**FORM10-QSB**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 
| **ý**                                                                                                                                                                                                                                                                                                                                                                                                                                 | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                          |
| **For the quarterly period ended September 30,  2004**                                                                                                                                                                                                                                                                                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                          |
| **OR**                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                          |
| **o**                                                                                                                                                                                                                                                                                                                                                                                                                                      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                          |
| **For the transition period from                                    to                                 .** |

 

###### **Commission FileNumber:  0-30598**

 

**WHITTIERENERGY CORPORATION**

(Exact Name of Registrantas Specified in Its Charter)

 
| **Nevada**                                                       |   | **20-0539412**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **333  Clay Street, Suite 1100  Houston, Texas 77002**           |
| (Address of Principal  Executive Offices)                        |

 

Registrant’s telephone number, including area code: **(713) 850-1880**

 

Indicate by check mark whether the Registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months, and (2) has been subject to suchfiling requirements for the past 90 days.

 

YES  ý                   NO  o

 

As of November 12, 2004 the Registrant had 11,523,402 shares of its $.001par value common stock issued and outstanding.

 

 

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**Part I – Summarized FinancialInformation**

**Item 1 – Financial Statements**

 

**Whittier Energy Corporation**

**Consolidated Balance Sheets**

**(In Thousands)**

 
| ** **                                                                        | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                        | ** ** | **(Unaudited)**         | ** ** | **(Audited)**          | ** ** |
|                                                                              |       |                    |       |                   |       |
| **Assets**                                                                        |       |                    |       |                   |       |
| Current assets:                                                                   |       |                    |       |                   |       |
| Cash and cash  equivalents                                                        |       | $                       | 1,353      |                   | $          | 1,037 |   |
| Accounts  receivable                                                              |       | 2,294                   |       | 1,199                  |       |
| Income tax  receivable                                                            |       | 38                      |       | 38                     |       |
| Prepaid assets                                                                    |       | 129                     |       | 76                     |       |
|                                                                              |       |                    |       |                   |       |
| Total current  assets                                                             |       | 3,814                   |       | 2,350                  |       |
|                                                                              |       |                    |       |                   |       |
| Deferred income  tax assets                                                       |       | 1,695                   |       | 883                    |       |
| Investments in  partnerships                                                      |       | 256                     |       | 240                    |       |
| Investments in  marketable securities                                             |       | 892                     |       | 775                    |       |
| Oil and gas  properties (successful efforts method), furniture and equipment, net |       | 18,980                  |       | 10,369                 |       |
|                                                                              |       |                    |       |                   |       |
| Total assets                                                                      |       | $                       | 25,637     |                   | $          | 14,617 |   |

 

*See accompanying notes.*

 

2

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**Whittier Energy Corporation**

**Consolidated Balance Sheets**

**(In Thousands)**

* *
| ** **                                                                                                                                                                                                           | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                           | ** ** | **(Unaudited)**         | ** ** | **(Audited)**          | ** ** |
|                                                                                                                                                                                                                 |       |                    |       |                   |       |
| **Liabilities  and stockholders’ equity**                                                                                                                                                                       |       |                    |       |                   |       |
| Current  liabilities:                                                                                                                                                                                                |       |                    |       |                   |       |
| Accounts payable                                                                                                                                                                                                     |       | $                       | 2,815      |                   | $          | 1,304 |   |
| Taxes payable                                                                                                                                                                                                        |       | 105                     |       | 19                     |       |
| Note payable,  current portion                                                                                                                                                                                       |       | 1,650                   |       | 560                    |       |
| Total current  liabilities                                                                                                                                                                                           |       | 4,570                   |       | 1,883                  |       |
|                                                                                                                                                                                                                 |       |                    |       |                   |       |
| Deferred income  tax liability                                                                                                                                                                                       |       | 1,732                   |       | 1,513                  |       |
| Note payable                                                                                                                                                                                                         |       | 6,215                   |       | 3,945                  |       |
| Subordinated  note payable                                                                                                                                                                                           |       | 1,787                   |       | —                 |       |
| Asset retirement  obligation                                                                                                                                                                                         |       | 100                     |       | 69                     |       |
| Commodity price  hedging contracts                                                                                                                                                                                   |       | 2,761                   |       | 574                    |       |
| Total  liabilities                                                                                                                                                                                                   |       | 17,165                  |       | 7,984                  |       |
|                                                                                                                                                                                                                 |       |                    |       |                   |       |
| Stockholders’  equity:                                                                                                                                                                                          |       |                    |       |                   |       |
| Common stock, no  par value, 100,000,000 shares authorized, 11,523,402 and 10,046,296 shares  issued and outstanding as of September 30, 2004 and December 31, 2003,  respectively                                   |       | 12                      |       | 10                     |       |
| Additional  paid-in capital                                                                                                                                                                                          |       | 5,202                   |       | 2,694                  |       |
| Accumulated  other comprehensive income (loss), unrealized gain (loss) on marketable  securities, net of taxes of $1,080 and $270,882, for the periods ended  September 30, 2004 and December 31, 2003, respectively |       | 2                       |       | (503                   | )          |
| Accumulated  other comprehensive loss, hedging contracts, net of taxes of $966,491 and  $200,912 for the periods ended September 30, 2004 and December 31, 2003,  respectively                                       |       | (1,795                  | )          | (373                   | )          |
| Retained  earnings                                                                                                                                                                                                   |       | 5,051                   |       | 4,805                  |       |
| Total  stockholders’ equity                                                                                                                                                                                     |       | 8,472                   |       | 6,633                  |       |
|                                                                                                                                                                                                                 |       |                    |       |                   |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                     |       | $                       | 25,637     |                   | $          | 14,617 |   |

 

*See accompanying notes.*

 

3

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**Whittier Energy Corporation**

**Consolidated Statements ofOperations (Unaudited)**

**(In Thousands, Except Share Data)**

 
| ** **                                                                                 | ** ** | **Three Months  Ended  September 30,  2004** | ** ** | **Three Months  Ended  September 30,  2003** | ** ** | **Nine Months  Ended  September 30,  2004** | ** ** | **Nine Months  Ended  September 30,  2003** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
|                                                                                       |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Oil and gas  revenues                                                                      |       | $                                            | 2,867      |                                         | $          | 1,506                                       |       | $                                           | 6,942      |   | $ | 4,413 |   |
|                                                                                       |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Costs and  expenses:                                                                       |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Lease operating  expenses                                                                  |       | 856                                          |       | 463                                          |       | 1,995                                       |       | 1,625                                       |       |
| Production taxes                                                                           |       | 260                                          |       | 128                                          |       | 633                                         |       | 443                                         |       |
| Depreciation,  depletion, and amortization                                                 |       | 662                                          |       | 368                                          |       | 1,696                                       |       | 865                                         |       |
| Exploration  expenses                                                                      |       | 203                                          |       | —                                       |       | 742                                         |       | —                                      |       |
| General and  administrative expenses                                                       |       | 409                                          |       | 233                                          |       | 1,146                                       |       | 689                                         |       |
|                                                                                       |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Total costs and  expenses                                                                  |       | 2,390                                        |       | 1,192                                        |       | 6,212                                       |       | 3,622                                       |       |
|                                                                                       |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Income from  operations                                                                    |       | 477                                          |       | 314                                          |       | 730                                         |       | 791                                         |       |
|                                                                                       |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Other income  (expense):                                                                   |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Interest and  dividend income                                                              |       | 1                                            |       | 1                                            |       | 2                                           |       | 2                                           |       |
| Interest expense                                                                           |       | (141                                         | )          | (49                                          | )          | (253                                        | )          | (149                                        | )          |
| Gain (loss) from  sales                                                                    |       | (2                                           | )          | —                                       |       | 244                                         |       | (31                                         | )          |
| Partnership  income                                                                        |       | 47                                           |       | 4                                            |       | 168                                         |       | 8                                           |       |
| Impairment of  partnership investments                                                     |       | —                                       |       | —                                       |       | —                                      |       | (733                                        | )          |
| Impairment of  marketable securities                                                       |       | —                                       |       | —                                       |       | (645                                        | )          | —                                      |       |
|                                                                                       |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Other expense                                                                              |       | (95                                          | )          | (44                                          | )          | (484                                        | )          | (903                                        | )          |
|                                                                                       |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Income (loss)  before income taxes and cumulative effect of change in accounting principle |       | 382                                          |       | 270                                          |       | 246                                         |       | (112                                        | )          |
| Provision for  income taxes                                                                |       | 178                                          |       | —                                       |       | —                                      |       | —                                      |       |
| Income (loss)  before cumulative effect of change in accounting principle                  |       | 560                                          |       | 270                                          |       | 246                                         |       | (112                                        | )          |
| Cumulative  effect of change in accounting principle                                       |       | —                                       |       | —                                       |       | —                                      |       | (6                                          | )          |
| Net income  (loss)                                                                         |       | $                                            | 560        |                                         | $          | 270                                         |       | $                                           | 246        |   | $ | (118 | ) |

 

*See accompanying notes.*

 

4

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| ** **                                                                            | ** ** | **Three Months  Ended  September 30,  2004** | ** ** | **Three Months  Ended  September 30,  2003** | ** ** | **Nine Months  Ended  September 30,  2004** | ** ** | **Nine Months  Ended  September 30,  2003** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
|                                                                                  |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Basic earnings  (loss) per share:                                                     |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Earnings (loss)  per share before cumulative effect of change in accounting principle |       | $                                            | .05        |                                         | $          | .03                                         |       | $                                           | .02        |   | $ | (.01 | ) |
| Cumulative  effect of change in accounting principle                                  |       | —                                       |       | —                                       |       | —                                      |       | (.00                                        | )          |
| Net income  (loss) per share                                                          |       | $                                            | .05        |                                         | $          | .03                                         |       | $                                           | .02        |   | $ | (.01 | ) |
|                                                                                  |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Weighted average  number of shares outstanding (basic)                                |       | 11,488,474                                   |       | 9,446,254                                    |       | 10,607,409                                  |       | 9,446,254                                   |       |
|                                                                                  |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Dilutive  earnings (loss) per share:                                                  |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Earnings (loss)  per share before cumulative effect of change in accounting principle |       | $                                            | .05        |                                         | $          | .03                                         |       | $                                           | .02        |   | $ | (.01 | ) |
| Cumulative  effect of change in accounting principle                                  |       | —                                       |       | —                                       |       | —                                      |       | (.00                                        | )          |
| Net income  (loss) per share                                                          |       | $                                            | .05        |                                         | $          | .03                                         |       | $                                           | .02        |   | $ | (.01 | ) |
|                                                                                  |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Weighted average  number of shares outstanding (diluted)                              |       | 12,228,224                                   |       | 10,046,254                                   |       | 11,321,537                                  |       | 10,046,254                                  |       |
|                                                                                  |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Basic shares  outstanding                                                             |       | 11,488,474                                   |       | 9,446,254                                    |       | 10,607,409                                  |       | 9,446,254                                   |       |
| Dilutive  securities outstanding:                                                     |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Series A  Preferred Stock                                                             |       | —                                       |       | 600,000                                      |       | —                                      |       | 600,000                                     |       |
| Stock options                                                                         |       | 739,750                                      |       | —                                       |       | 714,128                                     |       | —                                      |       |
| Diluted shares  outstanding, assuming conversion of dilutive securities               |       | 12,228,224                                   |       | 10,046,254                                   |       | 11,321,537                                  |       | 10,046,254                                  |       |

* *

*Seeaccompanying notes.*

 

5

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**Whittier Energy Corporation**

**Consolidated Statements of CashFlows (Unaudited)**

**(In Thousands)**

 
| ** **                                                                            | ** ** | **Nine Months  Ended  September 30, 2004** | ** ** | **Nine Months  Ended  September 30, 2003** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| **Cash  flows from operating activities**                                             |       |                                       |       |                                       |       |
| Net  income/(loss)                                                                    |       | $                                          | 246        |                                       | $          | (118 | ) |
| Adjustments to  reconcile net income/(loss) to net cash used in operating activities: |       |                                       |       |                                       |       |
| Depreciation,  depletion, and amortization                                            |       | 1,696                                      |       | 865                                        |       |
| Exploration  expense                                                                  |       | 463                                        |       | —                                     |       |
| (Gain)/loss on  the sale of oil and gas properties                                    |       | (246                                       | )          | 31                                         |       |
| Loss on sale of  marketable securities                                                |       | 2                                          |       | —                                     |       |
| Partnership  income                                                                   |       | (168                                       | )          | (8                                         | )          |
| Impairment of  marketable securities                                                  |       | 645                                        |       | —                                     |       |
| Impairment of  partnership investments                                                |       | —                                     |       | 733                                        |       |
| Cumulative  effect of change in accounting principle                                  |       | —                                     |       | 6                                          |       |
| (Increase)/decrease  in restricted cash                                               |       | —                                     |       | 25                                         |       |
| (Increase)/decrease  in accounts receivable                                           |       | (1,095                                     | )          | (543                                       | )          |
| (Increase)/decrease  in prepaids and other receivables                                |       | (53                                        | )          | (88                                        | )          |
| Increase/(decrease)  in accounts payable                                              |       | 1,511                                      |       | 916                                        |       |
| Increase/(decrease)  in taxes payable                                                 |       | 86                                         |       | —                                     |       |
| Increase/(decrease)  in other current liabilities                                     |       | —                                     |       | 96                                         |       |
| Net current  liabilities acquired in acquisition of Olympic Resources Ltd             |       | —                                     |       | (245                                       | )          |
| Net cash  provided by operating activities                                            |       | 3,087                                      |       | 1,670                                      |       |
|                                                                                  |       |                                       |       |                                       |       |
| **Cash  flows from investing activities**                                             |       |                                       |       |                                       |       |
| Investment in  oil and gas properties                                                 |       | (10,934                                    | )          | (1,433                                     | )          |
| Proceeds from  sale of oil and gas properties                                         |       | 525                                        |       | 36                                         |       |
| Net proceeds  from private placement                                                  |       | 2,331                                      |       | —                                     |       |
| Investments in  partnerships                                                          |       | (64                                        | )          | (104                                       | )          |
| Distributions  from partnerships                                                      |       | 217                                        |       | 160                                        |       |
| Proceeds from  the sale of marketable securities                                      |       | 7                                          |       | 20                                         |       |
| Net cash used in  investing activities                                                |       | (7,918                                     | )          | (1,321                                     | )          |
|                                                                                  |       |                                       |       |                                       |       |
| **Cash  flows from financing activities**                                             |       |                                       |       |                                       |       |
| Cash acquired in  merger with Olympic                                                 | ** ** | **—**                                 |       | 765                                        |       |
| Loan payments                                                                         |       | (690                                       | )          | (70                                        | )          |
| Proceeds from  senior credit facility                                                 |       | 4,050                                      |       | 560                                        |       |
| Proceeds from  subordinated convertible note                                          |       | 1,787                                      |       | —                                     |       |
| Net cash  provided by financing activities                                            |       | 5,147                                      |       | 1,255                                      |       |
|                                                                                  |       |                                       |       |                                       |       |
| Net increase  (decrease) in cash and cash equivalents                                 |       | $                                          | 316        |                                       | $          | 1,604 |   |
|                                                                                  |       |                                       |       |                                       |       |
| Cash and cash  equivalents at beginning of period                                     |       | 1,037                                      |       | 302                                        |       |
|                                                                                  |       |                                       |       |                                       |       |
| Cash and cash  equivalents at end of period                                           |       | $                                          | 1,353      |                                       | $          | 1,906 |   |
|                                                                                  |       |                                       |       |                                       |       |
| **Supplemental  cash flow disclosure**                                                |       |                                       |       |                                       |       |
| Interest paid                                                                         |       | 253                                        |       | 149                                        |       |
| Income taxes  paid                                                                    |       | —                                     |       | —                                     |       |
|                                                                                  |       |                                       |       |                                       |       |
| **Supplemental  schedule of non-cash investing and financing activities**             |       |                                       |       |                                       |       |
| Unrealized  (gain)/loss on marketable securities                                      |       | (2                                         | )          | (168                                       | )          |
| Unrealized  (gain)/loss on hedge contracts                                            |       | 1,795                                      |       | (12                                        | )          |
| Value of stock  warrants issued for purchase of South Texas Properties                |       | 135                                        |       | —                                     |       |

* *

*See accompanying notes.*

 

6

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**WHITTIER ENERGY CORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**1.             General**

 

Whittier EnergyCorporation (“Whittier”), a Nevada corporation, is an independent oil and gasexploration and production company engaged in the acquisition, exploration anddevelopment of oil and gas properties in the continental United States. As of September30, 2004, Whittier had three wholly owned subsidiaries, including WhittierEnergy Company (“Whittier Energy”), a Nevada corporation, Whittier Operating,Inc. (“Whittier Operating”), a Texas corporation, and Olympic Resources(Arizona) Ltd. (“Olympic Arizona”), an Arizona corporation. Whittier Operatingis a direct subsidiary of Whittier Energy. References to the “Company” refer toWhittier and its subsidiaries.

 

Whittier wasoriginally incorporated in the Province of British Columbia, Canada, in 1986,under the name Global Data Systems Corp. Global Data Systems was later renamedComtron Enterprises Inc. in November 1989. In October 1993, Comtron Enterpriseschanged its name to Olympic Resources Ltd. (“Olympic”). On September 10, 2003,Olympic’s wholly owned subsidiary, WEC Acquisition, Inc. (“WEC”), a Wyomingcorporation, merged into Whittier Energy, triggering a change in control of theCompany (the “Merger”). WEC was formed by Olympic during the quarter endedSeptember 30, 2003, solely for the Merger. WEC merged with and into WhittierEnergy with Whittier Energy surviving the Merger to become the wholly ownedsubsidiary of the Company. In exchange for their Whittier Energy common stock,the Whittier Energy shareholders received shares of the Company’s voting commonstock and Series A Convertible Preferred Stock.

 

As part of thecorporate restructuring of the Company, in December 2003 the Company’sstockholders approved a one-for-ten reverse stock split of the Company’s commonstock and the merger of Olympic into a newly formed, wholly owned subsidiary, “WhittierEnergy Corporation,” a Nevada corporation. On December 31, 2003, Olympic effectedthe one-for-ten reverse split of its common stock and consummated the merger ofOlympic with and into Whittier Energy Corporation. As a result of the reversesplit, the Company’s Series A Preferred Stockautomatically converted into shares of the Company’s split-adjusted commonstock and Whittier Energy’s former shareholders owned approximately 85% of theCompany’s outstanding voting common stock. In June 2004, the Company issuedwarrants and 1.38 million shares of common stock in a private offering.  As a result, Whittier Energy’s formerstockholders presently own approximately 79% of the Company’s outstandingcommon stock (see Note 11).

 

Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with accountingprinciples generally accepted in the United States have been condensed oromitted. Reference should be made to the relevant notes to the financialstatements included in the Company’s Annual Report on Form 10-KSB/A for thefiscal year ended December 31, 2003.

 

The informationfurnished herein was taken from the books and records of the Company withoutaudit. However, the information reflects all adjustments, which are, in theopinion of management, normal recurring adjustments necessary for the fairstatement of the results for the interim period presented. The results ofoperations for the interim period are not necessarily indicative of the resultsto be expected for any future interim period or for the year.

 

7

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**2.             Earnings(Loss) Per Share**

 

Basic and dilutive earnings or loss per common share is calculated bydividing net income or loss by the aggregate weighted average number of sharesoutstanding during the period. Diluted earnings per share considers thedilutive effect of the average number of common stock equivalents, consistingof the Company’s common stock options and warrants, outstanding during theperiod. All of the Company’s outstanding common stock equivalents as ofSeptember 30, 2003 were antidilutive, except for the Company’s Series A Preferred Stock issued as part of the Merger.

 

All share amounts for the periods ended September 30, 2004 and September30, 2003, respectively, have been adjusted to reflect the Company’s one-for-tenreverse stock split and conversion of its Series APreferred Stock into common stock on December 31, 2003.

 

**3.             ComprehensiveIncome (Loss)**

 

The Company applies theprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 130 “ReportingComprehensive Income,” which establishes standards for reporting comprehensiveincome (loss). In addition to net income, comprehensive income (loss) includesall changes to equity during a period, except those resulting from investmentsand distributions to the owners of the Company.

 

The Company recordedunrealized losses on cash flow hedging contracts as components of othercomprehensive income (loss) of $1,794,912, net of deferred taxes of $966,491,and $373,128, net of deferred taxes of $200,912, for the periods ended September30, 2004 and December 31, 2003, respectively. The Company also recordedunrealized gains (losses) on marketable securities as components of othercomprehensive income (loss) of $2,007 net of deferred tax of $1,080, and ($503,068),net of deferred taxes of $270,882, for the periods ended September 30, 2004 andDecember 31, 2003, respectively.

 

Total comprehensiveincome (loss) was ($648,247) and ($671,128) for the three and nine months endedSeptember 30, 2004, respectively. Comparatively, the Company recorded totalcomprehensive income of $489,684 and $62,082 for the three and nine monthsended September 30, 2003, respectively.

 

**4.             StockBased Compensation**

 

The Company accounts for stock based compensation using the intrinsicvalue method under APB 25 “Accounting for Stock Issued to Employees.” SFAS 123requires that pro forma information regarding net income or loss per share bedetermined as if the Company had accounted for its employee stock options underthe fair value method as defined in SFAS 123. We estimate the fair value foroptions issued during the period, if any, as of the date of grant using theBlack-Scholes option pricing model by using weighted average assumptions,volatility factors of the expected market price of the Company’s common stock,and the weighted average life expectancy of the options.

 

8

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In December 2003, the Company’s Board of Directors approved a Long TermIncentive Plan (the “Plan”), which was ratified by the Company’s stockholdersin July 2004. The Plan sets aside a total of 1.56 million shares of the Company’scommon stock for issuance to the Company’s officers, directors, employees, andconsultants. During January 2004, the Company granted a total of 729,000 optionsto purchase the Company’s common stock at an average exercise price of $1.75per share to certain directors, officers, and employees of the Company, ofwhich 15,000 options were cancelled in May 2004. The options vest ratably overa three-year period from the date of grant and have a term of five years. Thefair market value of the net options outstanding on the date of grant wasestimated to be $1,088,611 using the Black-Scholes option pricing model withthe following weighted average assumptions: risk free interest rate of 4%,dividend yield of 0%, volatility factors of the expected market price of theCompany’s common stock of 1.58, and a weighted average life expectancy of the optionsof 3.5 years. The Company issued an additional 59,500 options to variousemployees of the Company during the nine months ended September 30, 2004, withan average exercise price of $1.64 per share, also subject to three yearratable vesting with a term of five years. The fair market value of the optionson the date of grant was estimated to be approximately $51,000 using the BlackScholes option pricing model using weighted average assumptions applicable onthe date of grant.

 

The Company acquired 187,500 options previously issued by Olympic aspart of the Merger, all of which were fully vested as of the date of theMerger.

 

In December 2002,the FASB issued SFAS No. 148, *Accounting forStock-Based Compensation, an Amendment of SFAS No. 123 (“SFAS 123”)*in an effort to encourage the recognition of compensation expense for theissuance of stock options.  The Companyhas elected to continue accounting for stock-based compensation under APBOpinion No. 25 and disclose pro forma net income and earnings per share, as ifthe fair value based method of accounting defined in Statement 123 and 148 hadbeen applied.

 

For purposes ofpro forma disclosures, the estimated fair value of the options is amortized toexpense over the option’s vesting period. The Company’s pro forma information,in thousands, is as follows:

 
| ** **                                   | ** ** | **Three Months  Ended  September 30,  2004** | ** ** | **Three Months  Ended  September 30,  2003** | ** ** | **Nine Months  Ended  September 30,  2004** | ** ** | **Nine Months  Ended  September 30,  2003** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
|                                         |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Net income  (loss) under APB 25              |       | $                                            | 560        |                                         | $          | 270                                         |       | $                                           | 246        |   | $ | (118 | ) |
|                                         |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Effect of SFAS  123                          |       | (96                                          | )          | —                                       |       | (271                                        | )          | —                                      |       |
|                                         |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Pro forma net  income (loss)                 |       | $                                            | 464        |                                         | $          | 270                                         |       | $                                           | (25        | ) | $ | (118 | ) |
|                                         |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Pro forma basic  earnings (loss) per share   |       | $                                            | .04        |                                         | $          | .03                                         |       | $                                           | (.00       | ) | $ | (.01 | ) |
|                                         |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Pro forma  diluted earnings (loss) per share |       | $                                            | .04        |                                         | $          | .03                                         |       | $                                           | (.00       | ) | $ | (.01 | ) |

 

9

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#### **5.    New Accounting Standards**

#### ** **

In June 2001, theFASB issued SFAS 143, “Accounting for Asset Retirement Obligations.” TheStatement requires entities to record the fair value of a liability for legalobligations associated with the retirement obligations of tangible long-livedassets in the period in which it is incurred. When the liability is initiallyrecorded, the entity increases the carrying amount of the related long-livedasset. Over time, accretion of the liability is recognized each period, and thecapitalized cost is depreciated over the useful life of the related asset. Uponsettlement of the liability, an entity either settles the obligation for itsrecorded amount or incurs a gain or loss upon settlement. SFAS 143 is effectivefor fiscal years beginning after June 15, 2002. The Company adopted SFAS 143for the calendar year beginning January 1, 2003. As a result of the adoption,the Company recorded an asset retirement obligation of approximately $35,546,an increase to oil and gas properties of $32,156 and a non-cash charge of$6,361, which was recorded as a Cumulative Effect of Change in AccountingPrinciple at January 1, 2003. The pro-forma effect of the Company’s adoption ofSFAS 143 as of December 31, 2002 was insignificant to the Company’s financialresults and has not been presented.

 

As of September 30,2004, the Company’s future abandonment obligation was estimated to be $100,390,including $86,199 in costs capitalized to oil and gas properties subject todepletion and $14,191 in cumulative accretion expense. The Company incurred $2,385and $5,980 in accretion expense for the three and nine months ended September30, 2004, respectively. Comparatively, the Company had a total futureabandonment obligation outstanding as of December 31, 2003, of $68,698including $60,168 in costs capitalized to oil and gas properties and $8,530 incumulative accretion expense. The Company incurred $1,368 and $3,512 inaccretion expense for the three and nine months ended September 30, 2003,respectively.

 

InApril 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities.” SFAS 149 amends SFAS No.133, “Accountingfor Derivative Instruments and Hedging Activities.” SFAS 149 requires thatcontracts with comparable characteristics be accounted for similarly.  In addition, SFAS 149 also clarifies underwhat circumstances a contract with an initial net investment meets thecharacteristic of a derivative and clarifies when a derivative contains afinancing component. This statement became effective for contracts entered intoor modified after June 30, 2003. The adoption of this statement did not haveany material impact on the Company’s financial position, results of operations,or cash flows.

 

In January 2003, the FASBissued Interpretation 46 “Consolidation of Variable Interest Entities, anInterpretation of Accounting Research Bulletin No. 51” (“FIN 46”) (revisedDecember 2003). FIN 46 will significantly change whether certain variable interestentities (“VIEs”) are consolidated with their sponsors, transferors, orinvestors. FIN 46 introduces a new variable interest consolidation model, whichdetermines control (and consolidation) based on potential variability in gainsand losses of the entity being evaluated for consolidation. These provisionsapply immediately to variable interests in VIEs created after January 15, 2003and are effective for periods ending after December 15, 2003 for VIEs in whichthe Company holds a variable interest that it acquired prior to February 1,2003. The Company does not believe it has any ownership interests in applicableVIEs and, therefore, application of the Interpretation will not have anymaterial impact on the Company’s financial statements.

 

In May 2003, the FASBissued SFAS 150 “Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity.” This statement sets standardsfor classifying and measuring certain financial instruments withcharacteristics of both liabilities and equity. This statement was effectivefor financial instruments entered into after May 31, 2003.  The adoption of SFAS 150 had no effect on theCompany’s financial statements.

 

10

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In June 2001, theFASB issued SFAS No. 141, “Business Combinations,” which requires that allbusiness combinations after June 30, 2001 be accounted for using the purchasemethod of accounting and intangible assets be reported separately fromgoodwill. The FASB also issued SFAS No. 142, “Goodwill and Intangible Assets,” whichestablished that goodwill and other indefinite lived intangible assets shouldbe reviewed annually for impairment and not amortized ratably over a given timeperiod. An issue has arisen regarding the application of SFAS 141 and SFAS 142to the upstream oil and gas industry, among other extractive industries,whether acquisition costs relating to underlying oil and gas reserves should bereclassified as “intangible costs” other than capitalized oil and gas propertycosts. In March 2004, the Emerging Issues Task Force (“EITF”) reached aconsensus that mineral rights are tangible assets. The FASB, ratifying the EITF’sconsensus, issued FASB Staff Position 141-1 and 142-1 in April 2004, amendingSFAS No. 141 and SFAS No. 142 to define mineral rights as tangible assets.  In September 2004, the FASB staff issued aFASB Staff Position affirming that oil and gas mineral rights held under leaseand other contractual arrangements representing the right to extract reservesfor both undeveloped and developed leaseholds need not be classified separatelyfrom oil and gas properties. Therefore, the Company will continue to includeamounts related to undeveloped and developed leaseholds in oil and gasproperties on its consolidated financial statements.

 

In March 2004, an exposure draft was issued by the FASB that wouldamend SFAS No. 123 “Accounting for Stock Based Compensation” and SFAS No. 95 “Statementof Cash Flows.”  This exposure draft iseffective for interim or annual periods beginning after June 15, 2005 and wasissued to provide more complete and higher quality information for investors onemployee stock compensation matters than the current accounting rulesoffer.  As part of this proposal,share-based payments to employees, including stock options, would be treatedthe same as other forms of compensation by recognizing the related expense inthe income statement.  The expense of theshare-based payment would generally be measured at fair value on the date ofgrant.  The current accounting guidanceallows that the expense related to employee stock options be only disclosed inthe footnotes to the financial statements. The Company is currently evaluating the potential impact of the exposuredraft in the event the amendment should be adopted.

 

11

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**6.             MarketableSecurities**

 

The Company’s investments in marketable securities are classified as “available-for-sale”in accordance with SFAS 115, “Accounting for Certain Investments in Debt andEquity Securities.”  As a result, theseinvestments are carried at fair market value as of the relevant balance sheetdates.  Unrealized gains and losses areexcluded from net income and reported in a separate component of stockholder’sequity as cumulative other comprehensive income (loss).

 

The carrying amount and estimated market value of these investments asof September 30, 2004 and December 31, 2003 are as follows:

 
| ** **                                 | ** ** | **As of September 30, 2004** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | **Cost**                     | ** ** | **Fair Value** | ** ** |
|                                       |       |                         |       |   |   |
| Chaparral Resources,  Inc., 543,850 Shares |       | $                            | 543,850    |   | $ | 679,812 |   |
|                                       |       |                         |       |   |   |
| PYR Energy,  Inc., 173,625 Shares          |       | 327,723                      |       | 199,669 |   |
|                                       |       |                         |       |   |   |
| Vangold  Resources, Inc., 54,000 Shares    |       | 17,153                       |       | 12,332 |   |
|                                       |       |                         |       |   |   |
| Total                                      |       | $                            | 888,726    |   | $ | 891,813 |   |
|                                       |       |                         |       |   |   |
| ** **                                 | ** ** | **As of December 31, 2003**  | ** ** |
| ** **                                 | ** ** | **Cost**                     | ** ** | **Fair Value** | ** ** |
|                                       |       |                         |       |   |   |
| Chaparral  Resources, Inc., 543,850 Shares |       | $                            | 1,189,326  |   | $ | 549,288 |   |
|                                       |       |                         |       |   |   |
| PYR Energy,  Inc., 173,625 Shares          |       | 327,723                      |       | 168,416 |   |
|                                       |       |                         |       |   |   |
| Vangold  Resources, Inc., 100,000 Shares   |       | 31,765                       |       | 57,160 |   |
|                                       |       |                         |       |   |   |
| Total                                      |       | $                            | 1,548,814  |   | $ | 774,864 |   |

 

The Companyrecognizes any unrealized gain or loss on its marketable securities when thesecurities are sold or when the Company determines that a permanent impairmenthas occurred. As of March 31, 2004, the Company reclassified its unrealizedloss in Chaparral Resources, Inc. (“Chaparral”) as “other than temporary” andrecognized an impairment of $645,476, reducing the Company’s book basis in thesecurities to $543,850. The Company is evaluating its options to dispose of itsinvestment in Chaparral in order to utilize the proceeds for the acquisition,exploration and development of oil and gas properties.

 

After consideringthe write-down of the Chaparral common stock, the Company has classified the remainingunrealized gains and losses in its marketable securities as temporary in nature.The Company recorded unrealized losses as a component of other comprehensiveincome (loss) of $2,007, net of deferred taxes of $1,080, and $429,639, net ofdeferred taxes of $239,968, for the periods ended September 30, 2004 and 2003,respectively.

 

The Company’sPresident and Chief Executive Officer, Bryce Rhodes, currently serves as anindependent director on PYR’s board of directors, which classifies Mr. Rhodesas an insider of the company. Furthermore, Whittier Ventures, LLC, an affiliateof the Company, owns approximately 10% of the outstanding common stock ofChaparral.

 

12

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**7.             Investmentsin Partnerships**

 

**The original cost basis, cumulativedistributions and book value of the Company’s partnership investments as of September30, 2004, and December 31, 2003, were as follows:**

** **
| ** **                                                           | ** ** | **Investment  Cost Basis** | ** ** | **Cumulative  Distributions** | ** ** | **September 30, 2004  Net Book Value** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|----------------------------------------|------------|
|                                                                 |       |                       |       |                          |       |                                   |       |
| KAB Acquisition  L.P. - II, 8.0% Limited Partnership Interest        |       | $                          | 150,000    |                          | $          | (245,716                               | )          | $ | — |   |
| KAB Acquisition  L.P. - III, 6.4286% Limited Partnership Interest    |       | 150,000                    |       | (168,690                      | )          | —                                 |       |
| KAB Acquisition  L.L.L.P. - IV, 7.2% Limited Partnership Interest    |       | 150,000                    |       | (201,702                      | )          | —                                 |       |
| KAB Acquisition  L.L.L.P. - V, 7.5% Limited Partnership Interest     |       | 150,000                    |       | (128,481                      | )          | 21,519                                 |       |
| KAB Acquisition  L.L.L.P. - VI, 2.1825% Limited Partnership Interest |       | 150,000                    |       | (46,277                       | )          | 103,723                                |       |
| Avalanche  Royalty Partners LLC, 8.925% Membership Interest          |       | 341,000                    |       | (407,946                      | )          | —                                 |       |
| Rincon Energy  Partners, LLC, 10% Membership Interest                |       | 130,282                    |       | —                        |       | 130,282                                |       |
|                                                                 |       |                       |       |                          |       |                                   |       |
| Total                                                                |       | $                          | 1,221,282  |                          | $          | (1,198,812                             | )          | $ | 255,524 |   |
|                                                                 |       |                       |       |                          |       |                                   |       |
| ** **                                                           | ** ** | **Investment  Cost Basis** | ** ** | **Cumulative  Distributions** | ** ** | **December 31, 2003  Net Book Value**  | ** ** |
|                                                                 |       |                       |       |                          |       |                                   |       |
| KAB Acquisition  L.P. - II, 8.0% Limited Partnership Interest        |       | $                          | 150,000    |                          | $          | (198,781                               | )          | $ | — |   |
| KAB Acquisition  L.P. - III, 6.4286% Limited Partnership Interest    |       | 150,000                    |       | (150,258                      | )          | —                                 |       |
| KAB Acquisition  L.L.L.P. - IV, 7.2% Limited Partnership Interest    |       | 150,000                    |       | (165,735                      | )          | —                                 |       |
| KAB Acquisition  L.L.L.P. - V, 7.5% Limited Partnership Interest     |       | 150,000                    |       | (108,860                      | )          | 41,140                                 |       |
| KAB Acquisition  L.L.L.P. - VI, 2.1825% Limited Partnership Interest |       | 150,000                    |       | (20,085                       | )          | 129,915                                |       |
| Avalanche  Royalty Partners LLC, 8.925% Membership Interest          |       | 341,000                    |       | (338,027                      | )          | 2,973                                  |       |
| Rincon Energy  Partners, LLC, 10% Membership Interest                |       | 66,000                     |       | —                        |       | 66,000                                 |       |
|                                                                 |       |                       |       |                          |       |                                   |       |
| Total                                                                |       | $                          | 1,157,000  |                          | $          | (981,746                               | )          | $ | 240,028 |   |

 

**The Company records its book valuein partnership investments at the lower of cost or fair market value, lesscumulative cash distributions from each investment. Cash distributions inexcess of basis are recorded as partnership income and any impairment ofpartnership investment is recorded as a charge to income.  The Company periodically reviews itspartnership investments for impairment by comparing each investment’s bookvalue against its fair value. Management uses its best efforts to estimate fairvalue in its partnership investments, based on the historical and expectedfuture performance of each investment, as well as consideration of anysignificant events affecting the underlying assets of each partnership, whichmay limit the Company’s ability to recover its investment. Any resultingimpairment is recorded in earnings in the period the Company determines suchimpairment exists.**

** **

**The Company recognized partnershipincome of $47,066 and $168,279 for the three and nine months ended September 30,2004, respectively. Comparatively, the Company recognized partnership income of$4,349 and $7,925 for the three and nine months ended September 30, 2003. TheCompany also recognized a loss from the impairment of partnership investmentsof $733,247 for the period ended September 30, 2003, due to the total impairmentof the Company’s investments in the Odin Spirit and the Odin Neptune drillingpartnerships. The general partner of the Odin Neptune partnership disposed ofits principal asset, a semi-submersible rig, for nominal value in July 2003 andthe partnership was fully liquidated. The Odin Spirit partnership’s principalassets, two jack-up drilling rigs, were disposed of to satisfy its third partycreditor, which had foreclosed on the rigs in May 2003. Consequently, theCompany fully impaired both investments as of the quarter ended June 30, 2003.**

 

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**8.             Oiland Gas Properties**

 

Oil and gas properties are accounted for using the successful effortsmethod.  Under this method, explorationcosts (drilling costs of unsuccessful exploration wells, geological andgeophysical costs, and non-producing leasehold amortization and delay rentals)are charged to expense when incurred. Costs to develop producing properties, including drilling costs andapplicable leasehold acquisition costs, are capitalized.  Costs to drill exploratory wells that resultin additions to reserves are also capitalized.

 

Depreciation, depletion and amortization of producing properties,including depreciation of well and support equipment and amortization ofrelated lease costs, are determined by using a unit-of-production method basedupon estimated proved reserves. Acquisition costs of unproved properties are carried at cost untilexploration activities commence.

 

Under the successful efforts method of accounting for oil and gasproperties, the Company periodically assesses its proved properties forimpairments by comparing the aggregate net book value of its proved propertieswith their aggregate estimated future net cash flows. The Company performs aperiodic review for impairment of proved properties on a field by field basis.Unamortized capital costs are measured on a field basis and are reduced to fairvalue if it is determined that the sum of expected future net cash flows isless than the net book value. The Company determines if impairments haveoccurred through either adverse changes or as a result of its periodic reviewof its oil and gas properties. Impairment is measured on discounted cash flowsutilizing a discount rate appropriate for risks associated with the relatedproperties or based on fair market values. No impairment losses were recordedduring the interim periods ended September 30, 2004 and 2003, respectively.

 

The Company recognized $202,770 and $741,500 in exploration expense forthe three and nine months ended September 30, 2004, respectively, including $161,342in geological and geophysical costs incurred during the current period for 3Dseismic data and analysis for the Company’s recently acquired South TexasProperties. The Company incurred $117,554 in exploration expense as a result ofits unsuccessful attempt to sidetrack the Cavenham Forest 5-1 during the secondquarter of 2004.  The Company also expensed$462,604 relating to its non-operated interest in the Anvil Bar #75-26 well, drilledin the San Antonio prospect in Monterey County, California. Attempts tocomplete and stimulate the well in July 2004 were unsuccessful and the Companyfully expensed its costs related to the project in the quarter ended June 30,2004.

 

The Company recognized $1,695,524 in depletion, depreciation andamortization expense for the nine months ended September 30, 2004, compared to$864,752 for the nine months ended September 30, 2003. Comparatively, theCompany recognized $661,760 in depletion, depreciation and amortization expensefor the three months ended September 30, 2004, compared to $367,866 for thethree months ended September 30, 2003.

 

In May 2004, the Company acquired an average 73% working interest inthe Cut Off Field, located in Lafourche Parish,Louisiana, for $1.65 million dollars. In July 2004, the Company acquired an additional 14%average working interest in the field from two other non-related parties forapproximately $400,000, increasing the Company’s working interest in the field toapproximately 87%. The Company financed the May 2004 acquisition of the Cut Off Field using $1.0 million in principal from its existingcredit facility and available working capital.

 

14

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**9.             Acquisitionof South Texas Gas Properties**

 

In June 2004, the Company acquired various operated working interestsin three gas fields in South Texas for approximately $7.5 million (the “Properties”)from various third party owners (the “Sellers”). The Sellers had used theProperties for the exploration, development and production of oil and gas,which is the intended continued use for the acquired assets by the Company.

 

The Company acquired an average 78% working interest in the Properties’seven existing wells and an average 61% working interest in any futureundeveloped locations. Specifically, the Properties consist of workinginterests in the Tom Lyne Field in Live Oak County, Texas, the Scott &Hopper Field in Brooks County, Texas, and the North Rincon Field in StarrCounty, Texas.

 

The consideration paid for the Properties consisted of i) the paymentof approximately $5.7 million in cash; ii) the issuance of a six-year,approximate $1.8 million subordinated note bearing interest at a rate of 7% perannum and convertible into the Company’s common stock at a conversion price of$2.00 per share (the “Convertible Subordinated Note”); iii) a commitment todrill four wells over a 24-month period and to pay certain drilling costs onbehalf of the Sellers’ retained working interests in those wells (the “DrillingCommitment”); iv) certain future price sharing arrangements through June 30,2008 in the event actual prices per Mcf received by the Company exceed agreedupon pricing levels (the “Upside Price Sharing Agreement”); and v) the issuanceof a three year warrant to purchase 300,000 shares of the Company’s commonstock at an exercise price of $2.50 per share.

 

The $5.7 million cash portion of the purchase price was funded through$3.05 million in additional borrowings under the Company’s existing creditagreement (see Note 10), cash proceeds from the sale by the Company of equityin a private offering (see Note 11), and available working capital includingthe Company’s net revenues from the Properties from the March 1, 2004 effectivedate of the transaction. The approximate $1.8 million Convertible SubordinatedNote is more fully described in Note 10.

 

Under the terms of the Drilling Commitment, the Company must drill atotal of four wells, including two wells in the Scott & Hopper Field andtwo wells in the North Rincon Field, or reassign a portion of the undevelopedacreage in the Scott & Hopper and North Rincon fields to the Sellers.  The Company must begin drilling the first twowells on or before March 2005 and June 2005, respectively, in order for theCompany to retain its undeveloped acreage rights in each field.  The Company must begin drilling the next twowells on or before December 2005 and June 2006, respectively, or the Companywill reassign 50% of its undeveloped acreage rights in each field. The Companyhas also agreed to carry the Sellers’ drilling costs for the four wells up to “casingelection point” (i.e. the decision point on whether to complete the well orabandon it as a dry hole). The estimated capital costs to drill these wells,net to the Company’s interest and including the Sellers’ carried interests, isapproximately $3.1 million, which we expect to fund using future cash flowsfrom operations. In the event the Company does not drill the required wells,the Company’s interests in existing wells on the Properties would beunaffected, as well as the Company’s undeveloped acreage in the Tom Lyne Field,which is not subject to the Drilling Commitment.

 

The Company has also entered into a four-year gas price sharingagreement from July 1, 2004 through June 30, 2008. Under the terms of theUpside Price Sharing Agreement, the Sellers will receive 50% of the excess, ifany, of the Company’s net revenues for prices per Mcf received on productionfrom the Properties in excess of an agreed target price during the sharingperiod. The Company has hedged a significant portion of the gas production fromthe Properties in a manner consistent with the Company’s hedging arrangementson production from its existing properties. The net revenues per Mcf receivedwould be calculated as net revenues less hedge settlements, transportation andmarketing costs, divided by net volumes produced. Any resulting payments due tothe Sellers under the Upside Price Sharing Agreement at the end of each 12month period would be netted for any applicable production taxes, as well. Thetarget prices are $6.25, $6.50, $6.75, and $7.00 for the fiscal years endedJune 30, 2005, 2006, 2007, and 2008, respectively.

 

15

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Audited field level operating results for the Properties for the twoyears ended December 31, 2002 and 2003, respectively, and the unaudited interimthree months ended March 31, 2004 are as follows (in thousands):

 
| ** **                              | ** ** | **Three Months  Ended  March 31, 2004** | ** ** | **Year Ended  December 31, 2003** | ** ** | **Year Ended  December 31, 2002** | ** ** |
|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                              | ** ** | ** **                              | ** ** | ** **                        | ** ** | ** **                        | ** ** |
| Oil and gas  sales                      |       | $                                       | 811        |                              | $          | 2,363                             |       | $ | 694 |   |
| Production taxes                        |       | (60                                     | )          | (174                              | )          | (51                               | )          |
| Lease operating  expenses               |       | (75                                     | )          | (239                              | )          | (129                              | )          |
|                                    |       |                                    |       |                              |       |                              |       |
| Field operating  income before DD&A |       | $                                       | 676        |                              | $          | 1,950                             |       | $ | 514 |   |

 

**10.          NotesPayable**

 

On July 17, 2002, the Company signed a revolving credit agreement witha financial institution to borrow up to $15,000,000, based upon the amount ofproved reserves attributable to the Company’s oil and gas properties. Interestexpense is payable monthly at an interest rate equal to 1/4% over prime, aspublished by *The Wall Street Journal*. Thecredit agreement was amended in April 2004 to extend its maturity date to March1, 2006.

 

The Company had net borrowings under the credit agreement of $7,865,000and $4,505,000 as of September 30, 2004, and December 31, 2003, respectively. Duringthe nine months ended September 30, 2004, the Company borrowed a total of $4.05million under the credit agreement to finance its May 2004 acquisition of theCut Off field ($1.0 million) and its June 2004 acquisition of three South Texasgas properties further described in Note 9 ($3.05 million). The Company alsorepaid $690,000 in principal for the nine months ended September 30, 2004, inaccordance with the terms of the credit agreement.

 

Under the credit agreement, the Company incurred interest expense of $215,724and $149,377 during the nine months ended September 30, 2004 and 2003, respectively,all of which was expensed as incurred. As of September 30, 2004, the Companyutilized a total of $265,000 of its available borrowing base under the creditfacility to provide letters of credit against required state bonds in Louisianaand Texas relating to the Company’s operated oil and gas properties. The costsof maintaining the letters of credit, which are not reflected as principal drawdowns under the credit facility, are included in interest expense.

 

The credit agreement is collateralized by substantially all of theCompany’s assets and the Company is subject to various covenants,representations and warranties as established by the credit agreement. Theprimary covenants agreed to by the Company include the following:

 

**•**                  The Company will maintain a total Tangible Net Worthof not less than $4,900,000, plus (a) fifty percent (50%) of net income(excluding losses), and (b) one hundred (100%) of any increases in shareholders’equity resulting from the sale or issuance of equity interests.

** **

•                  The Company willmaintain a ratio of quarterly EBITDAX (net income before interest expenses,taxes, depreciation, depletion, amortization, exploration costs, and othernon-cash expenses less non-cash income and capitalized expenses) to quarterlyinterest expense of not less than 3.00.

 

•                  The Company willmaintain a current ratio, determined quarterly, of Current Assets to CurrentLiabilities, not inclusive of any current portion of principal outstandingunder the credit agreement, of at least one to one.

 

16

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The Company was in compliance with these covenants as of the three and ninemonths ended September 30, 2004 and 2003, respectively.

 

As of September 30, 2004, the Company has classified $1,650,000 of theoutstanding principal under the credit agreement as a current liability, basedon monthly principal payments required as a result of the Company’s latestborrowing base review by the bank performed in September 2004. The bank reviewsthe Company’s borrowing base every six months or in conjunction with a materialacquisition. The Company’s next borrowing base review is scheduled for March2005.

 

Anticipated future maturities of the credit line, based on principaloutstanding as of September 30, 2004, are as follows:

 
| **Year**   | ** ** | **Amount** | ** ** |
|------------|------------|------------|------------|
| 2004       |       | $          | 300,000    |   |
| 2005       |       | 1,800,000  |       |
| 2006       |       | 1,800,000  |       |
| 2007       |       | 1,800,000  |       |
| Thereafter |       | 2,165,000  |       |
|       |       |       |       |
| Total      |       | $          | 7,865,000  |   |

 

In November 2004, the Company borrowed$180,000 under the revolving credit agreement for the purchase of an additional11% working interest in the Rayne Field.

 

As discussed in Note 9, the Company issued to the Sellers of theProperties a Convertible Subordinated Note in the amount of $1,787,330. TheConvertible Subordinated Note, including any accrued interest thereon, is convertibleat any time during its term at a conversion price of $2.00 per share, is fullysubordinated to the Company’s existing credit agreement and may be paid off atany time without penalty to the Company.  No principal payments are required on the ConvertibleSubordinated Note during the first two years it is outstanding. In the eventthe Convertible Subordinated Note is not converted into the Company’s commonstock during this two year period, the Company will repay the principaloutstanding ratably over 48 months until either the Convertible SubordinatedNote has been fully repaid or the remaining principal outstanding on the ConvertibleSubordinated Note is converted into the Company’s common stock. The Companygranted the Sellers “piggy back” registration rights for the shares of commonstock underlying the Convertible Subordinated Note. The Company incurred$31,945 and $36,744 in interest expense on the convertible subordinated notefor the three and nine months ended September 30, 2004, respectively.

 

**11.          CommonStock and Common Stock Equivalents**

 

In December 2003, the Company’s stockholders approved a corporatereorganization of the Company, which included a one-for-ten reverse stocksplit, the reincorporation of the Company from Wyoming to Nevada, and the changeof the Company’s legal name from Olympic Resources Ltd. to Whittier EnergyCorporation. All common stock and common stock equivalents have beenretroactively adjusted to reflect the one-for-ten reverse split, which wasconsummated as of December 31, 2003.

 

In June 2004, the Company closed a private placement with accreditedinvestors for 1.38 million shares of the Company’s common stock priced at $1.75per share and three-year warrants to purchase anadditional 1.38 million shares of common stock at an exercise price of $2.50per share. The private offering was fully subscribed and resulted in totalproceeds to the Company of $2,415,000.  TheCompany also issued 29,613 shares of common stock and a related warrant topurchase an additional 29,613 shares of common stock at an exercise price of$2.50 per share to a registered broker/dealer as payment for services renderedas a placement agent in connection with the private placement.

 

17

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The Company used a significant portion of the net proceeds to finance,in part, its acquisition of the South Texas Properties. See Note 9.

 

The Company has filed a registration statement on Form SB-2 with theU.S. Securities and Exchange Commission to register a portion of (i) the commonstock and (ii) common stock underlying the warrants, issued in the privateoffering, as well as the common stock underlying the warrant and ConvertibleSubordinated Note issued to the Sellers in connection with the Company’sacquisition of the South Texas Properties. Pursuant to the terms of the private offering, if the registrationstatement is not declared effective on or before December 31, 2004, the Companywill be obligated to issue an additional 345,000 shares of common stock and anadditional 345,000 related common stock warrants to the participants in theoffering.

 

In December 2003, the Company’s Board of Directors approved the LongTerm Incentive Plan, which sets aside a total of 1.56 million shares of theCompany’s common stock for issuance to the Company’s officers, directors,employees, and consultants. During the nine months ended September 30, 2004,the Company granted a total of 773,500 options to purchase the Company’s commonstock at an average exercise price of $1.69 per share to certain employees,officers, and directors of the Company. The options vest ratably over a three-yearperiod from the date of grant and have a term of five years. The Plan wasratified by the Company’s stockholders at the Company’s annual meeting held inJuly 2004.

 

In March 2004, 35,000 options to acquire the Company’s common stock atan exercise price of $1.93 per share expired unexercised. In July 2004, optionsto acquire 14,500 shares of the Company’s common stock at an exercise price of$1.93 per share expired unexercised.

 

In June 2004, warrants to purchase 120,000 shares of the Company’scommon stock at an exercise price of $2.70 per share expired unexercised.

 

As discussed in Note 9, in June 2004, the Company issued to the Sellersof the Properties a three-year warrant to purchase 300,000 shares of theCompany’s common stock at an exercise price of $2.50 per share. The fair marketvalue of the warrant on the date of grant was estimated to be $135,000 usingthe Black-Scholes option pricing model with the following weighted averageassumptions: risk free interest rate of 3.26%, dividend yield of 0%, volatilityfactors of the expected market price of the Company’s common stock of .71, anda weighted average life expectancy of the options of 1.5 years.

 

In September 2004, a warrant to purchase 45,000 shares of the Company’scommon stock at an exercise price of $2.00 per share was fully exercised. Thewarrant was issued to Daryl Pollock, a director and former CEO of the Company, aspart of the merger of Whittier Energy and Olympic in September 2003. Thewarrant was subject to an automatic exercise provision effective on the one-yearanniversary of the Merger.

 

**12.          CommodityPrice Risk Hedging Instruments**

 

**The Company held various derivativeinstruments, including crude oil and natural gas option agreements known as “swaps”and “collars” as of September 30, 2004 and 2003, respectively. Swaps aredesigned to fix the price of anticipated sales of future production, whilecollars are designed to establish floor and ceiling prices on anticipated salesof future production. The Company entered into the contracts at the time itacquired certain operated oil and gas property interests as a means to managethe future price volatility on its sales of oil and gas production, as well asto achieve a more predictable cash flow from its oil and gas properties. TheCompany has designated its price hedging instruments as cash flow hedges inaccordance with SFAS 133.**

 

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The Company accounts for its derivatives as cash flow hedginginstruments, recognizes gains or losses on settlement of its hedginginstruments in oil and gas revenues, and reflects changes in their fair valueas a component of other comprehensive income, net of deferred taxes. TheCompany considers the ineffective portion of its hedging instruments to beimmaterial. The Company recognized pre-tax losses in oil and gas revenues of $465,768and $970,370, for the three and nine months ended September 30, 2004,respectively, due to realized settlements of its price hedge contracts duringthe relevant periods. Comparatively, the Company recognized pre-tax losses inoil and gas revenues of $168,495 and $524,296, for the three and nine monthsended September 30, 2003, respectively. The Company recorded unrealized losseson cash flow hedging contracts of $1,794,912, net of deferred taxes of $966,491,and $373,128, net of deferred taxes of $200,912, for the periods ended September30, 2004 and December 31, 2003, respectively.

 

Further details relating to the Company’s hedging activities are asfollows:

 

Hedging Contracts Held as of September 30, 2004:

 
| ** **                         | ** ** | ** **        | ** ** | **Nymex Contract Price** | ** ** |
|------------------------------------|------------|-------------------|------------|--------------------------|------------|
| **Contract Period and Type**       | ** ** | **Total  Volume** | ** ** | **Floor**                | ** ** | **Ceiling/Swap  Price** | ** ** |
|                               |       |              |       |                     |       |   |   |
| **Crude  Oil Contracts (barrels)** |       |              |       |                     |       |   |   |
| Swap Contracts:                    |       |              |       |                     |       |   |   |
| October 2004 –  December 2004 |       | 3,750             |       | N/A                      |       | $ | 22.15 |   |
| October 2004 –  December 2004 |       | 3,000             |       | N/A                      |       | $ | 31.05 |   |
| October 2004 –  December 2004 |       | 6,000             |       | N/A                      |       | $ | 38.38 |   |
| January 2005 –  December 2005 |       | 36,000            |       | N/A                      |       | $ | 34.75 |   |
|                               |       |              |       |                     |       |   |   |
| Collar  Contracts:                 |       |              |       |                     |       |   |   |
| October 2004 –  December 2004 |       | 8,750             |       | $                        | 18.00      |   | $ | 22.00 |   |
| October 2004 –  December 2004 |       | 6,000             |       | $                        | 24.00      |   | $ | 29.25 |   |
| January 2005 –  April 2005    |       | 15,000            |       | $                        | 19.75      |   | $ | 22.75 |   |
| January 2005 –  December 2005 |       | 12,000            |       | $                        | 26.00      |   | $ | 29.20 |   |
| April 2005 –  December 2005   |       | 9,000             |       | $                        | 26.00      |   | $ | 28.95 |   |
| January 2005 –  December 2005 |       | 18,000            |       | $                        | 31.00      |   | $ | 36.95 |   |
| January 2006 –  December 2006 |       | 96,000            |       | $                        | 30.00      |   | $ | 34.25 |   |
|                               |       |              |       |                     |       |   |   |
| **Natural  Gas Contracts (mmbtu)** |       |              |       |                     |       |   |   |
| Swap Contracts                     |       |              |       |                     |       |   |   |
| January 2005 –  December 2005 |       | 120,000           |       | N/A                      |       | $ | 6.02 |   |
|                               |       |              |       |                     |       |   |   |
| Collar  Contracts:                 |       |              |       |                     |       |   |   |
| October 2004 –  December 2004 |       | 6,000             |       | $                        | 4.07       |   | $ | 8.00 |   |
| October 2004 –  December 2004 |       | 15,000            |       | $                        | 4.00       |   | $ | 6.70 |   |
| January 2005 –  December 2005 |       | 120,000           |       | $                        | 4.00       |   | $ | 7.20 |   |
| October 2004 -  December 2004      |       | 90,000            |       | $                        | 6.30       |   | $ | 7.50 |   |
| January 2005 -  March 2005         |       | 72,000            |       | $                        | 6.20       |   | $ | 8.40 |   |
| April 2005 -  September 2005       |       | 144,000           |       | $                        | 5.75       |   | $ | 6.05 |   |
| October 2005 -  December 2005      |       | 72,000            |       | $                        | 5.75       |   | $ | 6.75 |   |
| January 2006 –  December 2006 |       | 120,000           |       | $                        | 5.00       |   | $ | 6.45 |   |

 

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Hedging Contracts Held as of December 31, 2003:

 
| ** **                          | ** ** | ** **       | ** ** | **Nymex Contract Price** | ** ** |
|-------------------------------------|------------|------------------|------------|--------------------------|------------|
| **Contract Period and Type**        | ** ** | **Total Volume** | ** ** | **Floor**                | ** ** | **Ceiling/Swap Price** | ** ** |
|                                |       |             |       |                     |       |   |   |
| **Crude  Oil Contracts (barrels)**  |       |             |       |                     |       |   |   |
| Swap Contracts:                     |       |             |       |                     |       |   |   |
| January 2004 –  December 2004  |       | 15,000           |       | N/A                      |       | $ | 22.15 |   |
|                                |       |             |       |                     |       |   |   |
| Collar  Contracts:                  |       |             |       |                     |       |   |   |
| January 2004 –  September 2004 |       | 9,000            |       | $                        | 24.50      |   | $ | 29.55 |   |
| January 2004 –  December 2004  |       | 35,000           |       | $                        | 18.00      |   | $ | 22.00 |   |
| January 2004 –  December 2004  |       | 24,000           |       | $                        | 24.00      |   | $ | 29.25 |   |
| January 2005 –  April 2005     |       | 15,000           |       | $                        | 19.75      |   | $ | 22.75 |   |
|                                |       |             |       |                     |       |   |   |
| **Natural  Gas Contracts (mmbtu)**  |       |             |       |                     |       |   |   |
| Collar  Contracts:                  |       |             |       |                     |       |   |   |
| January 2004 –  March 2004     |       | 39,900           |       | $                        | 4.00       |   | $ | 8.75 |   |

 

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**Item 2.** Management’sDiscussion and Analysis of Financial Condition and Results of Operations

** **

Business Combination of the Company and Whittier Energy 

 

On September 10, 2003, WEC merged with and into Whittier Energy withWhittier Energy surviving the Merger to become a wholly owned subsidiary of theCompany.  Although the Company was thelegal acquirer of Whittier Energy and continues as a publicly traded entity,Whittier Energy was the acquirer for accounting purposes. As a result, theCompany has conformed to Whittier Energy’s accounting methods following theMerger, including the use of a calendar year-end and reporting our oil and gasactivities using the successful efforts method of accounting. The Merger ismore fully described in the Company’s Form 8-K filed with the SEC on September25, 2003, as amended on November 20, 2003.

 

Company Background 

 

Whittier’s principal business is the acquisition, exploration, anddevelopment of oil and gas properties in the continental United States. Ourassets consist of operated and non-operated working interests, royaltyinterests, partnership interests, and mineral acreage in various oil and gasproperties, principally located in Louisiana, Texas, Oklahoma, and California,with minor property interests in Colorado, Utah, New Mexico, Wyoming, andPennsylvania.

 

Prior to 2002, the Company invested in non-operated working interests,royalty interests, and various limited partnership interests in oil and gasproperties, as well as other investments related to the oil and gas industry,such as drilling rig partnerships and private placements in marketablesecurities in public energy companies. These investments were funded throughinternally generated cash flows from operations.  During 2002, we expanded our investmentstrategy to include the acquisition of oil and gas properties we would operatedirectly and completed two significant operated property acquisitions. In April2002, Whittier Energy acquired an 89% working interest in the Beaver Dam CreekUnit in St. Helena Parish, Louisiana, for approximately $3.5 million. In July2002, Whittier Energy acquired a 100% working interest in the Big Wells Fieldin Dimmit County, Texas, for approximately $1.65 million. We financed thepurchase of the two properties using a combination of available working capitaland approximately $3.55 million in debt provided by a revolving credit facilityfrom a third party bank (the “Credit Facility”). The Credit Facility isdiscussed in more detail below.

 

Throughout 2003, we continued to execute our strategy to invest inoperated and non-operated oil and gas properties, including $400,000 to acquirean approximate 21% operated working interest in the Rayne Field in AcadiaParish, Louisiana in March 2003, the effective acquisition of our non-operatedgas properties (principally in California) through the September 2003 businesscombination with Olympic (non-cash), and the $1.2 million acquisition of a61.38% operated working interest in the Bonnie View Field in Refugio County,Texas in November 2003. The Company financed the purchase of the Rayne Fieldusing available working capital and $360,000 in borrowings from the CreditFacility, while the Bonnie View Field acquisition was financed using $600,000in working capital and $600,000 in principal from the Company’s CreditFacility.

 

During the nine months ended September 30, 2004, the Company hasaccelerated its growth through acquisitions and operated and non-operateddrilling activities. In February and March 2004, the Company acquired anadditional 10% working interest in the Bonnie View Field for approximately$195,000, utilizing proceeds from its February 2004 sale of its non-operating interestin the Cascade Unit for $525,000.

 

In May 2004, the Company acquired an approximate 73% operated workinginterest in the Cut Off Field in Lafourche Parish,Louisiana for approximately $1.65 million. The Company funded the acquisitionutilizing a combination of working capital and $1.0 million in additionalprincipal borrowed under the Credit Facility. The Company acquired anadditional 14% working interest in the Cut Off Field inJuly 2004 from two third party sellers for approximately $400,000, increasingits overall interest in the field to approximately 87%.

 

In June 2004, the Company acquired various operated working interestsin three gas fields in South Texas for approximately $7.5 million (the “Properties”),of which approximately 50% is considered undeveloped. The Company acquired anaverage 78% working interest in the Properties’ existing wells and an average61% working interest in any future undeveloped locations. The Propertiesconsist of working interests in the Tom Lyne Field in Live Oak County, Texas,the Scott & Hopper Field in Brooks County, Texas, and the North RinconField in Starr

 

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County, Texas.

 

The Company financed the acquisition of the Properties using a mixtureof operating cash flow, equity financing, bank financing, and convertiblesubordinated debt. The consideration paid for the Properties consisted of i)the payment of approximately $5.7 million in cash; ii) the issuance of asix-year, approximate $1.8 million subordinated note bearing interest at a rateof 7% per annum and convertible into the Company’s common stock at a conversionprice of $2.00 per share (the “Convertible Subordinated Note”); iii) acommitment to drill four wells over a 24 month period and pay certain drillingcosts on behalf of the Sellers’ retained working interests in those wells (the “DrillingCommitment”); iv) certain future price sharing arrangements through June 30,2008 in the event actual prices per Mcf received by the Company exceed agreedupon pricing levels; and v) the issuance of a three-year warrant to purchase300,000 shares of the Company’s common stock at an exercise price of $2.50 pershare.

 

The $5.7 million cash portion of the purchase price was funded through$3.05 million in additional borrowings under the Company’s Credit Facility,cash proceeds from the sale by the Company of equity in a private offering, andavailable working capital including the Company’s net revenues from theProperties from the March 1, 2004 effective date of the transaction. In June2004, the Company closed the private placement, raising $2.4 million throughthe issuance of 1.38 million shares of the Company’s common stock and anaccompanying three year warrant to purchase 1.38 million shares of common stockat an exercise price of $2.50 per share.

 

The terms of the acquisition are more fully described in Note 9 to theCompany’s financial statements included herein.

 

In November 2004, Whittier borrowed an additional $180,000 from theCredit Facility, which was utilized to acquire an additional 11% workinginterest in the Rayne field for approximately $174,000 increasing the Company’stotal working interest to approximately 33%.

 

As of December 31, 2003, the Company had total proved reserves of1,960,862 barrels of oil equivalent (“Boe”), consisting of 1,462,770 barrels ofoil and 2,989 million cubic feet of gas (“Mmcf”), of which 97% is consideredproved developed producing. Comparatively, we had total proved reserves of 1,802,769 Boe and 302,183 Boe as ofDecember 31, 2002 and December 31, 2001, respectively. This represents an 8.8%increase in proved reserves from 2002 and a 549% increase from 2001.  The Company added an additional 472,630 Boein proved reserves from its June 2004 acquisition of the South Texas’Properties, including 32,130 barrels of oil and 2,643 Mmcf of gas of which 59%are proved developed reserves. The Company will update its reserve estimatesfor all of its properties as of year end December 31, 2004, including obtainingindependent reserve estimates for the Cut Off Field.

 

Liquidity and Capital Resources

 

During the nine months ended September 30, 2004, the Company generatedapproximately $3.1 million in net cash flows from operations and had a networking capital deficit of approximately $.8 million. Not considering thecurrent portion of its Credit Facility, which includes anticipated principalpayments through September 30, 2005, the Company had positive net workingcapital of approximately $.9 million as of September 30, 2004.  The Company is currently producing, net toits interest, approximately 1,100****Boe per day, including 584****barrelsof oil per day (“Bopd”) and 3.1****million cubic feet of gas per day (“Mmcfd”),and is generating net positive cash flow from its operations.

 

The Credit Facility provides for a total potential revolving creditline of $15 million, the availability of which is determined based on the valueof the Company’s proved oil and gas reserves. During the nine months endedSeptember 30, 2004, we borrowed a total of $4.05 million in principal from theCredit Facility in order to finance producing property acquisitions, as well asrepaid $690,000 in principal. The Credit Facility is collateralized bysubstantially all of the Company’s assets and subjects the Company to variouscovenants, representations and warranties as established by the underlyingcredit agreement. The terms and conditions of the Credit Facility are morefully described in Note 10 to the Company’s financial statements includedherein.

 

As of September 30, 2004, the Company had $7.87 million in principaloutstanding under the Credit Facility, of which $1.65 million was classified asa current liability payable on or before September 30, 2005. The Company isrequired to repay principal at a rate of $150,000 per month beginning November1, 2004, subject to adjustment at the Company’s next borrowing base review bythe bank scheduled for March 2005. The Company expects to fully fund its futureprincipal payments required on the Credit Facility and its future capitalrequirements for the

 

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exploration and development of its existing oil and gasproperties using cash flows generated from operations. The ConvertibleSubordinated Note does not require any principal payments prior to June 2006and will not have any significant impact on the Company’s short-term liquidity.

 

The Company’s future liquidity, in both theshort and long-term, is principally dependent upon the volume of our oil andgas production, as well as the market price we receive on future sales of thatproduction. The Company’s proved reserves primarily consist of proved developedproducing reserves, which we believe provide a core basis of future productionand internal cash flow necessary to fund our day-to-day business activities.

 

We have hedged aportion of our production to manage our exposure to oil and gas pricevolatility, as well as to achieve more predictable cash flows from our oil andgas properties. The Company has also utilized hedges to support a higher borrowingbase under the Credit Facility, allowing the Company to access additional debtfinancing for its producing oil and gas property acquisitions. Hedging willprevent the Company from receiving the full advantage of increases in oil orgas prices above the fixed amount specified in the underlying hedge agreement.Whittier’s outstanding hedge positions as of September 30, 2004 are more fully described in Note 12 to theCompany’s financial statements included herein.

 

The long-term growth of the Company depends on our ability to replaceand extend our existing proved oil and gas reserve base, as well as to increaserates of production from new and existing properties in order to generatehigher oil and gas revenues. The Company seeks to accomplish steady andsustainable growth of its proved reserves and future production rates throughthe acquisition, exploration and development of additional oil and gasproperties, as well as continued exploitation and development of existingproperties. We presently intend to fund future growth using a combination ofavailable working capital, third party debt financing, and the issuance of ourequity and/or debt securities. The Company is also considering options todispose of its investment in certain marketable securities in order to reinvestthe proceeds into oil and gas properties.

 

Capital Commitments and Contingencies 

 

Under the terms of the Drilling Commitment, the Company must drill atotal of four wells, including two wells in the Scott & Hopper Field andtwo wells in the North Rincon Field, or reassign a portion of the undevelopedacreage in the Scott & Hopper and North Rincon fields to the Sellers.  The Company must begin drilling the first twowells on or before March 2005 and June 2005, respectively, in order for theCompany to retain its undeveloped acreage rights in each field.  The Company must begin drilling the next twowells on or before December 2005 and June 2006, respectively, or the Companywill reassign 50% of its undeveloped acreage rights in each field. The Companyhas also agreed to carry the Sellers’ drilling costs for the four wells up to “casingelection point” (i.e. the decision point on whether to complete the well orabandon it as a dry hole). The estimated capital costs to drill these wells,net to the Company’s interest and including the Sellers’ carried interests, isapproximately $3.1 million, which we expect to fund using future cash flowsfrom operations. In the event the Company does not drill the required wells,the Company’s interests in existing wells on the Properties would beunaffected, as well as the Company’s undeveloped acreage in the Tom Lyne Fieldwhich is not subject to the Drilling Commitment. The Company is in the processof sourcing a suitable rig for the initial Scott & Hopper well under theDrilling Commitment, which must be spudded on or before March 17, 2005.

 

In October and November 2004, Whittier acquired a 30% operated workinginterest in each of the Rachal and Amber prospects, respectively. The Companyintends to drill a well in the Rachal prospect in December 2004 and the testwell in the Amber prospect in the first quarter of 2005. The Company’sestimated total net drilling and completion costs related to these two wells isapproximately $390,000, which the Company intends to finance out of cash flowfrom operations.

 

Results of Operations 

 

*Forthe Quarter Ended September 30, 2004 compared with the Quarter Ended September30, 2003*

 

We generated net income of approximately $560,000, or $0.05 per share,for the quarter ended September 30, 2004, compared to net income of $270,000,or $0.03 per share, for the comparable period ended September 30, 2003, anincrease of approximately 107%. The$290,000 variance primarily relates to higher production and revenues duringthe latest quarter.

 

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During the quarter ended September 30, 2004, we generated oil and gasrevenues of approximately $2.9 million, or $33.01 per Boe, on production of approximately 86,856 Boe (47,774 Bbls oil and 234 Mmcf gas). For the comparable period in2003, we generated revenues of approximately $1.5 million, or $27.08 per Boe, on production ofapproximately 55,614 Boe (38,335 Bblsoil and 104 Mmcf gas). The 90% increase in revenues was based upon acombination of 56% higherproduction volumes as well as 22%higher average prices obtained for oil and gas sold during the current period.The increase in production in the current period resulted from the Company’sproducing property acquisitions since June 2003, including the East Corningfield (September 2003), the Bonnie View field (November 2003 and February2004), the Cut Off field (May and July 2004), and the Tom Lyne, Scott &Hopper and North Rincon fields in June 2004. The Company also experiencedhigher production from the Company’s investment in the Greater Mayfield area inOklahoma.

 

Lease operating expenses (“LOE”) increased by $393,000, or 85%, from$463,000 for the quarter ended September 30, 2003 to $856,000 for the quarterended September 30, 2004, while LOE per unit of production increased 18% from $8.33 per Boe to $9.86 perBoe between the two periods. Depletion, depreciation, and amortization (“DD&A”)increased from approximately $368,000, or $6.62 per Boe, for the quarter ended September 30, 2003, to$662,000, or $7.62 per Boe, forthe quarter ended September 30, 2004. The increase in operating costs relatesto additional workover and stimulation costs incurred during 2004 to enhanceproduction. The increase in DD&A is related to greater totalproduction during the current period as a result of our acquisitions completedin late 2003 and 2004, as well as a higher DD&A rate per unit of productionassociated with our California and South Texas gas property acquisitions.

 

The Company recognized approximately $203,000 in exploration expenseduring the three months ended September 30, 2004, including approximately$161,000 incurred to acquire and begin reprocessing 3D seismic data for theSouth Texas Properties purchased in June 2004.

 

General and administrative expenses were approximately $409,000 for thethree months ended September 30, 2004, compared to $233,000 for the comparableperiod ended September 30, 2003. The Company also recognized a deferred taxbenefit of approximately $178,000 for the quarter ended September 30, 2004, dueto deferred tax assets for tax loss carryforwards previously subject to avaluation allowance.

 

*Forthe Nine Months Ended September 30, 2004 compared with the Nine Months EndedSeptember 30, 2003*

 

We generated net income of approximately $246,000, or $0.02 per share,for the nine months ended September 30, 2004, compared to a net loss of($118,000), or ($0.01) per share, for the comparable period ended September 30,2003. The net income generated duringthe period ended September 30, 2004 was driven by higher production andrevenues during the period, partially offset by $742,000 in explorationexpenses, as well as the $645,000 impairment of the Company’s investment incertain marketable securities. The Company’s net loss for the nine months endedSeptember 30, 2003 was principally due to the $733,000 impairment of theCompany’s investment in certain drilling rig partnerships.

 

During the nine months ended September 30, 2004, we generated oil andgas revenues of approximately $6.9 million, or $31.49 per Boe, on production of approximately 220,468 Boe (130,699****Bbls oil and 539 Mmcf gas). For thecomparable period in 2003, we generated revenues of approximately $4.4 million,or $26.93 per Boe, on productionof approximately 163,871 Boe (120,630Bbls oil and 259 Mmcf gas). The 57% increase in revenues was basedprimarily upon higher production volumes (35%), as well as higher prices obtained for oil and gas soldduring the current period (17%).The increase in production in the current period resulted from the Company’sproducing property acquisitions since June 2003, including the East Corningfield (September 2003) the Bonnie View field (November 2003 and February 2004),the Cut Off field (May and July 2004), and the Tom Lyne, Scott & Hopper andNorth Rincon fields in June 2004. The Company also experienced higherproduction from the Company’s investment in the Greater Mayfield area inOklahoma.

 

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LOE increased by $370,000, or 23%, from $1,625,000 for the period endedSeptember 30, 2003 to $1,995,000 for the period ended September 30, 2004, whileLOE per unit of production decreased by 9%from $9.92 per Boe to $9.05 per Boe between the two periods.DD&A increased from approximately $865,000, or $5.28 per Boe, for the nine months ended September 30, 2003, to$1,696,000, or $7.69 per Boe,for the nine months ended September 30, 2004. The decrease in operating costs perunit of production relates to non-recurring workover and stimulation costsincurred during 2003 in the Beaver Dam Creek and Big Wells Fields in order toenhance production. The increase in DD&A is related to greater totalproduction during the current period as a result of our acquisitions completedin late 2003 and 2004, as well as a higher DD&A rate per unit of productionassociated with our California and South Texas gas property acquisitions.

 

The Company recognized approximately $742,000 in exploration expenseduring the nine months ended September 30, 2004, including $581,000 in dry holecosts and $161,000 in geological and geophysical costs of 3D seismic data andanalysis for the Company’s recently acquired South Texas gas properties. TheCompany incurred approximately $118,000 in exploration expense as a result ofits unsuccessful attempt to sidetrack the Cavenham Forest 5-1 well in theBeaver Dam Creek field due to mechanical problems. The Company also expensed$463,000 related to its non-operated interest in the Anvil Bar #75-26 well, drilled in the San Antonio prospect in MontereyCounty, California. Attempts to complete and stimulate the well in July 2004were unsuccessful and the Company fully expensed its costs related to theproject in the quarter ended June 30, 2004. All of the applicable costsassociated with the Anvil Bar well had been previously accrued by the Companyas of December 31, 2003.

 

General and administrative expenses were approximately $1,146,000 forthe nine months ended September 30, 2004, compared to $689,000 for the comparableperiod ended September 30, 2003. The increase of $457,000 reflects our enhancedoperational activity from the prior year, including establishing new corporateheadquarters in Houston, Texas, transitioning from a private to a publiccompany, and increasing the Company’s staff from one to six full-timeemployees.

 

For the nine months ended September 30, 2004, the Company recognized again of approximately $242,000 on the sale of an approximate 5% workinginterest in the Cascade Unit in Los Angeles County, California, for $525,000.The comparable period in 2003, the Company recognized a loss of $31,000 on thesale of a non-operated oil and gas property interest for approximately $36,000.

 

In the periodended September 30, 2004, the Company reclassified its unrealized loss inChaparral as “other than temporary” and recognized an impairment ofapproximately $645,000. The Company is evaluating its options to dispose of itsinvestment in Chaparral and intends to monetize its investment in order toutilize the proceeds for the acquisition, exploration and development of oiland gas properties.

 

During the period ended September 30, 2003, the Company recognized aloss on impairment of partnership investments of approximately $733,000, due tothe total impairment of our investments in the Odin Spirit and the Odin Neptunedrilling rig partnerships. The general partner of the Odin Neptune partnershipdisposed of its principal asset, a semi-submersible rig, for nominal value inJuly 2003 and the partnership was fully liquidated. The Odin Spirit partnership’sprincipal assets, two jack-up drilling rigs, were disposed of to satisfy itsthird party creditor, which had foreclosed on the rigs in May 2003.Consequently, the Company fully impaired both investments as of the quarterended June 30, 2003.

 

Off-Balance Sheet Arrangements

 

We are not a party to any off balance sheet arrangements.

 

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**Item 3.****Controls and Procedures**

 

**Evaluationof Disclosure Controls and Procedures**

 

### **Theterm “disclosure controls and procedures” (defined in Rule 13a-15(e)) refers tothe controls and procedures of a company that are designed to ensure thatinformation required to be disclosed by a company in the reports that it filesunder the Securities and Exchange Act of 1934 (the “Exchange Act”) is recorded,processed, summarized and reported within required time periods.  Whittier’s Chief Executive Officer and ChiefFinancial Officer, who also serves as the principal accounting officer, haveevaluated the effectiveness of the Company’s disclosure controls and proceduresas of a date within 90 days before the filing of this quarterly report, andthey concluded that, as of such date, Whittier’s controls and procedures wereeffective.**

 

 

**Part II– Other Information**

 

#### **Item2 – Changes in Securities**

 

On September 10, 2004, the Company issued 45,000 shares of common stockto Daryl Pollock, a director and former CEO of the Company, upon the automaticexercise of a warrant to purchase 45,000 shares of the Company’s common stockat an exercise price of $2.00 per share. The warrant was originally issued toMr. Pollock as part of the merger of Whittier Energy and the Company inSeptember 2003 and, pursuant to its terms, automatically converted into theCompany’s common stock at the one year anniversary date of the merger. Accordingto the terms and conditions of the warrant, deferred compensation owed to Mr.Pollock was applied to the aggregate exercise price of the warrant, and noproceeds were received by the Company.  TheCompany issued the warrant in reliance upon the exemption from registrationunder Section 4(2) of the Securities Act of 1933, as amended. The certificateissued to Mr. Pollock bears an appropriate restrictive legend under theSecurities Act of 1933, as amended.

 

#### **Item6 – Exhibits and Reports on Form 8-K**

#### ** **

**Open**

 

(a)                                  Exhibits

 

Exhibit 31.1           Certificationof Chief Executive Officer pursuant to Securities Exchange Act of 1934 Rule13a-14(a) or 15d-14(a)

 

Exhibit 31.2           Certificationof Chief Financial Officer pursuant to Securities Exchange Act of 1934 Rule13a-14(a) or 15d-14(a)

 

Exhibit 32.1           Certificationspursuant to Securities Exchange Act of 1934 Rule 13a-14(b) or 15d-14(b) and 18U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-OxleyAct of 2002

 

(b)                                 Reportson Form 8-K

 

(i)                                     8-K Report filed on July 2, 2004 – Item2. Acquisition of Assets.

 

(ii)                                  8-K Report filed on July 15, 2004 – Item5. Other Events.

 

(iii)                               8-K Report filed on July 15, 2004 – Item5. Other Events.

 

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### **Signatures**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| Dated:   November 12, 2004 |                        |
|-------------------------------------------|-----------------------------|
|                                      |                        |
|                                      |                        |
|                                      | Whittier Energy Corporation |
|                                      |                        |
|                                      |                        |
|                                      | By:                         | */s/ Bryce W. Rhodes* | * * |
|                                      |                        | Bryce W. Rhodes |
|                                      |                        | President, Chief Executive Officer, and Director |
|                                      |                        |   |
|                                      |                        |   |
|                                      | By:                         | */s/ Michael B. Young* | * * |
|                                      |                        | Michael B. Young |
|                                      |                        | Chief Financial Officer, Treasurer and Controller |
|                                      |                        | (Principal Financial and Accounting Officer) |

 

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