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                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                               ----------------

                                  FORM 10-KSB

                               ----------------

(Mark One)

  [X] Annual report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
  For the fiscal year ended December 31, 2000

  [_] Transition report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
  For the transition period from      to

                       Commission file number: 001-14745

                            3TEC ENERGY CORPORATION
                (Name of Small Business Issuer in Its Charter)

              Delaware                                 63-1081013
   (State or other jurisdiction of        (I.R.S. Employer Identification No.)
   incorporation or organization)

                          Two Shell Plaza, Suite 2400
                               777 Walker Street
                             Houston, Texas 77002
                                (713) 821-7100
  (Address, including zip code, and telephone number, including area code, of
                   registrant's principal executive offices)

                               ----------------

       Securities registered pursuant to Section 12(b) of the Act: None

          Securities registered pursuant to Section 12(g) of the Act:
                         Common Stock, $.02 Par Value
        Series C Convertible Redeemable Preferred Stock, $.02 Par Value

  Check whether the Registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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
[_]

  Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]

  Revenues of Registrant for fiscal year ended December 31, 2000 are
$104,823,153.

  The aggregate market value as of March 21, 2001 of voting and nonvoting
stock held by nonaffiliates of the Registrant was $192,671,375.

  As of March 21, 2001 the Registrant had 14,623,801 shares of Common Stock,
$.02 par value outstanding.

  The Registrant's definitive proxy statement, to be filed pursuant to
Regulation 14A on or before May 1, 2001, is incorporated by reference for the
information set forth in Part III of this Form 10-KSB.

  Transitional Small Business Disclosure Format: [_] Yes [X] No

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                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                           Page
                                 PART I                                    ----
<S>                                                                        <C>
Item 1. Business
    Background...........................................................    4
    Recent Developments..................................................    4
    Business Strategy....................................................    6
    Marketing............................................................    6
    Competition..........................................................    7
    Regulation...........................................................    7
    Employees............................................................    9
    Our Executive Offices................................................    9

Item 2. Properties
    Description of Our Properties........................................   10
    Natural Gas and Oil Reserves.........................................   11
    Volumes, Prices and Operating Expenses...............................   12
    Development, Exploration and Acquisition Capital Expenditures........   12
    Drilling Activity....................................................   13
    Productive Wells.....................................................   13
    Acreage Data.........................................................   13
    Current Activities...................................................   13

Item 3. Legal Proceedings................................................   14

Item 4. Submission of Matters to Vote of Security Holders................   14
                                 PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder
        Matters..........................................................   15

Item 6. Management's Discussion and Analysis of Financial Condition and
        Results of Operations............................................   16
    Overview.............................................................   16
    Certain Accounting Practices.........................................   16
    Liquidity and Capital Resources......................................   16
    Results of Operations................................................   17
    Year Ended December 31, 2000, Compared With Year Ended December 31,
     1999................................................................   18
    Year Ended December 31, 1999, Compared With Year Ended December 31,
     1998................................................................   19

Item 7.  Financial Statements............................................   19

Item 8.  Changes In and Disagreements with Accountants on Accounting and
         Financial Disclosure............................................   19
                                PART III

Item 9. Directors and Executive Officers of the Registrant...............   20

Item 10. Executive Compensation..........................................   20

Item 11. Security Ownership of Certain Beneficial Owners and Management..   20

Item 12. Certain Relationships and Related Transactions..................   20

Item 13. Exhibits, Financial Statement Schedules and Reports on Form 8-
         K...............................................................   20
    Glossary of Certain Oil and Gas Terms................................   24
    Signatures...........................................................   26
    Power of Attorney....................................................   26
</TABLE>

 Item 13(a) includes the Index of Exhibits to be filed with the Securities
 and Exchange Commission relative to this Report.


                                       2
<PAGE>

             Cautionary Statement About Forward-Looking Statements

  Some of the information in this Annual Report on Form 10-KSB, including
information incorporated by reference, contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section
21E of the Securities and Exchange Act of 1934. The forward-looking statements
speak only as of the date made and the Company undertakes no obligation to
update such forward-looking statements. These forward-looking statements may
be identified by the use of the words "believe," "expect," "anticipate,"
"will," "contemplate," "would" and similar expressions that contemplate future
events. These future events include the following matters:

  .  financial position;

  .  business strategy;

  .  budgets;

  .  amount, nature and timing of capital expenditures;

  .  drilling of wells;

  .  natural gas and oil reserves;

  .  timing and amount of future production of natural gas and oil;

  .  operating costs and other expenses;

  .  cash flow and anticipated liquidity;

  .  prospect development and property acquisitions; and

  .  marketing of natural gas and oil.

Numerous important factors, risks and uncertainties may affect the Company's
operating results, including:

  .  the risks associated with exploration;

  .  the ability to find, acquire, market, develop and produce new
     properties;

  .  natural gas and oil price volatility;

  .  uncertainties in the estimation of proved reserves and in the
     projection;

  .  future rates of production and timing of development expenditures;

  .  operating hazards attendant to the natural gas and oil business;

  .  downhole drilling and completion risks that are generally not
     recoverable from third parties or insurance;

  .  potential mechanical failure or under-performance of significant wells;

  .  climactic conditions;

  .  availability and cost of material and equipment;

  .  delays in anticipated start-up dates;

  .  actions or inactions of third-party operators of the Company's
     properties;

  .  the ability to find and retain skilled personnel;

  .  availability of capital;

  .  the strength and financial resources of competitors;

  .  regulatory developments;

  .  environmental risks; and

  .  general economic conditions.

  Any of the factors listed above and other factors contained in this Form 10-
KSB could cause the Company's actual results to differ materially from the
results implied by these or any other forward-looking statements made by the
Company or on its behalf. The Company cannot assure you that future results
will meet its expectations.


                                       3
<PAGE>

                                    PART I

Item 1. Business

Background

  3TEC Energy Corporation ("3TEC", "the Company", "we", "our" and "us") is the
successor to Middle Bay Oil Company, Inc. ("Middle Bay"), an Alabama
corporation formed on November 30, 1992. 3TEC was incorporated in Delaware on
November 24, 1999, as a wholly owned subsidiary of Middle Bay for the sole
purpose of merging with Middle Bay to effect a change in domicile to Delaware
and to change our name to 3TEC Energy Corporation. Effective December 7, 1999,
Middle Bay was merged into us and each share of common stock of Middle Bay was
converted into one share of our common stock. Our common stock is quoted on
the Nasdaq National Market under the symbol "TTEN".

  We are engaged in the acquisition, development, production and exploration
of oil and natural gas reserves. Our properties are concentrated in East Texas
and the Gulf Coast region, both onshore and in the shallow waters of the Gulf
of Mexico. We also own significant properties in the Permian and San Juan
basins and in the Mid-Continent region. Our management and technical staff
have substantial experience in each of these areas. As of December 31, 2000,
we had estimated total net proved reserves of 302 Bcfe, of which approximately
79% were natural gas and approximately 78% were proved developed, with an
estimated PV-10 value of $1.0 billion. During December 2000, our net daily
production averaged approximately 63.9 Mmcf of natural gas and 2.9 MBbls of
oil or 81.3 Mmcfe.

  We have increased our reserves and production principally through
acquisitions. We focus on properties that have a substantial proved reserve
component and which management believes to have additional exploitation
opportunities. Recently, we have also acquired a number of drilling prospects
covered by an extensive 3-D seismic database that we believe have exploration
potential. We have assembled an experienced management team and technical
staff with expertise in property acquisitions and development, reservoir
engineering, exploration and financial management.

  Since our formation in 1992, we have grown principally through several
acquisitions of proved properties in the Gulf Coast and Mid-Continent regions.
Acquisitions made in 1997 and 1998 significantly increased our reserves and
production but were primarily nonoperated properties with high per Mcfe lease
operating costs.

  In August 1999, W/E Energy Company L.L.C. ("W/E LLC"), an entity which is
owned by affiliates of EnCap Investments L.L.C. ("EnCap") and Floyd C. Wilson,
purchased a controlling interest in us for approximately $20.5 million in cash
and $875,000 in producing properties. Concurrently with the investment by W/E
LLC, Mr. Wilson was named our Chairman and Chief Executive Officer. Following
the change in control in August 1999 discussed below, during the fourth
quarter of 1999 and the first half of 2000 we closed several transactions that
changed our senior management team, capital structure and our property base.
In addition, we added several experienced professionals to our technical
staff. Because of these recent transactions, our historical results of
operations and cash flows will differ materially from, and will not be
representative of, our current and future results.

Recent Developments

  . Acquisition of Classic. On January 30, 2001, we acquired 100% of the
    issued and outstanding stock of Classic Resources Inc. ("Classic") for
    cash consideration of approximately $53.5 million. The purchase price is
    subject to certain post-closing adjustments customary in these types of
    transactions. We financed the acquisition of Classic under our existing
    credit facility. Classic's major properties, consisting of interests in
    the Beckville, Carthage, Oak Hill and Rodessa fields, are located near
    3TEC's existing properties in East Texas. The Classic properties produce
    primarily from the Cotton Valley formation and encompass approximately
    22,000 gross acres (14,500 net acres). 3TEC estimates these properties
    have unaudited total net proved reserves of 47 Bcfe, an associated PV-10
    value of $57.6 million and net daily

                                       4
<PAGE>

    production of approximately 11 Mmcfe, as of January 31, 2001. Combined
    with 3TEC's existing East Texas production, this core area will now
    produce approximately 39 Mmcfe per day for the Company. The estimated
    reserves for Classic are 96% gas on an equivalent basis and 99% operated.
    Classic owns interests in 87 producing wells with an average working
    interest of 72%. Approximately 63% of the reserves are classified as
    proved developed. The properties have a 10 year reserve-to-production
    ratio and low lease operating costs. 3TEC has identified 24 proved
    undeveloped locations and plans an active drilling program on Classic's
    properties in 2001.

  . Acquisition of HGW Properties. In November 2000, 3TEC acquired additional
    interests in the White Oak and Glenwood fields located in Upshur and
    Gregg Counties, Texas from H.G. Westerman and other third parties (the
    "HGW Properties"). Total cash consideration paid was $8.9 milion, which
    we financed under our existing credit facility. As of September 1, 2000,
    3TEC estimated that the net proved reserves of the HGW Properties were
    11.2 Bcfe with estimated net daily production of 1.8 Mmcfe.

  . Completion of Public Offering. On June 30, 2000, the Company completed a
    public offering of 8.05 million shares of the Company's common stock
    priced at $9.00 per share. The net proceeds, approximately $66.6 million,
    were used primarily to repay a portion of the outstanding debt under the
    Company's credit facility.

  . Acquisition of CWR Properties. On May 31, 2000, we acquired properties in
    East Texas operated by C.W. Resources, Inc. (the "CWR Properties") for
    cash consideration of approximately $52 million, which we financed under
    our credit facility. The CWR Properties are located in Upshur and Gregg
    Counties, Texas, in strategic proximity to our core East Texas
    properties. The CWR Properties encompass approximately 38,000 gross acres
    (10,100 net acres). As of December 31, 1999, Ryder Scott Company
    estimated that the net proved reserves of the CWR Properties were 67.8
    Bcfe with an associated PV-10 value at that date of $58.3 million. The
    CWR Properties produce from the Cotton Valley formation, and the reserves
    as of December 31, 1999 were approximately 92% natural gas and 51% were
    classified as proved developed.

  . Acquisition of Magellan. On February 3, 2000, we completed the
    acquisition of Magellan Exploration LLC ("Magellan") from certain
    affiliates of EnCap and other third parties for consideration of
    approximately $19 million, consisting of (a) 1,085,934 shares of common
    stock, (b) four year warrants to purchase up to 333,333 shares of common
    stock at $30.00 per share, (c) 617,009 shares of 5% Series D Convertible
    Preferred Stock with a redemption value of $24.00 per share and each
    convertible into one share of common stock and (d) the assignment of a
    performance based "back-in" working interest of 5% of Magellan's interest
    in 12 exploration prospects. The acquired properties are located both
    onshore and in the shallow waters of south Louisiana and consist of
    20,243 gross (11,244 net) acres in three prospective areas. As of
    December 31, 1999, Ryder Scott Company estimated that the net proved
    reserves of these properties were 25.3 Bcfe with an associated PV-10
    value of $39.8 million. These proved reserves as of December 31, 1999
    were approximately 67% natural gas and 69% were classified as proved
    undeveloped. In addition to the proved reserves, the Magellan properties
    contain several exploratory drilling locations that have been identified
    using 3-D seismic data. In April 2000, we purchased additional interests
    in certain of these properties from an unrelated party, bringing our
    total net purchase price for the Magellan properties to approximately $21
    million.

  . Acquisition of Floyd Oil Properties. In November 1999, we completed the
    acquisition of properties and interests managed by Floyd Oil Company (the
    "Floyd Oil Properties") for $90.2 million, consisting of $86.8 million in
    cash and 503,426 shares of our common stock. The majority of these
    properties are located in Texas and Louisiana and, as of December 31,
    1999, had estimated proved reserves of 165.5 Bcfe with an associated PV-
    10 value at that time of $146.1 million. Additionally, 76% of the
    acquired reserves are natural gas and 77% were classified as proved
    developed. We operate approximately 53% of these properties on a PV-10
    value basis. Floyd Oil Company is not affiliated with Floyd C. Wilson.


                                       5
<PAGE>

  . Acquisition of Control by W/E LLC. In August 1999, W/E Energy Company LLC
    (" W/E LLC"), which is owned by affiliates of EnCap Investments L.L.C.
    ("EnCap") and Floyd C. Wilson, purchased a controlling interest in us for
    approximately $20.5 million in cash and $875,000 in producing properties.
    As of December 31, 2000, W/E LLC owned approximately 11% of our
    outstanding common stock Concurrent with the investment by W/E LLC, Mr.
    Wilson was named our Chairman and Chief Executive Officer.

Business Strategy

Our business strategy is focused on the following:

  . Pursuit of Strategic Acquisitions. We continually review opportunities to
    acquire producing properties, leasehold acreage and drilling prospects.
    We seek to acquire operational control of properties that we believe have
    significant exploitation and exploration potential. We are especially
    focused on increasing our holdings in fields and basins in which we
    already own an interest.

  . Further Development of Existing Properties. We intend to further develop
    our properties that have proved reserves. We seek to add proved reserves
    and increase production through the use of advanced technologies,
    including detailed technical analysis of our properties, and by drilling
    in-fill locations and selectively recompleting existing wells. We also
    plan to drill step-out wells to expand known field limits. We intend to
    enhance the efficiency and quality control of these activities by
    operating the majority of our properties.

  . Growth Through Exploration. We conduct an active technology-driven
    exploration program that is designed to complement our property
    acquisition and development drilling efforts with moderate to high risk
    exploration projects that have greater reserve potential. We generate
    exploration prospects through the analysis of geological and geophysical
    data and the interpretation of 3-D seismic data. We intend to manage our
    exploration expenditures through the optimal scheduling of our drilling
    program and by selectively reducing our participation in certain
    exploratory prospects through sales of interests to industry partners.

  . Rationalization of Property Portfolio. We intend to actively pursue
    opportunities to reduce and control operating costs of our existing
    properties and properties we may acquire in the future through the
    consolidation of overlapping operations, the sale of marginal properties
    and by increasing the number of fields we operate as a percentage of our
    total properties.

  . Maintenance of Financial Flexibility. We intend to maintain a substantial
    unused borrowing capacity under our bank credit facility by periodically
    refinancing our bank debt in the capital markets when conditions are
    favorable. We believe our expanded base of internally generated cash flow
    and other financial resources, including our existing financial partners,
    provide us with the financial flexibility to pursue additional
    acquisitions of producing properties and leasehold acreage and to develop
    our project inventory in an optimal fashion.

Marketing

  We have marketed the natural gas and oil produced from our properties
through typical channels for these products. We generally sell our oil at
local field prices paid by the principal purchasers of oil. The majority of
our natural gas production is sold at current market rates.

  Both natural gas and oil are purchased by marketing companies, pipelines,
major oil companies, public utilities, industrial customers and other users
and processors of petroleum products. We are not confined to, or dependent
upon, any one purchaser or small group of purchasers. Accordingly, the loss of
a single purchaser, or a few purchasers, would not have a long-term material
effect on our business because there are numerous purchasers in the areas in
which we sell our production.

                                       6
<PAGE>

  In order to manage our exposure to price risks in the marketing of our
natural gas and oil production, we have in the past and may in the future
enter into natural gas and oil price hedging arrangements with respect to a
portion of our expected production. None of our natural gas or oil production
is currently hedged.

Competition

  We face competition from other oil and gas companies in all aspects of our
business, including acquisition of producing properties and oil and gas
leases, marketing of oil and gas, and obtaining goods, services and labor.
Many of our competitors have substantially larger financial and other
resources. Factors that affect our ability to acquire producing properties
include available funds, available information about the property and our
standards established for minimum projected return on investment. Competition
is also presented by alternative fuel sources, including heating oil and other
fossil fuels. We believe that we are competing and will compete effectively as
a result of our expertise in the acquisition, exploration, and development of
oil and gas reserves and our financial ability to take advantage of such
opportunities.

Regulation

  Federal Regulation of Transportation of Natural Gas. Historically, the
transportation and sale for resale of natural gas in interstate commerce have
been regulated by the Natural Gas Act of 1938, the Natural Gas Policy Act of
1978, and the regulations promulgated by the Federal Energy Regulatory
Commission. In the past, the federal government has regulated the prices at
which natural gas could be sold. Deregulation of natural gas sales by
producers began with the enactment of the Natural Gas Policy Act. In 1989,
Congress enacted the Natural Gas Wellhead Decontrol Act, which removed all
remaining Natural Gas Act and Natural Gas Policy Act price and non-price
controls affecting producer sales of natural gas effective January 1, 1993.
Congress could, however, reenact price controls in the future.

  Our sales of natural gas are affected by the availability, terms and cost of
pipeline transportation. The price and terms for access to pipeline
transportation remain subject to extensive federal regulation. Beginning in
April 1992, the Federal Energy Regulatory Commission issued Order No. 636 and
a series of related orders, which required interstate pipelines to provide
open-access transportation on a basis that is equal for all natural gas
suppliers. The Federal Energy Regulatory Commission has stated that it intends
for Order No. 636 to foster increased competition within all phases of the
natural gas industry. Although Order No. 636 does not directly regulate our
production and marketing activities, it does affect how buyers and sellers
gain access to the necessary transportation facilities and how we and our
competitors sell natural gas in the marketplace. The courts have largely
affirmed the significant features of Order No. 636 and the numerous related
orders, although some appeals remain pending and the Federal Energy Regulatory
Commission continues to review and modify its regulations regarding the
transportation of natural gas. One broad and significant pending review
involves examination of several questions, including whether the
transportation regulations should be changed to better operate together with
changes in state law that are introducing competition in retail natural gas
markets, whether the historical method of setting transportation rates based
on cost should be changed for certain transportation, whether short term
transportation capacity should be allocated based only on auctions, and
whether additional changes need to be made to long term transportation
policies to prevent a market bias in favor of short term transportation. We
cannot predict what action the Federal Energy Regulatory Commission will take
on these matters, nor can we accurately predict whether the Federal Energy
Regulatory Commission's actions will achieve the goal of increasing
competition in markets in which our natural gas is sold. However, we do not
believe that any action taken will affect us in a way that materially differs
from the way it affects other oil and natural gas producers.

  Additional proposals and proceedings that might affect the natural gas
industry are pending before Congress, the Federal Energy Regulatory Commission
and the courts. The natural gas industry historically has been very heavily
regulated; therefore, we cannot assure you that the less stringent regulatory
approach recently pursued by the Federal Energy Regulatory Commission and
Congress will continue.


                                       7
<PAGE>

  Federal Regulation of Transportation of Oil. Oil and sales of oil,
condensate and natural gas liquids by us are not currently regulated and are
made at market prices. Effective as of January 1, 1995, the Federal Energy
Regulatory Commission implemented regulations establishing an indexing system
for transportation rates for interstate common carrier oil pipelines. These
rates are generally indexed to inflation, subject to conditions and
limitations. These regulations may, over time, tend to increase transportation
costs or reduce wellhead prices for oil. However, we do not believe that these
regulations affect us any differently than other oil and gas producers,
gatherers and marketers.

  State Regulation. Our oil and gas operations are subject to various types of
regulation at the state and local levels. These regulations require drilling
permits, regulate the methods for developing new fields and the spacing and
operating of wells and waste prevention, and sometimes impose production
limitations. These regulations may limit our production from wells and the
number of wells or locations we can drill.

  Some states have adopted regulations with respect to gathering systems.
These regulations have not had a material effect on the operation of our
gathering systems, but we cannot predict whether any future regulations in
this area may have a material impact on our gathering systems.

  Federal, State and Indian Leases. Our operations on federal, state or Indian
oil and gas leases are subject to numerous restrictions, including
nondiscrimination statutes. We must conduct our operations on these leases
pursuant to permits and authorization and other regulations issued by the
Bureau of Land Management, Minerals Management Service and other agencies. The
Minerals Management Service currently has under consideration a proposal to
change the manner in which crude oil is valued for purposes of calculating
royalty due the government. If adopted, these changes would decrease reliance
on historical valuation methods and instead adopt an indexing method intended
to better reflect market value, but which may not reflect the proceeds
actually received in the sale of the oil. We cannot predict what action the
Minerals Management Service may ultimately take or how it will affect royalty
payable on our production from federal leases, however, if adopted, the
changes may tend to increase costs of royalty payments.

  Environmental Regulations. Our operations are subject to numerous laws and
regulations governing the discharge of materials into the environment or
otherwise relating to environmental protection. Our exploration and production
operations and facilities for gathering, treating, processing and handling
hydrocarbons and related exploration and production wastes are subject to
stringent environmental regulation. These laws and regulations sometimes
require government approvals before activities occur, limit or prohibit
activities because of protected areas or species, impose substantial
liabilities for pollution and provide penalties for noncompliance. As with the
industry generally, compliance with existing and anticipated regulations
increases our overall cost of business. These regulations, however, generally
affect us and our competitors similarly. Environmental laws and regulations
are subject to frequent change, and we are not able to predict the costs or
other impacts of environmental regulation on our future operations.

  The Comprehensive Environmental Response, Compensation, and Liability Act
("CERCLA"), also known as the "Superfund" law, imposes liability, without
regard to fault or the legality of the original conduct, on some classes of
persons that are considered to have contributed to the release or threat of
release of a "hazardous substance" into the environment. These persons include
the owner or operator of the disposal site or sites where the release occurred
and companies that disposed or arranged for the disposal of the hazardous
substances found at the site. Persons who are or were responsible for releases
of hazardous substances under CERCLA may be subject to joint and several
liability for the costs of cleaning up the hazardous substances that have been
released into the environment and for damages to natural resources, and it is
not uncommon for neighboring landowners and other third parties to file claims
for personal injury and property damage allegedly caused by the hazardous
substances released into the environment.

  Our operations are also subject to regulation of air emissions under the
Clean Air Act and comparable state and local requirements. Implementation of
these laws could lead to the gradual imposition of new air pollution control
requirements on our operations. As a result, we may incur capital expenditures
over the next several years

                                       8
<PAGE>

to upgrade our air pollution control equipment. We do not believe that our
operations would be materially affected by any such requirements, nor do we
expect such requirements to be any more burdensome to us than to other
companies our size involved in natural gas and oil exploration and production
activities.

  In addition, legislation has been proposed in Congress from time to time
that would reclassify some natural gas and oil exploration and production
wastes as "hazardous wastes," which would make the reclassified wastes subject
to much more stringent handling, disposal and clean-up requirements. If
Congress were to enact this legislation, it could increase our operating
costs, as well as those of the natural gas and oil industry in general.
Initiatives to further regulate the disposal of natural gas and oil wastes are
also pending in some states, and these various initiatives could have a
similar impact on us.

  The Clean Water Act imposes restrictions and controls on the discharge of
oil and gas wastes and other forms of pollutants into waters of the United
States. Federal law also imposes strict liability on owners of facilities for
consequences of an oil spill where the spill is in navigable waters or along
shorelines. These laws impose penalties for unauthorized discharges and
substantial liability for costs of removal and damages resulting from an
unauthorized discharge. State laws for the control of water pollution provide
similar penalties and liabilities. The cost of compliance with water pollution
laws has not historically been material to our operations. There can be no
assurance that changes in federal, state or local water pollution laws and
programs will not materially adversely affect our operations in the future.

  Our management believes that we are in substantial compliance with current
environmental laws and regulations that affect us and that continued
compliance with these requirements will not have a material adverse impact on
us.

Employees

  At December 31, 2000, we had 50 full-time employees. We believe that our
relationships with our employees are satisfactory. None of our employees is
covered by a collective bargaining agreement. From time to time, we use the
services of independent consultants and contractors to perform various
professional services, particularly in the areas of construction, design,
well-site surveillance, permitting and environmental assessment.

Our Executive Offices

  Our principal executive offices are located at Two Shell Plaza, 777 Walker
Street, Suite 2400, Houston, Texas 77002, and our telephone number is (713)
821-7100. Our website is www.3tecenergy.com.

                                       9
<PAGE>

Item 2. Properties

Description of Our Properties

  We present information regarding our natural gas and oil reserves,
properties, and operating results below, which does not include the properties
acquired in the acquisition of Classic as discussed above.

<TABLE>
<CAPTION>
                                     As of December 31, 2000
                         --------------------------------------------------
                         Estimated Net Proved Reserves              Percent    Proved      Budgeted
                         --------------------------------   PV-10    Total   Undeveloped 2001 Capital
                            Gas        Gas       Total      Value    PV-10    Drilling   Expenditures
                          (Mmcf)     (MBbls)    (Mmcfe)    ($000)    Value    Locations     ($000)
                         ---------- ---------- ---------- --------- -------  ----------- ------------
<S>                      <C>        <C>        <C>        <C>       <C>      <C>         <C>
East Texas..............    130,295     1,460     139,054   498,043   47.6%      136         20.0
Gulf Coast Area.........     62,033     2,566      77,428   340,576   32.5%       16         31.1
Permian/San Juan Area...     16,682     4,461      43,448   102,192    9.8%       --           --
Mid-Continent Area......     28,505     2,142      41,357   106,078   10.1%        8          1.1
Other Areas.............        178        43         436       475    0.0%       --           --
                         ---------- ---------  ---------- --------- ------       ---         ----
Total...................    237,693    10,672     301,723 1,047,364 100.00%      160         52.2
                         ========== =========  ========== ========= ======       ===         ====
</TABLE>

  East Texas. Four of our five largest fields are located in the East Texas
area. The Rosewood, Glenwood, White Oak and Oak Hill fields all produce from
the Cotton Valley formation and have numerous proved undeveloped drilling
locations. Many of these development drilling locations are based on a change
in regulatory field rules that now permit wells to be drilled on 80 acre
spacing as opposed to 160 acre spacing. Other significant fields in this
region include East Roanoke and East Gladewater. At December 31, 2000 we have
identified 136 proved undeveloped locations in this area. For 2001, we have
budgeted approximately $20 million for drilling of development wells and
exploitation activities in this area.

  Gulf Coast. We have established a substantial base of proved reserves and
undeveloped acreage with significant exploration potential along the Gulf
Coast of Texas and Louisiana. Through the acquisition of Magellan, we acquired
significant interests in Breton Sound Block 34 in Louisiana state waters and
the Garden City and Bay de Chene fields in south Louisiana. During 2000, we
participated in the drilling of four wells in these fields, all of which were
successful. We plan to drill two exploration wells to test the Hollywood and
Krumbar formations in Breton Sound Block 34 during 2001. Other significant
fields in south Louisiana include Riceville and Raceland. Along the Texas Gulf
Coast, we are active in two main areas, the Stuart City field in the Edwards
Reef Trend and the Segundo field in Webb County, Texas. In 2001, we have
budgeted approximately $31.1 million for development and exploration drilling
in this area.

  Permian, San Juan and Mid-Continent Areas. We own interests in numerous
fields in the Anadarko, Permian, San Juan and Arkoma basins of Kansas,
Oklahoma, Texas and New Mexico. Our largest fields in these areas are Puerto
Chiquito and Basin in the San Juan basin, Spivey-Grabs in south central Kansas
and West Stigler in eastern Oklahoma. In 2001, we have budgeted approximately
$1.1 million for development drilling and exploitation activities in these
areas.

  Classic Properties. Classic's major properties, consisting of interests in
the Beckville, Carthage, Oak Hill and Rodessa fields, are located near 3TEC's
existing properties in East Texas. The Classic properties produce primarily
from the Cotton Valley formation and encompass approximately 22,000 gross
acres (14,500 net acres). 3TEC estimates these properties have unaudited total
net proved reserves of 47 Bcfe, an associated PV-10 value of $57.6 million and
net daily production of approximately 11 Mmcfe, as of January 31, 2001.
Combined with 3TEC's existing East Texas production, this core area is now
producing approximately 39 Mmcfe per day for the Company. The estimated
reserves for Classic are 96% gas on an equivalent basis and 99% operated.
Classic owns interests in 87 producing wells with an average working interest
of 72%. Approximately 63% of the reserves are classified as proved producing.
The properties have a 10 year reserve-to-production ratio and low lease
operating costs. 3TEC has identified 24 proved undeveloped locations and has
budgeted approximately $11 million for development drilling on Classic's
properties in 2001. Ten wells are scheduled at Beckville and nine wells are
planned at Oak Hill during 2001.

                                      10
<PAGE>

Natural Gas and Oil Reserves

  The following table presents our estimated net proved natural gas and oil
reserves and the PV-10 value of our reserves as of December 31, 2000 and 1999,
excluding the Classic Properties. The period end prices of oil and natural gas
at December 31, 2000 and 1999, used in the PV-10 calculation were $25.31 and
$23.64 per barrel of oil and $9.40 and $2.23 per thousand cubic feet of
natural gas, respectively. Our estimated net proved natural gas and oil
reserves and the PV-10 value of our reserves as of December 31, 2000 and 1999,
are based on a reserve report prepared by Ryder Scott Company for our
properties. The PV-10 values shown in the table are not intended to represent
the current market value of the estimated natural gas and oil reserves we own.
For further information concerning the PV-10 values of these proved reserves,
please read note 14 of the notes to our December 31, 2000 consolidated
financial statements.

<TABLE>
<CAPTION>
                                                           December 31
                                                   ---------------------------
                                                      2000      1999    1998
                                                   ---------- -------- -------
      <S>                                          <C>        <C>      <C>
      Proved Reserves:
        Natural gas (Mmcf)........................    237,693  159,699  43,483
        Oil (MBbls)(1)............................     10,672    9,835   3,342
        Natural gas equivalents (Mmcfe)...........    301,725  218,709  63,535

      Proved Developed Reserves:
        Natural gas (Mmcf)........................    177,252  122,914  36,731
        Oil (MBbls)...............................      9,895    9,358   3,118
        Natural gas equivalents (Mmcfe)...........    236,622  179,062  55,439
        Estimated future net cash flows before
         income taxes, (in thousands)............. $1,996,831 $370,258 $71,464
        PV-10 value, (in thousands)............... $1,047,364 $198,615 $38,894
</TABLE>
--------
(1) Includes oil, condensate and plant product barrels

  There are numerous uncertainties in estimating quantities of proved reserves
and in projecting future rates of production and the timing of development
expenditures, including many factors beyond our control. The reserve data
herein are only estimates. Although we believe these estimates to be
reasonable, reserve estimates are imprecise and may be expected to change as
additional information becomes available. Estimates of oil and natural gas
reserves, of necessity, are projections based on engineering data, and there
are uncertainties inherent in the interpretation of this data, as well as the
projection of future rates of production and the timing of development
expenditures. Reservoir engineering is a subjective process of estimating
underground accumulations of oil and natural gas that cannot be exactly
measured. Therefore, estimates of the economically recoverable quantities of
oil and natural gas attributable to any particular group of properties,
classifications of the reserves based on risk of recovery and the estimates
are a function of the quality of available data and of engineering and
geological interpretation and judgment and the future net cash flows expected
therefrom, prepared by different engineers or by the same engineers at
different times, may vary substantially. There also can be no assurance that
the reserves set forth herein will ultimately be produced or that the proved
undeveloped reserves will be developed within the periods anticipated. Actual
production, revenues and expenditures with respect to our reserves will likely
vary from estimates, and the variances may be material. In addition, the
estimates of future net revenues from our proved reserves and the present
value thereof are based upon certain assumptions about future production
levels, prices and costs that may not be correct. We emphasize with respect to
the estimates prepared by independent petroleum engineers that PV-10 value
should not be construed as representative of the fair market value of our
proved oil and natural gas properties since discounted future net cash flows
are based upon projected cash flows which do not provide for changes in oil
and natural gas prices or for escalation of expenses and capital costs. The
meaningfulness of such estimates is highly dependent upon the accuracy of the
assumptions upon which they are based. Actual future prices and costs may
differ materially from those estimated.

                                      11
<PAGE>

Volumes, Prices and Operating Expenses

  The following table presents information regarding the production volumes
of, average sales prices received for, and average production costs associated
with, our sales of oil and natural gas for the periods indicated.

<TABLE>
<CAPTION>
                                                        Years Ended December 31
                                                        -----------------------
                                                         2000    1999    1998
                                                        ------- ------- -------
   <S>                                                  <C>     <C>     <C>
   Net Production Data:
     Natural gas (Mmcf)................................  17,764   4,738   3,847
     Oil (MBbls).......................................   1,139     532     581
     Natural gas equivalents (Mmcfe)...................  24,598   7,930   7,333

   Average Sale Prices:
     Natural gas ($ per Mcf)........................... $  4.12 $  2.18 $  2.00
     Oil ($ per Bbl)(1)................................   25.11   16.88   11.52
     Natural gas equivalents ($ per Mcfe)(1)...........    4.20    2.53    1.96

   Expenses: ($ per Mcfe)
     Lease operations.................................. $  0.62 $  0.80 $  0.95
     Production, severance and ad valorem taxes........ $  0.27 $  0.17 $  0.11
     Gathering, transportation and other............... $  0.09 $  0.02 $    --
     General and administrative........................ $  0.25 $  0.52 $  0.58
     Depreciation, depletion and amortization.......... $  0.80 $  0.84 $  0.97
</TABLE>
--------
(1) Includes the effect of our hedging activities.

Development, Exploration and Acquisition Capital Expenditures

  The following table presents information regarding our net costs incurred in
the purchase of properties and in exploration and development activities.

<TABLE>
<CAPTION>
                                                       Years Ended December 31,
                                                       -------------------------
                                                         2000    1999     1998
                                                       -------- ------- --------
                                                            (in thousands)
   <S>                                                 <C>      <C>     <C>
   Acquisition(1)..................................... $ 79,865 $91,424 $ 29,215
   Exploration........................................      695     824    1,802
   Development........................................   25,346   2,154    3,041
                                                       -------- ------- --------
       Total costs incurred........................... $105,906 $94,402 $ 34,058
                                                       ======== ======= ========
</TABLE>
--------
(1) Includes $18.5 million of costs allocated to the Magellan Acquisition
    properties, reflected within "Acquisition of Magellan Exploration LLC, net
    of cash acquired" in the Company's Consolidated Statement of Cash Flows.

                                      12
<PAGE>

Drilling Activity

  The following table shows our drilling activity for the years ended December
31, 2000, 1999 and 1998. In the table, "gross" refers to the total wells in
which we have a working interest and "net" refers to gross wells multiplied by
our working interest in these wells.

<TABLE>
<CAPTION>
                                                    Year Ended December 31,
                                               ---------------------------------
                                                  2000        1999       1998
                                               ----------- ---------- ----------
                                               Gross  Net  Gross Net  Gross Net
                                               ----- ----- ----- ---- ----- ----
   <S>                                         <C>   <C>   <C>   <C>  <C>   <C>
   Exploration Wells:
   Productive.................................   --     --   --    --    1  0.13
   Non-Productive.............................   --     --    5  0.90    8  0.79
                                                ---  -----  ---  ----  ---  ----
       Total..................................   --     --    5  0.90    9  0.92
                                                ===  =====  ===  ====  ===  ====
   Development Wells:
   Productive.................................   66  18.30   21  5.67   12  1.51
   Non-Productive.............................   --     --   --    --    2  1.10
                                                ---  -----  ---  ----  ---  ----
       Total..................................   66  18.30   21  5.67   14  2.61
                                                ===  =====  ===  ====  ===  ====
</TABLE>

Productive Wells

  The following table sets forth the number of productive natural gas and oil
wells in which we owned an interest as of December 31, 2000.

<TABLE>
<CAPTION>
                                                               Total Productive
                                                                     Wells
                                                               -----------------
                                                                 Gross     Net
                                                               --------- -------
      <S>                                                      <C>       <C>
      Natural Gas.............................................       883     316
      Oil.....................................................     1,465     383
                                                               --------- -------
          Total...............................................     2,348     699
                                                               ========= =======
</TABLE>

  Productive wells consist of producing wells and wells capable of production,
including natural gas wells awaiting pipeline connections to commence
deliveries and oil wells awaiting connection to production facilities. At
December 31, 2000, we operated approximately 455 wells.

Acreage Data

  The following table presents information regarding our developed and
undeveloped leasehold acreage as of December 31, 2000. Developed acreage
refers to acreage within producing units and undeveloped acreage refers to
acreage that has not been placed in producing units.

<TABLE>
<CAPTION>
                                      Developed     Undeveloped
                                       Acreage        Acreage         Total
                                   --------------- ------------- ---------------
                                    Gross    Net   Gross   Net    Gross    Net
                                   ------- ------- ------ ------ ------- -------
   <S>                             <C>     <C>     <C>    <C>    <C>     <C>
   Texas.......................... 227,924  76,352  8,180  2,159 236,104  78,511
   Louisiana......................  79,256  22,846    205    205  79,461  23,051
   Kansas.........................  40,080  11,533  6,401  3,479  46,481  15,012
   Oklahoma.......................  20,579  13,171  6,507  6,507  27,086  19,678
   Other.......................... 164,857  60,258    560    490 165,417  60,748
                                   ------- ------- ------ ------ ------- -------
       Total...................... 532,696 184,160 21,853 12,840 554,549 197,000
                                   ======= ======= ====== ====== ======= =======
</TABLE>

                                      13
<PAGE>

  Excluded from the acreage data are approximately 34,295 net mineral acres
owned by us, primarily in La Fourche, St. Mary and Terrebonne parishes of
Louisiana, all of which we believe have potential for oil and natural gas
exploration.

Current Activities

  As of March 21, 2001, 15 wells (4.0 net wells) were being drilled. Three
wells are in Louisiana, nine in Texas and three in Oklahoma.

Item 3. Legal Proceedings

  From time to time, we are party to various routine litigation proceedings
incidental to our business. We currently are not a party to any material
litigation.

Item 4. Submission of Matters to a Vote of Security Holders

  None.

                                      14
<PAGE>

                                    PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

Market Information

  Our common stock is currently quoted on the Nasdaq National Market under the
market symbol "TTEN." We held a Special Meeting of Shareholders on January 14,
2000, at which meeting our shareholders approved an Amendment to the Company's
Certificate of Incorporation which effected a 1-for-3 reverse stock split of
our common stock. The reverse stock split became effective on January 18,
2000. All share and share related numbers in this report have been prepared,
unless otherwise indicated, based on the number of shares outstanding after
the reverse split.

  The following table sets forth the high and low sales prices per share of
our common stock for the periods indicated on the Nasdaq National Market. The
high and low sales price amounts for periods prior to January 18, 2000, have
been adjusted to reflect the 1-for-3 reverse split of our common stock
effective on that date.

<TABLE>
<CAPTION>
      Period                                                        High   Low
      ------                                                       ------ ------
      <S>                                                          <C>    <C>
      2000
      First Quarter............................................... $11.44 $ 6.38
      Second Quarter..............................................  13.50   7.00
      Third Quarter...............................................  17.25   9.63
      Fourth Quarter..............................................  19.13  13.38

      1999
      First Quarter...............................................   8.63   4.13
      Second Quarter..............................................   8.06   5.25
      Third Quarter...............................................  14.44   7.50
      Fourth Quarter..............................................  13.59   7.13
</TABLE>

  On March 21, 2001 the last reported sales price of our common stock on the
Nasdaq National Market was $17.375 per share.

  On March 21, 2001 there were 1,368 holders of record of our common stock.

  Our transfer agent is American Stock Transfer and Trust Company located at
40 Wall Street, New York, New York 10005. You may call them toll free at (800)
937-5449 to answer any questions about transferring your stock.

  We have never declared or paid any cash dividends on our common stock. We
currently intend to retain future earnings, if any, for the operation and
development of our business and do not anticipate paying any cash dividends on
our common stock in the foreseeable future. In addition, our credit facility
prohibits us from paying cash dividends on our common stock. Any future
dividends are also restricted by the terms of our outstanding preferred stock
and may be restricted by any debt agreements which we may enter into from time
to time.

  We are obligated to pay net cash dividends in the amount of approximately
$750,000 per year on our Series D Preferred Stock which may be paid, at our
option, in cash or in additional shares of Series D Preferred Stock during the
three years ending February 1, 2003. Our credit facility permits the payment
of dividends on our Series D Preferred Stock.

                                      15
<PAGE>

Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operations

  You should read the following discussion and analysis in conjunction with
our audited consolidated financial statements. The following information
contains forward-looking statements. See "Cautionary Statement About Forward
Looking Statements".

 Overview

  We are engaged in the acquisition, development, production and exploration
of oil and natural gas reserves. Our properties are concentrated in East Texas
and the Gulf Coast region, both onshore and in the shallow waters of the Gulf
of Mexico. We also own significant properties in the Permian and San Juan
basins and in the Mid-Continent region. Our management and technical staff
have substantial experience in each of these areas. As of December 31, 2000,
we had estimated total net proved reserves of 302 Bcfe, of which approximately
79% were natural gas and approximately 78% were proved developed, with an
estimated PV-10 value of $1.0 billion. During December 2000, our net daily
production averaged approximately 63.9 Mmcf of natural gas and 2.9 MBbls of
oil or 81.3 Mmcfe.

  We have increased our reserves and production principally through
acquisitions. We focus on properties that have a substantial proved reserve
component and which management believes to have additional exploitation
opportunities. Recently, we have also acquired a number of drilling prospects
covered by an extensive 3-D seismic database that we believe have exploration
potential. We have assembled an experienced management team and technical
staff with expertise in property acquisitions and development, reservoir
engineering, exploration and financial management.

 Certain Accounting Practices

  We use the successful efforts method of accounting for our investments in
oil and natural gas properties. Under this method, we capitalize all direct
costs incurred in connection with the acquisition, drilling and development of
productive oil and natural gas properties. Costs associated with unsuccessful
exploration are expensed as incurred. Geological and geophysical costs and
costs of carrying and retaining unevaluated properties are expensed as
incurred. Depreciation, depletion and amortization of capitalized costs are
computed separately for each field based on the unit of production method
using only proved oil and gas reserves.

  We review our oil and gas properties on a field level for impairment when
circumstances indicate that the capitalized costs less accumulated
depreciation, depletion and amortization (the "Carrying Value") of the
property may not be recoverable. If the Carrying Value of the property exceeds
the expected future undiscounted cash flows, an amount equal to the excess of
the Carrying Value over the fair value of the property is charged to
operations. An impairment results in a non-cash charge to earnings but does
not affect cash flows.

 Liquidity and Capital Resources

  Cash Flow. We believe that our cash flows from operations are adequate to
meet the requirements of operating our business. However, future cash flows
are subject to a number of variables, including our level of production and
prices, and we cannot assure you that operations and other capital resources
will provide cash in sufficient amounts to maintain planned levels of capital
expenditures. Our principal operating sources of cash include sales of natural
gas and oil.

  Our earnings before interest, taxes, minority interest, depletion and
exploration ("EBITDAX") for the years ended December 31, 2000 and 1999, were
$73.7 million and $7.6 million, respectively. For the year 2001, we have
budgeted approximately $63 million for capital expenditures including $11
million budgeted for the Classic Properties. We are obligated to pay dividends
of approximately $750,000 per year on the Series D Preferred Stock which we
may pay in either cash or in additional shares of Series D Preferred Stock
during the three years ending February 1, 2003. We are obligated to pay
interest on the convertible subordinated notes of approximately $1.2 million
per year.

                                      16
<PAGE>

  Our activities in 2000 have been financed through operating cash flow,
together with bank borrowings and equity sales. Our primary source of
financing for acquisitions has been borrowing under our credit facility,
discussed below. On June 30, 2000, the Company completed a public offering of
8.05 million shares of the Company's common stock priced at $9.00 per share.
The net proceeds, approximately $66.6 million, were used primarily to repay a
portion of the outstanding debt under the Company's credit facility.


  We believe we will have sufficient cash flow from operations and borrowings
under our credit facility to meet our obligations and operating needs for the
coming year. However, future cash flows are subject to a number of variables,
including our level of production and prices, and we cannot assure you that
operations and other capital resources will provide cash in sufficient amounts
to maintain planned levels of capital expenditures.

  Credit Facility. Concurrent with the acquisition of the Floyd Oil
Properties, the Company entered into a $250 million credit facility (the
"Facility") with Bank One, NA as agent and four other banks. On May 31, 2000
and in connection with the acquisition of the CWR Properties, the Facility was
amended and restated to: (1) extend the maturity date of the Facility to May
31, 2003, (2) add an additional bank, and (3) increase the borrowing base to
$125 million. On March 12, 2001, the Company's borrowing base under its Credit
Facility was redetermined and set at $175 million. Additionally, two new banks
were added to the bank group. The borrowing base is to be redetermined semi-
annually on May 1 and November 1 and provides for interest as revised under
the Facility to accrue at a rate calculated at the Company's option as either
the bank's prime rate plus a low of zero to a high of 50 basis points or LIBOR
plus basis points increasing from a low of 150 to a high of 212.5 as loans
outstanding increase as a percentage of the borrowing base. As of December 31,
2000, the borrowing base was set at $140 million. As of December 31, 2000, the
Company was paying an average of 8.15% per annum interest on the principal
balance of the Facility. The loan matures on May 31, 2003. Prior to maturity,
no payments of principal are required so long as the borrowing base exceeds
the loan balance. The borrowings under the Facility are secured by
substantially all of the Company's oil and natural gas properties. At
December 31, 2000, the amount available to be borrowed under the credit
facility was approximately $77 million.

  In connection with the Facility we are required to adhere to certain
affirmative and negative covenants. The loan agreement contains a number of
dividend restrictions and restrictive covenants which, among other things,
require the maintenance of minimum current and interest coverage ratios.

  Market Risk. We generally sell our oil at local field prices paid by the
principal purchasers of oil. The majority of our natural gas production is
sold at spot prices. Accordingly, we are generally subject to the commodity
prices for these resources as they vary from time to time. Prices since mid-
1999 have generally followed an increasing trend, but the market continues to
have considerable volatility.

  Inflation and Changes in Prices. Our revenues and the value of our oil and
gas properties have been and will be affected by changes in natural gas and
crude oil prices. Our ability to maintain current borrowing capacity and to
obtain additional capital on attractive terms is also substantially dependent
on natural gas and crude oil prices. These prices are subject to significant
seasonal and other fluctuations that are beyond our ability to control or
predict. During 2000, we received an average of $25.11 per barrel of crude oil
and $4.12 per Mcf of gas. Costs and expenses are affected by the level of
inflation, which has had a significant effect in 2000. Should current
conditions in the industry be sustained, increased competition resulting in a
relative shortage of oilfield supplies and/or services, inflationary cost
pressures may continue.

 Results of Operations

  Our revenue, profitability, and future rate of growth are dependent upon
prevailing prices for oil and gas, which, in turn, depend upon numerous
factors such as economic, political, and regulatory developments as well as
competition from other sources of energy. The energy markets historically have
been highly volatile, and

                                      17
<PAGE>

future decreases in prices could have an adverse effect on our financial
position, results of operations, quantities of reserves that may be
economically produced, and access to capital.

  Due to our significant property and corporate acquisitions in 2000, our late
1999 change of control and our current capitalization structure, comparisons
of our historical financial position and results of operations from 2000 to
1999 can be difficult. You should read the following discussion and analysis
together with our audited consolidated financial statements and the related
notes for the fiscal years ended December 31, 2000 and 1999.

 2000 Compared With 1999

  Revenue. Total revenue for the year ended December 31, 2000 was $104.8
million, an increase of $82.6 million (372%) over total revenue for 1999 of
$22.2 million. Oil, natural gas and plant income revenues for the 2000 period
were $103.2 million compared to $20.0 million in 1999, an increase of $83.2
million (416%). Realized prices for the Company's production was $4.20/Mcfe in
2000 compared to $2.43/Mcfe in 1999, while production volumes increased to
24,598 Mmcfe in 2000 compared to 7,930 Mmcfe in 1999. Realized price increases
for 2000 over 1999 were reflective of the strong commodity price environment
in the industry, while being only minimally impacted by the company's hedging
activities in both years ($2.1 million loss in 2000 on oil hedging, and $0.2
million loss on gas hedging in 1999). Comparability of the company's revenues
and volumes were both driven by an aggressive developmental drilling program
in 2000 and the acquisition of the Floyd Oil Properties in November 1999, the
Magellan Properties in February 2000 and the CWR Properties in May 2000, which
were all significant contributors to the year over year increases.

  Gain on Sale of Properties and Other Revenue. In 2000 vs. 1999, property
divestments resulted in the recognition of gains of $0.8 million and $1.0
million, respectively. The Company continues to actively review and manage its
property portfolio for divestiture of non-strategic properties. Other revenues
in 2000 were $0.8 million compared to $1.0 million in 1999. Other revenue
consists primarily of interest, delay rental and lease bonus income.

  Expenses. Total expenses for the year ended December 31, 2000 were $58.4
million, an increase of $31.4 million (116%) from total expenses in 1999 of
$27.0 million. Comparability of total expenses was significantly impacted by
the company's aggressive developmental drilling program and the acquisition of
the Floyd Oil Properties in November 1999, the Magellan Properties in February
2000 and the CWR Properties in May 2000. On a per Mcfe basis, the Company's
lease operating expenses decreased by 23% to $0.62 in 2000 from $0.80 in 1999.
Production, severance and ad valorem tax increased by 59% to $0.27/Mcfe in
2000 from $0.17/Mcfe in 1999. Additionally, general and administrative,
interest and depreciation, depletion and amortization ("DD&A") expenses all
rose on a dollar basis in 2000 but decreased on a per Mcfe basis. General and
administrative expense was $0.25/Mcfe in 2000 compared to $0.52/Mcfe in 1999,
interest expense $0.31/Mcfe vs. $0.40/Mcfe in 1999, and DD&A $0.80/Mcfe in
2000 compared to $0.84/Mcfe in 1999.

  Income Taxes. The Company recorded a $14.4 million income tax provision
during 2000 as compared to a $1.4 million income tax benefit for 1999. The
results from the Company's operations generated pre-tax income of $46.1
million during 2000 vs. a pre-tax loss of $4.9 million in 1999. During 2000,
the Company's effective tax rate was approximately 32%. Also, the Company
became a cash taxpayer in 2000, with $8.0 million of the 2000 provision
recorded as a current tax payable.

  Net Income. The Company's 2000 net income of $31.7 million is compared to
the $3.4 million net loss in 1999. As discussed in the revenue and expenses
paragraphs above, the Company's significant drilling and acquisition success
during 2000, coupled with a very strong commodity price environment and cost
containment and improved efficiencies on a per unit basis, all attributed to
the current year net income result.

  Dividends to Preferred Shareholders. Dividends to preferred shareholders of
$1.5 million in 2000 is a $0.9 million increase (150%) over 1999 dividends of
$0.6 million. During 2000, the Company issued a new preferred

                                      18
<PAGE>

stock series, Series D, in connection with the Magellan Acquisition, which
accounted for $0.6 million of the increase. Additionally, during the third
quarter of 2000, the Company redeemed its Series C preferred stock and
recognized a non-cash charge to dividend expense of $0.5 million.

 1999 Compared With 1998

  Revenue. Total revenue for the year ended December 31, 1999 was $22.2
million, an increase of $4.5 million (25%) over total revenue for 1998 of
$17.7 million. Oil, natural gas and plant income revenues for the 1999 period
were $20.1 million compared to $15.0 million in 1998, an increase of $5.1
million (34%). Realized prices for the Company's production was $2.43/Mcfe in
1999 compared to $1.96/Mcfe in 1998, an increase of $0.47/Mcfe (24%), while
production volumes increased to 7,930 Mmcfe in 1999 compared to 7,333 Mmcfe in
1998, an 597 Mmcfe increase (8%). Realized price increases for 1999 over 1998
were representative of a stronger commodity price environment during the
period, while being only minimally impacted by the company's hedging
activities in 1999 (a $0.2 million loss in 1999 on gas hedging). The company's
revenues and volumes were both impacted by the acquisition of the Floyd Oil
Properties in November 1999, approximately $4.5 million in revenue from the
date of acquisition (November 23, 1999) to year-end, and production of 75 Mbls
of oil and 1,112 Mmcf of natural gas for the same period.

  Gain on Sale of Properties and Other Revenue. In 1999 vs. 1998, property
divestments resulted in the recognition of gains of $1.0 million and $1.9
million, respectively. Other revenues in 1999 were $1.0 million compared to
$0.5 million in 1998. Other revenue consists primarily of interest, delay
rental and lease bonus income.

  Expenses. Total expenses for the year ended December 31, 1999 were $27.0
million, an decrease of $0.1 million (0.4%) from total expenses in 1998 of
$27.1 million. On a per Mcfe basis, the Company's lease operating expenses
decreased by 16% to $0.80 in 1999 from $0.95 in 1998. Production, severance
and ad valorem tax increased by 55% to $0.17/Mcfe in 1999 from $0.11/Mcfe in
1998. Additionally, general and administrative expense was $0.52/Mcfe in 1999
compared to $0.58/Mcfe in 1998, interest expense $0.40/Mcfe vs. $0.27/Mcfe in
1998, and DD&A $0.84 in 1999 compared to $0.97 million in 1998. Impairment
expense was approximately $2.5 million, relating to impairments on fee mineral
acreage, non-producing leasehold and proved oil and gas properties,
principally attributable to decreasing oil prices in 1999.

  Income Taxes. The Company recorded a $1.4 million income tax benefit during
1999 as compared to a $2.8 million income tax benefit for 1998. The results
from the Company's operations generated pre-tax losses of $4.9 million during
1999 and $9.4 million in 1998. During 1999 and 1998, the Company's effective
tax rate was approximately 30%.

  Net Loss. The Company's 1999 net loss of $3.4 million is compared to the
$6.6 million net loss in 1998. As discussed in the revenue and expenses
paragraphs above, the Company's acquisition efforts during 1999, coupled with
a stronger overall commodity price environment and cost containment and
improved efficiencies on a per unit basis, all attributed to the current year
net income result.

  Dividends to Preferred Shareholders. Dividends to preferred shareholders of
$0.6 million in 1999 is a $0.5 million increase (500%) over 1998 dividends of
$0.1 million. During December 1998, the Company issued Series C Preferred
Stock in connection with the acquisition of the Enex Partnership (the "Enex
Partnership Acquisition"), obligating the Company to pay annual dividend of
approximately $0.5 million.

Item 7. Financial Statements

  The Consolidated Financial Statements that constitute this item follow the
text of this report. An index to the Consolidated Financial Statements and
Schedules appears in Item 13 of this report.

Item 8. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure

  None.

                                      19
<PAGE>

                                   PART III

Item 9. Directors and Executive Officers of the Registrant

  The Company's Definitive Proxy Statement for its 2001 Annual Meeting of
Stockholders, when filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934, will be incorporated by reference into this Annual
Report on Form 10-KSB pursuant to General Instruction E(3) of Form 10-KSB and
will provide the information required for Items 9, 10, 11 and 12 under Part
III.

Item 10. Executive Compensation

  The Company's Definitive Proxy Statement for its 2001 Annual Meeting of
Stockholders, when filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934, will be incorporated by reference into this Annual
Report on Form 10-KSB pursuant to General Instruction E(3) of Form 10-KSB and
will provide the information required for Items 9, 10, 11 and 12 under Part
III.

Item 11. Security Ownership of Certain Beneficial Owners and Management

  The Company's Definitive Proxy Statement for its 2001 Annual Meeting of
Stockholders, when filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934, will be incorporated by reference into this Annual
Report on Form 10-KSB pursuant to General Instruction E(3) of Form 10-KSB and
will provide the information required for Items 9, 10, 11 and 12 under Part
III.

Item 12. Certain Relationships and Related Transactions

  The Company's Definitive Proxy Statement for its 2001 Annual Meeting of
Stockholders, when filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934, will be incorporated by reference into this Annual
Report on Form 10-KSB pursuant to General Instruction E(3) of Form 10-KSB and
will provide the information required for Items 9, 10, 11 and 12 under Part
III.

Item 13. Exhibits, Financial Statement Schedules and Reports on Form 8-K

  (a) 1. Consolidated Financial Statements: See Index to Consolidated
Financial Statements on page F-1

    2. Exhibits: The following documents are filed as exhibits to this
  report:

<TABLE>
 <C>   <S>
  2.1  Agreement and Plan of Merger, dated December 21, 1999, by and between
       3TEC Energy Corporation, 3TM Acquisition L.L.C., Magellan Exploration,
       LLC and ECIC Corporation, EnCap Energy Capital Fund III, L.P., EnCap
       Energy Acquisition III-B, Inc., BOCP Energy Partners, L.P., and Pel-Tex
       Partners, L.L.C. (Incorporated by reference to Exhibit C to Form DEF14A,
       filed January 11, 2000.)

  2.2  Agreement and Plan of Merger, dated November 24, 1999, by and between
       3TEC Energy Corporation, a Delaware corporation, and Middle Bay Oil
       Company, Inc., an Alabama corporation. (Incorporated by reference to
       Exhibit A to Form DEF14A, filed October 25, 1999.)

  2.3  Form of Purchase Agreement between and among Middle Bay Oil Company,
       Inc. and private sellers of the properties managed by Floyd Oil Company.
       (Incorporated by reference to Exhibit 2.1 to Form 8-K filed December 7,
       1999.)

  2.4  Real Estate Exchange Agreement by and between Middle Bay Oil Company,
       Inc. and Floyd Oil Company. (Incorporated by reference to Exhibit 2.1 to
       Form 8-K/A filed December 17, 1999.)

  2.5  First Amendment to Agreement and Plan of Merger, effective as of January
       14, 2000, by and among 3TEC Energy Corporation, 3TM Acquisition L.L.C.,
       Magellan Exploration, LLC, ECIC Corporation, EnCap Energy Capital Fund
       III, L.P., EnCap Energy Acquisition III-B, Inc., BOCP Energy Partners,
       L.P., and Pel-Tex Partners, L.L.C. (Incorporated by reference to Exhibit
       2.1 to Form 8-K filed February 4, 2000.)
</TABLE>

                                      20
<PAGE>


<TABLE>
 <C>   <S>
  2.6  Second Amendment to Agreement and Plan of Merger, effective as of
       February 2, 2000, by and among 3TEC Energy Corporation, 3TM Acquisition
       L.L.C., Magellan Exploration, LLC, ECIC Corporation, EnCap Energy
       Capital Fund III, L.P., EnCap Energy Acquisition III-B, Inc., BOCP
       Energy Partners, L.P., and Pel-Tex Partners, L.L.C. (Incorporated by
       reference to Exhibit 2.2 to Form 8-K filed February 4, 2000.)

  2.7  Form of Agreement of Sale and Purchase by and between C.W. Resources,
       Inc., Westerman Royalty, Inc., and Carl A. Westerman and 3TEC Energy
       Corporation. (Incorporated by Reference to Exhibit 10.32 to Form S-2
       filed April 28, 2000.)

  3.1  Certificate of Incorporation of 3TEC Energy Corporation. (Incorporated
       by reference to Exhibit 3.1 of Form 8-K/A filed December 6, 1999.)

  3.2  Certificate of Amendment to the Certificate of Incorporation of 3TEC
       Energy Corporation. (Incorporated by reference to Exhibit 3.3 of Form
       10-KSB filed March 30, 2000.)

  3.3  Certificate of Merger of Middle Bay Oil Company, Inc. into 3TEC Energy
       Corporation. (Incorporated by reference to Exhibit 3.3 of Form 8-K/A
       filed December 16, 1999.)

  3.4  Bylaws of the Company. (Incorporated by reference to Exhibit C of the
       Company's definitive proxy statement filed October 25, 1999.)

  4.1  Certificate of Designation of Series B Preferred Stock of 3TEC Energy
       Corporation. (Incorporated by reference to Exhibit 3.1 to Form 8-K/A
       filed December 16, 1999.)

  4.2  Certificate of Designation of Series C Preferred Stock of 3TEC Energy
       Corporation. (Incorporated by reference to Exhibit 3.2 Form 8-K/A filed
       December 16, 1999.)

  4.3  Certificate of Designation of Series D Preferred Stock of 3TEC Energy
       Corporation. (Incorporated by reference to Exhibit 4.3 to Form 10-QSB
       filed May 15, 2000.)

 10.1  Securities Purchase Agreement, dated July 1, 1999 by and between the
       Company and 3TEC Energy Corporation. (Incorporated by reference to
       Exhibit C to the definitive Proxy Statement filed July 19, 1999.)

 10.2  Securities Purchase Agreement, dated August 27, 1999 by and between the
       Company and Shoemaker Family Partners, LP. (Incorporated by reference to
       Exhibit 10.2 to Form 10-QSB filed November 15, 1999.)

 10.3  Securities Purchase Agreement, dated August 27, 1999 by and between the
       Company and Shoeinvest II, LP. (Incorporated by reference to Exhibits to
       Exhibit 10.3 to Form 10-QSB filed November 15, 1999.)

 10.4  Securities Purchase Agreement, dated October 19, 1999 between The
       Prudential Insurance Company of America and the Company. (Incorporated
       by reference to Exhibit 10.1 to Form 8-K filed November 2, 1999.)

 10.5  Shareholders Agreement, dated August 27, 1999 by and among the Company,
       3TEC Energy Corporation and the Major Shareholders. (Incorporated by
       reference to Exhibit 10.5 to Form 10-QSB filed November 15, 1999.)

 10.6  Registration Rights Agreement, dated August 27, 1999 by and among the
       Company, 3TEC Energy Corporation, the Major Shareholders, Shoemaker
       Family Partners, LP and Shoeinvest II, LP. (Incorporated by reference to
       Exhibit 10.6 to Form 10-QSB filed November 15, 1999.)

 10.7  Amendment to Registration Rights Agreement, dated October 19, 1999 by
       and among the Company, W/E Energy Company, L.L.C. f/k/a 3TEC Energy
       Company L.L.C., f/k/a 3TEC Energy Corporation, Shoemaker Family
       Partners, LP, Shoeinvest II, LP, and The Prudential Insurance Company of
       America. (Incorporated by reference to Exhibit 10.2 to Form 8-K filed
       November 2, 1999.)
</TABLE>


                                       21
<PAGE>

<TABLE>
 <C>   <S>
 10.8  Participation Rights Agreement, dated October 19, 1999 by and among the
       Company, The Prudential Insurance Company of America and W/E Energy
       Company L.L.C. (Incorporated by reference to Exhibit 10.3 to Form 8-K
       filed November 2, 1999.)

 10.9  Employment Agreement, dated April 15, 2000 by and between Floyd C.
       Wilson and the Company. (Incorporated by reference to Exhibit 10.9 to
       Form S-2 filed April 28, 2000.)

 10.10 Employment Agreement, dated May 1, 2000, by and between R.A. Walker and
       the Company. (Incorporated by reference to Exhibit 10.9 to Form S-2
       filed April 28, 2000.)

 10.11 Letter Amendment No. 1 to Middle Bay Oil Company, Inc. Securities
       Purchase Agreement, dated November 23, 1999, by and between Middle Bay
       Oil Company, Inc. (n/k/a 3TEC Energy Corporation) and The Prudential
       Insurance Company of America (Incorporated by reference to Exhibit 10.21
       to Form S-2 filed April 28, 2000 and replacing the unexecuted Exhibit
       10.17 of Form 10-QSB filed November 15, 1999.)

 10.12 Intercreditor Agreement, dated as of November 23, 1999, among Middle Bay
       Oil Company, Inc., Bank One Texas, N.A. and 3TEC Energy Company L.L.C.
       (Incorporated by reference to Exhibit 10.18 to Form S-2 filed
       April 28, 2000.)

 10.13 Intercreditor Agreement, dated as of November 23, 1999, among Middle Bay
       Oil Company, Inc., Bank One Texas, N.A. and Shoemaker Family Partners,
       LP. (Incorporated by reference to Exhibit 10.18 to Form S-2 filed
       April 28, 2000.)

 10.14 Intercreditor Agreement, dated as of November 23, 1999, among Middle Bay
       Oil Company, Inc., Bank One Texas, N.A. and Shoeinvest II, LP.
       (Incorporated by reference to Exhibit 10.20 to Form S-2 filed
       April 28, 2000.)

 10.15 Amendment to Securities Purchase Agreement, dated as of November 23,
       1999, among Middle Bay Oil Company, Inc. and 3TEC Energy Company L.L.C.
       (Incorporated by reference to Exhibit 10.22 to Form S-2 filed April 28,
       2000.)

 10.16 Amendment to Securities Purchase Agreement, dated as of November 23,
       1999, among Middle Bay Oil Company, Inc. and Shoemaker Family Partners,
       LP. (Incorporated by reference to Exhibit 10.23 to Form S-2 filed April
       28, 2000.)

 10.17 Amendment to Securities Purchase Agreement, dated as of November 23,
       1999, among Middle Bay Oil Company, Inc. and Shoeinvest II, LP.
       (Incorporated by reference to Exhibit 10.24 to Form S-2 filed
       April 28, 2000.)

 10.18 Amended and Restated 1995 Stock Option and Stock Appreciation Rights
       Plan. (Incorporated by reference to Exhibit B to Form DEF 14A filed
       May 5, 1997.)

 10.19 Amendment No. 1 to the Amended and Restated 1995 Stock Option and Stock
       Appreciation Rights Plan. (Incorporated by reference to Exhibit B to
       Form DEF 14A filed May 5, 1998.)

 10.20 1999 Stock Option Plan. (Incorporated by reference to Exhibit E to Form
       DEF 14A filed October 25, 1999.)

 10.21 2000 Stock Option Plan (Incorporated by reference to Exhibit A to Form
       DEF 14A filed on May 1, 2000.)

 10.22 Second Restated Credit Agreement among 3TEC Energy Corporation, Enex
       Resources Corporation, Middle Bay Production Company, Inc., and Magellan
       Exploration, LLC, as Borrowers, and Bank One, Texas, N.A. and the
       Institutions named therein, as Lenders, Bank One, Texas, N.A., as
       Administrative Agent, Bank of Montreal as Syndication Agent and Banc One
       Capital Markets, Inc., as Arranger, dated May 31, 2000. (Incorporated by
       reference to Exhibit 10.28 to Form S-2/A filed June 6, 2000.)

 10.23 First Amendment to Shareholders' Agreement by and among 3TEC Energy
       Corporation, the W/E Shareholders and the Major Shareholders, dated May
       30, 2000. (Incorporated by reference to Exhibit 10.29 to Form S-2/A
       filed September 6, 2000.)
</TABLE>

                                       22
<PAGE>

<TABLE>
 <C>   <S>
 21.1  Subsidiaries of 3TEC Energy Corporation.*

 23.1  Consent of KPMG LLP, independent certified public accountants. *

 23.2  Consent of Ryder Scott Company, independent petroleum engineers. *
</TABLE>
--------
* Filed herewith

  (b) The following reports were filed on Form 8-K during the fourth quarter of
2000:

  None.

                                       23
<PAGE>

                     GLOSSARY OF CERTAIN OIL AND GAS TERMS

  The following are abbreviations and definitions of certain terms commonly
used in the oil and gas industry and herein:

  Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used herein in
reference to oil or other liquid hydrocarbons.

  Bcf. One billion cubic feet of natural gas.

  Bcfe. One billion cubic feet of natural gas equivalent, determined using the
ratio of six Mcf of natural gas to one Bbl of oil, condensate or natural gas
liquids.

  Btu or British Thermal Unit. The quantity of heat required to raise the
temperature of one pound of water by one degree Fahrenheit.

  Completion. The installation of permanent equipment for the production of
natural gas or oil, or in the case of a dry hole, the reporting of abandonment
to the appropriate agency.

  Condensate. Liquid hydrocarbons associated with the production of a
primarily natural gas reserve.

  Developed acreage. The number of acres that are allocated or assignable to
productive wells or wells capable of production.

  Development well. A well drilled into a proved natural gas or oil reservoir
to the depth of a stratigraphic horizon known to be productive.

  Exploratory well. A well drilled to find and produce natural gas or oil
reserves that are not proved, to find a new reservoir in a field previously
found to be productive of natural gas or oil in another reservoir or to extend
a known reservoir.

  Field. An area consisting of a single reservoir or multiple reservoirs all
grouped on or related to the same individual geological structural feature
and/or stratigraphic level.

  MBbls. One thousand barrels of oil or other liquid hydrocarbons.

  Mcf. One thousand cubic feet of natural gas.

  Mcfe. One thousand cubic feet equivalent, determined using the ratio of six
Mcf of natural gas to one Bbl of oil, condensate or natural gas liquids.

  Mmbtu. One million British Thermal Units.

  Mmcf. One million cubic feet of natural gas.

  Mmcfe. One million cubic feet equivalent, determined using the ratio of six
Mcf of natural gas to one Bbl of oil, condensate or natural gas liquids.

  Productive well. A well that is found to be capable of producing sufficient
quantities of oil and gas so that proceeds from the sale of the production are
greater than production expenses and taxes.

  Prospect. A specific geographic area which, based on supporting geological,
geophysical or other data and also preliminary economic analysis using
reasonably anticipated prices and costs, is deemed to have potential for the
discovery of oil and natural gas.

                                      24
<PAGE>

  Proved developed reserves. Reserves that can be expected to be recovered
through existing wells with existing equipment and operating methods.

  Proved reserves. The estimated quantities of oil, natural gas and natural
gas liquids that geological and engineering data demonstrate with reasonable
certainty to be recoverable in future years from known reservoirs under
existing economic and operating conditions.

  Proved undeveloped reserves. Reserves that are expected to be recovered from
new wells on developed acreage where the subject reserves cannot be recovered
without drilling additional wells.

  PV-10 value. The estimated future net revenue to be generated from the
production of proved reserves discounted to present value using an annual
discount rate of 10%. These amounts are calculated net of estimated production
costs and future development costs, using prices and costs in effect as of a
certain date, without escalation and without giving effect to non-property
related expenses, such as general and administrative expenses, debt service,
future income tax expense, or depreciation, depletion, and amortization.

  Recompletion. The completion of an existing well for production from a
formation that exists behind the casing of the well.

  Reservoir. A porous and permeable underground formation containing a natural
accumulation of producible natural gas and/or oil that is confined by
impermeable rock or water barriers and is individual and separate from other
reservoirs.

  Royalty interest. An interest in a natural gas and oil property entitling
the owner to a share of natural gas and oil production free of costs of
production.

  Standardized measure. The estimated future net cash flows from proved
natural gas and oil reserves computed using prices and costs, at a specific
date, after income taxes and discounted at 10%.

  Tcfe. One trillion cubic feet of natural gas equivalent, determined using
the ratio of six Mcf of natural gas to one Bbl of oil, condensate or natural
gas liquids.

  Undeveloped acreage. Lease acreage on which wells have not been drilled or
completed to a point that would permit the production of commercial quantities
of natural gas and oil regardless of whether such acreage contains proved
reserves.

  Working interest. The operating interest that gives the owner the right to
drill, produce and conduct operating activities on the property and receive a
share of production.

                                      25
<PAGE>

                                  SIGNATURES

  Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
by the undersigned, thereunto duly authorized, as of March 30, 2001.

                                                 3Tec Energy Corporation
                                                      (Registrant)

                                                  /s/ Floyd C. Wilson
                                          By: _________________________________
                                                      Floyd C. Wilson
                                                Chairman and Chief Executive
                                                          Officer

                               POWER OF ATTORNEY

  KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Floyd C. Wilson, his true and lawful attorney-
in-fact and agent, each with full power of substitution and resubstitution, to
sign any and all amendments (including post-effective amendments) to this
Annual Report on Form 10-KSB and to file the same, with exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorney-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he or she might or could do in person, hereby
ratifying and confirming all that said attorneys-in-fact, or their substitute
or substitutes, or any of them, shall do or cause to be done by virtue hereof.

  Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:

<TABLE>
<CAPTION>
              Signature                          Title                   Date
              ---------                          -----                   ----

<S>                                    <C>                        <C>
       /s/ Floyd C. Wilson             Chairman and Chief           March 30, 2001
______________________________________  Executive Officer
           Floyd C. Wilson

         /s/ R.A. Walker               President, Chief Financial   March 30, 2001
______________________________________  Officer, Director
             R.A. Walker

        /s/ Steve W. Herod             Executive Vice President--   March 30, 2001
______________________________________  Corporate Development,
            Steve W. Herod              Director

       /s/ Shane M. Bayless            Vice President--             March 30, 2001
______________________________________  Controller, Principal
           Shane M. Bayless             Accounting Officer

     /s/ Gary R. Christopher           Director                     March 30, 2001
______________________________________
         Gary R. Christopher

        /s/ Larry L. Helm              Director                     March 30, 2001
______________________________________
            Larry L. Helm

       /s/ David B. Miller             Director                     March 30, 2001
______________________________________
           David B. Miller

      /s/ D. Martin Phillips           Director                     March 30, 2001
______________________________________
          D. Martin Phillips
</TABLE>

                                      26
<PAGE>

                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
<S>                                                                       <C>
Independent Auditors' Report............................................. F-2
Consolidated Balance Sheets as of December 31, 2000 and 1999............. F-3
Consolidated Statements of Operations for the years ended December 31,
 2000 and 1999........................................................... F-4
Consolidated Statements of Cash Flows for the years ended December 31,
 2000 and 1999........................................................... F-5
Consolidated Statements of Changes in Stockholders' Equity for the years
 ended December 31, 2000 and 1999........................................ F-6
Notes to Consolidated Financial Statements............................... F-7
</TABLE>

                                      F-1
<PAGE>

                         INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders
3TEC Energy Corporation

  We have audited the accompanying consolidated balance sheet of 3TEC Energy
Corporation and subsidiaries as of December 31, 2000 and December 31, 1999 and
the related consolidated statements of operations, changes in stockholders'
equity, and cash flows for each of the years then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

  We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

  In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of 3TEC
Energy Corporation and subsidiaries as of December 31, 2000 and 1999, and the
results of their operations and their cash flows for each of the years then
ended in conformity with accounting principles generally accepted in the
United States of America.

                                          KPMG LLP

Houston Texas
March 16, 2001


                                      F-2
<PAGE>

                    3TEC ENERGY CORPORATION AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                    December 31,  December 31,
                                                        2000          1999
                                                    ------------  ------------
<S>                                                 <C>           <C>
                      ASSETS
Current Assets:
  Cash and cash equivalents........................ $  4,436,497  $  6,141,153
  Accounts receivable..............................   26,137,738     9,453,551
  Other............................................    5,389,848       176,226
                                                    ------------  ------------
    Total Current Assets...........................   35,964,083    15,770,930
Properties and Equipment, at cost:
  Oil and gas properties, successful efforts
   method..........................................  270,277,796   168,840,499
  Other property and equipment.....................    2,030,310     1,141,879
                                                    ------------  ------------
                                                     272,308,106   169,982,378
Accumulated depletion, depreciation and
 amortization......................................  (56,170,333)  (38,208,298)
Net Properties and Equipment.......................  216,137,773   131,774,080
                                                    ------------  ------------
Other Assets.......................................    2,662,201     1,698,496
                                                    ------------  ------------
TOTAL ASSETS....................................... $254,764,057  $149,243,506
                                                    ============  ============
       LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
  Accounts payable................................. $ 10,746,140  $  5,726,569
  Accrued liabilities..............................    2,191,826     1,576,731
  Series C Preferred stock redemption payable......    2,855,521            --
  Income taxes payable.............................    4,461,928            --
  Accounts payable--Stockholder Dissenters.........           --     1,118,678
  Other current liabilities........................      467,152       347,733
                                                    ------------  ------------
    Total Current Liabilities......................   20,722,567     8,769,711
Long-Term Liabilities Bank Debt....................   63,000,000    87,500,000
Senior Subordinated convertible notes..............   13,223,844    13,223,844
Other long-term liabilities........................       58,424       257,627
Minority Interest..................................    1,393,578     1,089,044
                                                    ------------  ------------
Total Long-Term Liabilities........................   77,675,846   102,070,515
                                                    ------------  ------------
Deferred income taxes..............................    6,770,981       290,643
                                                    ------------  ------------
TOTAL LIABILITIES..................................  105,169,394   111,130,869
                                                    ------------  ------------
Commitments and Contingencies......................           --            --
STOCKHOLDERS' EQUITY
  Preferred stock, $.02 par value, 20,000,000
   shares authorized 266,667 designated Series B,
   2,300,000 shares designated Series C and 725,167
   shares designated Series D, none other
   designated......................................           --            --
  Convertible preferred stock Series B, $7.50
   stated value, 266,667 shares issued and
   outstanding. $2,000,000 aggregate liquidation
   preference......................................    3,627,000     3,627,000
  Convertible preferred stock Series C, $5.00
   stated value, -0- and 1,139,506 shares issued
   and outstanding at December 31, 2000 and
   December 31, 1999, respectively.................           --     5,198,440
  Convertible preferred stock Series D, 5% $24.00
   stated value, 621,930 shares issued and
   outstanding at December 31, 2000, $14,926,320
   aggregate liquidation preference................    7,571,553            --
  Common stock, $.02 par value, 60,000,000 shares
   authorized, 14,687,906 and 5,338,771 shares
   issued at December 31, 2000 and December 31,
   1999, respectively..............................      293,758       106,778
  Additional paid-in capital.......................  136,382,775    57,775,199
  Retained earnings (deficit)......................    2,768,417   (27,408,062)
  Treasury stock; 69,807 and 7,258 shares at
   December 31, 2000 and December 31, 1999,
   respectively....................................   (1,048,840)   (1,186,718)
                                                    ------------  ------------
    TOTAL STOCKHOLDERS' EQUITY.....................  149,594,663    38,112,637
                                                    ------------  ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......... $254,764,057  $149,243,506
                                                    ============  ============
</TABLE>

          See accompanying notes to consolidated financial statements.

                                      F-3
<PAGE>

                    3TEC ENERGY CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                            Year Ended
                                                     -------------------------
                                                     December 31,   December
                                                         2000       31, 1999
                                                     ------------  -----------
<S>                                                  <C>           <C>
REVENUES:
  Oil, natural gas and plant income................  $103,210,199  $20,087,682
  Gain on sale of properties.......................       800,338    1,047,860
  Other............................................       812,616    1,020,456
                                                     ------------  -----------
    TOTAL REVENUES.................................  $104,823,153  $22,155,998
                                                     ------------  -----------
EXPENSES:
  Production --
    Lease operations...............................  $ 15,326,014  $ 6,315,063
    Production, severance and ad valorem tax.......     6,691,508    1,337,273
    Gathering, transportation and other............     2,223,396      135,932
  Geological and geophysical.......................       666,089      472,697
  Dry hole and impairments.........................        29,261    3,102,760
  General and administrative.......................     6,141,297    4,122,135
  Stock compensation...............................            --      729,938
  Severance payments...............................            --      624,420
  Compensation plan payments.......................            --      292,527
  Interest.........................................     7,555,529    3,204,768
  Depreciation, depletion and amortization.........    19,779,218    6,690,961
                                                     ------------  -----------
    TOTAL EXPENSES.................................  $ 58,412,312  $27,028,474
                                                     ------------  -----------
INCOME (LOSS) BEFORE INCOME TAXES, MINORITY
 INTEREST AND DIVIDENDS TO PREFERRED STOCKHOLDERS..    46,410,841   (4,872,476)
Minority Interest..................................      (304,534)      (2,323)
Income Tax (Provision) benefit.....................   (14,442,267)   1,442,524
                                                     ------------  -----------
NET INCOME (LOSS)..................................    31,664,040   (3,432,275)
Dividends to preferred stockholders................     1,487,561      574,080
                                                     ------------  -----------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON
 STOCKHOLDERS......................................  $ 30,176,479  $(4,006,355)
                                                     ============  ===========
EARNINGS (LOSS PER COMMON SHARE:
  Basic............................................  $       2.91  $     (1.14)
                                                     ============  ===========
  Diluted..........................................  $       2.28  $     (1.14)
                                                     ============  ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
  Basic............................................    10,382,836    3,519,532
                                                     ============  ===========
  Diluted..........................................    13,894,961    3,519,532
                                                     ============  ===========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                      F-4
<PAGE>

                    3TEC ENERGY CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                             Year Ended
                                                       ------------------------
                                                        December     December
                                                          2000         1999
                                                       -----------  -----------
<S>                                                    <C>          <C>
OPERATING ACTIVITIES
Net income (loss)....................................   31,664,040   (3,432,275)
Adjustments to reconcile net income to net cash
 provided by operating activities:
 Depreciation, depletion and amortization............   18,712,937    6,690,961
 Amortization of debt issue costs and other..........    1,066,281      377,885
 Dry hole and impairments............................       29,261    3,102,760
 Stock compensation expense..........................           --      729,938
 Gain on sale of properties..........................     (800,338)  (1,047,860)
 Deferred income taxes...............................    6,480,338   (1,442,524)
 Minority interest...................................      304,534        2,323
 Changes in operating assets and liabilities:
 Accounts receivable and other current assets........  (21,706,674)  (5,852,041)
 Account payable and accrued liabilities.............   (8,717,435)   2,272,159
                                                       -----------  -----------
CASH PROVIDED BY OPERATING ACTIVITIES................   44,467,804    1,401,326
INVESTING ACTIVITIES
 Payment for acquisition of assets managed by Floyd
  Oil Company........................................           --  (82,829,903)
 Proceeds from sales of oil and gas properties.......    5,840,574    6,230,420
 Proceeds from sales of other assets.................           --       13,363
 Acquisition of Magellan Exploration LLC, net of cash
  acquired...........................................     (417,789)          --
 Acquisition of oil and gas properties...............  (64,611,740)          --
 Development of oil and gas properties...............  (24,091,364)  (3,449,083)
 Additions of other assets...........................   (1,326,216)    (509,773)
 Payments from (advances to) stockholder.............           --      173,115
                                                       -----------  -----------
CASH USED BY INVESTING ACTIVITIES....................  (83,770,957) (80,371,861)
FINANCING ACTIVITIES
 Proceeds from long-term debt........................   66,100,000   91,036,000
 Proceeds from issuance of senior subordinated
  convertible notes..................................           --   13,223,844
 Proceeds from issuance of common stock..............   68,103,000   12,465,891
 Proceeds from exercise of stock options and
  warrants...........................................      704,893           --
 Payments on long-term debt..........................  (90,600,000)  30,990,568
 Preferred stock dividends...........................   (1,369,465)    (245,029)
 Treasury stock purchase--Alabama dissenters.........     (980,800)          --
 Redemption of Preferred Series C....................   (1,432,540)          --
 Debt, common stock and preferred stock issue and
  registration costs.................................   (2,926,591)  (1,418,246)
                                                       -----------  -----------
CASH PROVIDED BY FINANCING ACTIVITIES................   37,598,497   84,071,592
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS.....   (1,704,656)   5,101,057
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.......    6,141,153    1,040,096
                                                       -----------  -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD.............  $ 4,436,497  $ 6,141,153
                                                       ===========  ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
 Interest............................................  $ 7,539,124  $ 3,269,354
 Income Taxes........................................    3,500,000           --
Non-cash investing and financing activities:
 Common stock and warrants issued in acquisition of
  Magellan Exploration LLC...........................   10,572,935           --
 Preferred stock Series D issued in acquisition of
  Magellan Exploration LLC...........................    7,453,457           --
 Preferred Stock Series C conversions to common
  stock..............................................      362,480           --
 Preferred dividends incurred but not paid...........           --      329,051
 Common stock issued for acquisition of oil and gas
  properties from W/E LLC............................           --      875,000
 Common stock repurchase contingency accrual--Alabama
  dissenters.........................................      137,878    1,118,678
 Common stock issued in asset acquisition from Floyd
  Oil Company........................................           --    6,992,587
 Conversion of Preferred Series C into Common Stock..      910,379           --
 Preferred dividends paid in-kind....................      118,096           --
 Liability for redemption of Preferred Stock Series
  C..................................................    2,855,521           --
</TABLE>

          See accompanying notes to consolidated financial statements.


                                      F-5
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

          CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

                    YEARS ENDED DECEMBER 31, 2000 AND 1999

<TABLE>
<CAPTION>
                                        Preferred Stock
                  --------------------------------------------------------------
                       Series B             Series C               Series D         Common Stock
                  ------------------ -----------------------  ------------------ --------------------    Paid-in     Accumulated
                  Shares     Par       Shares        Par      Shares     Par       Shares      Par       Capital       Deficit
                  ------- ---------- ----------  -----------  ------- ---------- ----------  --------  ------------  ------------
<S>               <C>     <C>        <C>         <C>          <C>     <C>        <C>         <C>       <C>           <C>
Balance January
1, 1999.........  266,667  3,627,000  1,142,663    5,281,937       --         --  2,850,655    57,016    37,061,627   (23,401,707)
Preferred Series
C registration
costs...........                                     (67,711)
Common stock and
warrants issued
to W/E Energy
Company LLC.....                                                                  1,585,185    31,703    10,668,297
Common stock and
warrants issued
to related
party...........                                                                     22,222       444       149,556
Common stock and
warrants issued
to the
Prudential
Insurance Co. of
America.........                                                                    351,680     7,034     2,366,810
Common stock
issued in asset
acquisition from
Floyd Oil
Company.........                                                                    503,426    10,069     6,982,518
Stockholder
dissenters
repurchase
contingency.....
Common stock
regisgtration
costs...........                                                                                           (365,571)
Preferred Series
C conversions...                        (13,157)     (65,786)                         4,103        82        65,704
Preferred Series
C issued as
consulting fee..                         10,000       50,000
Employee stock
option plan
expense.........                                                                                            729,938
Employee stock
option
exercises.......                                                                     21,500       430       116,320
Net Loss........                                                                                                       (3,432,275)
Preferred stock
dividends.......                                                                                                         (574,080)
                  ------- ---------- ----------  -----------  ------- ---------- ----------  --------  ------------  ------------
Balance December
31, 1999........  266,667 $3,627,000  1,139,506  $ 5,198,440       --         --  5,338,771  $106,778  $ 57,775,199  $(27,408,062)
                  ======= ========== ==========  ===========  ======= ========== ==========  ========  ============  ============
Common stock
ussued in merger
with Magellan
Exploration
LLC.............                                                                  1,085,934    21,718    10,251,217
Warrants issued
in merger with
Magellan
Exploration
LLC.............                                                                                            300,000
Preferred Series
D issued in
merger with
Magellan
Exploration
LLC.............                                              617,009  7,453,457
Stockholder
dissenters
repurchase
contingency
adjustment......                                                                                                               --
Preferred Series
C conversions...                        (72,496)    (362,480)                        63,465     1,268       361,212
Common stock
issued..........                                                                  8,050,000   161,000    67,942,000
Common stock
offering and
registration
costs...........                                                                                         (1,496,651)
Preferred Series
C redemption....                     (1,067,010)  (4,835,960)                        36,527       729       547,170
Reverse split
fractional
shares..........                                                                       (314)       (6)
Employee stock
option
exercises.......                                                                     95,190     1,904       647,990
Warrant
exercises.......                                                                     18,333       367        54,632
Net Income......                                                                                                       31,664,040
Preferred stock
dividends.......                                                4,921    118,096                                       (1,487,561)
                  ------- ---------- ----------  -----------  ------- ---------- ----------  --------  ------------  ------------
Balance December
31, 2000........  266,667 $3,627,000         --  $        --  621,930 $7,571,553 14,687,906  $293,758  $136,382,775     2,768,417
                  ======= ========== ==========  ===========  ======= ========== ==========  ========  ============  ============
<CAPTION>
                   Treasury
                     Stock
                  ------------ Stockholders'
                      Par         Equity
                  ------------ --------------
<S>               <C>          <C>
Balance January
1, 1999.........      (68,040)   22,557,833
Preferred Series
C registration
costs...........                    (67,711)
Common stock and
warrants issued
to W/E Energy
Company LLC.....                 10,700,000
Common stock and
warrants issued
to related
party...........                    150,000
Common stock and
warrants issued
to the
Prudential
Insurance Co. of
America.........                  2,373,844
Common stock
issued in asset
acquisition from
Floyd Oil
Company.........                  6,992,587
Stockholder
dissenters
repurchase
contingency.....   (1,118,678)   (1,118,678)
Common stock
regisgtration
costs...........                   (365,571)
Preferred Series
C conversions...                         --
Preferred Series
C issued as
consulting fee..                     50,000
Employee stock
option plan
expense.........                    729,938
Employee stock
option
exercises.......                    116,750
Net Loss........                 (3,432,275)
Preferred stock
dividends.......                   (574,080)
                  ------------ --------------
Balance December
31, 1999........  $(1,186,718) $ 38,112,637
                  ============ ==============
Common stock
ussued in merger
with Magellan
Exploration
LLC.............                 10,272,935
Warrants issued
in merger with
Magellan
Exploration
LLC.............                    300,000
Preferred Series
D issued in
merger with
Magellan
Exploration
LLC.............                  7,453,457
Stockholder
dissenters
repurchase
contingency
adjustment......      137,878       137,878
Preferred Series
C conversions...                         --
Common stock
issued..........                 68,103,000
Common stock
offering and
registration
costs...........                 (1,496,651)
Preferred Series
C redemption....                 (4,288,061)
Reverse split
fractional
shares..........                         --
Employee stock
option
exercises.......                    649,894
Warrant
exercises.......                     54,999
Net Income......                 31,664,040
Preferred stock
dividends.......                 (1,369,465)
                  ------------ --------------
Balance December
31, 2000........   (1,048,840)  149,594,663
                  ============ ==============
</TABLE>

          See accompanying notes to consolidated financial statements

                                      F-6
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                          December 31, 2000 and 1999

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 Organization

  3TEC Energy Corporation, (formerly Middle Bay Oil Company, Inc.), was
incorporated under the laws of the state of Alabama on November 20, 1992. The
Company was reincorporated in Delaware on December 7, 1999 and changed its
name to 3TEC Energy Corporation. The reincorporation and name change were part
of a series of transactions related to a securities purchase agreement that
closed on August 27, 1999 between the Company and W/E Energy Company, LLC
("W/E LLC"), formerly known as 3TEC Energy Company, LLC, whereby the Company
received $21.4 million in cash and oil and natural gas properties for the sale
of common stock, warrants and debt securities (See Note 3).

  3TEC Energy Corporation and its subsidiaries (the "Company") are engaged in
the acquisition, development, production and exploration of oil and natural
gas in the contiguous United States. The Company considers its business to be
a single operating segment. Effective November 23, 1999, the Company acquired
oil and natural gas properties and interests managed by Floyd Oil Company
("Floyd Oil Company") from a group of private sellers. Effective February 3,
2000, the company acquired oil and natural gas properties through a merger
with Magellan Exploration, LLC. Effective May 31, 2000, the Company acquired
oil and natural gas properties from C.W. Resources, Inc. (the "CWR
Properties"). Effective November 15, 2000, the Company acquired oil and
natural gas properties from H.G. Westerman (the "HGW Properties") and a group
of private sellers.

 Significant Accounting Policies

  The Company's accounting policies reflect industry standards and conform to
generally accepted accounting principles. The more significant of such
policies are described below.

 Principles of Consolidation

  The consolidated financial statements include the accounts of the Company
and Enex Resources Corporation ("Enex") an 80% owned subsidiary. The equity of
the minority interests in Enex is shown in the consolidated financial
statements as "minority interest". All significant intercompany balances and
transactions have been eliminated in consolidation.

 Reclassifications

  Certain prior-year amounts have been reclassified to conform with current
year presentation.

 Consolidated Statements of Cash Flows

  For the purpose of cash flows, the Company considers all highly liquid
investments with a maturity date of three months or less to be cash
equivalents. Significant transactions may occur which do not directly affect
cash balances and as such will not be disclosed in the Consolidated Statements
of Cash Flows. Certain of such non-cash transactions are disclosed in the
Consolidated Statements of Shareholders' Equity relating to shares issued as
compensation, and shares issued for stock and debt of an acquired company.

                                      F-7
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


 Oil and Gas Properties

  The Company follows the successful efforts method of accounting for oil and
natural gas properties, and accordingly, capitalizes all direct costs incurred
in connection with the acquisition, drilling and development of productive oil
and natural gas properties. Costs associated with unsuccessful exploration are
charged to expense currently. Geological and geophysical costs and costs of
carrying and retaining unevaluated properties are charged to expense.
Depreciation, depletion and amortization of capitalized costs are computed
separately for each field based on the unit-of-production method using only
proved oil and natural gas reserves. In arriving at such rates, commercially
recoverable reserves have been estimated by independent petroleum engineering
firms. The Company reviews its undeveloped properties continually and charges
them to expense on a property-by-property basis when it is determined that
they have been condemned by dry holes, or have otherwise diminished in value.
The Company recorded no impairments on its undeveloped properties, principally
fee minerals and non-producing leasehold costs, for the year ended December
31, 2000 and $1.5 million during 1999. Gains and losses are recorded on sales
of interests in proved properties and on sales of entire interests in unproved
properties. For the years ended December 31, 2000 and 1999, the Company
realized gains on sales of properties of $0.8 million and $1.0 million,
respectively.

  Proved oil and natural gas reserves are the estimated quantities of oil,
natural gas and natural gas liquids which are expected to be recoverable in
future years from known reservoirs under existing economic and operating
conditions. Reservoirs are considered proved if economic productability is
supported by either actual production or conclusive formation tests.

  The Company reviews long-lived assets for impairment when events or changes
in circumstances indicate that the carrying value of such an asset may not be
recoverable. This review consists of a comparison of the carrying value of the
asset to the asset's expected future undiscounted cash flows. Estimates of
expected future cash flows represent management's best estimate based on
reasonable and supportable assumptions and projections. If the expected future
cash flows, assuming escalated prices, are less than the carrying value of the
asset, an impairment exists and is measured as the excess of the carrying
value over the estimated fair value of the asset. The Company estimates
discounted future net cash flows to determine fair value. Any impairment
provisions recognized are permanent and may not be restored in the future. For
the years ended December 31, 2000 and 1999, the Company's proved properties
were assessed for impairment on an individual field basis and the Company
recorded impairment provisions on certain producing properties of $-0- and
$1.0 million, respectively.

 Revenue Recognition of Production Imbalances

  Oil and natural gas revenues are recorded using the sales method, whereby
the Company recognizes revenues based on the amount of oil and natural gas
sold to purchasers on its behalf not withstanding its ownership percentage. At
December 31, 2000 and 1999, the Company's net imbalance position was
immaterial.

 Hedging

  In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities ("SFAS 133"). In June 1999, the FASB issued SFAS 137,
Accounting for Derivative Instruments and Hedging Activities--Deferral of the

                                      F-8
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999

Effective Date of FASB Statement No. 133. In June 2000, the FASB issued SFAS
138, Accounting for Derivative Instruments and Hedging Activities, an
amendment of FASB Statement No. 133. SFAS 133, as amended, establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair market value. The statement requires that changes in the derivative's
fair value be recognized currently in earnings unless specific hedge criteria
are met. Special accounting for qualifying hedges allows a derivative's gains
and losses to offset related results on the hedged item in the income
statement, and requires that a company must formally document, designate and
assess the effectiveness of transactions that receive hedge accounting. The
Company adopted SFAS 133 effective January 1, 2001. Based upon the historical
volatility of oil and gas commodity prices, the Company expects that SFAS 133
could increase volatility in the Company's earnings and other comprehensive
income for periods where hedging activities are present.

  SFAS 133, in part, allows hedge accounting. SFAS 133 provides that the
effective portion of the gain or loss on a loss on a derivative instrument
designated and qualifying as a cash flow hedging instrument be reported as a
component of other comprehensive income and be reclassified into earnings in
the same period during which the hedged forecasted transaction affects
earnings. The remaining gain or loss on the derivative instrument, if any,
must be recognized currently in earnings.

  As of December 31, 2000, the Company has not entered into any derivative
financial instruments or derivative commodity instruments.

 Earnings Per Share

  Basic earnings and loss per common share are based on the weighted average
shares outstanding without any dilutive effects considered. Diluted earnings
and loss per share reflect dilution from all potential common shares,
including options, warrants and convertible preferred stock and convertible
notes. Diluted loss per share does not include the effect of any potential
common shares if the effect would be to decrease the loss per share.

  For the year ended December 31, 1999, the Company had a weighted average of
1,149,476 combined stock options, warrants and convertible preferred stock and
notes outstanding, respectively, which were not included in the computation of
diluted loss per share, because the effect of the assumed exercise of these
stock options, warrants and convertible securities would have an antidilutive
effect on the computation of diluted loss per share. At December 31, 2000, the
Company had a weighted average of 3,789,456, combined stock options, warrants
and convertible preferred stock and notes outstanding, respectively. The
weighted average shares for 2000, excluding 277,331 of Preferred C shares,
were included in the computation of diluted earnings per share for the year
ending December 31, 2000.

                                      F-9
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999

  All share and per share amounts have been retroactively adjusted for a one-
for-three reverse split that was approved by the Company's shareholders on
January 14, 2000.

 Concentrations of Market Risk

  The future results of the Company will be affected by the market prices of
oil and natural gas. The availability of a ready market for oil and natural
gas in the future will depend on numerous factors beyond the control of the
Company, including weather, production of other oil and natural gas, imports,
marketing of competitive fuels, proximity and capacity of oil and natural gas
pipelines and other transportation facilities, any oversupply or undersupply
of oil and natural gas, the regulatory environment, and other regional and
political events, none of which can be predicted with certainty.

 Concentrations of Credit Risk

  Financial instruments which subject the Company to concentrations of credit
risk consist primarily of cash and accounts receivable. The Company places its
cash investments with high credit qualified financial institutions. Risk with
respect to receivables is concentrated primarily in the current production
revenue receivable from multiple oil and natural gas purchasers, and is
typical in the industry. No single customer accounted for greater than 10% of
the Company's total oil and natural gas sales for the years ended
December 31, 2000 and 1999.

 Use of Estimates

  Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities to prepare the financial
statements in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.

                                     F-10
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


(2) ACQUISITIONS

  On May 31, 2000, we completed the acquisition of the CWR Properties located
in East Texas for cash consideration of approximately $51.7 million. The
effective date of the acquisition was January 1, 2000, and the operations are
included in the Company's consolidated financial statements beginning June 1,
2000. The CWR Properties acquisition was financed under our existing credit
facility, which we amended prior to closing the acquisition. The total
purchase price was allocated principally to oil and natural gas properties
using the purchase method of accounting.

  On February 3, 2000, we completed the acquisition of Magellan Exploration
LLC (the "Magellan Acquisition"), from certain affiliates of EnCap Investments
L.L.C., a Delaware limited liability company and an investor in W/E LLC
("EnCap Investments"), and other third parties for consideration consisting of
(a) 1,085,934 shares of common stock, (b) four year warrants to purchase up to
333,333 shares of common stock at $30.00 per share, (c) 617,009 shares of 5%
Series D Convertible Preferred Stock with a redemption value of $24.00 per
share and (d) the assignment of a performance based "back-in" working interest
of 5% of Magellan's interest in 12 exploration prospects. The total purchase
price of approximately $19 million was allocated principally to proved
undeveloped oil and natural gas properties using the purchase method of
accounting.

  On November 23, 1999, the Company completed the acquisition of oil and
natural gas properties and interests, managed by Floyd Oil Company, owned by a
group of private sellers (the "Floyd Oil Acquisition") for $86.8 million in
cash and 503,426 shares of Company common stock. Prior to the acquisition,
there was no relationship between Floyd C. Wilson, President of the Company
and Floyd Oil Company. The effective date of the acquisition was January 1,
1999 and the cost was allocated using the purchase method of accounting. The
total purchase price of $90.2 million, considering post-closing adjustments
and transaction costs, was allocated principally to oil and natural gas
properties.

  The following pro forma data presents the results of the Company for the
year ended December 31, 1999, as if the Floyd Oil Acquisition and the CWR
Acquisition had occurred on January 1, 1999, and the results of the Company
for the year ended December 31, 2000 as if the CWR Acquisition had occurred on
January 1, 2000. The pro forma data assumes the acquisition of the respective
properties and the debt and equity financing transactions related to these
acquisitions. The pro forma results are presented for comparative purposes
only and are not necessarily indicative of the results which would have been
obtained had the acquisitions been consummated as presented. The pro forma
financial data does not include the financial information for Magellan, which
is not significant with respect to the operations of the Company for the
period presented (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                               Pro Forma         Pro Forma
                                              Year Ended        Year Ended
                                           December 31, 2000 December 31, 1999
                                           ----------------- -----------------
                                              (unaudited)       (unaudited)
      <S>                                  <C>               <C>
      Total revenues......................     $109,714           $66,167
      Net income attributable to common
       stockholders.......................       32,552             5,667
      Net income per basic share
       attributable to common
       stockholders.......................         3.14              0.45
</TABLE>


                                     F-11
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999

(3)  COMMON STOCK, WARRANT AND SENIOR SUBORDINATED CONVERTIBLE NOTE SALE TO
     W/E ENERGY COMPANY, L.L.C. ("W/E LLC")

  On August 27, 1999, the Company closed a Securities Purchase Agreement (the
"Agreement") for a total of $21.4 million with W/E Energy Company, LLC ("W/E
LLC"). The Securities Purchase Agreement and contemplated transactions were
approved by the stockholders at the Company's annual meeting on August 10,
1999.

  The controlling person of W/E LLC is EnCap Investments L.L.C., a Delaware
limited liability company ("EnCap Investments"). The sole member of EnCap
Investments is El Paso Field Services Company, a Delaware corporation ("El
Paso Field Services"). The controlling person of El Paso Field Services is El
Paso Corporation, a Delaware corporation. The Company received $9.8 million in
cash and properties valued at $875,000 for 1,585,185 shares of common stock
and 1,200,000 warrants (the "Warrants") and $10.7 million for a 5-year senior
subordinated convertible note with a face value of $10.7 million (See Note 6).

  W/E LLC's ownership at December 31, 2000 is approximately 11% of the current
outstanding shares of common stock.

(4) RELATED PARTY TRANSACTIONS

  David B. Miller and D. Martin Phillips, directors of the Company, are
managing directors of EnCap Investments, which is the controlling person of
W/E, LLC which owns approximately 11% of the common stock of the Company,
excluding shares attributable to the warrants and convertible notes, as of
December 31, 2000. Floyd C. Wilson, Chairman and Chief Executive Officer of
the Company, is also a member of W/E LLC. Gary R. Christopher, a shareholder
and director of the Company, is employed by Kaiser-Francis Oil Co., which owns
approximately 8% of the common stock of the Company as of December 31, 2000.

  The Company paid EnCap Investments a fee of $500,000 in connection with a
private equity shelf facility related to the CWR Properties acquisition. As
required by the Company's Credit Facility, the private equity shelf facility
would have allowed the Company to require EnCap Investments to purchase up to
$20 million of a new class of exchangeable preferred stock from the Company.
Upon completion of the Company's public offering of common stock on June 30,
2000, the shelf facility expired.

(5) LONG-TERM DEBT

  Long-term debt at December 31, 2000 and 1999, consisted of the following (in
thousands):

<TABLE>
<CAPTION>
                                                                 2000    1999
                                                                ------- -------
      <S>                                                       <C>     <C>
      $250 million Credit Facility............................. $63,000 $87,500
      Less current maturities..................................      --      --
                                                                ------- -------
      Long-term debt excluding current maturities.............. $63,000 $87,500
                                                                ======= =======
</TABLE>

  Concurrent with the Floyd Oil Acquisition, the Company entered into a $250
million credit facility (the "Facility") with Bank One, NA as agent and four
other banks. On May 31, 2000 and in connection with the CWR Acquisition, the
Facility was amended and restated to: (1) extend the maturity date of the
Facility to May 31, 2003, (2) add an additional bank, and (3) increase the
borrowing base to $125 million. As of December 31, 2000, the borrowing base
was set at $140 million. The borrowing base is to be redetermined semi-
annually on May 1 and November 1 and provides for interest as revised under
the Facility to accrue at a rate calculated at the Company's option as either
the bank's prime rate plus a low of zero to a high of 50 basis points or LIBOR
plus basis points increasing from a low of 150 to a high of 212.5 as loans
outstanding increase as a percentage of the borrowing base. As of December 31,
2000, the Company was paying an average of 8.15% per annum interest on the
principal balance of the Facility. The loan matures on May 31, 2003. Prior to
maturity, no payments of principal are required so long as the borrowing base
exceeds the loan balance. The borrowings under the Facility are secured by
substantially all of the Company's oil and natural gas properties.

                                     F-12
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


  The Facility is governed by various financial and other covenants, including
requirements to maintain a current ratio of one to (1:1), and an interest rate
coverage ratio. Additionally, limitations on asset dispositions, declaration
and payment of cash dividends and the entering into hedge transactions without
the bank's consent are included. Aggregate amounts of expected required
repayments of long term debt at December 31, 2000 are as follows (in
thousands):

<TABLE>
      <S>                                                                <C>
      2001.............................................................. $    --
      2002..............................................................      --
      2003..............................................................  63,000
      Thereafter........................................................      --
                                                                         -------
          Total......................................................... $63,000
                                                                         =======
</TABLE>

  On March 12, 2001, the Company's borrowing base under its Credit Facility
was redetermined and set at $175 million. Additionally, two new banks were
added to the bank group.

(6) SENIOR SUBORDINATED CONVERTIBLE NOTES

  On August 27, 1999, senior subordinated convertible promissory notes (the
"Senior Subordinated Notes") were sold to W/E LLC and affiliates of Alvin V.
Shoemaker ("Shoemaker"), a former director and significant shareholder, for
$10.7 million and $150,000, respectively. On October 19, 1999, $2.4 million of
Senior Subordinated Notes were sold to The Prudential Insurance Company of
America ("Prudential"). The Senior Subordinated Notes bear interest at an
annual rate of 9%. Interest is payable beginning on December 31, 1999, every
March 31, June 30, September 30 and December 31, until maturity on August 27,
2004. The Company may defer payment of fifty percent (50%) of the first eight
quarterly interest payments. The Senior Subordinated Notes may be prepaid,
without premium or penalty, in whole or in part, at any time after August 27,
2001. The holders of the Senior Subordinated Notes may convert all or any
portion of outstanding principal and accrued interest at any time into shares
of Company common stock at a conversion price of $9.00 per common share, a
total of 1,469,316 common shares. The conversion price may be adjusted from
time to time based on the occurrence of certain events. In the event of a
change in control, the entire outstanding principal balance and all accrued
but unpaid interest is immediately due and payable.

  The Senior Subordinated Notes rank senior in right of payment to all Company
notes and indebtedness other than the Facility.

(7) INCOME TAXES

  The components of income tax expense (benefit) for the years ended December
31, 2000 and 1999 consisted of the following (in thousands):

<TABLE>
<CAPTION>
                                                                 December 31,
                                                                ---------------
                                                                 2000    1999
                                                                ------- -------
      <S>                                                       <C>     <C>
      Current.................................................. $ 7,962 $    --
      Deferred.................................................   6,480  (1,443)
                                                                ------- -------
      Total.................................................... $14,442 $(1,443)
                                                                ======= =======
</TABLE>

                                     F-13
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


  The reconciliation of income tax computed at the U.S. federal statutory tax
rates to the provision for income taxes is as follows (in thousands):

<TABLE>
<CAPTION>
                                                               December 31,
                                                              ----------------
                                                               2000     1999
                                                              -------  -------
      <S>                                                     <C>      <C>
      Income tax provision (benefit) at statutory rate....... $16,137  $(1,656)
      State income taxes, net of federal benefit.............   1,364       --
      Decrease in valuation allowance........................  (2,523)    (151)
      Increase due to non-deductible stock compensation......      --      248
      Utilization of Sec. 29 tax credits.....................    (400)      --
      Other..................................................    (136)     116
                                                              -------  -------
      Total.................................................. $14,442  $(1,443)
                                                              =======  =======
</TABLE>

  The Company's net deferred tax liability at December 31, 2000 and 1999 is as
follows (in thousands):

<TABLE>
<CAPTION>
                                                                2000     1999
                                                               -------  -------
      <S>                                                      <C>      <C>
      Deferred tax liability
        Oil and natural gas properties........................ $ 9,547  $ 1,428
                                                               -------  -------
      Deferred tax asset
        NOL carryforward......................................  (5,812)  (6,643)
        AMT tax credit carryforward...........................     (36)     (36)
        Other.................................................    (495)    (547)
                                                               -------  -------
                                                                (6,343)  (7,226)
        Valuation allowance...................................   3,566    6,089
                                                               -------  -------
      Net deferred tax liability.............................. $ 6,770  $   291
                                                               =======  =======
</TABLE>

  In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred
tax asset will not be realized. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment. Based upon projections for future
taxable income over the periods in which the deferred tax assets are
deductible and the Section 382 limitation discussed below, management believes
it is more likely than not that the Company will realize the benefits of these
deductible differences, net of the existing valuation allowances at December
31, 2000 and 1999. The net change in the total valuation allowance for the
year ended December 31, 2000 was approximately $2.5 million and the amount
remaining at December 31, 2000 is $3.6 million.

  The Enex Acquisition caused an ownership change pursuant to Section 382 in
March 1998. As a result of this ownership change, the Company's use of its net
operating loss carryforwards subsequent to that date will be limited. The
Floyd Oil Acquisition in November 1999 also caused an ownership change
pursuant to Section 382. As a result of these changes, the Company's use of
its net operating loss carryforwards subsequent to that date will be limited.
In February 2000, Enex had an ownership change pursuant to Section 382 with
respect to its net operating losses.

  As of December 31, 2000, the Company had net operating loss carryforwards of
approximately $16.6 million, expiring beginning in 2009 through 2019.

                                     F-14
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


(8) RETIREMENT PLAN AND EMPLOYEE INCENTIVE PLAN

  All of the employees of the Company are eligible to participate in a defined
contribution plan that provides for maximum employee contributions of 15% of
total wages paid to employees for the year and Company contributions. Company
contributions made to the plan for the year ending December 31, 2000 was
$135,225. There was no contribution made to the plan during 1999.

  In March 1995, the Board of Directors adopted an employee incentive
compensation plan (the "Plan") for the benefit of Company employees. The Plan
benefits were equal to one percent (1%) of the annual net profit from oil and
natural gas properties acquired or discovered on or after January 1, 1994 and
one percent (1%) of the annual sales proceeds from any oil and natural gas
properties sold on or after January 1, 1994. The Compensation Committee of the
Board of Directors had sole authority regarding the amount and timing of
payment of any Plan benefits to eligible employees. On August 27, 1999, the
Company paid $274,625 to the eligible participants in the Plan and terminated
the Plan pursuant to the terms of the W/E LLC agreement. The payment was equal
to 100% of the Plan benefits through August 27, 1999. The entire amount of the
payment, including associated taxes of $17,902, was recognized during the year
ended December 31, 1999. Prior to the Compensation Committee's authorization,
the Plan benefits were not accrued as an expense in the financial statements
because the likelihood that the Compensation Committee would determine that
the benefits would be payable to eligible employees was less than probable.

(9) STOCK OPTION PLANS

  The Company's stock option plans authorize the granting of options to key
employees and non-employee directors at prices equivalent to the market value
at the date of grant. Options generally become exercisable in the following
manner: 50% upon the date of grant with the remaining 50% exercisable in three
annual installments commencing one year after the date grant and, if not
exercised, expire 10 years from the date of grant. The Company accounts for
employee stock-based compensation using the intrinsic value method and since
the exercise price of the options granted is equal to the quoted market price
of the Company's stock at the grant date, no compensation costs have been
recognized for its stock option plans. Had compensation cost for the Company's
Plans been determined based on the fair value at the grant date for stock
options granted for the year ending December 31, 1999, the Company's net
income (loss) and income (loss) per share would have been adjusted to the pro
forma amounts listed below (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                      December 31, December 31,
                                                          2000         1999
                                                      ------------ ------------
      <S>                                             <C>          <C>
      Net Income (Loss)
        As Reported..................................   $30,176      $(4,006)
        Pro Forma....................................   $21,889      $(4,110)
      Net Income (Loss) per common share, diluted
        As Reported..................................   $  2.28      $ (1.14)
        Pro Forma....................................   $  1.58      $ (1.17)
</TABLE>

  The fair value of grants was estimated on the date of grant using the Black
Scholes option pricing model with the following weighted-average assumptions
used in 2000 and 1999, respectively: risk free interest rates of 6.48% and
4.78%, expected volatility of 72% and 77%, no dividend yield, and an expected
life of the option of 3 years in 2000 and 1999. The weighted average fair
value of stock options granted in 2000 and 1999 was $5.72 and $2.40 per share,
respectively.

                                     F-15
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


  A summary of the status of the Company's plans as of December 31, 2000 and
1999, and changes during the years ended on those dates is presented below:

<TABLE>
<CAPTION>
                                                              Average Exercise
                                                    Shares    Price Per Share
                                                   ---------  ----------------
   <S>                                             <C>        <C>
   Options and warrants outstanding at January 1,
    1999..........................................   303,722       $16.71
     Granted in 1999..............................    66,667       $ 4.50
     Exercised in 1999............................   (21,500)      $ 5.43
     Forfeited in 1999............................   (12,967)      $17.40
                                                   ---------       ------
   Options and warrants outstanding at December
    31, 1999......................................   335,922       $15.00
     Granted in 2000(1)........................... 2,898,500       $11.07
     Exercised in 2000............................   (95,190)      $ 6.83
     Forfeited in 2000............................  (248,160)      $16.39
                                                   ---------       ------
   Options and warrants outstanding at December
    31, 2000...................................... 2,891,072       $11.15
   Options and warrants outstanding at December
    31, 1999......................................   335,922       $15.00

   Options and warrants exercisable at December
    31, 2000...................................... 1,442,995        11.16
   Options and warrants exercisable at December
    31, 1999......................................   335,922        15.00
   Options available for grant at December 31,
    2000..........................................   275,298
   Options available for grant at December 31,
    1999..........................................   657,300
</TABLE>
--------
(1) Includes 300,000 options granted under the Company's 2001 Stock Option
    Plan. The Company's Board of Directors has approved both the option grant
    and the 2001 Plan. The plan will be submitted for shareholder approval at
    the Company's annual meeting.

  At December 31, 2000, the range of exercise prices and weighted average
remaining contractual life of options outstanding was $4.50 to $15.19 and 9.47
years, respectively.

  On August 24, 1999, the Company amended the 1995 Plan due to the change in
control that resulted from the Agreement (See Note 3). The 1995 Plan was
amended to extend the exercise date for all options issued prior to July 1,
1999 to one year from the following dates: (1) the termination date of
employees if the termination date is without cause and occurred during the
six-month period commencing with the closing of the Agreement; (2) the date of
termination for employees terminated for "Good Reason" as defined in such
employee's employment agreement; and (3) the date of resignation of a holder
who is also a director who resigns at closing of the Agreement.

  The extension of the exercise period of the employee stock options resulted
in a new measurement date and compensation expense, equal to the intrinsic
value of all of the outstanding options, of approximately $730,000, was
recognized as stock compensation during the year ended December 31, 1999.

  Options to acquire 75,000 shares of the Company common stock at an exercise
price of $16.50 were granted outside of the 1995 Plan on February 13, 1997 to
certain officers of the Company. Warrants to acquire 25,000 shares of the
Company common stock at an exercise price of $15.00 were granted outside of
the 1995 Plan on September 15, 1998 to a consultant and were forfeited in
2000. Both grants are included in the table above.

  New warrants to purchase 1,216,822 shares and 266,226 shares of common stock
at $3.00 per share were issued on August 27, 1999 and October 19, 1999,
respectively, and warrants to purchase 333,333 shares of common stock at
$30.00 per share were issued on February 3, 2000, are excluded from the table
above because the warrants were issued in conjunction with the sales of stock
and are not stock-based compensation.

                                     F-16
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


(10) STOCKHOLDERS' EQUITY

 Preferred Stock--Series B

  In connection with the merger of Shore Oil Company, effective June 30, 1997,
the Company issued 266,667 shares of Series B Preferred Stock ("Series B").
The Series B is nonvoting and pays no dividends. The Series B has a
liquidation value of $7.50 per share. Until December 31, 2002, any holder of
the Series B may convert all or any portion of Series B shares into Company
Common Stock ("Common") at the greater ratio of (i) three shares of Series B
for one share of Common or (ii) at a ratio based upon the "Alternative
Conversion Factor." The Alternative Conversion Factor is determined by
dividing the net increase in value of approximately 40,000 net mineral acres
owned by the Company in South Louisiana by $8,000,000 and multiplying the
product by 355,333 to arrive at the potential number of total Common shares
all holders would receive upon conversion. In no event shall the aggregate
total number of shares of Common into which the Series B are converted be less
than 88,889 shares or exceed 444,444 shares, unless further increased for any
anti-dilution provisions. Upon expiration of the conversion period, unless the
Company has given notice to redeem the Series B, all of the shares of the
Series B shall be automatically converted.

  At December 31, 2000, the value of the fee minerals had increased to a level
that resulted in the Series B shares being convertible into an additional
42,426 common shares applying the Alternative Conversion Factor. At December
31, 2000, none of the Series B had been converted.

 Preferred Stock--Series C

  On August 31, 2000, the Company sent notices to the holders of its Series C
Preferred Stock (the "Series C") advising that the Series C would be redeemed
on September 30, 2000. The Series C had a redemption price of $5.00 per share
and the holders had the right to convert their Series C shares into Company
common stock at a ratio of one share of common for three shares of Series C
prior to September 30, 2000. A total of 2,101,827 shares of the Series C were
outstanding on September 30, 2000 with 1,293,521 (62%) held by the Company's
80% owned subsidiary, Enex Resources Corporation. 109,580 Series C shares were
converted to 36,527 shares of common stock and approximately 1,992,247 Series
C shares were redeemed. On a consolidated basis, the Company's liability for
the Series C redemption was approximately $4.8 million. At December 31, 2000,
$2.9 million remained to be funded. As a result of the Series C redemption,
the Company recognized a charge to dividend expense of $498,706.

 Preferred Stock--Series D

  On February 3, 2000, we completed the acquisition of Magellan Exploration
LLC (the "Magellan Acquisition"), from certain affiliates of EnCap Investments
L.L.C., a Delaware limited liability company and an investor in W/E LLC
("EnCap Investments"), and other third parties for consideration consisting of
(a) 1,085,934 shares of common stock, (b) four year warrants to purchase up to
333,333 shares of common stock at $30.00 per share, (c) 617,009 shares of 5%
Series D Convertible Preferred Stock with a redemption value of $24.00 per
share and (d) the assignment of a performance based "back-in" working interest
of 5% of Magellan's interest in 12 exploration prospects. The total purchase
price of approximately $19 million was allocated principally to proved
undeveloped oil and natural gas properties.

 Common Stock

  On June 30, 2000, the Company completed its public offering of 8.05 million
shares of the Company's common stock (prices at $9.00 per share). The net
proceeds, approximately $66.6 million, were used primarily to repay a portion
of the outstanding debt under the amended Credit Facility.

                                     F-17
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


  On January 14, 2000, the Company's stockholders voted to affect a one-for-
three reverse split of the Company's common stock for the stockholders of
record on December 9, 1999. The reverse stock split resulted in a decrease of
10,677,542 in the number of shares issued at December 31, 1999, 14,515 of
which are held in treasury. The par value of these shares was transferred to
additional paid-in capital. All common share and earnings per common share
amounts have been retroactively restated in the accompanying consolidated
financial statements to reflect the reverse stock split.

  On August 27, 1999, the Company sold to W/E LLC 1,585,185 shares of common
stock and five-year warrants to purchase 1,200,000 shares of common stock for
$9.8 million in cash and oil and natural gas properties valued at $875,000. On
the same date, the Company sold 22,222 shares of common stock and five-year
warrants to purchase 16,822 shares of common stock to Shoemaker for $150,000
(See Notes 3 and 6).

  On October 19, 1999, the Company closed a private placement of securities to
Prudential. The economic terms and conditions of the private placement are
similar to those of the securities purchase agreement with W/E LLC and
Shoemaker entered into on July 1, 1999. The private placement consisted of the
sale of 351,681 shares of common stock and five-year warrants to purchase
266,226 shares at $3.00 per share of common stock for $2.4 million and a five-
year senior subordinated convertible note for $2.4 million (See Note 6).

  The warrants issued to W/E LLC, Shoemaker and Prudential are exercisable for
$3.00 per share and expire five years from the issue date. Sixty percent of
the warrants were immediately exercisable, in whole or in part at any time
until the expiration date. An additional 10% of the warrants may be exercised
at each anniversary of the grant date until expiration. At December 31, 2000,
1,025,296 warrants were exercisable. On the occurrence of either a change of
control, payment in full of the Senior Notes or conversion of the entire
principal balance of the Senior Subordinated Notes, all of the warrants become
immediately exercisable. If less than the entire principal balance of the
Senior Subordinated Notes are converted, a pro-rata portion of the warrants
will be convertible based on the portion of the Senior Subordinated Notes that
are converted.

(11) COMMITMENTS AND CONTINGENCIES

  On November 18, 1999, the Company's shareholders approved a reincorporation
of the Company from Alabama to Delaware (See Note 1). The Alabama Code has a
shareholder dissent provision that allows a shareholder to dissent from the
reincorporation and demand cash payment equal to the fair value of the common
stock owned at the date of the reincorporation. Before the November 18
meeting, the Company received shareholder dissents representing ownership of
99,438 shares of common stock. Over the period December 15, 1999 to January
25, 2000, the Company received formal demands for payment from the dissenting
shareholders (the "dissenters"). At December 31, the Company had accrued the
estimated cash payment to the dissenters of approximately $1.1 million. The
Company made an offer to the dissenters on March 14, 2000 and the dissenters
made a counteroffer in late March. One May 26, 2000, the Company agreed to a
settlement with the dissenters for them to surrender 62,549 shares of common
stock for a total of $980,800, including interest. The settlement closed on
June 30, 2000 and the shares are held by the Company as treasury stock. A
shareholder holding 36,889 shares of common stock agreed to withdraw his
dissent.

 Commitments and Contingencies

  The Company has commitments for operating leases (primarily for office
space) in Houston, Texas. Rental expense for office space was $390,452 in 2000
and $267,337 in 1999. Future minimum lease expenses at December 31, 2000 are
$489,545 in 2001; $509,226 in 2002; $502,888 in 2003; $499,094 in 2004;
$83,056 in 2005; and $-0- in years thereafter.

                                     F-18
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


  The Company is a defendant in various legal proceedings which are considered
routine litigation incidental to the Company's business, the disposition of
which management believes will not have a material effect on the financial
position or results of operations of the Company.

(12) FINANCIAL INSTRUMENTS

  In February 2000, the Company entered into fixed swap agreements covering
2,000 barrels of oil per day for the period March through October 2000 at a
weighted average NYMEX West Texas Intermediate price of $25.96 per barrel.
During the year ended December 31, 2000, the Company's oil revenues were
reduced by the effect of the hedge by $2,131,253.

  In April 1999, the Company entered into costless collar hedges for
approximately 3,650 Mcf per day with a weighted average floor and ceiling of
$2.06 and $2.20, respectively, for the months of May through October of 1999.
During the year ending December 31, 1999, the Company incurred hedging losses
of approximately $164,000.

  At December 31, 2000, the Company had no open derivative instruments.

  Fair value of cash, receivables and payables approximates carrying value.
Fair value of long-term debt also approximates carrying value due to the
nature of the Facility, whereby the interest rates are floating rates which
reflect market rates.

  The estimated fair value of the $13.2 million senior subordinated
convertible notes was $13.1 million.

(13) SUBSEQUENT EVENTS

  On January 30, 2001, the Company acquired 100% of the issued and outstanding
stock of Classic Resources Inc. ("Classic") for cash consideration of
approximately $53.5 million. The purchase price is subject to certain post-
closing adjustments customary in transactions of this type. Classic is a
privately-held exploration and production company with properties located in
East Texas. The Company estimates these properties to have unaudited total net
proved reserves of 47 Bcfe and net daily production of 11 Mmcfe, as of January
31, 2001. The acquisition of Classic was financed under the Company's existing
Credit Facility.

  On March 12, 2001, the Company's borrowing base under its Credit Facility
was redetermined and set at $175 million. Additionally, two new banks were
added to the bank group.

                                     F-19
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


(14) SUPPLEMENTAL OIL AND NATURAL GAS INFORMATION (UNAUDITED)

 Capitalized Costs and Costs Incurred

  The following tables present the capitalized costs related to oil and
natural gas producing activities and the related depreciation, depletion,
amortization and impairment as of December 31, 2000 and 1999 and costs
incurred in oil and natural gas property acquisition, exploration and
development activities (in thousands) for the years ended December 31, 2000
and 1999.

<TABLE>
<CAPTION>
                                                              2000      1999
                                                            --------  --------
   <S>                                                      <C>       <C>
   Capitalized Costs
     Proved properties....................................  $263,801  $162,455
     Nonproducing leasehold...............................     6,477     6,385
     Accumulated depreciation, depletion, amortization and
      impairment..........................................   (54,260)  (37,861)
                                                            --------  --------
       Net capitalized costs..............................  $216,018  $130,979
                                                            ========  ========
   Costs Incurred
     Proved properties....................................  $ 79,770  $ 91,081
     Unproved properties..................................        95       343
     Exploration costs....................................       695       824
     Development costs....................................    25,346     2,154
                                                            --------  --------
       Total..............................................  $105,906  $ 94,402
                                                            ========  ========
   Depletion, depreciation, amortization and impairment...  $ 18,459  $  9,067
                                                            ========  ========
</TABLE>

 Estimated Quantities of Reserves

  The Company has interests in oil and natural gas properties that are located
principally in Texas, Louisiana, Kansas, Oklahoma and New Mexico. The Company
does not own or lease any oil and natural gas properties outside the United
States. There are no quantities of oil and natural gas subject to long-term
supply or similar agreements with any governmental agencies.

  The Company retains independent engineering firms to provide year-end
estimates of the Company's future net recoverable oil, natural gas and natural
gas liquids reserves. In 2000 and 1999, such estimates were prepared by Ryder
Scott Company. The reserve information was prepared in accordance with
guidelines established by the Securities and Exchange Commission.

  Estimated proved net recoverable reserves as shown below include only those
quantities that can be expected to be commercially recoverable at prices and
costs in effect at the balance sheet dates under existing regulatory practices
and with conventional equipment and operating methods. Proved developed
reserves represent only those reserves expected to be recovered through
existing wells. Proved undeveloped reserves include those reserves expected to
be recovered from new wells or on undrilled acreage or from existing wells on
which a relatively major expenditure is required for recompletion.

                                     F-20
<PAGE>

                   3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                          December 31, 2000 and 1999


  Net quantities of proved developed and undeveloped reserves of oil,
including condensate and natural gas liquids, for the years ended December 31,
2000 and 1999 are summarized as follows:

<TABLE>
<CAPTION>
                                                   2000              1999
                                              ----------------  ---------------
                                                Oil               Oil
                                              (MBbls)    Gas    (MBbls)   Gas
                                                (1)     (MMcf)   (1)     (MMcf)
                                              -------  -------  ------  -------
   <S>                                        <C>      <C>      <C>     <C>
   Proved Reserves
     Beginning of year.......................  9,835   159,699  3,342    43,483
     Purchases of reserves in place..........  1,981    85,437  6,866   126,557
     Extensions and discoveries..............     51     2,699     12     1,226
     Revisions of previous estimates.........    659     8,698    502    (5,136)
     Sales of reserves in place..............   (715)   (1,076)  (355)   (1,693)
     Production for the year................. (1,139)  (17,764)  (532)   (4,738)
                                              ------   -------  -----   -------
       End of year........................... 10,672   237,693  9,835   159,699
                                              ======   =======  =====   =======
   Proved Developed Reserves
     Beginning of year.......................  9,358   122,914  3,118    36,731
                                              ======   =======  =====   =======
     End of year.............................  9,895   177,252  9,358   122,914
                                              ======   =======  =====   =======
</TABLE>
--------
(1) Includes oil, condensate and plant product barrels.

 Standardized Measure of Discounted Future Net Cash Flows From Proved Reserves

  The following is a summary of the standardized measure of discounted future
net cash flows related to the Company's proved oil and natural gas reserves.
For these calculations, estimated future cash flows from estimated future
production of proved reserves are computed using oil and natural gas prices as
of the end of each period presented. Future development and production costs
attributable to the proved reserves were estimated assuming that existing
conditions would continue over the economic lives of the individual leases and
costs were not escalated for the future. Estimated future income taxes were
calculated by applying statutory tax rates (based on current law adjusted for
permanent differences and tax credits) to the estimated future pre-tax net
cash flows related to proved oil and natural gas reserves, less the tax basis
of the properties involved.

  The Company cautions against using this data to determine the value of its
oil and natural gas properties. To obtain the best estimate of the fair value
of the oil and natural gas properties, forecasts of future economic
conditions, varying discount rates, and consideration of other than proved
reserves would have to be incorporated into the calculation. In addition,
there are significant uncertainties inherent in estimating quantities of
proved reserves and in projecting rates of production that impair the
usefulness of the data.

  The standardized measure of discounted future net cash flows relating to
proved oil and natural gas reserves for the years ended December 31, 2000 and
1999 are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                            2000       1999
                                                         ----------  --------
   <S>                                                   <C>         <C>
   Future cash inflows.................................. $2,349,534  $594,023
   Future production costs and development costs........   (352,703) (223,765)
   Future income tax expenses...........................   (676,227)  (92,975)
                                                         ----------  --------
   Future net cash flows................................  1,320,604   277,283
   10% discount to reflect timing of cash flows.........   (627,930) (128,542)
                                                         ----------  --------
   Standardized measure of discounted future net cash
    flows............................................... $  692,674  $148,741
                                                         ==========  ========
</TABLE>

                                     F-21
<PAGE>

                    3TEC ENERGY CORPORATION AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

                           December 31, 2000 and 1999


  The following are the principal sources of changes in the standardized
measure of discounted future net cash flows for the years ended December 31,
2000 and 1999 (in thousands):

<TABLE>
<CAPTION>
                                                             2000      1999
                                                           --------  --------
   <S>                                                     <C>       <C>
   Sales of oil and natural gas, net of production cost... $(78,969) $(12,300)
   Net changes in prices and production cost..............  479,690    18,646
   Extensions and discoveries.............................   22,909     1,945
   Purchases of reserves..................................  749,702   150,295
   Sales of reserves......................................   (8,789)   (1,643)
   Revisions of previous quantity estimates...............   39,442    (1,994)
   Net change in income taxes.............................  304,816   (49,874)
   Accretion of discount..................................   19,843     3,889
   Changes in production rates (timing) and other......... (984,711)      883
                                                           --------  --------
   Change for year........................................ $543,933  $109,847
                                                           ========  ========
</TABLE>

  The period end prices of oil and natural gas at December 31, 2000 and 1999,
used in the above table were $25.31 and $23.64 per barrel of oil and $9.40 and
$2.23 per thousand cubic feet of natural gas, respectively.

                                      F-22