Stone Energy (SGY) 10-Q 2004 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

or

|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to           

Commission file number 1-12074

STONE ENERGY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

                                           Delaware                                                                 72-1235413
                             (State or Other Jurisdiction                                                (I.R.S. Employer
                         of Incorporation or Organization)                                        Identification No.)

                              625 E. Kaliste Saloom Road                                                     70508
                                    Lafayette, Louisiana                                                         (Zip Code)
                   (Address of Principal Executive Offices)

Registrant's Telephone Number, Including Area Code:  (337) 237-0410

     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  |_|

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
                                                                                    Yes |X|     No  |_|

     As of November 4, 2004 there were 26,674,044 shares of the registrant's Common Stock, par value $.01 per share, outstanding.

TABLE OF CONTENTS

		Page
PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheet        as of September 30, 2004 and December 31, 2003	1
	Condensed Consolidated Statement of Income        for the Three and Nine Months Ended September 30, 2004 and 2003	2
	Condensed Consolidated Statement of Cash Flows        for the Nine Months Ended September 30, 2004 and 2003	3
	Notes to Condensed Consolidated Financial Statements	4
	Report of Independent Registered Public Accounting Firm	9
Item 2.	Management's Discussion and Analysis of Financial        Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	14
Item 4.	Controls and Procedures	15
PART II. – OTHER INFORMATION
Item 1.	Legal Proceedings	15
Item 6.	Exhibits	16
	Signature	17

PART I  -  FINANCIAL INFORMATION

Item 1.    Financial Statements

STONE ENERGY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands of dollars)

	September 30, 2004		December 31, 2003
Assets	(Unaudited)		(Note 1)
Current assets:
Cash and cash equivalents	$50,871		$17,100
Accounts receivable	85,317		75,066
Deferred taxes	7,441		3,407
Other current assets	3,651		2,507
Total current assets	147,280		98,080
Oil and gas properties – full-cost method of accounting:
Proved, net of accumulated depreciation, depletion          and amortization of $1,472,203 and $1,319,337, respectively	1,328,507		1,210,333
Unevaluated	120,321		107,600
Building and land, net	5,408		5,202
Fixed assets, net	5,001		5,269
Other assets, net	8,900		7,793
Total assets	$1,615,417		$1,434,277
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable to vendors	$91,119		$87,646
Undistributed oil and gas proceeds	39,724		30,793
Fair value of hedging contracts	19,294		7,336
Other accrued liabilities	15,368		10,779
Total current liabilities	165,505		136,554
Long–term debt	370,000		370,000
Deferred taxes	181,650		130,935
Asset retirement obligations	82,657		78,877
Fair value of hedging contracts	4,627		4,770
Other long–term liabilities	2,557		2,864
Total liabilities	806,996		724,000
Commitments and contingencies
Common stock	267		264
Treasury stock	(1,462	)	(1,550	)
Additional paid–in capital	463,696		455,391
Retained earnings	362,163		264,935
Accumulated other comprehensive loss	(16,243	)	(8,763	)
Total stockholders’ equity	808,421		710,277
Total liabilities and stockholders’ equity	$1,615,417		$1,434,277

The accompanying notes are an integral part of this balance sheet.

STONE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In thousands of dollars, except per share amounts)
(Unaudited)

		Three Months Ended September 30,				Nine Months Ended September 30,
		2004		2003		2004		2003
Operating revenue:
	Oil production	$56,752		$40,492		$167,548		$127,394
	Gas production	71,554		75,501		236,562		263,357
	Total operating revenue	128,306		115,993		404,110		390,751
Operating expenses:
	Normal lease operating expenses	19,666		15,121		53,526		45,827
	Major maintenance expenses	11,090		5,209		19,980		10,451
	Production taxes	2,169		1,410		5,892		4,368
	Depreciation, depletion and amortization	46,139		42,020		142,943		124,785
	Accretion expense	1,463		1,573		4,389		4,719
	Salaries, general and administrative expenses	3,378		3,641		10,668		10,578
	Incentive compensation expense	588		577		1,705		1,914
	Derivative expenses	1,069		2,153		3,029		6,407
	Total operating expenses	85,562		71,704		242,132		209,049
Income from operations		42,744		44,289		161,978		181,702
Other (income) expenses:
	Interest	4,050		4,760		11,987		15,448
	Other income	(637	)	(691	)	(1,994	)	(2,058	)
	Other expense	-		538		2,383		538
	Early extinguishment of debt	-		4,661		-		4,661
	Total other expenses	3,413		9,268		12,376		18,589
Income before taxes		39,331		35,021		149,602		163,113
Provision for income taxes:
	Current	-		-		-		-
	Deferred	13,766		12,254		52,361		57,086
	Total income taxes	13,766		12,254		52,361		57,086
Income before cumulative effects of accounting       changes, net of tax		25,565		22,767		97,241		106,027
	Cumulative effect of accounting changes, net of tax	-		-		-		1,225
Net income		$25,565		$22,767		$97,241		$107,252
Basic earnings per share:
	Income before effects of accounting changes, net of tax	$0.96		$0.86		$3.66		$4.02
	Cumulative effects of accounting changes, net of tax	-		-		-		0.05
	Basic earnings per share	$0.96		$0.86		$3.66		$4.07
Diluted earnings per share:
	Income before effects of accounting changes, net of tax	$0.95		$0.86		$3.62		$3.99
	Cumulative effects of accounting changes, net of tax	-		-		-		0.05
	Diluted earnings per share	$0.95		$0.86		$3.62		$4.04
	Average shares outstanding	26,640		26,378		26,561		26,366
	Average shares outstanding assuming dilution	26,918		26,589		26,890		26,560

The accompanying notes are an integral part of this statement.

STONE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands of dollars)
(Unaudited)

	Nine Months Ended September 30,
	2004		2003
Cash flows from operating activities:
Net income	$97,241		$107,252
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, depletion and amortization	142,943		124,785
Accretion expense	4,389		4,719
Provision for deferred income taxes	52,361		57,086
Derivative expenses	3,029		6,407
Cumulative effect of accounting changes	-		(1,225	)
Early extinguishment of debt	-		1,744
Other non-cash items	1,156		525
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable	(10,251	)	935
Increase in other current assets	(2,195	)	(1,089	)
Increase in other accrued liabilities	12,946		10,826
Investment in derivative contracts	(1,683	)	(516	)
Other	(21	)	58
Net cash provided by operating activities	299,915		311,507
Cash flows from investing activities:
Investment in oil and gas properties	(280,934	)	(231,446	)
Proceeds from sale of oil and gas properties	11,948		-
Increase in other assets	(1,458	)	(1,604	)
Net cash used in investing activities	(270,444	)	(233,050	)
Cash flows from financing activities:
Proceeds from bank borrowings	22,000		90,000
Repayment of bank borrowings	(22,000	)	(61,000	)
Redemption of senior subordinated notes	-		(100,000	)
Deferred financing costs	(2,357	)	(143	)
Proceeds from exercise of stock options	6,657		1,197
Net cash provided by (used in) financing activities	4,300		(69,946	)
Net increase in cash and cash equivalents	33,771		8,511
Cash and cash equivalents, beginning of period	17,100		27,609
Cash and cash equivalents, end of period	$50,871		$36,120

The accompanying notes are an integral part of this statement.

STONE ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Interim Financial Statements

        The condensed consolidated financial statements of Stone Energy Corporation and subsidiary as of September 30, 2004 and for the three and nine-month periods ended September 30, 2004 and 2003 are unaudited and reflect all adjustments (consisting only of normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the interim period. The condensed consolidated balance sheet at December 31, 2003 has been derived from the audited financial statements at that date. The consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with management’s discussion and analysis of financial condition and results of operations, contained in our Annual Report on Form 10-K for the year ended December 31, 2003. The results of operations for the three and nine-month periods ended September 30, 2004 are not necessarily indicative of future financial results.

Note 2 – Earnings Per Share

        Basic net income per share of common stock was calculated by dividing net income applicable to common stock by the weighted-average number of common shares outstanding during the period. Diluted net income per share of common stock was calculated by dividing net income applicable to common stock by the weighted-average number of common shares outstanding during the period plus the weighted-average number of dilutive shares for stock options granted to nonemployee directors and employees. There were approximately 278,000 and 211,000 dilutive shares for the three months ended September 30, 2004 and 2003, respectively, and 329,000 and 194,000 dilutive shares for the nine months ended September 30, 2004 and 2003, respectively.

        Options that were considered antidilutive because the exercise price of the option exceeded the average price of our stock for the applicable period totaled approximately 747,000 and 936,000 shares in the three months ended September 30, 2004 and 2003, respectively, and 624,000 and 1,047,000 shares in the nine months ended September 30, 2004 and 2003, respectively.

        During the three months ended September 30, 2004 and 2003, approximately 12,000 and 55,000 shares of common stock, respectively, were issued upon the exercise of stock options by employees and nonemployee directors. For the nine months ended September 30, 2004 and 2003, approximately 242,000 and 88,000 shares of common stock, respectively, were issued upon the exercise of stock options and the issuance of restricted and treasury stock.

Note 3 – Hedging Activities

        We enter into hedging transactions to secure a commodity price for a portion of future production that is acceptable at the time of the transaction. The primary objective of these activities is to reduce our exposure to the risk of declining oil and natural gas prices during the contractual term of the hedge. We do not enter into hedging transactions for trading purposes.

        The following table illustrates our hedging positions as of October 1, 2004:

	Put Contracts
	Natural Gas			Oil
	Daily Volume (MMBtus/d)	Floor	Unamortized Cost (millions)	Daily Volume (Bbls/d)	Floor	Unamortized Cost (millions)
2004	90,000	$3.50	$0.6	7,500	$25.00	$0.5

	Zero Premium Collars
	Natural Gas			Oil
	Daily Volume (MMBtus/d)	Floor Price	Ceiling Price	Daily Volume (Bbls/d)	Floor Price	Ceiling Price
2005	20,000	$4.50	$10.25	4,000	$28.00	$52.90
2005	20,000	4.00	13.50	4,000	28.00	52.75

	Fixed Price Gas Swaps
	Daily Volume (MMBtus/d)	Price
2004	15,000	$3.42
2005	15,000	3.42

        During the three months ended September 30, 2004 and 2003, we realized net decreases in gas revenue related to swaps of $2.3 million and $0.6 million, respectively. During the nine months ended September 30, 2004 and 2003, we realized net decreases in gas revenue related to swaps of $6.7 million and $1.1 million, respectively.

Note 4 – Long-Term Debt

        Long-term debt consisted of the following:

	September 30, 2004	December 31, 2003
	(Unaudited)
	(In millions)
8¼% Senior Subordinated Notes due 2011	$200	$200
Bank debt	170	170
Total long-term debt	$370	$370

        On April 30, 2004, we entered into a four-year $500 million senior unsecured credit facility with a syndicated bank group. The new facility has an initial borrowing base of $425 million and replaces the previous $350 million credit facility. Borrowings outstanding at September 30, 2004 under our bank credit facility totaled $170.0 million, and letters of credit totaling $13.1 million have been issued under the facility. At September 30, 2004, we had $241.9 million of borrowings available under the credit facility and the weighted average interest rate under the credit facility was approximately 3.1%. The borrowing base under the new credit facility is re-determined periodically based on the bank group’s evaluation of our proved oil and gas reserves.

Note 5 – Comprehensive Income

        The following table illustrates the components of comprehensive income for the three and nine months ended September 30, 2004 and 2003:

	Three Months Ended September 30,			Nine Months Ended September 30,
	2004		2003	2004		2003
	(In millions) (Unaudited)
Net income	$25.6		$22.8	$97.2		$107.3
Other comprehensive income (loss), net of tax effect:
Net change in fair value of derivatives	(4.4	)	2.3	(7.5	)	(4.6	)
Amortization of other comprehensive income from the ineffective swap	-		0.5	-		1.7
Total other comprehensive income (loss)	(4.4	)	2.8	(7.5	)	(2.9	)
Comprehensive income	$21.2		$25.6	$89.7		$104.4

Note 6 – Asset Retirement Obligations

        We adopted Statement of Financial Accounting Standard (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations” on January 1, 2003. Upon adoption, we recognized a credit for a cumulative transition adjustment of $5.3 million, net of tax, for existing asset retirement obligation liabilities, asset retirement costs and accumulated depreciation. In addition, we recorded a $32.1 million increase in the capitalized costs of our oil and gas properties, net of accumulated depreciation, and recognized $76.3 million in additional liabilities related to asset retirement obligations. During the third quarter of 2004 and 2003, we recognized expenses of $1.5 million and $1.6 million, respectively, related to the accretion of our asset retirement obligations. For the nine-month periods ended September 30, 2004 and 2003, we recognized accretion expense of $4.4 million and $4.7 million, respectively. As of September 30, 2004, accretion expense represented the only change in the asset retirement obligations since December 31, 2003. As required by SFAS No. 143, our estimate of our asset retirement obligations does not give consideration to the value that the related assets could have to other parties.

        On September 28, 2004, the Securities and Exchange Commission adopted Staff Accounting Bulletin (“SAB”) No. 106, which expressed the Staff’s views regarding the application of SFAS No. 143 by oil and gas companies following the full cost accounting method. SAB No. 106 indicates that estimated dismantlement and abandonment costs that will be incurred as a result of future development activities on proved reserves are to be included in the estimated future cash flows in the full cost ceiling limitation. SAB No. 106 also indicates that these estimated costs are to be included in the costs to be amortized. We expect to begin applying SAB No. 106 in the first quarter of 2005, when it becomes effective for us.

Note 7 – Changes in Accounting Principle

        Units of Production Method. Effective January 1, 2003, management elected to change to the units of production method of amortizing proved oil and gas property costs versus the formerly used future gross revenue method. Management believes that this change in method is preferable because it removes fluctuations in depreciation, depletion and amortization (“DD&A”) expense caused by product pricing volatility within a reporting period and is a method more widely used in the oil and gas industry. The cumulative effect of the change in accounting principle was $4.0 million, net of tax, and was recorded as a non-cash charge during the first quarter of 2003.

        Entitlement Method. Management elected to begin recognizing production revenue under the Entitlement method effective January 1, 2003. Management believes that this method is preferable because revenues and production are accounted for in the period in which the earnings process is complete. The cumulative effect of the change to the Entitlement method was immaterial.

Note 8 – Stock-Based Compensation

        In October 1995, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123, “Accounting for Stock-Based Compensation,” which became effective with respect to us in 1996. Under SFAS No. 123, companies can either record expense based on the fair value of stock-based compensation upon issuance or elect to remain under the current method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” whereby no compensation cost is recognized upon grant if certain requirements are met. The FASB has issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” which has amended APB Opinion 28 No., “Interim Financial Reporting,” to require a tabular presentation similar to that called for in annual statements in condensed quarterly statements if, for any period presented, the intrinsic value method of APB Opinion No. 25 is used. We have continued to account for our stock-based compensation under APB Opinion No. 25. However, we have adopted the disclosure provisions of SFAS No. 148.

        If the compensation expense for stock-based compensation plans had been determined consistent with the expense recognition provisions under SFAS No. 123, our net income and basic and diluted earnings per share for the three and nine months ended September 30, 2004 and 2003 would have approximated the pro forma amounts below:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
	(In millions, except per share amounts) (Unaudited)
Net income	$25.6		$22.8		$97.2		$107.3
Add: Stock-based compensation expense included in net income, net of tax	-		-		-		-
Less: Stock-based compensation expense using fair value method, net of tax	(1.4	)	(1.5	)	(4.1	)	(4.3	)
Pro forma net income	$24.2		$21.3		$93.1		$103.0
Basic earnings per share	$0.96		$0.86		$3.66		$4.07
Pro forma basic earnings per share	0.91		0.81		3.51		3.91
Diluted earnings per share	$0.95		$0.86		$3.62		$4.04
Pro forma diluted earnings per share	0.90		0.80		3.46		3.88

        On March 31, 2004, the FASB issued a proposed Statement, “Share-Based Payment,” that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for equity instruments of the enterprise, such as stock options. The proposed Statement would eliminate the ability to account for share-based compensation transactions using the APB Opinion No. 25 and generally would require instead that such transactions be accounted for using a fair value-based method. Stone currently accounts for stock-based compensation using APB Opinion No. 25. On October 13, 2004, the FASB concluded that SFAS No. 123R, “Share-Based Payment,” which will require companies to measure compensation cost for all share-based payments at fair value, will be effective for interim or annual periods beginning after June 15, 2005. The proposed Statement, if adopted, would require us to begin accounting for stock options under this method beginning in three month period ended September 30, 2005. It is currently not known whether the implementation of this proposed Standard would result in financial results materially different from those presented above.

Note 9 – Commitments and Contingencies

        In September 2004, Stone and other defendants were served with an amended petition filed by the State of Louisiana and the Iberia Parish School Board in Case Number 101934, Iberia Parish, Louisiana, alleging contamination and damage to portions of Section 16, Township 12 South, Range 11 East in the Bayou Pigeon Field as a result of oil and gas exploration and production activities. The Company believes it was named as a defendant in error and intends to vigorously defend this action.

        We have been named as a defendant in a number of lawsuits arising in the ordinary course of business. While the outcome of these lawsuits cannot be predicted with certainty, we do not expect these matters to have a material adverse effect on our financial position, cash flow or results of operations.

Note 10 – Sale of Rocky Mountain Properties

        Stone sold its interests in 21 non-core properties located in various regions of the Rocky Mountains for approximately $8 million effective June 1, 2004. In accordance with the full cost method of accounting, proceeds from the sale were recorded as an addition to Stone’s accumulated DD&A balance. The divested properties comprise approximately one percent of Stone’s total estimated proved reserves at December 31, 2003 and included approximately 28% of Stone’s wells in the Rockies. All of the divested properties were held by Stone’s wholly owned subsidiary, Stone Energy, L.L.C.

Note 11 – Subsequent Events

        On October 19, 2004, we announced an exploration agreement with Kerr-McGee Oil and Gas Corp. covering several undeveloped leases in the Gulf of Mexico, including deep water. Under the agreement, we have initially committed approximately $50 million to acquire varying interests in these leases and to participate in six commitment wells to be drilled by the end of 2005. In addition, we also intend to evaluate additional drilling opportunities on the respective leases through 2006.

        Stone has exercised its preferential right to acquire additional working interests in South Timbalier Blocks 143, 164, 165, 166 and 171 for approximately $125 million, pending the execution of an Asset Purchase Agreement. After completion of the acquisition, Stone will hold a majority working interest in the blocks. The wells applicable to these working interests are currently flowing at an average net daily rate of approximately 57 MMcfe. Stone expects to close this acquisition late in the fourth quarter of 2004 and intends to finance this acquisition with available cash and borrowings under its bank credit facility.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE STOCKHOLDERS OF
STONE ENERGY CORPORATION:

We have reviewed the accompanying condensed consolidated balance sheet of Stone Energy Corporation (a Delaware corporation) as of September 30, 2004, and the related condensed consolidated statements of income for the three- and nine-month periods ended September 30, 2004 and 2003, and the condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2004 and 2003. These financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Stone Energy Corporation as of December 31, 2003, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the year then ended (not presented herein) and in our report dated February 27, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Ernst & Young LLP        

New Orleans, Louisiana
November 2, 2004

Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations

        This Form 10-Q and the information referenced herein contain statements that constitute “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. The words “plan,” “expect,” “project,” “estimate,” “assume,” “believe,” “anticipate,” “intend,” “budget,” “forecast,” “predict” and other similar expressions are intended to identify forward-looking statements. These statements appear in a number of places and include statements regarding our plans, beliefs or current expectations, including the plans, beliefs and expectations of our officers and directors. We use the terms “Stone,” “Stone Energy,” “Company,” “we,” “us” and “our” to refer to Stone Energy Corporation.

        When considering any forward-looking statement, one should keep in mind the risk factors that could cause our actual results to differ materially from those contained in any forward-looking statement. Important factors that could cause actual results to differ materially from those in the forward-looking statements herein include the timing and extent of changes in commodity prices for oil and gas, operating risks and other risk factors as described in our 2003 Annual Report on Form 10-K as filed with the Securities and Exchange Commission. Furthermore, the assumptions that support our forward-looking statements are based upon information that is currently available and is subject to change. We specifically disclaim all responsibility to publicly update any information contained in a forward-looking statement or any forward-looking statement in its entirety and therefore disclaim any resulting liability for potentially related damages. All forward-looking statements attributable to Stone Energy Corporation are expressly qualified in their entirety by this cautionary statement.

Overview

        Stone Energy Corporation is an independent oil and gas company engaged in the acquisition, exploration, development, production and operation of oil and gas properties. Currently, our property base consists of 70 active properties, 59 in the Gulf Coast Basin and 11 in the Rocky Mountains, and 55 primary term leases in the Gulf of Mexico. We serve as operator on 41 of our active properties, which enables us to better control the timing and costs of operations.

Recent Events

        On October 19, 2004, we announced an exploration agreement with Kerr-McGee Oil and Gas Corp. covering several undeveloped leases in the Gulf of Mexico, including deep water. Under the agreement, we have initially committed approximately $50 million to acquire varying interests in these leases and to participate in six commitment wells to be drilled by the end of 2005. In addition, we also intend to evaluate additional drilling opportunities on the respective leases through 2006.

        Stone has exercised its preferential right to acquire additional working interests in South Timbalier Blocks 143, 164, 165, 166 and 171 for approximately $125 million, pending the execution of an Asset Purchase Agreement. After completion of the acquisition, Stone will hold a majority working interest in the blocks. The wells applicable to these working interests are currently flowing at an average net daily rate of approximately 57 MMcfe. Stone expects to close this acquisition late in the fourth quarter of 2004 and intends to finance this acquisition with available cash and borrowings under its bank credit facility.

Critical Accounting Policies

        Our 2003 Annual Report on Form 10-K describes the accounting policies that we believe are critical to the reporting of our financial position and operating results and that require management’s most difficult, subjective or complex judgments. Our most significant estimates are:

• remaining proved oil and gas reserves;
• timing of our future drilling activities;
• accruals of operating costs and production revenue;
• timing and estimates of future costs to develop and abandon our oil and gas properties;
• the effectiveness and estimated fair value of derivative positions; and
• classification of unevaluated property costs.

        This Quarterly Report on Form 10-Q should be read together with the discussion contained in our 2003 Annual Report on Form 10-K regarding these critical accounting policies.

Other Factors Affecting Our Business and Financial Results

        In addition to the matters discussed above, our business, financial condition and results of operations are affected by a number of other factors. This Quarterly Report on Form 10-Q should be read in conjunction with the discussion in our 2003 Annual Report on Form 10-K regarding these other factors, including risk factors described therein.

Results of Operations

        The following tables set forth certain information with respect to our oil and gas operations.

	Three Months Ended September 30,
	2004	2003	Variance		% change
Production:
Oil (MBbls)	1,358	1,379	(21	)	(2%	)
Gas (MMcf)	12,919	15,310	(2,391	)	(16%	)
Oil and gas (MMcfe)	21,067	23,584	(2,517	)	(11%	)
Revenue data (in thousands) (a):
Oil revenue	$56,752	$40,492	$16,260		40%
Gas revenue	71,554	75,501	(3,947	)	(5%	)
Total oil and gas revenue	$128,306	$115,993	$12,313		11%
Average prices (a):
Oil (per Bbl)	$41.79	$29.36	$12.43		42%
Gas (per Mcf)	5.54	4.93	0.61		12%
Oil and gas (per Mcfe)	6.09	4.92	1.17		24%
Expenses (per Mcfe):
Normal lease operating expenses (b)	$0.93	$0.64	$0.29		45%
Salaries, general and administrative expenses	0.16	0.15	0.01		7%
DD&A expense on oil and gas properties	2.16	1.75	0.41		23%

	Nine Months Ended September 30,
	2004	2003	Variance		% change
Production:
Oil (MBbls)	4,454	4,186	268		6%
Gas (MMcf)	42,000	47,255	(5,255	)	(11%	)
Oil and gas (MMcfe)	68,724	72,371	(3,647	)	(5%	)
Revenue data (In thousands) (a):
Oil revenue	$167,548	$127,394	$40,154		32%
Gas revenue	236,562	263,357	(26,795	)	(10%	)
Total oil and gas revenue	$404,110	$390,751	$13,359		3%
Average prices (a):
Oil (per Bbl)	$37.62	$30.43	$7.19		24%
Gas (per Mcf)	5.63	5.57	0.06		1%
Oil and gas (per Mcfe)	5.88	5.40	0.48		9%
Expenses (per Mcfe):
Normal lease operating expenses (b)	$0.78	$0.63	$0.15		24%
Salaries, general and administrative expenses	0.16	0.15	0.01		7%
DD&A expense on oil and gas properties	2.05	1.69	0.36		21%
(a)  Includes the cash settlement of hedging contracts.
(b)  Excludes major maintenance expenses.

        Net Income.   During the third quarter of 2004, net income totaled $25.6 million, or $0.95 per share, compared to $22.8 million, or $0.86 per share reported for the third quarter of 2003. For the nine months ended September 30, 2004, net income totaled $97.2 million, or $3.62 per share, compared to $107.3 million, or $4.04 per share, during the comparable 2003 period. All per share amounts are on a diluted basis. The increase in third quarter net income was primarily due to a 42% increase in realized oil prices, offset by production declines for both oil and natural gas.

        Prices.    Prices realized during the third quarter of 2004 averaged $41.79 per Bbl of oil and $5.54 per Mcf of natural gas, or 24% higher, on an Mcfe basis, than third quarter 2003 average realized prices of $29.36 per Bbl of oil and $4.93 per Mcf of natural gas. Average realized prices during the first nine months of 2004 were $37.62 per Bbl of oil and $5.63 per Mcf of natural gas compared to $30.43 per Bbl of oil and $5.57 per Mcf of natural gas realized during the first nine months of 2003. All unit pricing amounts include the cash settlement of hedging contracts.

        During the third quarters of 2004 and 2003, hedging transactions reduced the average price we received for natural gas by $0.18 and $0.04 per Mcf, respectively. Hedging transactions during the first nine months of 2004 and 2003 also decreased the average price we received for natural gas by $0.16 and $0.02 per Mcf, respectively.

        Production.    Oil production during each of the third quarter of 2004 and 2003 totaled approximately 1.4 million barrels. Natural gas production during the third quarter of 2004 totaled 12.9 Bcf or 16% less than the 15.3 Bcf produced during the third quarter of 2003. The decline in third quarter 2004 production volumes was due to the combined impact of shut-ins for rig mobilizations and Hurricane Ivan. Year-to-date 2004 production totaled 4.5 million barrels of oil and 42.0 Bcf of natural gas compared to 4.2 million barrels of oil and 47.3 Bcf of natural gas produced during the comparable 2003 period.

        As previously announced, shut-ins for Hurricane Ivan resulted in the deferral of September production volumes from the Gulf of Mexico approximating 1.7 billion cubic feet of natural gas equivalent. Certain fields in the Main Pass and Mississippi Canyon areas remain shut-in due to hurricane damage to non-operated wells and platforms, as well as downstream production facilities and pipelines owned by third parties, which has impacted Stone’s ability to restore production at these fields. Currently, Stone has eight Gulf of Mexico properties curtailed or shut-in from Hurricane Ivan representing net daily production of approximately 62 million cubic feet of natural gas equivalent (MMcfe). Stone expects production from these fields to return beginning in the first quarter of 2005. The Company is exploring ways to hasten the return of production including associated gas re-injection and pipeline rerouting. For the fourth quarter of 2004, Stone expects net daily production to average between 180-200 MMcfe. This estimate assumes no contribution from the wells shut-in as a result of Hurricane Ivan.

        Oil and Gas Revenue.   Due primarily to the 42% increase in realized oil prices, oil and gas revenue increased 11% to $128.3 million, compared to $116.0 million for the third quarter of 2003. Year-to-date 2004 oil and gas revenue totaled $404.1 million compared to $390.8 million during the comparable 2003 period.

        Expenses.    Normal lease operating expenses during the third quarter of 2004 totaled $19.7 million or 30% higher than normal lease operating expenses of $15.1 million for the comparable quarter in 2003. For the first nine months of 2004, normal lease operating expenses totaled $53.5 million compared to $45.8 million during the comparable period of 2003. The increase in normal lease operating costs for 2004 was the combined result of an increase in the number of active offshore properties, higher oil production volumes during 2004, which are more costly to produce as compared to natural gas, the extra costs associated with storm-related shut-ins and evacuations and increases in overall service costs over 2003.

        Major maintenance expenses, which represent major repair and maintenance costs that vary from period to period, totaled $11.1 million during the third quarter of 2004 compared to $5.2 million in the third quarter of 2003. Third quarter 2004 major maintenance expenses consisted primarily of replacement wells at Lafitte and Vermilion Block 131, a tubing replacement at West Delta Block 98 and a pipeline repair at East Cameron Block 64. During the nine months ended September 30, 2004 and 2003, major maintenance expenses totaled $20.0 million and $10.5 million, respectively. Stone expects fourth quarter 2004 major maintenance expenses to decrease approximately 25% over third quarter 2004 major maintenance expenses based upon planned operations.

        Effective January 1, 2003, management elected to change to the units of production method of amortizing proved oil and gas property costs versus the formerly used future gross revenue method. The cumulative effect of the change in accounting principle was $4.0 million, net of tax, and was recorded as a charge during the first quarter of 2003. Depreciation, depletion and amortization (“DD&A”) on oil and gas properties for the third quarter of 2004 totaled $45.5 million compared to $41.3 million for the third quarter of 2003. For the nine months ended September 30, 2004 and 2003, DD&A expense totaled $140.9 million and $122.6 million, respectively. The increase in 2004 DD&A on a unit basis is the result of increases in the per unit full-cycle cost of finding and developing proved reserves and the impact of drilling results.

        As a result of debt repayments and the redemption of our $100 million of senior subordinated notes during 2003, interest expense for the third quarter of 2004 decreased 15% to $4.1 million, compared to $4.8 million during the third quarter of 2003. For the nine months ended September 30, 2004, interest expense totaled $12.0 million compared to $15.4 million during the comparable period in 2003.

Recent Accounting Developments

        Stock-Based Compensation.   On March 31, 2004, the FASB issued a proposed Statement, “Share-Based Payment,” that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for equity instruments of the enterprise, such as stock options. The proposed Statement would eliminate the ability to account for share-based compensation transactions using the APB Opinion No. 25 and generally would require instead that such transactions be accounted for using a fair value-based method. Stone currently accounts for stock-based compensation using APB Opinion No. 25. On October 13, 2004, the FASB concluded that SFAS No. 123R, “Share-Based Payment,” which will require companies to measure compensation cost for all share-based payments at fair value, will be effective for interim or annual periods beginning after June 15, 2005. The proposed Statement, if adopted, would require us to begin accounting for stock options under this method beginning in three month period ended September 30, 2005. It is currently not known whether the implementation of this proposed Standard would result in financial results materially different from those presented inItem No. 1 Financial Statements, Note 8 – Stock-Based Compensation.

        Staff Accounting Bulletin No. 106.   On September 28, 2004, the Securities and Exchange Commission adopted Staff Accounting Bulletin (“SAB”) No. 106, which expressed the Staff’s views regarding the application of SFAS No. 143 by oil and gas companies following the full cost accounting method. SAB No. 106 indicates that estimated dismantlement and abandonment costs that will be incurred as a result of future development activities on proved reserves are to be included in the estimated future cash flows in the full cost ceiling limitation. SAB No. 106 also indicates that these estimated costs are to be included in the costs to be amortized. We expect to begin applying SAB No. 106 in the first quarter of 2005, when it becomes effective for us.

Hedging Activities

        The following is a breakdown of derivative expenses for the respective periods:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2004	2003	2004	2003
	(In thousands) (Unaudited)
Amortization of cost of put contracts	$1,069	$1,305	$3,029	$3,774
Amortization of other comprehensive income from swap	-	848	-	2,633
Total derivative expenses	$1,069	$2,153	$3,029	$6,407

Liquidity and Capital Resources

        Cash Flow.   Net cash flow provided by operating activities for the nine months ended September 30, 2004 was $299.9 million compared to $311.5 million reported in the comparable period in 2003. Net cash flow used in investing activities totaled $270.4 million and $233.1 million during the first nine months of 2004 and 2003, respectively, which primarily represents our investment in oil and gas properties. Net cash flow provided by (used in) financing activities totaled $4.3 million and ($69.9) million for the nine months ended September 30, 2004 and 2003, respectively, which primarily represents borrowings and repayments under our bank credit facility. In total, cash and cash equivalents increased from $17.1 million as of December 31, 2003 to $50.9 million as of September 30, 2004.

        We had a working capital deficit at September 30, 2004 of $18.2 million. Working capital deficits are not unusual at the end of a period. We believe that our working capital balance should be viewed in conjunction with availability of borrowings under our bank credit facility when measuring liquidity. SeeBank Credit Facility.

        Capital Expenditures.   Third quarter 2004 additions to oil and gas property costs totaled $81.7 million, which included $18.6 million of acquisition costs (includes promoted drilling costs), $4.0 million of capitalized salaries, general and administrative expenses and $1.7 million of capitalized interest. Year-to-date 2004 additions to oil and gas property costs totaled $283.8 million, which include $68.1 million of acquisition costs (includes promoted drilling costs), $11.9 million of capitalized salaries, general and administrative expenses and $5.0 million of capitalized interest. These investments were financed by cash flow from operating activities, borrowings under our credit facility and working capital.

        Budgeted Capital Expenditures.   Our estimated 2004 capital expenditures budget, excluding acquisitions and capitalized salaries, general and administrative expenses and interest, was recently increased approximately 10% by our board of directors to $310 million. While the 2004 capital expenditures budget does not include any projected acquisitions, we continue to seek growth opportunities that fit our specific acquisition profile.

        Based upon our outlook for oil and gas prices and production rates, we expect cash flow from operations to be sufficient to fund the remaining 2004 capital expenditures budget, excluding acquisitions. However, if oil and gas prices or production rates fall below our current expectations, we believe that the available borrowings under our bank credit facility will be sufficient to fund the capital expenditures in excess of operating cash flow.

        Bank Credit Facility.   On April 30, 2004, we entered into a four-year $500 million senior unsecured credit facility with a syndicated bank group. The new facility has an initial borrowing base of $425 million and replaces the previous $350 million credit facility. Borrowings outstanding at September 30, 2004 under our bank credit facility totaled $170.0 million, and letters of credit totaling $13.1 million have been issued under the facility. At November 4, 2004, we had $241.9 million of borrowings available under the credit facility and the weighted average interest rate under the credit facility was approximately 3.1%. The borrowing base under the new credit facility is re-determined periodically based on the bank group’s evaluation of our proved oil and gas reserves.

Defined Terms

        Oil and condensate are stated in barrels (“Bbls”) or thousand barrels (“MBbl”). Natural gas is stated herein in billion cubic feet (“Bcf”), million cubic feet (“MMcf”) or thousand cubic feet (“Mcf”). Oil and condensate are converted to natural gas at a ratio of one barrel of liquids per nine Mcf of gas. Bcfe, MMcfe, and Mcfe represent one billion cubic feet, one million cubic feet and one thousand cubic feet of gas equivalent, respectively. MMBtu represents one million British Thermal Units and BBtu represents one billion British Thermal Units. An active property is an oil and gas property with existing production. A primary term lease is an oil and gas property with no existing production, in which we have a specific time frame to establish production without losing the rights to explore the property. Liquidity is defined as the ability to obtain cash quickly either through the conversion of assets or incurrence of liabilities.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Commodity Price Risk

        Our major market risk exposure continues to be the pricing applicable to our oil and gas production. Our revenues, profitability and future rate of growth depend substantially upon the market prices of oil and natural gas, which fluctuate widely. Oil and gas price declines and volatility could adversely affect our revenue, cash flows and profitability. Price volatility is expected to continue. In order to manage our exposure to oil and gas price declines, we occasionally enter into hedging arrangements to secure a price for a portion of our expected oil and natural gas production. We do not enter into hedging transactions for trading purposes.

        Our hedging policy provides that not more than one-half of our estimated production quantities can be hedged without the consent of the Board of Directors. See Item 1. Financial Statements – Note 3 – Hedging Activities for a detailed discussion of hedges in place to manage our exposure to oil and natural gas price declines.

Interest Rate Risk

        Stone had long-term debt outstanding of $370.0 million at September 30, 2004, of which $200.0 million, or approximately 54%, bears interest at a fixed rate of 8¼%. The remaining $170.0 million of debt outstanding at September 30, 2004 bears interest at a floating rate. At November 4, 2004, the weighted average interest rate under our floating-rate debt was approximately 3.1%. At September 30, 2004, we had no interest rate hedge positions in place to reduce our exposure to changes in interest rates.

        Since the filing of our 2003 Annual Report on Form 10-K, there have been no material changes in reported market risk as it relates to interest rates and commodity prices.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

        Our chief executive officer and our chief financial officer, with the participation of other members of our senior management, reviewed and evaluated the effectiveness of Stone’s disclosure controls and procedures as of the end of the quarterly period ended September 30, 2004. Based on this evaluation, our chief executive officer and chief financial officer believe:

• Stone’s disclosure controls and procedures were effective to ensure that information required to be disclosed by Stone in the reports it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms; and
   
• Stone’s disclosure controls and procedures were effective to ensure that information required to be disclosed by Stone in the reports that it files or submits under the Securities Exchange Act of 1934 was accumulated and communicated to Stone’s management, including Stone’s chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Controls Over Financial Reporting

        There has not been any change in our internal control over financial reporting that occurred during our quarterly period ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.   Legal Proceedings

        In September 2004, Stone and other defendants were served with an amended petition filed by the State of Louisiana and the Iberia Parish School Board in Case Number 101934, Iberia Parish, Louisiana, alleging contamination and damage to portions of Section 16, Township 12 South, Range 11 East in the Bayou Pigeon Field as a result of oil and gas exploration and production activities. The Company believes it was named as a defendant in error and intends to vigorously defend this action.

Item 6.   Exhibits

(a)	Exhibits
	*15.1 –Letter from Ernst & Young LLP dated November 2, 2004, regarding unaudited interim financial information.
	*31.1 –Certification of Principal Executive Officer of Stone Energy Corporation as required by Rule 13a-14(a) of the Securities Exchange Act of 1934.
	*31.2 –Certification of Principal Financial Officer of Stone Energy Corporation as required by Rule 13a-14(a) of the Securities Exchange Act of 1934.
	†*32.1 –Certification of Chief Executive Officer and Chief Financial Officer of Stone Energy Corporation pursuant to 18 U.S.C § 1350.
*	Filed herewith
†	Not considered to be "filed" for the purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section.

SIGNATURE

        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 hereunto duly authorized.

	STONE ENERGY CORPORATION
Date: November 8, 2004	By:    /s/ James H. Prince                   James H. Prince         Executive Vice President and          Chief Financial Officer

EXHIBIT INDEX

	*15.1 –Letter from Ernst & Young LLP dated November 2, 2004, regarding unaudited interim financial information.
	*31.1 –Certification of Principal Executive Officer of Stone Energy Corporation as required by Rule 13a-14(a) of the Securities Exchange Act of 1934.
	*31.2 –Certification of Principal Financial Officer of Stone Energy Corporation as required by Rule 13a-14(a) of the Securities Exchange Act of 1934.
	†*32.1 –Certification of Chief Executive Officer and Chief Financial Officer of Stone Energy Corporation pursuant to 18 U.S.C § 1350.
*	Filed herewith
†	Not considered to be "filed" for the purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section.