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UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10QSB

(Mark One)

[X] Quarterly report under Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended March, 31, 2007

[   ] Transition report under Section 13 or 15(d) of
the Securities Exchange Act of 1934

For the transition period from ____________ to
______________

Commission file number 333-72230

TERAX ENERGY, INC.(Name of Small Business Issuer in Its Charter)

|Nevada                   | 88-0475757                       
|------------------------ | ---------------------------------
|(State of Incorporation) | (IRS Employer Identification No.)

13355 Noel Road 1370 One Galleria TowerDallas, TX 75240(Address of Principal Executive
Offices)

(972) 503-0900(Issuer's Telephone Number)

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

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

Indicate by check mark whether the registrant is a shell Terax
(as defined in Rule 12b-2 of the Exchange Act).Yes [   ] No [X]

As of May 15, 2007, Terax had 3,685,256 shares of its par value
  $0.001 common stock issued and outstanding.

Transitional Small Business Disclosure Format (check one):
Yes [   ] No [X]

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Quarterly Report on Form 10-QSB for theQuarterly Period
Ending March 31, 2007

Table of Contents

|PART I.FINANCIAL INFORMATION | 3      
|---------------------------- | -------
|                             |        
|                             | Item 1.
|                             |        
|                             |        
|                             |        
|                             |        
|                             |        
|                             |        
|                             |        
|                             |        
|                             |        
|                             | Item 2.
|                             |        
|                             | Item 3.
|                             |        
|PART II.OTHER INFORMATION    | 18     
|                             |        
|                             | Item 1.
|                             |        
|                             | Item 2.
|                             |        
|                             | Item 3.
|                             |        
|                             | Item 4.
|                             |        
|                             | Item 5.
|                             |        
|                             | Item 6.
|                             |        
|Signatures                   | 23     

1

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Terax Energy, Inc. Consolidated Balance
Sheet(Unaudited)

|                                                                               |   | March 31,  |   |   | June 30,    |  
|------------------------------------------------------------------------------ | - | ---------- | - | - | ----------- | -
|                                                                               |   | 2007       |   |   | 2006        |  
|                                                                               |   |            |   |   |             |  
|ASSETS                                                                         |   |            |   |   |             |  
|                                                                               |   |            |   |   |             |  
|Current assets:                                                                |   |            |   |   |             |  
|Cash                                                                           | $ | 10,647     |   | $ | 779,872     |  
|Prepaid expenses, and
      advances to operators                              |   | 3,576      |   |   | 559,669     |  
|Total current assets                                                           |   | 14,223     |   |   | 1,339,541   |  
|                                                                               |   |            |   |   |             |  
|Property, Plant and Equipment:                                                 |   |            |   |   |             |  
|Oil and natural gas
      properties, successful efforts method of accounting: |   |            |   |   |             |  
|Proved properties, net of accumulated
      depletion and impairment           |   | 724,220    |   |   | 718,967     |  
|Unproved properties not
      being amortized, net of impairment               |   | 9,843,838  |   |   | 9,591,386   |  
|Pipeline and gathering system, net of
      accumulated depreciation           |   | 5,386,277  |   |   | 5,767,339   |  
|Furniture and
      equipment, net of accumulated depreciation                 |   | 73,199     |   |   | 128,083     |  
|Total property, plant and
      equipment                                      |   | 16,027,534 |   |   | 16,205,775  |  
|                                                                               |   |            |   |   |             |  
|Other assets                                                                   |   | 12,471     |   |   | 12,471      |  
|Total
      assets                                                             | $ | 16,054,228 |   | $ | 17,557,787  |  
|                                                                               |   |            |   |   |             |  
|LIABILITIES AND STOCKHOLDERS' EQUITY
      (DEFICIT)                           |   |            |   |   |             |  
|                                                                               |   |            |   |   |             |  
|Current liabilities:                                                           |   |            |   |   |             |  
|Accounts payable and accrued expense                                           | $ | 6,065,311  |   | $ | 5,144,658   |  
|Accrued liabilities                                                            |   | 1,010,821  |   |   | 436,586     |  
|Short term debt                                                                |   | 2,600,000  |   |   | 2,500,000   |  
|Derivative liability                                                           |   | 47,299     |   |   | 16,458,719  |  
|Total current liabilities                                                      |   | 9,723,431  |   |   | 24,539,963  |  
|                                                                               |   |            |   |   |             |  
|Asset retirement obligation                                                    |   | 24,539     |   |   | 24,399      |  
|                                                                               |   |            |   |   |             |  
|Stockholders' equity (deficit):                                                |   |            |   |   |             |  
|Preferred stock, $0.001
      par value, 250,000                               |   | -          |   |   | -           |  
|shares authorized,
      zero shares issued and outstanding                    |   |            |   |   |             |  
|Common stock, $0.001
      par value, 15,000,000                               |   | 3,067      |   |   | 3,029       |  
|shares authorized,
      3,066,583 and 3,028,951 shares                        |   |            |   |   |             |  
|issued and outstanding at March 31, 2007 and June 30, 2006                     |   |            |   |   |             |  
|Additional paid-in capital                                                     |   | 16,151,009 |   |   | 16,098,052  |  
|Accumulated deficit                                                            |   | (9,847,818 | ) |   | (23,107,656 | )
|                                                                               |   |            |   |   |             |  
|Total
      stockholders' equity (deficit)                                     |   | 6,306,258  |   |   | (7,006,575  | )
|                                                                               |   |            |   |   |             |  
|Total liabilities and
      stockholders' equity (deficit)                     | $ | 16,054,228 |   | $ | 17,557,787  |  

See accompanying notes to the consolidated financial
statements.

2

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Terax Energy, Inc. Consolidated Statements of Operations
(Unaudited)

|                                              |   | Three-Months Ended |   |   | Nine-Months Ended |  
|--------------------------------------------- | - | ------------------ | - | - | ----------------- | -
|                                              |   | March
      31,    |   |   | March
      31,   |  
|                                              |   | 2007               |   |   | 2006              |  
|                                              |   |                    |   |   |                   |  
|Revenue                                       | $ | -                  |   | $ | -                 |  
|                                              |   |                    |   |   |                   |  
|Expenses:                                     |   |                    |   |   |                   |  
|Depreciation and depletion
      expense      |   | 151,131            |   |   | 7,475             |  
|Impairment
      of oil and gas properties    |   | -                  |   |   | -                 |  
|General and administrative
      expenses     |   | 244,437            |   |   | 832,228           |  
|Total
      expenses                          |   | 395,568            |   |   | 839,703           |  
|                                              |   |                    |   |   |                   |  
|Net operating (loss)                          |   | (395,568           | ) |   | (839,703          | )
|                                              |   |                    |   |   |                   |  
|Other income (expense):                       |   |                    |   |   |                   |  
|Dividend income                               |   | -                  |   |   | 43,902            |  
|Interest
      (expense)                      |   | (99,645            | ) |   | (460,702          | )
|Gain (loss) on derivative
      liability     |   | 37,522             |   |   | (18,535,627       | )
|Other                                         |   | -                  |   |   | (243              | )
|Other income
      (expense)                  |   | (62,123            | ) |   | (18,952,670       | )
|                                              |   |                    |   |   |                   |  
|Net income (loss)                             | $ | (457,691           | ) | $ | (19,792,373       | )
|                                              |   |                    |   |   |                   |  
|Basic and diluted net income (loss) per share | $ | (0.15              | ) | $ | (6.98             | )
|                                              |   |                    |   |   |                   |  
|Weighted average number of                    |   |                    |   |   |                   |  
|common shares
      outstanding               |   |                    |   |   |                   |  
|basic and diluted                             |   | 3,061,081          |   |   | 2,837,047         |  

See accompanying notes to the consolidated financial
statements.

3

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Terax Energy, Inc. Consolidated Statements of Cash
Flows(Unaudited)

|                                                                      |   | For the Nine-Months Ended |  
|--------------------------------------------------------------------- | - | ------------------------- | -
|                                                                      |   | March
      31,           |  
|                                                                      |   | 2007                      |  
|Cash flows from operating activities:                                 |   |                           |  
|Net income (loss)                                                     | $ | 13,259,834                |  
|Adjustments to reconcile net loss :                                   |   |                           |  
|Shares issued for compensation                                        |   | 52,995                    |  
|Shares issued for
      interest expense                              |   | -                         |  
|Asset retirement obligations                                          |   | 2,319                     |  
|Depreciation, depletion
      and amortization                        |   | 513,963                   |  
|Impairment of oil and gas properties                                  |   | 998,911                   |  
|Write off of fixed
      assets                                       |   | 4,753                     |  
|Unrealized (gain) loss on derivative
      liability                  |   | (16,411,419               | )
|Changes in current assets and liabilities:                            |   |                           |  
|Increase and decrease in
      prepaid expenses and operator advances |   | 556,093                   |  
|Increase
      in accounts payable                                    |   | 45,393                    |  
|Increase in accrued liabilities                                       |   | 571,953                   |  
|Decrease
      in deposits                                            |   | -                         |  
|Net cash used in operating activities                                 |   | (405,205                  | )
|                                                                      |   |                           |  
|Cash flows from investing activities                                  |   |                           |  
|Purchases
      of oil and gas leases                                 |   | (252,451                  | )
|Investments in drilling and
      equipment                           |   | (160,265                  | )
|Investments
      in pipeline and gathering system                    |   | (70,534                   | )
|Investments in furniture
      and fixtures                           |   | -                         |  
|Disposition
      of equipment and automobile                         |   | 19,230                    |  
|Net cash used in investing activities                                 |   | (464,020                  | )
|                                                                      |   |                           |  
|Cash flows from financing activities                                  |   |                           |  
|Proceeds
      from notes payable                                     |   | 100,000                   |  
|Payments on notes payable                                             |   | -                         |  
|Issuance
      of common stock, net of offering cost                  |   | -                         |  
|Net cash provided by financing activities                             |   | 100,000                   |  
|                                                                      |   |                           |  
|Net (decrease) increase in cash                                       |   | (769,225                  | )
|Cash  beginning of period                                            |   | 779,872                   |  
|Cash  ending of period                                               | $ | 10,647                    |  
|                                                                      |   |                           |  
|Supplemental disclosures:                                             |   |                           |  
|Interest
      paid                                                   | $ | -                         |  
|Income taxes paid                                                     | $ | -                         |  
|Non-cash transactions:                                                |   |                           |  

4

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Terax Energy, Inc.

Notes to Unaudited Interim Consolidated Financial
Statements

Note 1 - Basis of Presentation

The
consolidated interim financial statements included herein are presented in
accordance with United States generally accepted accounting principles, and have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Notes to the financial statements which would substantially
duplicate the disclosure contained in the audited financial statements for the
period ended June 30, 2006 as reported in Form 10-KSB have been omitted.

These
statements reflect all adjustments, consisting of normal recurring adjustments
which, in the opinion of management, are necessary for fair presentation of the
information contained therein. It is suggested that these consolidated interim
financial statements be read in conjunction with the financial statements of
Terax for the period ended June 30, 2006 and notes thereto included in Teraxs
Form 10-KSB.

Note 2  Going Concern

Terax's
financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and settlement of liabilities and
commitments in the normal course of business for the foreseeable future. Since
inception, Terax has accumulated losses aggregating to $9,847,818, negative
working capital of $9,709,208 and has insufficient working capital to meet
operating needs for the next twelve months as of March 31, 2007, all of which
raise substantial doubt about Terax's ability to continue as a going concern.

Terax
has numerous litigation related matters, see Note 6 for details, which also
raise significant doubt about Teraxs ability to continue as a going concern.

Management's
plans for Terax's continued existence include selling additional stock, the sale
of assets, or borrowing additional funds to pay current accounts payable,
short-term debt, and overhead expenses. In addition, Terax will need to raise
additional capital for development of its properties or enter into joint
ventures with other operators in order to execute its business plan.

Teraxs
future success is dependent upon its ability to achieve profitable operations,
generate cash from operating activities, and obtain additional financing. There
is no assurance that Terax will be able to generate sufficient cash from
operations, sell additional shares of common stock, or borrow additional funds.

Terax's
inability to obtain additional cash could have a material adverse effect on its
financial position, results of operations, and its ability to continue in
existence. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.

Note 3  Stockholders Equity

Reverse stock split

On
January 29, 2007, a 1 to 20 (one to twenty) reverse split of Teraxs common
shares was implemented which resulted in 3,066,583 outstanding common shares at
February 20, 2007. The total authorized common and preferred shares were also
adjusted which resulted in authorized shares of 15,000,000 and 250,000,
respectively.All outstanding warrants were also adjusted on a 1
to 20 (one to twenty) ratio and the strike price was increased 20 (twenty) times
the original strike price. All share and per share information has been
retroactively restated in the consolidated financial statements to reflect the
reverse stock split.

5

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Sale of Securities

On
February 7, 2006, Terax entered into a series of securities purchase agreements
to sell units consisting of common stock and warrants to four institutional
investors for the sale of an aggregate of 640,280 shares of Teraxs common stock
and warrants to purchase an additional 640,280 shares of common stock, for an
aggregate purchase price of $16,007,000. The unit purchase price of the common
stock and corresponding warrant was $1.25 per unit. The warrants are exercisable
at an exercise price of $1.50 per share and expire on February 6, 2011. Terax
has the right to require exercise of all of the warrants in the event that (i) a
registration statement registering the resale of the warrants is then in effect
and (ii) the volume weighted average trading price per share of Teraxs common
stock for each of the previous thirty trading days is in excess of $2.50 per
share.

With
respect to the February 7, 2006 private placement, Terax also entered into
registration rights agreements with the investors to register the resale of the
shares of common stock sold in the offering and issuable upon exercise of the
warrants. Subject to the terms of the registration rights agreement, Terax is
required to file the registration statement with the Securities and Exchange
Commission within 30 days of the closing, to use its best efforts to cause the
Registration Statement to be declared effective under the Securities Act of 1933
(the Act) within 60 days following the closing date of the offering, or 120
days following the closing of the offering if the registration statement is
reviewed by the Securities and Exchange Commission. In the event the
registration statement is not filed or declared effective when due, Terax is
obligated to pay the investors liquidated damages in the amount of 1.5% of the
purchase price for each month in which Terax is in default.

Terax
is accounting for the warrants associated with the sale of its common stock in
the February 7, 2006 private placement in accordance with SFAS 133 Accounting
for Derivative instruments and Hedging Activities and EITF 00-19 Accounting
for Derivative Financial Instruments Indexed to and Potentially Settled in a
Teraxs Own Stock. The accounting treatment of these derivative financial
instruments requires that Terax record the derivatives at their fair values as
of the date of the sale of the common stock and at fair value as of each
subsequent balance sheet date as a liability.

At
March 31, 2007 the fair value of the warrants was determined utilizing the Black
Scholes valuation model. The fair value of the warrants at March 31, 2007 was
$47,299. The significant assumptions used in the valuation were: the exercise
price as noted above; Teraxs common stock price on March 31, 2007, which was
$.26 per share; expected volatility of 84.42%; risk free interest rate of
approximately 4.5%, and a term of three years and ten months. The resulting
unrealized change in fair value of $16,411,419 from June 30, 2006 to March 31,
2007 was recorded in the statement of operations as a gain on derivative
liability resulting in a net gain on derivative liability for the period of
$16,411,419.

Securities Issued for Compensation

On
September 21, 2006, Terax issued 625 shares of common stock to a former Director
as compensation. The share price of the stock on September 21, 2006, was $0.51
per share and therefore $6,375 was recorded in equity and general and
administrative expenses.

Note 4  Oil and Gas Properties

Impairment of Oil and Gas Properties

The
long-lived assets of the Company, which are subject to evaluation, consist
primarily of oil and gas properties. During the nine months ended March 31,
2007, the Company recorded an impairment loss of $998,911 on proved producing
oil and gas properties.

6

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Asset Retirement Obligations

Terax
follows the provisions of Financial Accounting Standards Board Statement No.
143, Accounting for Asset Retirement Obligations (SFAS No. 143). This accounting
standard requires entities to record the fair value of a liability for an asset
retirement obligation in the period in which it is incurred. When the liability
is initially recorded, the entity capitalizes a cost by increasing the carrying
amount of the related long-lived asset. Over time, the liability is accreted to
its present value each period, and the capitalized cost is depreciated over the
useful life of the related asset. Upon settlement of the liability, an entity
either settles the obligation for its recorded amount or incurs a gain or loss
upon settlement.

Following
is a reconciliation of the asset retirement obligation liability as of March 31,
2007:

Asset retirement obligation at June 30,
      2006
    $
    24,399Liabilities incurred
    
    -Liabilities settled
    
    -Accretion expense
    
    140Asset retirement obligation at March 31,
      2007
    $
    24,539


Note 5  Note Payable

On
May 12, 2006, Terax issued a promissory note in the principal amount of
$2,500,000 to an investor. The note bears interest at the rate of 12.5% per
annum, payable on repayment of the Note. The Note is due on demand after
December 31, 2006. In addition, interest in the amount of $125,000 is due and
payable in 71,429 shares of Teraxs common stock at closing. The note is secured
by a security interest in all of Teraxs oil and gas leases and pipeline right
of ways and easements in Erath County, Texas, as well as well and pipeline
equipment and personal property, contracts and agreements, and production from
Teraxs wells located on the leases. In the Event of Default, the holder of the
note has the right but not the obligation to seek remedies for repayment of the
notes including but not limited to foreclosure and sale of the secured assets.
During the nine months ended March 31, 2007, Terax has accrued $255,069 in
interest. The total interest accrued to date is $297,021. On January 19, 2007,
Terax received a notice of default and a demand letter from the lender seeking
repayment in full on the outstanding note. See managements plans to address
this and other liquidity issues discussed in Note 2 above.

On
January 23, 2007, the Company issued a demand note in the principal amount of
$500,000 (the Note) to Century Capital Management, Ltd., which is controlled
by Andrew Hromyk, a director of Terax Energy, Inc. The initial advance under the
agreement was $100,000. The Note bears interest at prime rate plus three percent
(3%) per annum, payable on repayment of the Note. The Note is due on demand by
the lender. The Note is secured by a security interest in all of the Companys
oil and gas leases and pipeline right of ways and easements in Comanche County,
Texas. In the Event of Default, the holder of the Note has the right, but not
the obligation, to seek remedies for repayment of the Note including but not
limited to foreclosure and sale of the secured assets. As of March 31, 2007,
approximately $2,111 in interest has been accrued and unpaid.

Note 6  Other Obligations

Registration Obligation

Subject
to the terms of the registration rights agreement, Terax was required to file
the registration statement with the Securities and Exchange Commission within 30
days of the closing, to use its best efforts to cause the Registration Statement
to be declared effective under the Securities Act of 1933 (the Act) within 60
days following the closing date of the offering, or 120 days following the
closing of the offering if the registration statement is reviewed by the
Securities and Exchange Commission. In the event the registration statement is
not filed or declared effective when due, Terax is obligated to pay the
investors liquidated damages in the amount of 1.5% of the purchase price for
each month in which Terax is in default.

7

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The
date the registration needed to become effective with the Securities and
Exchange Commission to avoid any registration penalty was June 7, 2006. However,
Terax did not get the registration effective with the Securities and Exchange
Commission until August 14, 2006. As a result Terax has incurred a total
registration penalty of $536,783 which has been accrued as of March 31, 2007.

Litigation

On
July 20, 2006, an action was commenced in the District Court of Erath County,
Texas, against Terax by Centex Pipeline Construction, Inc. for failure to pay
for services performed, breach of contract and to foreclose on Centexs mechanic
lien. The Complaint alleges that Terax and Centex entered into an agreement to
install certain components of a gas pipeline gathering system on Teraxs
Mitchell Ranch property in Erath County, Texas. The Complaint further alleges
that Centex completed work on June 5, 2006 and that Terax has failed to pay
certain outstanding invoices. Centex has filed a mechanics lien to create a
security interest against the gathering line and compressor station. Centex is
seeking damages in the amount of $510,319 plus interest, attorney fees and entry
of an Order of Sale directing the sale by public auction of the property covered
by Centexs mechanic lien.

On
December 13, 2006, Centex obtained a judgment against Terax which provided that
any payments to Centex were to be made to Centex and the bank which has an
interest in Centexs receivable from Terax. Provided Terax can get the funds,
its our plan is to seek a settlement with Centex and its bank.

On
August 28, 2006, an action was commenced in the District Court of Travis County,
Texas, against Terax, Andrew Hromyk and Starr County Energy, Inc. by Sam Warren
and Tennessee Eastern Oil & Gas, Inc. for damages for breach of a personal
services contract with the Plaintiffs, or in the alternative, based upon the
doctrine of quantum merit, for value of services which Plaintiffs allegedly
rendered to Defendants. The complaint alleges that in early 2006, Tennessee
Eastern and Starr County entered into an agreement to purchase certain oil and
gas properties located in Tennessee, which agreement was terminated. The
complaint alleges that Hromyk continued discussions with Plaintiff Warren and
indicated that a lawsuit filed against Terax by William Rhea was impeding the
potential sale of the Tennessee property, at which point, Warren offered to
assist with settling the William Rhea lawsuit. The complaint further alleged
that Plaintiffs negotiated and mediated a settlement of the William Rhea lawsuit
and that after the lawsuit was settled, the Defendants breached their agreement
to purchase the Tennessee property for $5.7 million. The Plaintiffs are seeking
a judgment against the Defendants in the amount of $5.7 million and attorneys
fees and expenses and costs of court.

On
November 10, 2006, the Plaintiff and the Defendants met for negotiations and
reached a settlement agreement subject to documentation. Terax will agree to pay
$50,000 for settlement of all claims against Terax. To date the settlement has
not been finalized and no payments have been made to the Plaintiff.

On
September 22, 2006, an action was commenced in the District Court of Erath
County, Texas, by Geosite, Inc. against Terax and Bill Chester for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $10,930 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Geosite lawsuit in a timely manner but plans to reach a settlement with Geosite
in the near future provided funds are available.

On
October 3, 2006, an action was commenced in the District Court of Erath County,
Texas, by Digital Mud Logging, LLC against Terax for breach of contract and
foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$11,200 allegedly owed to the Plaintiff, interest, and attorneys fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the Digital Mud
Logging, LLC lawsuit in a timely manner but plans to reach a settlement with
Digital Mud in the near future provided funds are available

8

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On
October 5, 2006, an action was commenced in the District Court of Erath County,
Texas, by BJ Services Company, USA against Terax for breach of contract and
foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$475,844 allegedly owed to the Plaintiff, interest, and attorneys fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the BJ Services
lawsuit in a timely manner.

On
November 3, 2006, Terax was notified that BJ Services filed a Motion for Summary
Judgment with the court. On December 7, 2006, the court issued an abstract of
judgment in favor of BJ Services Company; Terax plans to reach a settlement with
BJ Services in the near future provided the funds are available.

On
October 10, 2006, an action was commenced in the District Court of Erath County,
Texas, by J.D. Fields & Company, Inc. against Terax for breach of contract
and foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$305,216 allegedly owed to the Plaintiff, interest, and attorneys fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the J. D.
Fields lawsuit in a timely manner but plans to reach a settlement with J.D.
Fields in the near future provided funds are available.

On
January 8, 2007, J.D. Fields filed a motion for a summary judgment with the
court and hearing has been set for February 27, 2007.

On
October 18, 2006, an action was commenced in the District Court of Erath County,
Texas, by Schlumberger Technology Corporation against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $49,288 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Schlumberger lawsuit in a timely manner but plans to reach a settlement with
Schlumberger in the near future provided funds are available.

On
October 19, 2006, an action was commenced in the Precinct 3, Place 3, Justice of
the Peace Court, Dallas County, Texas, by Riviera Finance of Texas, Inc. on
behalf of NTX Roadrunner Transportation, LLC against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $3,938 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. The court set a hearing on
January 18, 2007, and on January 30, 2007, the court issued a default judgment.
Terax plans to reach a settlement with Riviera in the near future provided funds
are available.

On
October 19, 2006, an action was commenced in the District Court of Erath County,
Texas, by Baker Hughes Oilfield Operations, Inc. against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $55,523 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Baker Hughes lawsuit in a timely manner but plans to reach a settlement with
Baker Hughes in the near future provided funds are available.

On
October 26, 2006, an action was commenced in the District Court of Erath County,
Texas, by Jay Mills Contracting, Inc. against Terax for breach of contract and
foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$72,979 allegedly owed to the Plaintiff, interest, and attorneys fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the Jay Mills
lawsuit in a timely manner but plans to reach a settlement with Jay Mills in the
near future provided funds are available.

9

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On
November 2, 2006, an action was commenced in the County Court at Law No.2,
Dallas County, Texas, by Leam Drilling Systems, Inc. against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $113,489 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax plans to respond to the
Leam Drilling lawsuit in a timely manner but plans to reach a settlement with
Leam Drilling in the near future provided funds are available. On December 21,
2006, the court set a non jury trial for June 19, 2007.

On
November 8, 2006, an action was commenced in the District Court of Erath County,
Texas, by Ideal Energy Directional Drilling Services, Inc. against Terax for
breach of contract and foreclosure of lien. The Plaintiff alleges that Terax has
failed to pay for certain goods, merchandise, or services sold to Terax. The
complaint is seeking $52,500 allegedly owed to the Plaintiff, interest, and
attorneys fees and an order of foreclosure of Plaintiffs lien. Terax has
responded to the Ideal lawsuit in a timely manner but plans to reach a
settlement with Ideal Energy Directional Drilling in the near future provided
funds are available.

On
November 9, 2006, an action was commenced in the District Court of Erath County,
Texas, by Red River Well Service, Ltd, Mercer Well Service, Basin Tool, Shale
Tank Truck, LP, and Bell Supply I, LP (the Plaintiffs) against Terax for
breach of contract and foreclosure of lien. The Plaintiffs alleges that Terax
has failed to pay for certain goods, merchandise, or services sold to Terax. The
complaint is seeking $279,078 allegedly owed to the Plaintiff, interest, and
attorneys fees and an order of foreclosure of Plaintiffs lien. Terax plans to
respond to the Plaintiffs lawsuit in a timely manner but plans to reach a
settlement with Plaintiffs in the near future provided funds are available.

On
December 5, 2006, an action was commenced in the County Court at Law No.2 in
Midland County, Texas, by Alliance Drilling Fluids, LLC against Terax for breach
of contract and foreclosure of lien. The Plaintiff alleges that Terax has failed
to pay for certain goods, merchandise, or services sold to Terax. The complaint
is seeking $18,890 allegedly owed to the Plaintiff, interest and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Alliance lawsuit in a timely manner, but plans to reach a settlement with
Alliance Drilling Fluids in the near future provided funds are available.

On
December 10, 2006, an action was commenced in the District Court of Erath
County, Texas, by Brett Construction Company, Inc. against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $16,852 allegedly owed to the Plaintiff, interest attorneys fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the Brett
lawsuit in a timely manner but plans to reach a settlement with Brett
Construction in the near future provided funds are available.

On
January 29, 2007, Brett Construction filed a motion for summary judgment with
the court but Terax plans to reach a settlement with Brett Construction in the
near future provided funds are available.

On
December 26, 2006, an action was commenced in the District Court of Erath
County, Texas, by Alamo Field Services, Inc. against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $142,195 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Alamo lawsuit in a timely manner but plans to reach a settlement with Alamo
Field Services in the near future provided funds are available.

On
January 3, 2007, an action was commenced in the District Court of Erath County,
Texas, by Integrated Production Services, LLC. against Terax for breach of
contract and foreclosure of its lien. The Plaintiff alleges that Terax has
failed to pay for certain goods, merchandise, or services sold to Terax. The
complaint is seeking $200,800 allegedly owed to the Plaintiff, interest, and
attorneys fees and an order of foreclosure of Plaintiffs lien. Terax has
responded to the Integrated lawsuit in a timely manner

10

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but plans to reach a settlement with Integrated Production
Services in the near future provided funds are available.

On
January 8, 2007, an action was commenced in the District Court of Erath County,
Texas, by Mangums Oilfield Services, Inc. against Terax for breach of contract
and foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$25,955 plus interest and allegedly owed to the Plaintiffs attorney fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the Mangums
lawsuit in a timely manner but plans to reach a settlement with Mangums
Oilfield Services in the near future provided funds are available.

On
January 10, 2007, an action was commenced in the District Court of Erath County,
Texas, by Lenward Caraway Enterprises, LLC. against Terax for breach of contract
and foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$116,617 allegedly owed to the Plaintiff, interest, and attorneys fees. Terax
has responded to the Lenward Caraway lawsuit in a timely manner but plans to
reach a settlement with Lenward Caraway in the near future provided funds are
available.

On
January 29, 2007, an action was commenced in the District Court of Dallas
County, Texas, by CDM Resources Management, Ltd. against Terax for breach of
contract. The Plaintiff alleges that Terax has failed to pay for certain goods,
merchandise, or services sold to Terax. The complaint is seeking $73,601
allegedly owed to the Plaintiff, interest, and attorneys fees. Terax plans to
respond to CDMs lawsuit in a timely manner but plans to reach a settlement with
CDM Resources in the near future provided funds are available.

Note 7  Subsequent Events

On
April 26, 2007, Terax entered into a Purchase and Sale Agreement with Westar
Oil, Inc. (Westar) pursuant to which the Company agreed to sell approximately
3.8 million shares of its common stock to Westar. The 3.8 million shares will be
approximately 55% of the total outstanding and issued shares of the Company once
the transaction is completed. At the initial closing, Terax sold 618,000 common
shares at a price of $0.21 per share for a consideration of $129,780. Pursuant
to the terms of the Purchase and Sale Agreement a second closing will be held,
provided that as of July 15, 2007, there shall not be any bankruptcy or
insolvency proceeding against the Company, pursuant to which Terax will sell to
Westar the remaining 3,182,000 share of common stock a price of $0.21 per share
or total of $668,220. Westar has represented that the shares are for investment
purposes and there is no provision in the agreement for registration of the
shares. As part of the agreement, Terax agreed to elect Westars nominee for a
Director and Chief Executive Officer of the Company.

ITEM 2. PLAN OF OPERATIONS

Forward-Looking Statements

This report contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. All statements
other than statements of historical fact are forward-looking statements for
purposes of federal and state securities laws, including, but not limited to,
any projections of earnings, revenue or other financial items; any statements of
the plans, strategies and objections of management for future operations; any
statements concerning proposed new services or developments; any statements
regarding future economic conditions or performance; any statements or belief;
and any statements of assumptions underlying any of the foregoing.

Forward-looking statements may include the words may,
could, estimate, intend, continue, believe, expect or anticipate
or other similar words. These forward-looking statements present our

11

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estimates and assumptions only as of the date of this report.
Except for our ongoing securities laws, we do not intend, and undertake no
obligation, to update any forward-looking statement.

Although we believe that the expectations reflected in any of
our forward-looking statements are reasonable, actual results could differ
materially from those projected or assumed in any of our forward-looking
statements. Our future financial condition and results of operations, as well as
any forward-looking statements, are subject to change and inherent risks and
uncertainties. The factors impacting these risks and uncertainties include, but
are not limited to:

| | o | increased competitive pressures
        from existing competitors and new entrants;                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                   
| | o | increases in interest rates
        or our cost of borrowing or a default under any material debt agreements;                                                                     
| |   |                                                                                                                                                                                   
| | o | deterioration in general
        or regional economic conditions;                                                                                                                 
| |   |                                                                                                                                                                                   
| | o | adverse state or federal
        legislation or regulation that increases the costs of compliance, or adverse
        findings by a regulator with respect to existing operations;
| |   |                                                                                                                                                                                   
| | o | loss of customers or sales
        weakness;                                                                                                                                      
| |   |                                                                                                                                                                                   
| | o | inability to achieve future
        sales levels or other operating results;                                                                                                      
| |   |                                                                                                                                                                                   
| | o | fluctuations of oil and gas
        prices;                                                                                                                                       
| |   |                                                                                                                                                                                   
| | o | the unavailability of funds
        for capital expenditures; and                                                                                                                 
| |   |                                                                                                                                                                                   
| | o | operational inefficiencies
        in distribution or other systems.                                                                                                              

For a detailed description of these and other factors that
could cause actual results to differ materially from those expressed in any
forward-looking statement, please see Factors That May Affect Our Results of
Operation in this document and in our Report on Form 10-KSB for the period
ended June 30, 2006.

Overview

We are an oil and gas exploration, development and production
company. Our properties are located in the Fort Worth Basin. Our corporate
strategy is to continue building value in Terax through the development and
acquisition of gas and oil assets that exhibit consistent, predictable, and
long-lived production. Our current focus is exploring the gas reserves located
in the Barnett Shale formations of the Fort Worth Basin.

We have consolidated mineral lease positions in both Erath and
Comanche counties. Our current focus is on the development and production of our
Erath County properties. We have begun the evaluation process of our Comanche
County properties but any further evaluation will require Terax to resolve its
financial situation.

We may seek acquisition opportunities which compliment our
current focus. We intend to fund our development activity primarily through
proceeds from various private placements sufficient enough to evaluate our
mineral leases.

Our revenue, profitability, and future growth rate depend
substantially on factors beyond our control, such as economic, political, and
regulatory developments and competition from other sources of energy. Oil and
natural gas prices historically have been volatile and may fluctuate widely in
the future. Sustained periods of low prices for oil or natural gas could
materially and adversely affect our financial position, our results of
operations, the quantities of oil and natural gas reserves that we can
economically produce and our access to capital.

Results of Operations

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Third Quarter of 2007 Compared to Third Quarter of 2006

The following overview provides a summary of key information
concerning our financial results for the third quarter of our fiscal year ending
June 30, 2007.

| |                                           |   | Three Months   |   |   | Three Months   |   |   | Increase   |  
| | ----------------------------------------- | - | -------------- | - | - | -------------- | - | - | ---------- | -
| |                                           |   | March 31, 2007 |   |   | March 31, 2006 |   |   | (Decrease) |  
| | Revenue                                   | $ | -              |   | $ | -              |   | $ | -          |  
| |                                           |   |                |   |   |                |   |   |            |  
| | Expenses:                                 |   |                |   |   |                |   |   |            |  
| | Depletion and depreciation                |   | 151,131        |   |   | 7,475          |   |   | 143,656    |  
| | Impairment of
      properties            |   | -              |   |   | -              |   |   | -          |  
| | General and administrative                |   | 244,437        |   |   | 832,228        |   |   | (587,791   | )
| | Total
      expenses                      |   | 395,568        |   |   | 839,703        |   |   | (444,135   | )
| |                                           |   |                |   |   |                |   |   |            |  
| | (Loss) from operations                    |   | (395,568       | ) |   | (839,703       | ) |   | 444,134    |  
| |                                           |   |                |   |   |                |   |   |            |  
| | Other income (expense):                   |   |                |   |   |                |   |   |            |  
| | Dividend income                           |   | -              |   |   | 43,902         |   |   | (43,902    | )
| | Interest expenses                         |   | (99,645        | ) |   | (460,702       | ) |   | 361,057    |  
| | Other                                     |   | -              |   |   | (243           | ) |   | 243        |  
| | Gain (loss) on
      derivative liability |   | 37,522         |   |   | (18,535,627    | ) |   | 18,573,149 |  
| | Net Income( loss)                         | $ | (457,691       | ) |   | (19,792,373    | ) |   | 19,334,682 |  

Revenue

Terax had no revenue for the third quarter of fiscal 2007 and
2006. Production on Teraxs properties did not begin until the fourth quarter of
2006. In August and September 2006 Terax shut in all of its production due to
its financial situation.

Expenses

Operations on Teraxs oil and gas properties did not begin
until the fourth quarter of 2006 and all production was shut in during August
and September 2006. Terax did not incur any lease operating, depletion and
depreciation, or impairment expenses on oil and gas properties for the third
quarter of 2006 and no lease operating expenses or impairment expenses on oil
and gas properties were incurred in third quarter of 2007.

General and administrative expenses for the third quarter of
2007 as compared to the third quarter of 2006 were $244,437 and $832,228,
respectively, for a decrease of $587,791. The decrease in general and
administrative expenses was primarily due to a reduction in professional fees in
the third quarter of 2007 of $387,324 compared to 2006.

Other Income (Expense)

Dividend income for the third quarter of 2007 and 2006 was $nil
and $43,902, respectively, for a decrease of $43,902 which was the result of a
decrease in funds available in an interest bearing account.

Interest expense for the third quarter of 2007 and 2006 was
$99,645 and $460,702, respectively, for a decrease of $361,057. During the third
quarter of 2007and 2006 the outstanding debt was $2,500,000 and $5,000,000,
respectively, but the debt in the third quarter of 2006 was outstanding for only
part of the

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quarter. The rate of interest for the debts in the third
quarter of 2007 and 2006 was approximately the same but the debt holder in 2006
was issued stock with a value of $375,000 in addition to the interest
earned.

The gain on derivative liability in the third quarter of 2007
was $37,522 compared to a loss of $18,535,627 in the third quarter of 2006 for
decrease of $18,573,149.

Net Income (Loss)

Our net loss for the third quarter of 2007 was $457,691
compared to a net loss of $19,792,373 for the third quarter of 2006, for an
decrease in net loss of $19,334,682. Of this decrease in net loss, $18,573,149
was attributable to non-cash gain associated with derivative liability offset by
$143,656 increase in non-cash cost associated with depletion and depreciation
expenses.

First Nine Months of 2007 Compared to First Nine Months of
2006

The following overview provides a summary of key information
concerning our financial results for the first nine months of our fiscal year
ending June 30, 2007.

| |                                 |   | Nine Months    |   |   | Nine Months    |   |   | Increase   |  
| | ------------------------------- | - | -------------- | - | - | -------------- | - | - | ---------- | -
| |                                 |   | March 31, 2007 |   |   | March 31, 2006 |   |   | (Decrease) |  
| | Revenue                         | $ | 189,139        |   | $ | -              |   | $ | 189,139    |  
| |                                 |   |                |   |   |                |   |   |            |  
| | Expenses:                       |   |                |   |   |                |   |   |            |  
| | Depletion and depreciation      |   | 513,963        |   |   | 10,864         |   |   | 503,099    |  
| | Impairment of
      properties  |   | 998,911        |   |   | -              |   |   | 998,911    |  
| | General and administrative      |   | 1,573,933      |   |   | 2,472,748      |   |   | (898,815   | )
| | Total
      expenses            |   | 3,086,807      |   |   | 2,483,612      |   |   | 603,195    |  
| |                                 |   |                |   |   |                |   |   |            |  
| | (Loss) from operations          |   | (2,897,668     | ) |   | (2,483,612     | ) |   | (414,056   | )
| |                                 |   |                |   |   |                |   |   |            |  
| | Other income (expense):         |   |                |   |   |                |   |   |            |  
| | Dividend income                 |   | 3,262          |   |   | 74,841         |   |   | (71,579    | )
| | Interest expenses               |   | (257,179       | ) |   | (493,251       | ) |   | 236,072    |  
| | Other                           |   | -              |   |   | (25,878        | ) |   | 25,878     |  
| | Gain (Loss) on
      derivative |   | 16,411,419     |   |   | (18,535,627    | ) |   | 34,947,046 |  
| | liability                       |   |                |   |   |                |   |   |            |  
| |                                 |   |                |   |   |                |   |   |            |  
| | Net Income ( loss)              | $ | 13,259,834     |   |   | (21,463,527    | ) | $ | 34,723,361 |  

Revenue

Total revenue for the first nine months of 2007 and 2006 was
$189,139 and $0, respectively. Production on the Companys properties did not
begin until the fourth quarter of 2006. In August and September 2006 Terax shut
in all of its production due to its financial situation.

Expenses

Operations on the Companys oil and gas properties did not
begin until the fourth quarter of 2006. Therefore the Company did not incur any
lease operating, depletion and deprecation, and impairment expenses for the
first nine months of 2006.

14

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General and administrative expenses for the first nine months
of 2007 as compared to the first nine months of 2006 were $1,573,933 and
$2,472,748, respectively, for a decrease of $898,815. The decrease in general
and administrative expenses is due primarily to severance payment to a former
officer in the first nine months of 2006.

Other Income (Expense)

Dividend income for the first nine months of 2007 and 2006 was
$3,262 and $74,841, respectively, for a decrease of $71,579 which was the result
of a decrease in funds available in an interest bearing account.

Interest expense for the first nine months of 2007 and 2006 was
$257,179 and $493,251, respectively, for a decrease of $236,072. During the
first nine months of 2007 and 2006 the outstanding debt was $2,500,000 and
$5,000,000, respectively, but the debt was outstanding for only part of the
quarter in 2006. The rate of interest for the debt in the first nine months of
2007 was the same as the interest rate on the debt in the first nine months of
2006. The rate of interest for the debts in the third quarter of 2007 and 2006
was approximately the same but the debt holder in 2006 was issued stock with a
value of $375,000 in addition to the interest earned.

The gain on derivative liability in the first nine months of
2007 was $16,411,419 compared to a loss of $18,535,627 for an increase of
$34,947,046.

Net Income (Loss)

Our net income for the first nine months of 2007 was
$13,259,834 compared to a net loss of $21,463,527 for the first nine months of
2006, for an increase in the income of $34,723,361. Of this increase,
$34,947,046 was attributable to non-cash income associated with derivative
liability offset by $503,099 non-cash cost associated with depletion and
depreciation expenses.

Liquidity and Capital Resources

As
of March 31, 2007 we had a net working capital deficit of $9,709,208 compared to
a net working capital deficit of $23,200,422 at year end June 30, 2006. If the
non-cash derivative liability is not considered, the working capital deficit
would be $9,661,909 at March 31, 2007 and $6,741,703 at June 30, 2006. The
$13,491,214 increase in our working capital position was primarily attributable
to the decrease in derivative liability of $16,411,419, offset by a decrease in
prepaid expense and advances to operators of $556,093, an increase in accounts
payable of $920,653 and an increase in accrued liabilities of $574,235.

Net
cash flow used in operations was $405,205 for the nine months ended March 31,
2007. The primary use of cash in operating activities was to fund our net loss.
Net cash used in investing activities for the nine months was $464,020 and
primarily consisted of an increase in purchases of oil and gas leases of
$252,451, an increase in investment in drilling and equipment, and an investment
in pipeline and gathering system of $160,265, compared to $19,110,551 in
purchases of oil and gas leases, drilling and equipment; and pipeline and
gathering for the nine months ended March 31, 2006.

There
was $100,000 in net cash provided by financing activities during the nine months
ended March 31, 2007, compared to $22,249,880 provided from the sale of stock
for the nine months ended March 31, 2006. The cash provided in the nine months
ended March 31, 2006 was from both equity and debt financings. From August 8,
2005 through September 14, 2005, Terax issued 739,000 Units at a price of $10.00
per Unit for gross proceeds to Terax of $7,390,000. Each Unit consisted of eight
shares of our common stock (each a Unit Share) and four non-transferable share
purchase warrants (each a Unit Warrant). Each Unit Warrant is exercisable into
one share of our common stock (each a Warrant Share) at an exercise price of
$1.75 per share. During the nine months ended March 31, 2006, Terax borrowed
$325,000 bearing interest at 6% per annum and $7,500,000 bearing interest at
12.5% per annum. The notes had interest of $493,251 during the first nine months
of 2006. In May 2006, Terax borrowed $2,500,000 which was still outstanding at
March 31, 2007. The interest rate on the $2,500,000

15

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is 12.5% per annum and the note had accrued interest of
$297,021 at March 31, 2007. On January 19, 2007, Terax received notice of
default from the lender and a demand for payment.

Our
liquidity has continued to be adversely affected during the nine months ended
March 31, 2007, due to Terax not being able to secure additional financing to
fund its operations. Since March 31, 2007, Terax has continued to seek financing
for its operations but has been unsuccessful.

Terax
has numerous litigation related matters which also raise significant doubt about
Teraxs ability to continue as a going concern.

Satisfaction of our cash obligations for the next 12 months

Our
current capital resources, together with our expected cash flow from operations,
are not sufficient to continue and maintain our operations (including resolution
of amounts relating to pending litigation discussed elsewhere in this document)
over the course of the next twelve months. If Terax does not secure additional
financing in the near term it will be forced to seek other alternatives
including the sale of assets to repay its current creditors. This includes
resources for the payment of our anticipated overhead expenses and current
liabilities. If Terax is successful in securing sufficient capital to repay its
creditors, it will need additional capital to continue its operations and
evaluate its properties. We would, therefore, continue to seek to raise capital
over the next 12 months as we attempt to finance the development of our existing
projects and in order to fund our future growth and exploration activities. This
may take the form of either debt-based financing, or sale of equity securities.
If we are unable to obtain additional funds when we need them or if we cannot
obtain funds on terms favorable to us, we may need to delay, scale back, or
eliminate plans for further development efforts.

Our
oil and gas properties have been shut-in until Terax can resolve its current
working capital deficit. We have no significant history of earnings or cash flow
from our operations. A critical component of our operating plan impacting our
continued existence is to efficiently manage the costs associated with
exploratory drilling efforts, our ability to obtain additional capital through
additional equity and/or debt financing, and joint venture or working interest
partnerships will also be important to our expansion plans. In the event we
experience any significant problems assimilating acquired assets into our
operations or cannot obtain the necessary capital to pursue our strategic plan,
we may have to significantly curtail our operations. This would materially
impact our ability to continue operations.

We
will need additional capital to proceed with the current phase of our operations
and the continued field development of our Erath County properties.

Over
the next twelve months, our existing capital combined with cash flow from
operations will not be sufficient to sustain operations and our planned
expansion.

We
believe we will continue to incur operating losses over the next twelve months.
Our lack of operating history makes predictions of future operating results
difficult to ascertain. Our prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development and production, particularly companies in the oil and gas
industry. Such risks include, but are not limited to, an evolving and
unpredictable business model and the management of growth. To address these
risks we must, among other things, implement and successfully execute our
business and marketing strategy, continue to develop and upgrade technology and
products, respond to competitive developments, and attract, retain and motivate
qualified personnel. There can be no assurance that we will be successful in
addressing such risks, and the failure to do so can have a material adverse
effect on our business prospects, financial condition, and results of
operations.

All
of the leases purchased by Terax are paid up oil and gas leases which do not
require future payments. If we begin production of oil or natural gas on a lease
before the end of the primary lease term, we may retain that lease without
additional cost. If production is established, we are required to pay the
leaseholder a portion of the oil or gas production as royalty payments which
range from 16.66% to

16

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21.5% . If production is not established during the primary
term of the lease, in most cases, we have the right but not the obligation to
extend the lease for an additional 2 years in Erath and an additional 3 years in
Comanche by making an additional lump sum payment to the leaseholder, as
provided for in each lease. If oil and gas production is not established within
the additional two years period, the lease is returned to the leaseholder and we
have no additional rights to the lease.

As of March 31, 2007, we had assets of $16,054,228, and
$9,747,970 in liabilities, resulting in a stockholders equity of $6,306,258.

Significant changes in the number of employees

During the nine month period ended March 31, 2007, there were
reductions in the number of employees and full-time consultants. The number of
employees has been reduced from 4 to 2 and the numbers of full-time consultants
were reduced from 6 to none.

Our desired personnel structure could be divided into three
broad categories: management and professional, administrative, and project field
personnel. As in most small companies, the divisions between these three
categories are somewhat indistinct, as employees are engaged in various
functions as projects and work loads demand.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or
are reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results or
operations, liquidity, capital expenditures or capital resources that is
material to investors.

Critical Accounting Policies and Estimates

Our discussion of financial condition and results of operations
is based upon the information reported in our financial statements. The
preparation of these statements requires us to make assumptions and estimates
that affect the reported amounts of assets, liabilities, revenues, and expenses
as well as the disclosure of contingent assets and liabilities at the date of
our financial statements. We base our assumptions and estimates on historical
experience and other sources that we believe to be reasonable at the time.
Actual results may vary from our estimates due to changes in circumstances,
weather, politics, global economics, mechanical problems, general business
conditions, and other factors. Our significant accounting policies are detailed
in Note 1 to our financial statements included in our Annual Report. We have
outlined below certain of these policies as being of particular importance to
the portrayal of our financial position and results of operations and which
require the application of significant judgment by our management.

Revenue Recognition

It is our policy to recognize revenue when production is sold
to a purchaser at a fixed or determinable price.

Successful Efforts Method of Accounting

We account for our oil and natural gas operations using the
successful efforts method of accounting. Under this method, all costs associated
with property acquisition, exploration, and development of oil and gas reserves
are capitalized. Costs capitalized include acquisition costs, geological and
geophysical expenditures, lease rentals on undeveloped properties and cost of
drilling and equipping productive wells. In the event we do not find proved
reserves, geological and geophysical costs, and costs of carrying and retaining
unproved properties are expensed. All of our properties are located within the
continental United States.

Oil and Natural Gas Reserve Quantities

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Reserve quantities and the related estimates of future net cash
flows affect our periodic calculations of depletion and impairment of our oil
and natural gas properties. Proved oil and natural gas reserves are the
estimated quantities of crude oil, natural gas, and natural gas liquids which
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future periods from known reservoirs under existing economic and
operating conditions. Reserve quantities and future cash flows included in the
Form 10-KSB are prepared in accordance with guidelines established by the SEC
and FASB.

ITEM 3. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures: As of
the end of the period covered by this report, our management carried out an
evaluation, under the supervision of our Chief Executive Officer and Principal
Financial Officer of the effectiveness of the design and operation of our system
of disclosure controls and procedures pursuant to the Securities and Exchange
Act, Rule 13a- 15(e) an 15d-15(e) under the Exchange Act). Based on that
evaluation, our chief executive officer and chief financial officer concluded
that our disclosure controls and procedures were effective to provide reasonable
assurance that information we are required to disclose in reports that we file
or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commissions
rules and forms, and that such information is accumulated and communicated to
our management, including our Chief Executive Officer and, Principal Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.

Change in Internal controls: There were no changes in
internal controls over financial reporting that occurred during the period
covered by this report that have materially affected, or are reasonably likely
to materially effect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

On
July 20, 2006, an action was commenced in the District Court of Erath County,
Texas, against Terax by Centex Pipeline Construction, Inc. for failure to pay
for services performed, breach of contract and to foreclose on Plaintiffs
mechanic lien. The Complaint alleges that Terax and Centex entered into an
agreement for to install certain components of a gas pipeline gathering system
on Teraxs Mitchell Ranch property in Erath County, Texas. The Complaint further
alleges that the Plaintiff completed work on June 5, 2006 and that Terax has
failed to pay certain outstanding invoices. The Plaintiffs has filed a
mechanics lien to create a security interest against the gathering line and
compressor station. The Plaintiffs is seeking damages in the amount of $510,319
plus interest, attorney fees and entry of an Order of Sale directing the sale by
public auction of the property covered by the Plaintiffs mechanic lien.

On
December 13, 2006, Centex obtained a judgment against Terax which provided that
any payments to Centex were to be made to Centex and the bank which has an
interest in Centexs receivable from Terax. Provided Terax can get the funds,
its our plan is to seek a settlement with Centex and its bank.

On
August 28, 2006, an action was commenced in the District Court of Travis County,
Texas, against Terax, Andrew Hromyk and Starr County Energy, Inc. by Sam Warren
and Tennessee Eastern Oil & Gas, Inc. for damages for breach of a personal
services contract with the Plaintiffs, or in the alternative, based upon the
doctrine of quantum merit, for value of services which Plaintiffs allegedly
rendered to Defendants. The complaint alleges that in early 2006, Tennessee
Eastern and Starr County entered into an agreement to purchase certain oil and
gas properties located in Tennessee, which agreement was terminated. The
complaint alleges that Hromyk continued discussions with Plaintiff Warren and
indicated that a lawsuit filed against Terax by William Rhea was impeding the
potential sale of the Tennessee

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property, at which point, Warren offered to assist with
settling the William Rhea lawsuit. The complaint further alleged that Plaintiffs
negotiated and mediated a settlement of the William Rhea lawsuit and that after
the lawsuit was settled, the Defendants breached their agreement to purchase the
Tennessee property for $5.7 million. The Plaintiffs are seeking a judgment
against the Defendants in the amount of $5.7 million and attorneys fees and
expenses and costs of court.

On
November 10, 2006, the Plaintiff and the Defendants met for negotiations and
reached a settlement agreement subject to documentation. Terax will agree to pay
$50,000 for settlement of all claims against Terax. To date the settlement has
not been finalized and no payments have been made to the Plaintiff.

On
September 22, 2006, an action was commenced in the District Court of Erath
County, Texas, by Geosite, Inc. against Terax and Bill Chester for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $10,930 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Geosite lawsuit in a timely manner but plans to reach a settlement with Geosite
in the near future provided funds are available.

On
October 3, 2006, an action was commenced in the District Court of Erath County,
Texas, by Digital Mud Logging, LLC against Terax for breach of contract and
foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$11,200 allegedly owed to the Plaintiff, interest, and attorneys fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the Digital Mud
Logging, LLC lawsuit in a timely manner but plans to reach a settlement with
Digital Mud in the near future provided funds are available

On
October 5, 2006, an action was commenced in the District Court of Erath County,
Texas, by BJ Services Company, USA against Terax for breach of contract and
foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$475,844 allegedly owed to the Plaintiff, interest, and attorneys fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the BJ Services
lawsuit in a timely manner.

On
November 3, 2006, Terax was notified that BJ Services filed a Motion for Summary
Judgment with the court. On December 7, 2006, the court issued an abstract of
judgment in favor of BJ Services Company; Terax plans to reach a settlement with
BJ Services in the near future provided the funds are available.

On
October 10, 2006, an action was commenced in the District Court of Erath County,
Texas, by J.D. Fields & Company, Inc. against Terax for breach of contract
and foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$305,216 allegedly owed to the Plaintiff, interest, and attorneys fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the J. D.
Fields lawsuit in a timely manner but plans to reach a settlement with J.D.
Fields in the near future provided funds are available.

On
January 8, 2007, J.D. Fields filed a motion for a summary judgment with the
court and hearing has been set for February 27, 2007.

On
October 18, 2006, an action was commenced in the District Court of Erath County,
Texas, by Schlumberger Technology Corporation against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $49,288 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Schlumberger lawsuit in a timely manner but plans to reach a settlement with
Schlumberger in the near future provided funds are available.

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On
October 19, 2006, an action was commenced in the Precinct 3, Place 3, Justice of
the Peace Court, Dallas County, Texas, by Riviera Finance of Texas, Inc. on
behalf of NTX Roadrunner Transportation, LLC against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $3,938 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Riviera lawsuit in a timely manner but plans to reach a settlement with Riviera
in the near future provided funds are available. The court set a hearing on
January 18, 2007, and on January 30, 2007, the court issued a default judgment.

On
October 19, 2006, an action was commenced in the District Court of Erath County,
Texas, by Baker Hughes Oilfield Operations, Inc. against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $55,523 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Baker Hughes lawsuit in a timely manner but plans to reach a settlement with
Baker Hughes in the near future provided funds are available.

On
October 26, 2006, an action was commenced in the District Court of Erath County,
Texas, by Jay Mills Contracting, Inc. against Terax for breach of contract and
foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$72,979 allegedly owed to the Plaintiff, interest, and attorneys fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the Jay Mills
lawsuit in a timely manner but plans to reach a settlement with Jay Mills in the
near future provided funds are available.

On
November 2, 2006, an action was commenced in the County Court at Law No.2,
Dallas County, Texas, by Leam Drilling Systems, Inc. against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $113,489 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax plans to respond to the
Leam Drilling lawsuit in a timely manner but plans to reach a settlement with
Leam Drilling in the near future provided funds are available. On December 21,
2006, the court set a non jury trial for June 19, 2007.

On
November 8, 2006, an action was commenced in the District Court of Erath County,
Texas, by Ideal Energy Directional Drilling Services, Inc. against Terax for
breach of contract and foreclosure of lien. The Plaintiff alleges that Terax has
failed to pay for certain goods, merchandise, or services sold to Terax. The
complaint is seeking $52,500 allegedly owed to the Plaintiff, interest, and
attorneys fees and an order of foreclosure of Plaintiffs lien. Terax has
responded to the Ideal lawsuit in a timely manner but plans to reach a
settlement with Ideal Energy Directional Drilling in the near future provided
funds are available.

On
November 9, 2006, an action was commenced in the District Court of Erath County,
Texas, by Red River Well Service, Ltd, Mercer Well Service, Basin Tool, Shale
Tank Truck, LP, and Bell Supply I, LP (the Plaintiffs) against Terax for
breach of contract and foreclosure of lien. The Plaintiffs alleges that Terax
has failed to pay for certain goods, merchandise, or services sold to Terax. The
complaint is seeking $279,078 allegedly owed to the Plaintiff, interest, and
attorneys fees and an order of foreclosure of Plaintiffs lien. Terax plans to
respond to the Plaintiffs lawsuit in a timely manner but plans to reach a
settlement with Plaintiffs in the near future provided funds are available.

On
December 5, 2006, an action was commenced in the County Court at Law No.2 in
Midland County, Texas, by Alliance Drilling Fluids, LLC against Terax for breach
of contract and foreclosure of lien. The Plaintiff alleges that Terax has failed
to pay for certain goods, merchandise, or services sold to Terax. The complaint
is seeking $18,890 allegedly owed to the Plaintiff, interest and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Alliance lawsuit in a timely manner, but plans to reach a settlement with
Alliance Drilling Fluids in the near future provided funds are available.

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On
December 10, 2006, an action was commenced in the District Court of Erath
County, Texas, by Brett Construction Company, Inc. against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $16,852 allegedly owed to the Plaintiff, interest attorneys fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the Brett
lawsuit in a timely manner but plans to reach a settlement with Brett
Construction in the near future provided funds are available.

On
January 29, 2007, Brett Construction filed a motion for summary judgment with
the court but Terax plans to reach a settlement with Brett Construction in the
near future provided funds are available.

On
December 26, 2006, an action was commenced in the District Court of Erath
County, Texas, by Alamo Field Services, Inc. against Terax for breach of
contract and foreclosure of lien. The Plaintiff alleges that Terax has failed to
pay for certain goods, merchandise, or services sold to Terax. The complaint is
seeking $142,195 allegedly owed to the Plaintiff, interest, and attorneys fees
and an order of foreclosure of Plaintiffs lien. Terax has responded to the
Alamo lawsuit in a timely manner but plans to reach a settlement with Alamo
Field Services in the near future provided funds are available.

On
January 3, 2007, an action was commenced in the District Court of Erath County,
Texas, by Integrated Production Services, LLC. against Terax for breach of
contract and foreclosure of its lien. The Plaintiff alleges that Terax has
failed to pay for certain goods, merchandise, or services sold to Terax. The
complaint is seeking $200,800 allegedly owed to the Plaintiff, interest, and
attorneys fees and an order of foreclosure of Plaintiffs lien. Terax has
responded to the Integrated lawsuit in a timely manner but plans to reach a
settlement with Integrated Production Services in the near future provided funds
are available.

On
January 8, 2007, an action was commenced in the District Court of Erath County,
Texas, by Mangums Oilfield Services, Inc. against Terax for breach of contract
and foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$25,955 plus interest and allegedly owed to the Plaintiffs attorney fees and an
order of foreclosure of Plaintiffs lien. Terax has responded to the Mangums
lawsuit in a timely manner but plans to reach a settlement with Mangums
Oilfield Services in the near future provided funds are available.

On
January 10, 2007, an action was commenced in the District Court of Erath County,
Texas, by Lenward Caraway Enterprises, LLC. against Terax for breach of contract
and foreclosure of lien. The Plaintiff alleges that Terax has failed to pay for
certain goods, merchandise, or services sold to Terax. The complaint is seeking
$116,617 allegedly owed to the Plaintiff, interest, and attorneys fees. Terax
has responded to the Lenward Caraway lawsuit in a timely manner but plans to
reach a settlement with Lenward Caraway in the near future provided funds are
available.

On
January 29, 2007, an action was commenced in the District Court of Dallas
County, Texas, by CDM Resources Management, Ltd. against Terax for breach of
contract. The Plaintiff alleges that Terax has failed to pay for certain goods,
merchandise, or services sold to Terax. The complaint is seeking $73,601
allegedly owed to the Plaintiff, interest, and attorneys fees. Terax plans to
respond to CDMs lawsuit in a timely manner but plans to reach a settlement with
CDM Resources in the near future provided funds are available.

Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds.

During the period covered by this Report Terax has not sold any
securities not registered under the Securities Act which were not previously
reported in Form 8-K filings made by Terax.

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Item 3. Defaults Upon Senior Securities.

On May 12, 2006, Terax issued a promissory note in the
principal amount of $2,500,000 (the Note) to an investor. The Note bears
interest at the rate of 12.5% per annum, payable on repayment of the Note. The
Note is due on demand after December 31, 2006. In addition, interest in the
amount of $125,000 is due and payable in 71,429 shares of Teraxs common stock
at closing. The Note is secured by a security interest in all of Teraxs oil and
gas leases and pipeline right of ways and easements in Erath County, Texas, as
well as well and pipeline equipment and personal property, contracts and
agreements, and production from Teraxs wells located on the leases. In the
Event of Default, the holder of the note has the right but not the obligation to
seek remedies for repayment of the notes including but not limited to
foreclosure and sale of the secured assets. During the nine months ended March
31, 2007, Terax has accrued $255,068 in interest. The total interest accrued to
date is $297,021. On January 19, 2007, Terax received notice of default from the
lender and a demand for payment.

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

None

Item 5. Other Information.

None.

Item 6. Exhibits.

|31.1 | Certification
        of Chief Executive Officer and Principal Financial Officer pursuant to
        Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange
        Act of 1934, as amended
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     |                                                                                                                                                                                                                   
|32.1 | Certification
        pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
        of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer and Principal
        Financial Officer)          

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SIGNATURES

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

|                   | TERAX ENERGY, INC.                                         
|------------------ | -----------------------------------------------------------
|                   |                                                            
|                   |                                                            
|Date: May 15, 2007 | By: /s/ Linda Contreras                                    
|                   | Linda Contreras                                            
|                   | Chief
      Executive Officer (Principal Executive Officer)
|                   | and Principal Financial Officer                            

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