**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-QSB/A**

 

**(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**                                                                                                                                                |

 
| **CANO  PETROLEUM, INC.**                                                           |
|-------------------------------------------------------------------------------------|
| (Exact name of small  business issuer as specified in its charter)                  |
|                                                                                |
| **Delaware**                                                                        | ** ** | **77-0635673** |
| (State or other  jurisdiction of incorporation or  organization)                    |   | (IRS Employer  Identification No.) |
|                                                                                |
| **The Oil  & Gas Commerce Building**                                            |
| **309 West  7th Street, Suite 1600**                                                |
| **Fort  Worth, TX 76102**                                                           |
| (Address of principal  executive offices)                                           |
|                                                                                |
| **(817)  698-0900**                                                                 |
| (Issuer’s telephone  number)                                                   |
|                                                                                |
| **Not  Applicable**                                                                 |
| (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 acourt.  Yes o    No o

 

**APPLICABLEONLY TO CORPORATE ISSUERS**

 

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

 

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

 

 

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**EXPLANATORY NOTE**

 

**This amended report for thequarterly period ended September 30, 2004 on Form 10-QSB/A is being filed tocorrectly****accountfor the beneficial conversion feature of certain issuances of the Company’sSeries C Preferred Stock.  On the datesof certain issuances of the Company’s Series C Preferred Stock, the quotedmarket price of the Company’s common stock was higher than the conversion priceof the Series C Preferred Stock of $3.75 per share, resulting in a beneficialconversion feature. Previously, the Company had not recognized the value of thebeneficial conversion feature as a discount to preferred stock and a charge toearnings available to common stockholders analogous to a preferred dividend.Accordingly, the Company has restated its balance sheet and statement ofoperations for the three-month period ended September 30, 2004.  Restatement of the three-month period ended September 30,2004 resulted in a $336,534 increase in accumulated deficit with acorresponding increase in additional paid-in capital. Because the Series CPreferred Stock is convertible into common stock on the date of issuance, thediscount is immediately recognized as a charge to accumulated deficit, and therefore,there was no impact to Series C Preferred Stock on the balance sheet as of September 30,2004.  There was no impact to thestatement of cash flows.  This isdiscussed in Note 2 to the financial statements.**

 

**The table below outlines the line item adjustments related to therestatement of the three month period ended September 30, 2004.**

 

| ** **                            | ** ** | **Three Months Ended   September 30, 2004** | ** ** |
|---------------------------------------|------------|--------------------------------------------------|------------|
| ** **                            | ** ** | **As Restated**                                  | ** ** | **As Previously  Reported** | ** ** |
| Additional paid-in capital            |       | $                                                | 8,979,671  |   | $ | 8,643,137 |   |
| Accumulated deficit                   |       | (7,618,526                                       | )          | (7,281,992 | ) |
| Net loss applicable to  common shares |       | (1,002,207                                       | )          | (665,673 | ) |
| Basic and diluted loss per  share     |       | $                                                | (0.10      | ) | $ | (0.06 | ) |

 

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**PART I -FINANCIAL INFORMATION**

 

**Item 1.****FinancialStatements.**

 

**CANOPETROLEUM, 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                                                                                                                      |       | 8,979,671                    |       |
| Accumulated deficit                                                                                                                             |       | (7,618,526                   | )          |
| Deferred compensation                                                                                                                           |       | (1,936,874                   | )          |
| Total stockholders’ equity                                                                                                                 |       | 7,148,722                    |       |
| **TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                            |       | $                            | 8,745,941  |   |

 

***See accompanyingnotes to these unaudited financial statements.***

 

1

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**CANOPETROLEUM, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                      | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| **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 administrative                      |       | 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 | ) |
|                                            |       |                                       |       |   |   |
| Preferred stock discount                        |       | 336,534                                    |       | — |   |
|                                            |       |                                       |       |   |   |
| **Loss applicable to common stock**             |       | $                                          | (1,002,207 | ) | $ | (23,294 | ) |
|                                            |       |                                       |       |   |   |
| **Net loss per share - basic and  diluted**     |       | $                                          | (0.10      | ) | $ | (0.00 | ) |
|                                            |       |                                       |       |   |   |
| **Weighted average common shares  outstanding** |       |                                       |       |   |   |
| Basic and diluted                               |       | 10,482,204                                 |       | 6,982,204 |   |

 

***See accompanyingnotes to these unaudited financial statements.***

 

2

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**CANOPETROLEUM, 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 |   |
|                                                                  |       |                                        |       |   |   |
| Supplemental disclosure of  noncash transactions:                     |       |                                        |       |   |   |
| Preferred stock discount                                              |       | $                                           | 336,534    |   | — |   |

 

***See accompanyingnotes to these unaudited financial statements***

 

3

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***CANO PETROLEUM, INC.***

 

**NOTES TOFINANCIAL STATEMENTS**

 

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

 

The interim consolidated financial statements of Cano Petroleum, Inc.are unaudited and contain all adjustments (consisting primarily of normalrecurring accruals) necessary for a fair statement of the results for theinterim periods presented.  Results for interim periods are notnecessarily indicative of results to be expected for a full year or for previouslyreported periods due in part to the volatility in prices for crude oil andnatural gas, the timing of acquisitions, interruption in production and thesuccess of drilling activity.  You should read these consolidated interimfinancial statements in conjunction with the audited consolidated financialstatements and notes thereto included in Cano’s Form 10-KSB dated June 30,2004.

 

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

 

During July and August of 2004, we received additional grossproceeds of $4.6 million from the sale of 4,600 shares of Series C ConvertiblePreferred Stock at a price of $1,000 per share.  This increased our totalgross proceeds from the issuances of preferred stock to $8.0 million (netproceeds totaled $7.7 million) as of September 30, 2004.

 

On the dates of certain issuances of our Series C Preferred Stock, thequoted market price of our common stock was higher than the conversion price ofour Series C Preferred Stock of $3.75 per share, resulting in a beneficialconversion feature.  We have recognized the value of the beneficialconversion feature as a discount to preferred stock and a charge to lossapplicable to common stockholders analogous to a preferred dividend.  Becausethe Series C Preferred Stock is convertible into common stock on the date of issuance,the discount is immediately recognized as a charge to accumulated deficit, andtherefore, there was no impact to Series C Preferred Stock on the balance sheetas of September 30, 2004.  Theamount of the beneficial conversion feature was $336,534.  There was no impact to the statement of cashflows.

 

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

 

Ladder Company Oil and Gas Properties — On July 2, 2004, we acquired all ofthe outstanding common stock of the Ladder Companies, Inc., a Delawarecorporation, in consideration for approximately $2.2 million, net of operatingincome.  The Ladder Companies are comprised of two companies — LadderEnergy Company, a Delaware corporation, and Tri-Flow, Inc., anOklahoma corporation.  The Ladder Companies are engaged in oil and gasexploration and production activities.  The acquisition was effective onMay 1, 2004, and net operating income from that date through closing wasapplied to the purchase price.

 

Nowata Oil Properties — On September 14, 2004, we acquired oil and gas producing leasesfrom the Nowata Oil Properties LLC for approximately $2.5 million.  Theleases are located in Nowata County, Oklahoma.  The effective date of thepurchase is September 1, 2004.

 

The Ladder and Nowata acquisitions were recorded based on the purchasemethod of accounting.  The purchase price was allocated to the acquiredassets and assumed liabilities based on their fair values.  Thecalculation of the purchase price and allocation to assets is as follows:

 

4

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| ** **                                  | ** ** | **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 properties is based onmanagement’s valuation of the properties, which was derived in part byreference to reserve reports prepared by an independent petroleum engineeringfirm.  Based on the engineer’s reports and Cano’s internal analysis, webelieve the value assigned to these properties is reasonably supported.

 

***Pro Forma Financial Information***

The following condensed pro forma information gives effect to theacquisitions as if they had occurred on July 1, 2004 and 2003,respectively.  The pro forma information has been included in the Notes asrequired by GAAP and is provided for comparison purposes only.  The actualresults could differ.  The pro forma financial information is notindicative of the financial results that would have occurred had the businesscombinations been effective on and as of the dates indicated and should not beviewed as indicative of operations in the future.

 

**CanoPetroleum, Inc.**

**Pro FormaInformation**

**For theThree Months Ended September 30**

 
| ** **                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Operating revenues                          |       | $        | 1,393,397  |     | $          | 920,212 |   |
| Net loss applicable to  common stockholders |       | $        | (865,456   | )        | $          | (72,189 | ) |
| Net loss per share -basic  and diluted      |       | $        | (0.08      | )        | $          | (0.01 | ) |

 

**4.****             ****RELATED PARTY TRANSACTION**

 

On August 16, 2004, we agreed to purchase an additional 10%revenue interest in the Davenport field from Cano Energy Corporation (“CEC”). This increases our revenue interest in the Davenport field to 65%.  Inconsideration for the additional 10% revenue interest, we agreed to pay$667,000 cash to CEC as follows: (1) $525,000 cash upon signing the purchaseagreement; and (2) $142,000 cash on or before October 16, 2004 if certainconditions were met.  The $525,000 payment was paid in August 2004,and the remaining amount was paid in October 2004.  Our CEO, S.Jeffrey Johnson, 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 paidwas based on third party valuation.  The purchase of these fixed assetswas contemplated as part of the merger as discussed in Cano’s Form 10-KSB datedJune 30, 2004.

 

5

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

 

As discussed in Cano’s Form 10-KSB dated June 30, 2004, pursuantto the terms of the Merger Agreement, funds totaling $866,339 were placed inescrow and were dedicated to improvements and drilling in the Davenportfield.  We commenced the drilling activities in the Davenport field duringSeptember 2004, which will be funded by this escrowed amount.  At September 30,2004, the escrow balance was $672,339. This escrow balance is consideredrestricted and is stated as “Restricted Cash” in the Consolidated BalanceSheet.

 

**6.****             ****ASSET RETIREMENT OBLIGATION**

 

Our financial statements reflect the provisions of Statement ofFinancial Accounting Standards No. 143,*Accounting for Asset Retirement Obligations*.  Our assetretirement obligation (“ARO”) primarily represents the estimated present valueof the amount we will incur to plug, abandon and remediate our producing propertiesat the end of their productive lives, in accordance with applicable statelaws.  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 table describes the changes in our asset retirementobligations during the three months ended September 30:

 

| ** **                                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Asset retirement  obligation July 1, 2004    |       | $        | 84,272     |     | $          | — |   |
| Liabilities incurred  during the period:          |       |     |       |     |       |
| Acquisition 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 retirement obligations are recorded as current or non-currentliabilities based on the estimated timing of the anticipated cash flows.

 

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

 

As discussed in Cano’s Form 10-KSB dated June 30, 2004, pursuantto the terms of the Merger Agreement, eight individuals (seven of who are nowemployed by Cano and one who is a member of the board of directors) were issued5,165,000 shares of common stock.  These shares were placed inescrow.  The shares will vest to the individuals based on a combination ofcontinued employment (“compensation shares”) and achieving certain performancegoals during the next two years (“performance shares”).  The compensationshares amounted to 2,659,975 shares and the performance shares amounted to2,505,025 shares.  Any shares that are not released from escrow will bereturned to Treasury Stock.  At the merger date, we recognized $2,324,250of “Deferred Compensation” and “Additional Paid-in Capital” in the ConsolidatedBalance Sheet.  The shares were recorded based on the quoted market priceat the time of the transaction.  At September 30, 2004, the balanceof Deferred Compensation is $1,936,874, net of amortization expense.

 

**8.****             ****NET LOSS PER COMMON SHARE**

 

Basic net income (loss) per common share is computed by dividing thenet income (loss) attributable to common shareholders by the weighted averagenumber of shares of common stock outstanding during the period.  Dilutednet income (loss) per common share is computed in the same manner, but alsoconsiders the effect of the convertible preferred stock.  The convertiblepreferred stock is not considered for the three months ended September 30,2004 as its effect would be anti-dilutive.

 

6

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The weighted average shares used in the basic loss per common sharecomputations for September 30, 2004 and 2003 were 10,482,204 shares and6,982,204 shares, respectively.  The shares at September 30, 2004exclude 5,165,000 contingently issuable shares as discussed in Note 7.

 

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

 

During October 2004, we received additional gross proceeds of$750,000 from the sale of 750 shares of Series C Convertible PreferredStock.  This increased our total gross proceeds from the issuance ofpreferred stock to $8.75 million. On the date of this issuance of our Series CConvertible Preferred Stock, the quoted market price of our common stock washigher than the conversion price of our Series C Preferred Stock of $3.75 pershare, resulting in a beneficial conversion feature amounting to approximately$80,000.

 

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

 

***Litigation***

Occasionally, we are involved in various lawsuits and certaingovernmental proceedings arising in the ordinary course of business.  Ourmanagement and legal counsel do not believe that the ultimate resolution ofsuch matters, will have a material effect on our financial position or resultsof operations, although an unfavorable outcome could have a material adverseeffect on the operations of a given interim period or year.

 

***Other***

To date, our expenditures to comply with environmental or safetyregulations have not been significant and are not expected to be significant inthe future. However, new regulations, enforcement policies, claims for damagesor other events could result in significant future costs.

 

**Item 2.****  Management’sDiscussion and Analysis or Plan of Operation.**

 

**Forward-Looking Statements**

 

The information in this report on Form 10-QSB/A 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 identifythese statements as forward looking and provide meaningful cautionarystatements identifying important factors that could cause actual results todiffer from the projected results. All statements other than statements ofhistorical fact made in this report are forward looking. In particular, thestatements herein regarding industry prospects and future results of operationsor financial position are forward-looking statements. Forward-lookingstatements reflect management’s current expectations and are inherentlyuncertain. Our actual results may differ significantly from management’sexpectations as a result of many factors, including, but not limited to, thevolatility in prices for crude oil and natural gas, the timing of acquisitions,interruption in production and the success of drilling operations and secondaryrecovery efforts.

 

The following discussion and analysis should be read in conjunctionwith the consolidated financial statements of Cano Petroleum, Inc. andsubsidiaries and notes thereto, included herewith. This discussion should notbe construed to imply that the results discussed herein will necessarilycontinue 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.

 

7

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**Plan of Operation**

 

***Overall Strategy***

 

We are a growing independent oil and gas company engaged in acquisitionand development of mature fields with established oil and gas reserves thathave declined to marginal production levels, yet still possess significantremaining upside exploitation potential.  We have increased production andreserves on the properties that we own and intend to continue to increaseproduction and reserves on those properties, as well as new acquisitions,through drilling new wells and implementing other development programs, such aswell workovers and secondary recovery operations.  Additionally, we reviewexisting operations to determine if actions can be taken to increase efficiencyand reduce operating costs.  Our focus on mature fields reduces the riskof drilling dry holes.

 

We believe significant opportunities exist to acquire mature fieldsthat have upside potential. The major energy companies are focusing theirattention and resources toward the discovery and development of largefields.  In addition, the major companies have larger internal overheadcosts that prevent them from fully developing production from existing, maturefields.  Also, the recent economics of the oil and gas market haveimproved as prices have risen substantially. These factors contribute toprovide ample opportunities for smaller independent companies to purchasemature U.S. fields that have been vacated by major energy companies. We expectthat there will be increased competition for such properties in the future.

 

We will continue to target potential acquisition candidates in adisciplined manner.  By adhering to our disciplined approach, we plan toprevent overpaying for acquisition and development opportunities.

 

Our competitive advantage is our in-house expertise and low internaloverhead.  We employ independent engineers and geologists to aid inevaluating the economic merits of drilling plans and potential acquisitions. We believe that the incremental cost of hiring independent engineering firmsjustifies the expense because they provide a check and balance on ouracquisition and development plans.  Further, employing third party expertson a case-by-case basis enables us to maintain low operating expenses andadhere to our commitment to keep fixed costs low.

 

**Liquidity and Capital Resources**

 

We intend to finance future acquisitions of oil and gas properties,drilling programs, and extensive field development activities with acombination of issuances of equity, obtaining bank loans, and cash flow fromoperations.

 

***Financing and Investing Activities***

 

As discussed in Note 2, as of September 30, 2004, we have receivedgross proceeds totaling $8.0 million from the issuance of preferred stock, ofwhich $4.6 million was received during the current quarter.  Theseproceeds were our primary source to fund the Davenport Merger, as discussed inour Form 10-KSB dated June 30, 2004, and the following acquisitionscompleted during the current quarter:

 

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

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

•                  Purchase of an additional 10% revenueinterest in the Davenport field for $0.5 million (Note 4).

 

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Based on reserve reports prepared by independent petroleum engineersdated July 1, 2004, our total reserves are summarized as follows:

 
| ** **                                              | ** ** | **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 on the value of theproved producing reserves, defined as reserves that can be expected to berecovered from existing wells with existing equipment and operatingmethods.  During the fourth quarter of 2004, we intend to seek a bank loansecured by our proved producing reserves to provide a source of cash to fundour operating activities and acquisitions.

 

During October 2004, we received additional gross proceeds of$750,000 from the sale of 750 shares of Series C Convertible PreferredStock.  This increased our total gross proceeds from the issuance ofpreferred stock to $8.75 million.  For future consideration, we willcontinue to consider issuances of equity as a potential option to provide cashto fund our operating activities and acquisitions.

 

***Operating Activities***

 

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

 

•                  Because the Nowata acquisition was effectiveon September 1, 2004, our quarterly results include only one month ofNowata operating results.  We expect the Nowata properties, based oncurrent production and prices, to generate cash flow of $150,000 to $200,000monthly.

•                  The current quarter includes the effect ofadditional costs for operational improvements at the Rich Valley and Davenportfields.  Those operational improvements are aimed at an improvement in theinfrastructure and increasing volumes produced.  We expect to seeincreased revenue from these two fields in future months.

•                  In the Davenport field, we have drilled twowells and are currently evaluating the results.  If the results arefavorable 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 beoffset as a result of the volatility of the price we receive for the oil andgas produced by us.

 

**Results of Operations**

 

For the three months ended September 30, 2004, we had a lossapplicable to common stock of $1,002,207, or $0.10 per share.

 

***OperatingRevenues***

 

For the current quarter, our total operating revenues were$864,160.  The average quarterly price we received for sales of crude oiland natural gas production were approximately $44.30 per bbl and $5.90 per mcf,respectively.  Our sales of crude oil and natural gas totaledapproximately 13,100 bbls and 43,600 mcf, respectively.  Because wegenerate revenues from the sale of oil and natural gas we

 

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produce from our reserves, our results of operations are directly impacted bythe price that we can receive for the oil and gas produced.

 

We expect operating revenues to increase due to the actions we areundertaking as previously discussed under “Liquidity and Capital Resources -Operating Activities.”

 

***Operating Expenses***

 

For the current quarter, our total operating expenses were$1,534,646.  Our operating expenses consist primarily of lease operatingexpenses, general and administrative, depletion and depreciation, and deferredcompensation expense, as discussed in Note 7.

 

During the current quarter, our lease operating expenses includedexpenditures for operational improvements made at Davenport and Rich Valleythat we anticipate will contribute toward increased operating revenue in futuremonths.  We will continue to evaluate potential operational improvementsfor all three fields.

 

Our general and administrative expenses consist of support services forour operating activities, along with investor relation costs of approximately$213,000.

 

**Off Balance Sheet Arrangements**

 

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

 

**Item 3.****  Controlsand Procedures.**

 

As of the end of the period covered by this report, we conducted anevaluation, under the supervision and with the participation of our chiefexecutive officer and chief financial officer of our disclosure controls andprocedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the ExchangeAct). Based upon this evaluation, our chief executive officer and chieffinancial officer concluded that our disclosure controls and procedures areeffective to ensure that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported, within the time periods specified in the Commission’srules and forms.  There was no change in our internal controls or in otherfactors that could affect these controls during our last fiscal quarter thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**PART II —OTHER INFORMATION**

 

**Item 1.****  LegalProceedings.**

 

We are not currently a party to, nor is any ofour property currently the subject of, any pending legal proceeding.  Noneof our directors, officers or affiliates is involved in a proceeding adverse toour business or has a material interest adverse to our business.

 

**Item 2.****  UnregisteredSales of Equity Securities and Use of Proceeds.**

 

During July and August of 2004, we received gross proceeds of$4.6 million from the sale of 4,600 shares of Series C Convertible PreferredStock at a price of $1,000 per share.  This sale of preferred stock wasexempt from registration requirements pursuant to Section 4(2) of theSecurities Act of 1933, as amended (the “Securities Act”), and/or Regulation D,promulgated pursuant to the Securities Act.

 

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**Item 3.****  Defaults Upon Senior Securities.**

 

There has been no material default in the payment of principal,interest, a sinking or purchase fund installment, or any other material defaultnot cured within 30 days, with respect to any indebtedness exceeding fivepercent of our total assets.  There also is no material arrearage in thepayment of dividends or any other material delinquency not cured within 30days, with respect to any class of preferred stock which is registered or whichranks prior to any class of our registered securities, or with respect to anyclass of preferred stock of any significant subsidiary.

 

**Item 4.****  Submissionof Matters to a Vote of Security Holders.**

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

 

**Item 5.****  OtherInformation.**

None.

 

 **Item 6.****  Exhibits.**

 

References to “the Company” in the following exhibit list mean CanoPetroleum, Inc., a Delaware corporation.

 
| **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).                                                                                                                                                                                               |
| 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                                                                                                                                                                                                                                                                                                |

 

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|   |   | 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:    February 22,  2005 | By:                      | /s/ S. Jeffrey Johnson |
|                                                  |                     | S. Jeffrey Johnson |
|                                                  |                     | Chief Executive Officer |
|                                                  |                     |
|                                                  |                     |   |
| Dated:    February 22,  2005 | By:                      | /s/ Michael J. Ricketts |
|                                                  |                     | Michael J. Ricketts |
|                                                  |                     | Chief Financial Officer and  Principal Accounting Officer |

 

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