  
 
                             

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    Capital Expenditures
 
    Capital expenditures from the cash flow statement were $80 million for the six months ended June 30, 2006. Of this amount approximately $71 million was for exploration and development costs related to oil and gas properties and the remaining $9 million was for plugging and abandonment activities.
 
    Included in the $71 million for exploration and development costs related to oil and gas properties was approximately $46 million of costs for the Gulf of Mexico Shelf Area which included the drilling costs of eight wells and completion and development of our discoveries. Four of the eight wells were successful, one was unsuccessful and three were in progress. In the Onshore Louisiana area we spent $8 million, which was associated with the drilling and beginning stage of completion for our Prairie Beach discovery. Interest of approximately $3 million and general and administrative costs allocable directly to exploration and development projects of approximately $4 million were capitalized for the first six months of 2006. The remainder of the capital expended includes the acquisition of seismic and leases and costs related to our Gulf of Mexico deepwater area.
 
    Capital expenditures for the remainder of 2006 are forecast to be approximately $79 million and include:
    the completion and development of our 2006 discoveries, including development wells;
 
    the non-discretionary drilling of exploratory wells;
 
    the acquisition of seismic and leases; and
 
    capitalized interest and general and administrative costs.
    In addition, we are projecting to spend $21 million in the second half of 2006 for asset retirement obligations.
 
    Off-Balance Sheet Arrangements
 
    In December 2003, we announced the formation of a limited liability company, Medusa Spar LLC, which now 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 Medusa Spar LLC in return for approximately $25 million in cash and a 10% ownership interest in the LLC. The LLC will earn 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 allows us to defer the cost of the Spar production facility over the life of the Medusa Field. Our cash proceeds were used to reduce the balance outstanding under our senior secured credit facility. The LLC used $83.7 million of cash proceeds from non-recourse financing and a cash contribution by one of the LLC owners to acquire its 75% interest in the Spar. The balance of Medusa Spar LLC is owned by Oceaneering International, Inc. (NYSE:OII) and Murphy Oil Corporation (NYSE:MUR). We are accounting for our 10% ownership interest in the LLC under the equity method.

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    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,  
    2006     2005     2006     2005  
Net production :
                               
Oil (MBbls)
    443       590       958       1,230  
Gas (MMcf)
    2,581       2,313       4,530       5,060  
Total production (MMcfe)
    5,239       5,850       10,281       12,443  
Average daily production (MMcfe)
    57.6       64.3       56.8       68.7  
 
                               
Average sales price:
                               
Oil (Bbls) (a)
  $ 59.99     $ 41.53     $ 56.74     $ 39.41  
Gas (Mcf)
    7.93       7.43       8.44       7.15  
Total (Mcfe)
    8.98       7.12       9.01       6.81  
 
                               
Oil and gas revenues:
                               
Oil revenue
  $ 26,580     $ 24,484     $ 54,379     $ 48,493  
Gas revenue
    20,477       17,184       38,259       36,187  
 
                       
Total
  $ 47,057     $ 41,668     $ 92,638     $ 84,680  
 
                       
 
                               
Oil and gas production costs:
                               
Lease operating expense
  $ 7,365     $ 6,197     $ 13,270     $ 12,733  
 
                               
Additional per Mcfe data:
                               
Sales price
  $ 8.98     $ 7.12     $ 9.01     $ 6.81  
Lease operating expense
    1.41       1.06       1.29       1.02  
 
                       
Operating margin
  $ 7.57     $ 6.06     $ 7.72     $ 5.79  
 
                       
 
                               
Depletion, depreciation and amortization
  $ 2.82     $ 2.34     $ 2.78     $ 2.34  
General and administrative (net of management fees)
  $ 0.37     $ 0.48     $ 0.36     $ 0.36  
(a)   Below is a reconciliation of the average NYMEX price to the average realized sales price per barrel of oil:
                                 
Average NYMEX oil price
  $ 70.70     $ 53.17     $ 67.09     $ 51.51  
Basis differential and quality adjustments
    (7.83 )     (7.37 )     (7.93 )     (6.89 )
Transportation
    (1.29 )     (1.28 )     (1.28 )     (1.30 )
Hedging
    (1.59 )     (2.99 )     (1.14 )     (3.91 )
 
                       
Average realized oil price
  $ 59.99     $ 41.53     $ 56.74     $ 39.41  
 
                       

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    Comparison of Results of Operations for the Three Months Ended June 30, 2006 and the Three Months Ended June 30, 2005.
 
    Oil and Gas Production and Revenues
 
    Total oil and gas revenues increased 13% to $47.1 million in the second quarter of 2006 from $41.7 million in the second quarter of 2005. The increase was primarily due to higher product prices. Total production on an equivalent basis for the second quarter of 2006 decreased by 10% versus the second quarter of 2005.
 
    Gas production during the second quarter of 2006 totaled 2.6 Bcf and generated $20.5 million in revenues compared to 2.3 Bcf and $17.2 million in revenues during the same period in 2005. The average gas price after hedging impact for the second quarter of 2006 was $7.93 per Mcf compared to $7.43 per Mcf for the same period last year. The 12% increase in production was primarily due to production from our new wells at East Cameron Block 90, North Padre Island Block 913, High Island Block 73 and West Cameron Block 295. The increase was partially offset by normal and expected declines in production from our Habanero, High Island Block 119 and Mobile Bay area fields and older properties.
 
    Oil production during the second quarter of 2006 totaled 443,000 barrels and generated $26.6 million in revenues compared to 590,000 barrels and $24.5 million in revenues for the same period in 2005. The average oil price received after hedging impact in the second quarter of 2006 was $59.99 per barrel compared to $41.53 per barrel in the second quarter of 2005. The decrease in production for the second quarter of 2006 compared to the second quarter of 2005 was primarily due to normal and expected declines in production from our Habanero Field and older properties.
    Lease Operating Expenses
 
    Lease operating expenses were $7.4 million for the three-month period ended June 30, 2006, an increase of $1.2 million compared to the same period in 2005. The increase was primarily due to new wells coming on line, higher costs for fuel and marine transportation and an increase in insurance rates for our policies which were renewed on April 1, 2006. The increase was partially offset by a decrease in throughput charges for Habanero resulting from lower production.
 
    Depreciation, Depletion and Amortization
 
    Depreciation, depletion and amortization for the three months ended June 30, 2006 and 2005 was $14.8 million and $13.7 million, respectively. The 8% increase was primarily due to a higher depletion rate resulting from higher cost associated with exploration and development in the Gulf of Mexico.
 
    Accretion Expense
 
    Accretion expense for the three-month periods ended June 30, 2006 and 2005 of $1.3 million and $770,000, respectively, represents accretion of our asset retirement obligations. The increase was primarily due to the addition of plugging and abandonment obligations associated with new discoveries and an increase in plugging and abandonment estimates. See Note 7 to the Consolidated Financial Statements.

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    General and Administrative
 
    General and administrative expenses, net of amounts capitalized, were $1.9 million and $2.8 million for the three-month periods ended June 30, 2006 and 2005, respectively. The 31% decrease was primarily due to non-cash charges totaling $928,000 that were recognized in the second quarter of 2005 for the accelerated vesting of performance shares pursuant to the terms of the plan due to death or disability for an executive officer and two directors of the Company.
 
    Interest Expense
 
    Interest expense decreased by 3% to $4.1 million during the three months ended June 30, 2006 from $4.3 million during the three months ended June 30, 2005. This decrease is primarily attributable to an increase in capitalized interest resulting from an increase in our investment in unevaluated properties over the last year due to expanded exploration activities.
 
    Income Taxes
 
    Income tax expense was $6.3 million and $4.7 million for the three-month periods ended June 30, 2006 and 2005, respectively. The increase was due to an increase in income before income taxes.
    Comparison of Results of Operations for the Six Months Ended June 30, 2006 and the Six Months Ended June 30, 2005.
 
    Oil and Gas Production and Revenues
 
    Total oil and gas revenues increased 9% to $92.6 million in the first half of 2006 from $84.7 million in the first half of 2005. The increase was primarily due to higher product prices. Total production on an equivalent basis for the first half of 2006 decreased by 17% versus the first half of 2005.
 
    Gas production during the six-months ended June 30, 2006 totaled 4.5 Bcf and generated $38.3 million in revenues compared to 5.1 Bcf and $36.2 million in revenues during the same period in 2005. The average gas price after hedging impact for the first half of 2006 was $8.44 per Mcf compared to $7.15 per Mcf for the same period last year. The decrease in production was primarily due to normal and expected declines in production from our Habanero, High Island Block 119, and Mobile Bay area fields and older properties. The decrease was partially offset by production from our new wells at East Cameron Block 90, North Padre Island Block 913, High Island Block 73 and West Cameron Block 295.
 
    Oil production during the six-months ended June 30, 2006 totaled 958,000 barrels and generated $54.4 million in revenues compared to 1,230,000 barrels and $48.5 million in revenues for the same period in 2005. The average oil price received after hedging impact in the first half of 2006 was $56.74 per barrel compared to $39.41 per barrel in the first half of 2005. The decrease in production was primarily due to normal and expected declines in production from our Habanero Field and older properties.

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    Lease Operating Expenses
 
    Lease operating expenses were $13.3 million for the six-month period ended June 30, 2006, an increase of $537,000 compared to the same period in 2005. The increase was primarily due to new wells coming on line, higher costs for fuel and marine transportation and an increase in insurance rates for our policies which were renewed on April 1, 2006. The increase was partially offset by the shut-in of our Main Pass Block 163 Field after the first quarter of 2005, which became uneconomic and is being plugged and abandoned, and a decrease in throughput charges for Habanero resulting from lower production.
 
    Depreciation, Depletion and Amortization
 
    Depreciation, depletion and amortization for the six-months ended June 30, 2006 and 2005 was $28.6 million and $29.1 million, respectively. The 2% decrease was primarily due to lower production volumes for the first half of 2006 compared to the same period last year. The decrease was partially offset by a higher depletion rate primarily due to higher cost associated with exploration and development in the Gulf of Mexico.
 
    Accretion Expense
 
    Accretion expense for the six-month period ended June 30, 2006 and 2005 of $2.8 million and $1.6 million, respectively, represents accretion of our asset retirement obligations. The increase was primarily due to the addition of plugging and abandonment obligations associated with new discoveries and an increase in plugging and abandonment estimates. See Note 7 to the Consolidated Financial Statements.
 
    General and Administrative
 
    General and administrative expenses, net of amounts capitalized, were $3.7 million and $4.5 million for the six-month periods ended June 30, 2006 and 2005, respectively. The 19% decrease was primarily due to non-cash charges totaling $928,000 that were recognized in the second quarter of 2005 for the accelerated vesting of performance shares pursuant to the terms of the plan due to death or disability for an executive officer and two directors of the Company.
 
    Interest Expense
 
    Interest expense decreased by 6% to $8.3 million during the six months ended June 30, 2006 from $8.8 million during the six months ended June 30, 2005. This decrease is primarily attributable to an increase in capitalized interest resulting from an increase in our investment in unevaluated properties over the last year due to expanded exploration activities.
 
    Income Taxes
 
    Income tax expense was $12.8 million and $9.6 million for the six-month periods ended June 30, 2006 and 2005, respectively. The increase was due to an increase in income before income taxes.

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    Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
    The Company’s revenues are derived from the sale of its crude oil and natural gas production. The prices for oil and gas remain extremely volatile and sometimes experience large fluctuations as a result of relatively small changes in supply, weather conditions, economic conditions and government actions. From time to time, the Company enters into derivative financial instruments to manage oil and gas price risk.
 
    The Company may utilize fixed price “swaps”, which reduce the Company’s exposure to decreases in commodity prices and limit the benefit the Company might otherwise have received from any increases in commodity prices.
 
    The Company may utilize price “collars” to reduce the risk of changes in oil and gas prices. Under these arrangements, no payments are due by either party so long as the market price is above the floor price and below the ceiling price set in the collar. If the price falls below the floor, the counter-party to the collar pays the difference to the Company, and if the price rises above the ceiling, the counter-party receives the difference from the Company.
 
    Callon may purchase “puts” which reduce the Company’s exposure to decreases in oil and gas prices while allowing realization of the full benefit from any increases in oil and gas prices. If the price falls below the floor, the counter-party pays the difference to the Company.
 
    The Company enters into these various agreements from time to time to reduce the effects of volatile oil and gas prices and does not enter into derivative transactions for speculative purposes. However, certain of the Company’s derivative positions may not be designated as hedges for accounting purposes.
 
    See Note 4 to the Consolidated Financial Statements for a description of the Company’s outstanding derivative contracts at June 30, 2006. There have been no significant changes in market risks faced by the Company since the end of 2005.
    Item 4. CONTROLS AND PROCEDURES
 
    Evaluation of Disclosure Controls and Procedures. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. The Company’s principal executive and financial officer has concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) were effective as of June 30, 2006.
 
    There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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CALLON PETROLEUM COMPANY
PART II. OTHER INFORMATION
Item 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
The Company held its annual meeting of shareholders on May 4, 2006. At the annual meeting, two Class III directors of the board of directors of the Company were elected to hold office until the Company’s annual meeting of shareholders in 2009 or until their respective successors have been duly elected and qualified. The votes cast for each of the directors proposed in the Company’s definitive proxy statement on Schedule 14A, out of a total of 19,516,239 shares outstanding on the record date for the annual meeting, were as follows:
                         
            For     Withheld  
Fred L. Callon
  Class III     15,685,582       1,892,353  
L. Richard Flury
  Class III     15,742,161       1,835,774  
There were no abstentions, votes against or broker non-votes cast with respect to the election of directors.
The shareholders of the Company ratified the appointment of Ernst & Young LLP as the Company’s independent registered public accounting firm for 2006. There were 17,550,825 votes in favor and 27,110 votes against or abstained. There were no votes withheld or broker non-votes with respect to the ratification of the appointment of Ernst & Young LLP.
The shareholders of the Company also approved and ratified the Callon Petroleum Company 2006 Stock Incentive Plan. There were 8,591,032 votes in favor and 6,078,128 votes against or abstained.
Item 6. EXHIBITS
    Exhibits
  3.   Articles of Incorporation and By-Laws
  3.1   Certificate of Incorporation of the Company, as amended (incorporated by reference from Exhibit 3.1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 filed March 15, 2004, File No. 001-14039)
 
  3.2   Bylaws of the Company (incorporated by reference from Exhibit 3.2 of the Company’s Registration Statement on Form S-4, filed August 4, 1994, Reg. No. 33-82408)
  4.   Instruments defining the rights of security holders, including indentures

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  4.1   Specimen Common Stock Certificate (incorporated by reference from Exhibit 4.1 of the Company’s Registration Statement on Form S-4, filed August 4, 1994, Reg. No. 33-82408)
 
  4.2   Rights Agreement between Callon Petroleum Company and American Stock Transfer & Trust Company, Rights Agent, dated March 30, 2000 (incorporated by reference from Exhibit 99.1 of the Company’s Registration Statement on Form 8-A, filed April 6, 2000, File No. 001- 14039)
 
  4.3   Form of Warrant entitling certain holders of the Company’s 10.125% Senior Subordinated Notes due 2002 to purchase common stock from the Company (incorporated by reference to Exhibit 4.13 of the Company’s Form 10-Q for the period ended June 30, 2002, File No. 001-14039)
 
  4.4   Form of Warrants dated December 8, 2003 and December 29, 2003 entitling lenders under the Company’s $185 million amended and restated Senior Unsecured Credit Agreement, dated December 23, 2003, to purchase common stock from the Company (incorporated by reference to Exhibit 4.14 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, File No. 001-14039)
 
  4.5   Indenture for the Company’s 9.75% Senior Notes due 2010, dated March 15, 2004, between Callon Petroleum Company and American Stock Transfer & Trust Company (incorporated by reference to Exhibit 4.16 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, File No. 001-14039)
  31.   Certifications
  31.1   Certification of Chief Executive and Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32.   Section 1350 Certifications
  32.1   Certification of Chief Executive and Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  CALLON PETROLEUM COMPANY
 
 
Date: August 7, 2006  By:   /s/ Fred L. Callon    
    Fred L. Callon, President and Chief Executive Officer (on behalf of the registrant and as the principal financial officer)   

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Table of Contents

         
Exhibit Index
             
Exhibit Number   Title of Document
 
           
3.   Articles of Incorporation and By-Laws
 
           
 
    3.1     Certificate of Incorporation of the Company, as amended (incorporated by reference from Exhibit 3.1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 filed March 15, 2004, File No. 001-14039)
 
           
 
    3.2     Bylaws of the Company (incorporated by reference from Exhibit 3.2 of the Company’s Registration Statement on Form S-4, filed August 4, 1994, Reg. No. 33-82408)
 
           
4.   Instruments defining the rights of security holders, including indentures
 
           
 
    4.1     Specimen Common Stock Certificate (incorporated by reference from Exhibit 4.1 of the Company’s Registration Statement on Form S-4, filed August 4, 1994, Reg. No. 33-82408)
 
           
 
    4.2     Rights Agreement between Callon Petroleum Company and American Stock Transfer & Trust Company, Rights Agent, dated March 30, 2000 (incorporated by reference from Exhibit 99.1 of the Company’s Registration Statement on Form 8-A, filed April 6, 2000, File No. 001- 14039)
 
           
 
    4.3     Form of Warrant entitling certain holders of the Company’s 10.125% Senior Subordinated Notes due 2002 to purchase common stock from the Company (incorporated by reference to Exhibit 4.13 of the Company’s Form 10-Q for the period ended June 30, 2002, File No. 001-14039)
 
           
 
    4.4     Form of Warrants dated December 8, 2003 and December 29, 2003 entitling lenders under the Company’s $185 million amended and restated Senior Unsecured Credit Agreement, dated December 23, 2003, to purchase common stock from the Company (incorporated by reference to Exhibit 4.14 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, File No. 001-14039)

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Exhibit Number   Title of Document
 
           
 
    4.5     Indenture for the Company’s 9.75% Senior Notes due 2010, dated March 15, 2004, between Callon Petroleum Company and American Stock Transfer & Trust Company (incorporated by reference to Exhibit 4.16 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, File No. 001-14039)
 
           
31.   Certifications
 
           
 
    31.1     Certification of Chief Executive and Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
           
32.   Section 1350 Certifications
 
 
    32.1     Certification of Chief Executive and Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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