** **

** **

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-QSB**

** **
| **(Mark  One)** |
|-----------------|
| **ý**      | **QUARTERLY REPORT UNDER SECTION  13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD  ENDED SEPTEMBER 30, 2004**

** ** |
| **o**           | **TRANSITION REPORT UNDER SECTION  13 OR 15(d) OF THE EXCHANGE ACT**

** ** |
|            |   | **For the transition period from                       to                     **

**Commission file number**                                             |

 

**CANOPETROLEUM, INC.**

(Exactname of small business issuer as specified in its charter)

 

| **Delaware**                                                    | ** ** | **77-0635673**                     |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (IRS Employer Identification  No.) |

 

**TheOil & Gas Commerce Building309 West 7th Street, Suite 1600**

**FortWorth, TX 76102**

(Address ofprincipal executive offices)

 

**(817)698-0900**

(Issuer’stelephone number)

 

**NotApplicable**

(Former name,former address and former fiscal year, if changed since last report)

 

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Act during thepast 12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes ý     No o

 

**APPLICABLEONLY TO ISSUERS INVOLVED IN BANKRUPTCY**

**PROCEEDINGSDURING THE PRECEDING FIVE YEARS**

 

Check whether the registrant filed all documents andreports required to be filed by Section 12, 13 or 15(d) of the ExchangeAct after the distribution of securities under a plan confirmed by a court.  Yes o     No o

 

**APPLICABLEONLY TO CORPORATE ISSUERS**

 

State the number of shares outstanding of each of theissuer’s classes of common equity, as of the latest practicable date:  15,647,204 shares of common stock, $.0001 parvalue per share, as of November 12, 2004.

 

Transitional Small Business Disclosure Format (Checkone): Yes o    No ý

 

 

 

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**PART I - FINANCIALINFORMATION**

** **

**Item 1. Financial Statements.**

 

**CANO PETROLEUM,INC.**

**CONSOLIDATEDBALANCE SHEET**

**(Unaudited)**

 
| ** **                                                                                                                                     | ** ** | **September 30,**

**2004** | ** **    |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|---------------|
| ASSETS                                                                                                                                         |       |                        |          |
| **Current assets**                                                                                                                             |       |                        |          |
| Cash and cash equivalents                                                                                                                      |       | $                           | 135,548       |   |
| Restricted cash                                                                                                                                |       | 672,339                     |          |
| Accounts receivable                                                                                                                            |       | 727,263                     |          |
| Other current assets                                                                                                                           |       | 97,482                      |          |
| Total current assets                                                                                                                           |       | 1,632,632                   |          |
| ** **                                                                                                                                     |       |                        |          |
| **Oil and gas properties****,  successful efforts method**                                                                                     |       | 6,975,879                   |          |
| Less accumulated depletion and depreciation                                                                                                    |       | (98,799                     | )             |
| Net oil and gas properties                                                                                                                     |       | 6,877,080                   |          |
|                                                                                                                                           |       |                        |          |
| Fixed assets, net                                                                                                                              |       | 135,063                     |          |
| Investment in Ladder                                                                                                                           |       | —                      |          |
| Goodwill                                                                                                                                       |       | 101,166                     |          |
| **TOTAL ASSETS**                                                                                                                               | ** ** | **$**                       | **8,745,941** | ** ** |
|                                                                                                                                           |       |                        |          |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                     |       |                        |          |
| **Current liabilities**                                                                                                                        |       |                        |          |
| Accounts payable                                                                                                                               |       | $                           | 933,716       |   |
| Oil and gas payable                                                                                                                            |       | 156,830                     |          |
| Accrued liabilities                                                                                                                            |       | 104,419                     |          |
| Current portion of asset retirement obligations                                                                                                |       | 16,989                      |          |
| Total current liabilities                                                                                                                      |       | 1,211,954                   |          |
| **Long-term liabilities**                                                                                                                      |       |                        |          |
| Asset retirement obligations                                                                                                                   |       | 385,265                     |          |
| **Commitments and contingencies (Note 10)**                                                                                                    |       |                        |          |
| **Stockholders’ equity**                                                                                                                  |       |                        |          |
| Preferred stock                                                                                                                                |       |                        |          |
| Series A, no shares issued or outstanding                                                                                                      |       | —                      |          |
| Series B; 8,000 shares authorized and 2,000 shares issued and  outstanding (liquidation preference of $2,000,000)                              |       | 1,861,463                   |          |
| Series C; 8,000 shares authorized and 6,000 shares issued and  outstanding (liquidation preference of $6,000,000)                              |       | 5,861,423                   |          |
| Common stock, par value $.0001 per share; 50,000,000 authorized;  15,647,204 issued and outstanding, including 5,165,000 shares held in escrow |       | 1,565                       |          |
| Additional paid-in capital                                                                                                                     |       | 8,643,137                   |          |
| Accumulated deficit                                                                                                                            |       | (7,281,992                  | )             |
| Deferred compensation                                                                                                                          |       | (1,936,874                  | )             |
| Total stockholders’ equity                                                                                                                |       | 7,148,722                   |          |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                            | ** ** | **$**                       | **8,745,941** | ** ** |

 

***See accompanying notes to these unauditedfinancial statements.***

 

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**CANO PETROLEUM,INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                     | ** ** | **Three Months Ended**

**September 30,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                     | ** ** | **2003**                                  | ** ** | **2004** | ** ** |
| **Operating Revenues:**                        |       |                                      |       |   |   |
| Crude oil and natural gas sales                |       | $                                         | 843,160    |   | $ | — |   |
| Overhead revenue                               |       | 21,000                                    |       | — |   |
| Total revenue                                  |       | 864,160                                   |       | — |   |
| ** **                                     |       |                                      |       |   |   |
| **Operating Expenses:**                        |       |                                      |       |   |   |
| Lease operating expenses                       |       | 474,044                                   |       | — |   |
| General and adminstrative                      |       | 661,566                                   |       | 23,294 |   |
| Deferred compensation expense                  |       | 290,532                                   |       | — |   |
| Accretion of asset retirement obligations      |       | 5,050                                     |       | — |   |
| Depletion and depreciation                     |       | 103,454                                   |       | — |   |
| Total operating expenses                       |       | 1,534,646                                 |       | 23,294 |   |
| ** **                                     |       |                                      |       |   |   |
| **Loss from operations **                 |       | (670,486                                  | )     | (23,294 | )  |
|                                           |       |                                      |       |   |   |
| Interest income and deductions, net            |       | 4,813                                     |       | — |   |
| ** **                                     |       |                                      |       |   |   |   |   |
| **Net loss**                                   |       | $                                         | (665,673)  |   | $ | (23,294 | )  |
|                                           |       |                                      |       |   |   |
| **Net loss per share - basic and diluted**     |       | $                                         | (0.06)     |   | $ | (0.00 | )  |
|                                           |       |                                      |       |   |   |
| **Weighted average common shares outstanding** |       |                                      |       |   |   |
| Basic and diluted                              |       | 10,482,204                                |       | 6,982,204 |   |
|                                                |            |                                           |            |  |  |  |  |  |  |  |

*** ***

***See accompanying notes to theseunaudited financial statements.***

 

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**CANO PETROLEUM,INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                           | ** ** | **Three Months Ended**

**September 30,** | ** **  |
|----------------------------------------------------------------------|------------|-------------------------------------------|-------------|
| ** **                                                           | ** ** | **2004**                                  | ** **  | **2003** | ** ** |
| **Cash  flow from operating activities:**                            |       |                                      |        |   |   |
| Net loss                                                             |       | $                                         | (665,673    | ) | $ | (23,294 | ) |
| Adjustments needed to reconcile to net cash flow used in operations: |       |                                      |        |   |   |
| Accretion of asset retirement obligations                            |       | 5,050                                     |        | — |   |
| Depletion and depreciation                                           |       | 103,454                                   |        | — |   |
| Deferred compensation expense                                        |       | 290,532                                   |        | — |   |
|                                                                 |       |                                      |        |   |   |
| Changes in assets and liabilities relating to operations:            |       |                                      |        |   |   |
| Accounts receivable                                                  |       | (710,983                                  | )           | — |   |
| Accounts payable                                                     |       | 595,818                                   |        | 5,732 |   |
| Accrued liabilities                                                  |       | (12,567                                   | )           | — |   |
| Oil and gas sales payable                                            |       | 125,269                                   |        | — |   |
| Other current assets                                                 |       | (84,012                                   | )           | — |   |
|                                                                 | ** ** | ** **                                | ** **  | ** ** |   |
| **Net cash used in operations**                                      | ** ** | **(353,112**                              | **)**       | **(17,562** | **)** |
|                                                                 |       |                                      |        |   | ** ** |
| **Cash flow from investing activities:**                             |       |                                      |        |   |   |
| Additions to oil and gas properties                                  |       | (373,082                                  | )           | — |   |
| Additions to other fixed assets                                      |       | (144,251                                  | )           | — |   |
| Cash restricted for development activities                           |       | 194,000                                   |        | — |   |
| Acquisition of additional Davenport revenue interest                 |       | (525,000                                  | )           | — |   |
| Acquisition of Nowata                                                |       | (2,512,610                                | )           | — |   |
| Acquisition of Ladder                                                | ** ** | (2,111,517                                | )           | — |   |
| **Net cash used in investing activities**                            |       | **(5,472,460**                            | **)**       | — |   |
| ** **                                                           |       |                                      |        |   |   |
| **Cash flow from financing activities:**                             |       |                                      |        |   |   |
| Proceeds from issuance of preferred stock, net                       |       | 4,385,841                                 |        | — |   |
| **Net cash from financing activities**                               | ** ** | **4,385,841**                             |        | — |   |
| ** **                                                           | ** ** | ** **                                |        |   |   |
| Net decrease in cash and cash equivalents                            |       | (1,439,731                                | )           | (17,562 | )  |
|                                                                 |       |                                      |        |   |   |
| Cash and cash equivalents at beginning of period                     |       | 1,575,279                                 |        | 20,000 |   |
|                                                                 |       |                                      |        |   |   |
| **Cash and cash equivalents at end of period**                       | ** ** | **$**                                     | **135,548** |   | **$** | **2,438** |   |

 

***See accompanying notes to these unaudited financial statements***

 

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***CANO PETROLEUM, INC.***

 

**NOTESTO FINANCIAL STATEMENTS**

 

 

**1.****             ****BASIS OF PRESENTATION**

 

The interim consolidated financial statements of CanoPetroleum, Inc. are unaudited and contain all adjustments (consisting primarilyof normal recurring accruals) necessary for a fair statement of the results forthe interim periods presented.  Resultsfor interim periods are not necessarily indicative of results to be expectedfor a full year or for previously reported periods due in part to thevolatility in prices for crude oil and natural gas, the timing of acquisitions,interruption in production and the success of drilling activity.  You should read these consolidated interim financialstatements in conjunction with the audited consolidated financial statementsand notes thereto included in Cano’s Form 10-KSB dated June 30, 2004.

 

**2.****             ****PREFERRED STOCK FINANCINGS**

 

During July and August of 2004, we receivedadditional gross proceeds of $4.6 million from the sale of 4,600 shares ofSeries C Convertible Preferred Stock at a price of $1,000 per share.  Thisincreased our total gross proceeds from the issuances of preferred stock to$8.0 million (net proceeds totaled $7.7 million) as of September 30, 2004.

 

**3.****             ****ACQUISITIONS**

 

Ladder Company Oil and Gas Properties— On July 2, 2004, we acquired all of theoutstanding common stock of the Ladder Companies, Inc., a Delaware corporation,in consideration for approximately $2.2 million, net of operating income. The Ladder Companies are comprised of two companies — Ladder Energy Company, aDelaware corporation, and Tri-Flow, Inc., an Oklahoma corporation.  TheLadder Companies are engaged in oil and gas exploration and productionactivities.  The acquisition was effective on May 1, 2004, and netoperating income from that date through closing was applied to the purchaseprice.

 

Nowata Oil Properties — On September 14, 2004, we acquired oil and gasproducing leases from the Nowata Oil Properties LLC for approximately $2.5million.  The leases are located in Nowata County, Oklahoma.  Theeffective date of the purchase is September 1, 2004.

 

The Ladder and Nowata acquisitions were recorded basedon the purchase method of accounting.  The purchase price was allocated tothe acquired assets and assumed liabilities based on their fair values. The calculation of the purchase price and allocation to assets is as follows:

 

 
| ** **                             | ** ** | **Ladder** | ** ** | **Nowata** | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|
| - Net Acquisition Price                |       | $          | 2,248,542  |       | $          | 2,512,610 |   |
| - Asset Retirement Obligations         |       | 241,905    |       | 71,027     |       |
| - Assurance of Payment of Indebtedness |       | 47,975     |       | —     |       |
| - Total Purchase Price                 |       | $          | 2,538,422  |       | $          | 2,583,637 |   |
|                                   |       |       |       |       |       |
| Allocation of Purchase Price:          |       |       |       |       |       |
| - Cash                                 |       | $          | 110,075    |       | $          | — |   |
| - Accounts Receivable                  |       | 2,917      |       | —     |       |
| - Prepaid Assets                       |       | 13,470     |       | —     |       |
| - Oil & Gas Properties             |       | 2,411,960  |       | 2,583,637  |       |
|                                   |       | $          | 2,538,422  |       | $          | 2,583,637 |   |
|                                        |            |            |            |            |            |  |  |  |  |  |

 

 

The fair value assigned to the oil and gas propertiesis based on management’s valuation of the properties, which was derived in partby reference to reserve reports prepared by an independent petroleumengineering

 

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firm.  Based on the engineer’s reports and Cano’sinternal analysis, we believe the value assigned to these properties isreasonably supported.

 

***Pro Forma FinancialInformation)***

The following condensed pro forma information giveseffect to the acquisitions as if they had occurred on July 1, 2004 and2003, respectively.  The pro formainformation has been included in the Notes as required by GAAP and is providedfor comparison purposes only.  The actual results could differ.  Thepro forma financial information is not indicative of the financial results thatwould have occurred had the business combinations been effective on and as ofthe dates indicated and should not be viewed as indicative of operations in thefuture.

 

**CanoPetroleum, Inc.**

**ProForma Information**

**Forthe Three Months Ended September 30**

 

| ** **                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Operating revenues                     |       | $        | 1,393,397  |     | $          | 920,212 |   |
| Net loss                               |       | $        | (528,922   | )        | $          | (72,189 | ) |
| Net loss per share - basic and diluted |       | $        | (0.05      | )        | $          | (0.01 | ) |
|                                        |            |          |            |          |            |  |  |  |  |  |

 

 

**4.****             ****RELATED PARTYTRANSACTION**

 

On August 16, 2004, we agreed to purchase anadditional 10% revenue interest in the Davenport field from Cano EnergyCorporation (“CEC”).  This increases our revenue interest in the Davenportfield to 65%.  In consideration for the additional 10% revenue interest,we agreed to pay $667,000 cash to CEC as follows: (1) $525,000 cash uponsigning the purchase agreement; and (2) $142,000 cash on or before October 16,2004 if certain conditions were met.  The$525,000 payment was paid in August 2004, and the remaining amount was paid inOctober 2004.  Our CEO, S. JeffreyJohnson, is a principal shareholder of Cano Energy Corporation.

 

On July 21, 2004, we agreed to purchase the furniture,fixtures, and office equipment of CEC for approximately $114,000.  The amount paid was based on third partyvaluation.  The purchase of these fixedassets was contemplated as part of the merger as discussed in Cano’s Form10-KSB dated June 30, 2004.

 

**5.****             ****RESTRICTED CASH**

 

As discussed in Cano’s Form 10-KSB dated June 30,2004, pursuant to the terms of the Merger Agreement, funds totaling $866,339were placed in escrow and were dedicated to improvements and drilling in theDavenport field.  We commenced the drilling activities in the Davenportfield during September 2004, which will be funded by this escrowedamount.  At September 30, 2004, the escrow balance was $672,339. Thisescrow balance is considered restricted and is stated as “Restricted Cash” inthe Consolidated Balance Sheet.

 

**6.****             ****ASSET RETIREMENTOBLIGATION**

 

Our financial statements reflect the provisions ofStatement of Financial Accounting Standards No. 143,*Accounting for Asset Retirement Obligations*.  Ourasset retirement obligation (“ARO”) primarily represents the estimated presentvalue of the amount we will incur to plug, abandon and remediate our producingproperties at the end of their productive lives, in accordance with applicablestate laws.  We determine our ARO by calculating the present value of estimatedcash flows related to the liability.  At September 30, 2004, ourliability for ARO was $402,254, of which $385,265 is considered longterm.  We recognized accretion expense of $5,050.

 

The following tabledescribes the changes in our asset retirement obligations during the threemonths ended September 30:

 

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| ** **                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Asset retirement obligation July 1, 2004    |       | $        | 84,272     |     | $          | — |   |
| Liabilities incurred during the period:     |       |     |       |     |       |
| Acquistion of Ladder Energy Company         |       | 241,905  |       | —   |       |
| Acquisition of Nowata Properties            |       | 71,027   |       | —   |       |
| Accretion expense                           |       | 5,050    |       | —   |       |
| Asset retirement obligation at September 30 |       | $        | 402,254    |     | $          | — |   |
|                                             |            |          |            |          |            |  |  |  |  |

 

Our asset retirementobligations are recorded as current or non-current liabilities based on theestimated timing of the anticipated cash flows.

 

**7.****             ****DEFERRED COMPENSATION**

 

As discussed in Cano’s Form 10-KSB dated June 30,2004, pursuant to the terms of the Merger Agreement, eight individuals (sevenof who are now employed by Cano and one who is a member of the board ofdirectors) were issued 5,165,000 shares of common stock.  These shares were placed in escrow.  Theshares will vest to the individuals based on a combination of continued employment(“compensation shares”) and achieving certain performance goals during the nexttwo years (“performance shares”).  The compensation shares amounted to2,659,975 shares and the performance shares amounted to 2,505,025 shares. Any shares that are not released from escrow will be returned to TreasuryStock.  At the merger date, we recognized $2,324,250 of “DeferredCompensation” and “Additional Paid-in Capital” in the Consolidated BalanceSheet.  The shares were recorded based on the quoted market price at thetime of the transaction.  At September 30, 2004, the balance ofDeferred Compensation is $1,936,874, net of amortization expense.

 

**8.****             ****NETLOSS PER COMMON SHARE**

 

Basic net income (loss) per common share is computedby dividing the net income attributable to common shareholders by the weightedaverage number of shares of common stock outstanding during the period. Diluted net income (loss) per common share is computed in the same manner, butalso considers the effect of the convertible preferred stock.  The convertible preferred stock is notconsidered for the three months ended September 30, 2004 as its effect would beanti-dilutive.

 

The weighted average shares used in the basic loss percommon share computations for September 30, 2004 and 2003 were 10,482,204shares and 6,982,204 shares, respectively.  The shares at September 30,2004 exclude 5,165,000 contingently issuable shares as discussed in Note 7.

 

**9.****             ****SUBSEQUENT EVENT**

 

During October 2004, we received additional grossproceeds of $750,000 from the sale of 750 shares of Series C ConvertiblePreferred Stock.  This increased ourtotal gross proceeds from the issuance of preferred stock to $8.75 million.

 

**10.****      ****COMMITMENTS ANDCONTINGENCIES**

 

***Litigation***

Occasionally, we are involved in various lawsuits andcertain governmental proceedings arising in the ordinary course ofbusiness.  Our management and legal counsel do not believe that theultimate resolution of such matters, will have a material effect on ourfinancial position or results of operations, although an unfavorable outcome couldhave a material adverse effect on the operations of a given interim period oryear.

 

***Other***

To date, our expenditures to comply with environmentalor safety regulations have not been significant and are not expected to besignificant in the future. However, new regulations, enforcement policies,claims for damages or other events could result in significant future costs.

 

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**Item2.  Management’s Discussion and Analysisor Plan of Operation.**

 

**Forward-Looking Statements**

 

The information in this report on Form 10-QSB containsforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. This Act provides a “safe harbor” forforward-looking statements to encourage companies to provide prospectiveinformation about themselves so long as they identify these statements asforward looking and provide meaningful cautionary statements identifyingimportant factors that could cause actual results to differ from the projectedresults. All statements other than statements of historical fact made in thisreport are forward looking. In particular, the statements herein regardingindustry prospects and future results of operations or financial position areforward-looking statements. Forward-looking statements reflect management’scurrent expectations and are inherently uncertain. Our actual results maydiffer significantly from management’s expectations as a result of manyfactors, including, but not limited to, the volatility in prices for crude oiland natural gas, the timing of acquisitions, interruption in production and thesuccess of drilling operations and secondary recovery efforts.

 

The following discussion and analysis should be readin conjunction with the consolidated financial statements of Cano Petroleum,Inc. and subsidiaries and notes thereto, included herewith. This discussionshould not be construed to imply that the results discussed herein willnecessarily continue into the future, or that any conclusion reached herein willnecessarily be indicative of actual operating results in the future. Suchdiscussion represents only the best present assessment of management.

 

**Plan of Operation**

 

***Overall Strategy***

 

We are a growing independent oil and gas companyengaged in acquisition and development of mature fields with established oiland gas reserves that have declined to marginal production levels, yet stillpossess significant remaining upside exploitation potential.  We haveincreased production and reserves on the properties that we own and intend tocontinue to increase production and reserves on those properties, as well asnew acquisitions, through drilling new wells and implementing other developmentprograms, such as well workovers and secondary recovery operations.  Additionally,we review existing operations to determine if actions can be taken to increaseefficiency and reduce operating costs.  Our focus on mature fields reducesthe risk of drilling dry holes.

 

We believe significant opportunities exist to acquiremature fields that have upside potential. The major energy companies arefocusing their attention and resources toward the discovery and development oflarge fields.  In addition, the major companies have larger internaloverhead costs that prevent them from fully developing production fromexisting, mature fields.  Also, the recent economics of the oil and gasmarket have improved as prices have risen substantially. These factorscontribute to provide ample opportunities for smaller independent companies topurchase mature U.S. fields that have been vacated by major energy companies.We expect that there will be increased competition for such properties in thefuture.

 

We will continue to target potential acquisitioncandidates in a disciplined manner.  By adhering to our disciplinedapproach, we plan to prevent overpaying for acquisition and developmentopportunities.

 

Our competitive advantage is our in-house expertiseand low internal overhead.  We employ independent engineers and geologiststo aid in evaluating the economic merits of drilling plans and potentialacquisitions.  We believe that the incremental cost of hiring independentengineering firms justifies the expense because they provide a check andbalance on our acquisition and development plans.  Further, employingthird party experts on a case-by-case basis enables us to maintain lowoperating expenses and adhere to our commitment to keep fixed costs low.

 

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**Liquidity and Capital Resources**

 

We intend to financefuture acquisitions of oil and gas properties, drilling programs, and extensivefield development activities with a combination of issuances of equity,obtaining bank loans, and cash flow from operations.

 

***Financing and InvestingActivities***

 

As discussed in Note 2, as of September 30, 2004, wehave received gross proceeds totaling $8.0 million from the issuance ofpreferred stock, of which $4.6 million was received during the currentquarter.  These proceeds were our primarysource to fund the Davenport Merger, as discussed in our Form 10-KSB dated June30, 2004, and the following acquisitions completed during the current quarter:

 

•                  Acquisition of the Nowata Oil Properties LLC for $2.5 million (Note 3).

•                  Acquisition of the Ladder Companies, Inc. for $2.2million (Note 3).  For operationalpurposes, we refer to Ladder as the Rich Valley field.

•                  Purchase of an additional 10% revenue interest in the Davenport fieldfor $0.5 million (Note 4).

 

Based on reserve reports prepared by independentpetroleum engineers dated July 1, 2004, our total reserves are summarized asfollows:

 
|                                                    | **Davenport** | ** ** | **Ladder**  | ** ** | **Nowata**  | ** ** | **Total**

**Reserves** | ** ** |
|---------------------------------------------------------|---------------|------------|-------------|------------|-------------|------------|-------------------------|------------|
| **Proved:**                                             |          |       |        |       |        |       |                    |       |
| Oil - barrel (“bbl”)                          | 213,245       |       | 231,807     |       | 995,753     |       | 1,440,805               |       |
| Gas — thousand cubic feet (“mcf”)        | —        |       | 2,341,858   |       | —      |       | 2,341,858               |       |
| **Proved Barrels of Equivalent (“BOE”)  Oil** | **213,245**   | ** ** | **622,117** | ** ** | **995,753** | ** ** | **1,831,115**           | ** ** |
|                                                    |          |       |        |       |        |       |                    |       |
| **Proved Producing (BOE)**                              | **12,608**    | ** ** | **468,556** | ** ** | **995,753** | ** ** | **1,476,917**           |       |

 

Banks typically lend to oil and gas companies based onthe value of the proved producing reserves, defined as reserves that can beexpected to be recovered from existing wells with existing equipment andoperating methods.  During the fourth quarter of 2004, we intend to seek abank loan secured by our proved producing reserves to provide a source of cashto fund our operating activities and acquisitions.

 

During October 2004, we received additional grossproceeds of $750,000 from the sale of 750 shares of Series C ConvertiblePreferred Stock.  This increased ourtotal gross proceeds from the issuance of preferred stock to $8.75million.  For future consideration, wewill continue to consider issuances of equity as a potential option to providecash to fund our operating activities and acquisitions.

 

***Operating Activities***

 

For the quarter ended September 30, 2004, net cashused in operating activities was $0.4 million. Factors that could contribute to increases in our future cash flow fromoperating activities include the following:

 

•                  Because the Nowata acquisition was effective on September1, 2004, our quarterly results include only one month of Nowata operatingresults.  We expect the Nowataproperties, based on current production and prices, to generate cash flow of$150,000 to $200,000 monthly.

•                  The current quarter includes the effect of additionalcosts for operational improvements at the Rich Valley and Davenportfields.  Those operational improvementsare aimed at an improvement in the 

 

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infrastructure and increasing volumes produced.  We expect to see increased revenue from thesetwo fields in future months.

•                  In the Davenport field, we have drilled two wells andare currently evaluating the results.  Ifthe results are favorable we can expect to see increased revenue.

 

These potential increases in operating cash flowscould be offset, in part, by increased general and administrative expenses tosupport our expanding operations. Potential increases could also be offset as a result of the volatilityof the price we receive for the oil and gas produced by us.

 

**Results of Operations**

 

For the three months ended September 30, 2004, we hada net loss of $665,673, or $0.06 per share.

 

***OperatingRevenues***

 

For the current quarter, our total operating revenueswere $864,160.  The average quarterlyprice we received for sales of crude oil and natural gas production wereapproximately $44.30 per bbl and $5.90 per mcf, respectively.  Our sales of crude oil and natural gastotaled approximately 13,100 bbls and 43,600 mcf, respectively.  Because we generate revenues from the sale ofoil and natural gas we produce from our reserves, our results of operations aredirectly impacted by the price that we can receive for the oil and gasproduced.

 

We expect operating revenues to increase due to the actionswe are undertaking as previously discussed under “Liquidity and CapitalResources - Operating Activities.”

 

***Operating Expenses***

 

For the current quarter, our total operating expenseswere $1,534,646.  Our operating expensesconsist primarily of lease operating expenses, general and administrative,depletion and depreciation, and deferred compensation expense, as discussed inNote 7.

 

During the current quarter, our lease operatingexpenses included expenditures for operational improvements made at Davenportand Rich Valley that we anticipate will contribute toward increased operatingrevenue in future months.  We willcontinue to evaluate potential operational improvements for all three fields.

 

Our general and administrative expenses consist ofsupport services for our operating activities, along with investor relationcosts of approximately $213,000.

 

**Off Balance Sheet Arrangements**

 

We do not have any off balance sheet arrangements asof September 30, 2004 or as of the date of this report.

 

**Item 3.  Controls and Procedures.**

 

As of the end of theperiod covered by this report, we conducted an evaluation, under thesupervision and with the participation of our chief executive officer and chieffinancial officer of our disclosure controls and procedures (as defined in Rule13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation,our chief executive officer and chief financial officer concluded that ourdisclosure controls and procedures are effective to ensure that information requiredto be disclosed by us in the reports that we file or submit under the ExchangeAct is recorded, processed, summarized and reported, within the time periodsspecified in the Commission’s rules and forms.  There was no significantchange our internal controls or in other factors that could significantlyaffect these controls subsequent to the date of the evaluation.

 

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**PARTII — OTHER INFORMATION**

 

**Item1.  Legal Proceedings.**

 

We are not currently aparty to, nor is any of our property currently the subject of, any pendinglegal proceeding.  None of our directors, officers or affiliates isinvolved in a proceeding adverse to our business or has a material interestadverse to our business.

 

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

During July andAugust of 2004, we received gross proceeds of $4.6 million from the saleof 4,600 shares of Series C Convertible Preferred Stock at a price of $1,000per share.  This sale of preferred stock was exempt from registrationrequirements pursuant to Section 4(2) of the Securities Act of 1933, asamended (the “Securities Act”), and/or Regulation D, promulgated pursuant tothe Securities Act.

 

**Item3.  Defaults Upon Senior Securities.**

 

                Therehas been no material default in the payment of principal, interest, a sinkingor purchase fund installment, or any other material default not cured within 30days, with respect to any indebtedness exceeding five percent of our totalassets.  There also is no materialarrearage in the payment of dividends or any other material delinquency notcured within 30 days, with respect to any class of preferred stock which isregistered or which ranks prior to any class of our registered securities, orwith respect to any class of preferred stock of any significant subsidiary.

 

**Item4.  Submission of Matters to a Vote ofSecurity Holders.**

                Therewere no matters submitted to a vote of security holders during the periodcovered by this report.

 

**Item5.  Other Informtion.**

                None.

 

**Item6.  Exhibits.**

 

References to “theCompany” in the following exhibit list mean Cano Petroleum, Inc., a Delawarecorporation.

 
| **Exhibit Number** | ** ** |  

**Description**                                                                                                                                                                                                                                                                                                                                                              |
|--------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                |       | Agreement  and Plan of Merger made as of the 26th day of May 2004, by and among Huron Ventures,  Inc. Davenport Acquisition Corp., Davenport Field Unit Inc., the shareholders  of Davenport Field Unit Inc., Cano Energy Corporation and Big Sky Management  Ltd. (Incorporated by reference to Form 8-K, filed with the Securities and  Exchange Commission on June 8, 2004). |
| 2.2                |       | Management  Stock Pool Agreement (Incorporated by reference to Form 8-K/A, filed with the  Securities and Exchange Commission on August 11, 2004).                                                                                                                                                                                                                                   |
| 2.3                |       | Investment  Escrow Agreement (Incorporated by reference to Form 8-K/A, filed with the  Securities and Exchange Commission on August 11, 2004).                                                                                                                                                                                                                                       |
| 2.4                |       | Stock  Purchase Agreement dated June 30, 2004, by and between Petroleum, Inc.,  as Buyer, and Jerry D. Downey and Karen S. Downey, as Sellers (Incorporated  by reference to Form 8-K, filed with the Securities and Exchange Commission  on July 15, 2004).                                                                                                               |
| 3.1                |       | Certificate  of Incorporation (Incorporated by reference to the Company’s registration  statement on Form 10-SB (File No. 000-50386), filed with the Securities and  Exchange Commission on September 4, 2003).                                                                                                                                                                 |
| 3.2                |       | Certificate of Ownership, amending the  Company’s Certificate of Incorporation (Incorporated by reference to the  Company’s annual report on Form 10-KSB for the fiscal year ended June 30,  2004, filed with the Securities and Exchange Commission on September 23,  2004).                                                                                              |
| 3.3                |       | Bylaws (Incorporated by reference  to the Company’s registration statement on Form 10-SB (File No. 000-50386),  filed with the Securities and Exchange Commission on September 4, 2003).                                                                                                                                                                                        |
| 4.1                |       | Certificate  of Designation for Series B Convertible Preferred Stock (Incorporated by  reference to Form 8-K, filed with the Securities and Exchange Commission on  June 8, 2004).                                                                                                                                                                                              |

 

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| 4.2  |   | Certificate  of Designation for Series C Convertible Preferred Stock (Incorporated by  reference to Form 8-K, filed with the Securities and Exchange Commission on  July 15, 2004).                                                                   |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1 |   | Employment Agreement of S. Jeff Johnson (Incorporated  by reference to Form 8-K/A, filed with the Securities and Exchange Commission  on August 11, 2004).                                                                                                 |
| 10.2 |   | Employment  Agreement of Michael Ricketts (Incorporated by reference to Form  8-K/A, filed with the Securities and Exchange Commission on August 11, 2004).                                                                                                |
| 10.3 |   | Employment  Agreement of Tom Cochrane (Incorporated by reference to Form 8-K/A, filed  with the Securities and Exchange Commission on August 11, 2004).                                                                                                    |
| 10.4 |   | Purchase and Sale Agreement, dated August 16, 2004, by and between Cano Energy Corporation and Cano Petroleum, Inc. (Incorporated by reference to Form 8-K, filed with the Securities and Exchange Commission on August 25, 2004).                         |
| 31.1 |   | Certification by Chief  Executive Officer, required by Rule 13a-14(a) or Rule 15d-14(a) of the  Exchange Act, promulgated pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                                      |
| 31.2 |   | Certification by Chief  Financial Officer, required by Rule 13a-14(a) or Rule 15d-14(a) of the  Exchange Act, promulgated pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                                      |
| 32.1 |   | Certification by Chief  Executive Officer, required by Rule 13a-14(b) or Rule 15d-14(b) of the  Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States  Code, promulgated pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2 |   | Certification by Chief  Financial Officer, required by Rule 13a-14(b) or Rule 15d-14(b) of the  Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States  Code, promulgated pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

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** **

**SIGNATURES**

 

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
|   | **CANO PETROLEUM, INC.** |
|--------|--------------------------|
|   |                     |   |
|   |                     |   |
| Dated: | November 15, 2004        | By: | /s/ S. Jeffrey Johnson |
|   |                     | S. Jeffrey Johnson |
|   |                     | Chief Executive Officer |
|   |                     |
|   |                     |   |
| Dated: | November 15, 2004        | By: | /s/ Michael J. Ricketts |
|   |                     | Michael J. Ricketts |
|   |                     | Chief Financial Officer  and

Principal Accounting  Officer |

 

 

 

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