<PAGE>   1

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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

                                    FORM 10-K

[X]     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
                              EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998


                                       OR

[ ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
                              EXCHANGE ACT OF 1934

                   Commission File No. 0-19136 (Common Stock)
                      and 333-9045 (Series B Senior Notes)
                      and 333-38075 (Series D Senior Notes)

                           NATIONAL ENERGY GROUP, INC.
             (Exact name of registrant as specified in its charter)

                 DELAWARE                                    58-1922764
     (State or other jurisdiction of                        (IRS Employer
      incorporation or organization)                     Identification No.)

          4925 GREENVILLE AVENUE
              DALLAS, TEXAS                                     75206
 (Address of principal executive offices)                    (Zip code)

                                 (214) 692-9211
              (Registrant's telephone number, including area code)
           Securities registered pursuant to Section 12(b) of the Act:
                                      None
           Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $0.01 par value
                                (Title of Class)
            Securities registered pursuant to Securities Act of 1933:
                    Series B Senior Notes, 10 3/4% due 2006
                    Series D Senior Notes, 10 3/4% due 2006

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments hereto to this Form 10-K. Yes [X] No [ ]

         The aggregate market value of the shares of Common Stock held by
non-affiliates of the Registrant, as of March 24, 1999, (based upon the last
sales price of $.10 as reported by the OTC Bulletin Board was $3,341,072.

         40,527,482 shares of the Registrant's common stock, $0.01 par value,
were outstanding on March 24, 1999.

         The information required by Part III of this Report is incorporated by
reference from Registrant's definitive proxy statement for its 1999 Annual
Meeting of Stockholders (to be filed with the Commission not later than April
30,1999, or in the event of delay of the annual meeting, from a Form 10-KA filed
no later than April 30, 1999).


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<PAGE>   2


                                TABLE OF CONTENTS

<TABLE>
<CAPTION>

                                                      PART I
                                                                                                            Page
                                                                                                            ----
<S>                                                                                                         <C>
ITEMS 1. AND 2. BUSINESS AND PROPERTIES
              Background and Recent Development.............................................................   3
              Forward-Looking Statements....................................................................   3
              Principal Areas of Operations.................................................................   4
              Oil and Natural Gas Reserves..................................................................   6
              Oil and Natural Gas Production and Unit Economics.............................................   7
              Productive Well Summary.......................................................................   8
              Leasehold Acreage.............................................................................   8
              Drilling Activity.............................................................................   9
              Title to Oil and Natural Gas Properties.......................................................   9
              Production and Sales Prices...................................................................   9
              Control Over Production Activities............................................................   9
              Markets and Customers.........................................................................   9
              Regulation....................................................................................  10
              Operational Hazards and Insurance.............................................................  13
              Competition...................................................................................  13
              Office Space..................................................................................  13
              Employees.....................................................................................  13
ITEM 3.       LEGAL PROCEEDINGS.............................................................................  14
ITEM 4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........................................  14

                                                     PART II

ITEM 5.       MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
                  STOCKHOLDER MATTERS.......................................................................  15
              Market Information............................................................................  15
              Holders.......................................................................................  15
              Dividends on Common Stock.....................................................................  15
ITEM 6.       SELECTED FINANCIAL DATA.......................................................................  16
ITEM 7.       MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                  CONDITION AND RESULTS OF OPERATIONS.......................................................  18
              Overview......................................................................................  18
              Results of Operations.........................................................................  19
              Liquidity and Capital Resources...............................................................  21
              Future Capital Requirements...................................................................  22
              103/4% Senior Notes Due 2006................................................................... 23
              Credit Facilities.............................................................................  23
              Preferred Stock...............................................................................  24
              Financial Reporting Impact of Full Cost Method of Accounting..................................  25
              Recent Accounting Pronouncements..............................................................  25
              Changes in Prices and Inflation...............................................................  25
              Year 2000.....................................................................................  26
ITEM 7A.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....................................  27
ITEM 8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................................................  27
ITEM 9.       CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
                  ON ACCOUNTING AND FINANCIAL DISCLOSURE....................................................  27
</TABLE>


                                       1
<PAGE>   3

<TABLE>
<CAPTION>


                                                     PART III
<S>                                                                                                          <C>
ITEM 10.      DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................................  27
ITEM 11.      EXECUTIVE COMPENSATION........................................................................  27
ITEM 12.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................................  28
ITEM 13.      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................  28

                                                      PART IV

ITEM 14.      EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K...............................  29
              Signatures....................................................................................  36
</TABLE>


                                       2
<PAGE>   4



                                                      PART I

ITEMS 1. AND 2. BUSINESS AND PROPERTIES

BACKGROUND AND RECENT DEVELOPMENTS

     National Energy Group, Inc. was incorporated under the laws of the State of
Delaware on November 20, 1990. Effective June 11, 1991, Big Piney Oil and Gas
Company and VP Oil, Inc. merged with and into the Company. On August 29, 1996,
Alexander Energy Corporation was merged with and into a wholly-owned subsidiary
of the Company, which subsidiary was merged with and into the Company on
December 31, 1996.

     The Company is an independent energy company which has historically engaged
in the exploration, acquisition, exploitation, development and operation of oil
and natural gas properties in major producing basins onshore in Texas,
Louisiana, Oklahoma, Arkansas, and Mississippi, and offshore in the Gulf of
Mexico.

     On December 4, 1998 the Company's 10 3/4% Senior Note bondholders filed an
Involuntary Petition for an Order for Relief under Chapter 11 of Title 11 of the
United States Bankruptcy Code in the United States Bankruptcy Court for the
Northern District of Texas, Dallas Division, due to non-payment of interest due
December 2, 1998, after expiration of a 30-day grace period. On December 23,
1998, the Company filed in the Bankruptcy Court, an Answer to and Motion to
Dismiss the pending Involuntary Petition. The Company's Motion affirmed that it
(i) was meeting its obligations and generally paying its debts as they became
due, unless such debts were the basis of a bona fide dispute and (ii) had
arranged with the lender under its credit facility to borrow additional funds
sufficient to pay the interest due on the 10 3/4% Senior Notes, conditioned upon
the Court's dismissal of the Involuntary Petition. However, on February 8, 1999,
the Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary
Petition. An Order for Relief was entered by the Bankruptcy Court on February
11, 1999. The Order for Relief places the Company under the protection of the
Court and precludes payment of the interest on the Senior Notes at this time.
The Company shall act as debtor-in-possession and will continue to operate its
business and manage its properties in the ordinary course of business during its
Chapter 11 proceeding. The Company anticipates proposing a Plan of
Reorganization within 120 days of February 11, 1999 or at such time as may be
extended by the Court. As of December 4, 1998, the Company discontinued the
accrual of interest related to unsecured liabilities subject to compromise.

     Due to the Chapter 11 filing and severely depressed oil prices, the Company
has suspended its exploratory drilling program. The Company will limit its
capital expenditures to ordinary course enhancement of current production
through workovers, recompletions, and other production enhancing activities
deemed to be economic given current depressed oil and gas prices. Development
drilling is anticipated to be limited to (i) ordinary course non-operated wells
in which the Company owns limited working interests and in which the failure to
participate may result in drainage, depletion or loss of current reserves and
(ii) operated wells deemed to be economical given current oil and gas prices.
Large expenditures for developmental drilling may require court approval and
none are planned at this time.

    At December 31, 1998, the Company had estimated Proved Reserves, as
determined from reserve reports prepared by the Company's in-house engineers, of
104.9 Bcfe with a PV10% at that date of approximately $75.9 million. The
reserves were approximately 74% natural gas and 88% Proved Developed Reserves.

FORWARD-LOOKING STATEMENTS

    This document includes "forward-looking statements" within the meaning of
various provisions of the Securities Act and the Securities Exchange Act of
1934, as amended. The words "expect," "estimate." "anticipate," "predict,"
"believe," and similar expressions and variations thereof are intended to
identify forward-looking statements. All statements, other than statements of
historical facts, included in this document that address activities, events, or
developments that the Company expects or anticipates will or may occur in the
future, including such things as estimated future net revenues from oil and
natural gas reserves and the present value thereof, drilling of wells, future
production of oil and gas, future capital expenditures (including the amount and
nature thereof), business strategy 





                                       3

<PAGE>   5


and measures to implement strategy, competitive strengths, goals, expansion, and
growth of the Company's business and operations, plans, references to future
success, references to intentions as to future matters and other such matters
are forward-looking statements and include statements regarding the interest,
belief or current expectations of the Company, its directors, or its officers
regarding such matters. These statements are based on certain assumptions and
analyses made by the Company in light of its experience and its perception of
historical trends, current conditions and expected future developments as well
as other factors it believes are appropriate under the circumstances. However,
whether actual results and developments will conform with the Company's
expectations and predictions is subject to a number of risks and uncertainties,
including the risk factors discussed in this document, future oil and gas
prices, future operating costs, severance and excise taxes, actions and
approvals of the Bankruptcy Court, general economic, market or business
conditions, the opportunities (or lack thereof) that may be presented to and
pursued by the Company, competitive actions by other oil and natural gas
companies, changes in laws or regulations, and other factors, many of which are
beyond the control of the Company. Consequently, all of the forward-looking
statements made in this document are qualified by these cautionary statements
and there can be no assurance that the actual results or developments
anticipated by the Company will be realized or, even if substantially realized,
that they will have the expected consequences to or effects on the Company or
its business or operations. Such statements are not guarantees of future
performance and actual results or developments may differ materially from those
projected in the forward-looking statements.

PRINCIPAL AREAS OF OPERATIONS

    Due to the Chapter 11 filing and severely depressed oil prices, the Company
has suspended its exploratory drilling program. However, the Company currently
has an inventory of exploratory prospects in Louisiana and offshore at Mustang
Island.

    Historically, the Company has developed and exploited existing properties by
drilling Development Wells, and recompleting and reworking existing wells. The
Company will continue to participate in non-operated wells as described above
and continue its drilling operations where economical in accordance with the
rulings and procedures set forth by the Court.

    The following table sets forth the Company's principal areas of operations
and the Company's Proved Reserves of oil and natural at December 31, 1998. See -
"Oil and Natural Gas Properties".

<TABLE>
<CAPTION>

                                                                          NATURAL
                                             OIL AND         NATURAL        GAS
                                            CONDENSATE        GAS         EQUIVALENT       % OF
                                              (MBBLS)        (MMCF)        (MMCFE)         TOTAL
                                           ------------   ------------   ------------   ------------
<S>                                        <C>            <C>            <C>            <C>
Area:
   Mid-Continent .......................            594         42,230         45,793           43.6%
   East and West Texas .................          1,262         24,658         32,232           30.8
   Gulf Coast ..........................          2,758         10,354         26,900           25.6
                                           ============   ============   ============   ============
     Total .............................          4,614         77,242        104,925          100.0%
                                           ============   ============   ============   ============
</TABLE>

     The following table sets forth the Company's production by principal area
of operation for the year ended December 31, 1998:

<TABLE>
<CAPTION>

                                                                          NATURAL
                                             OIL AND         NATURAL        GAS
                                            CONDENSATE        GAS         EQUIVALENT       % OF
                                              (MBBLS)        (MMCF)        (MMCFE)         TOTAL
                                           ------------   ------------   ------------   ------------
<S>                                        <C>            <C>            <C>            <C>
Area:
   Mid-Continent .......................             99          5,722          6,317           33.8%
   East and West Texas .................            485          4,199          7,109           38.1
   Gulf Coast ..........................            654          1,334          5,259           28.1
                                           ============   ============   ============   ============
     Total .............................          1,238         11,255         18,685          100.0%
                                           ============   ============   ============   ============
</TABLE>

    MID-CONTINENT AREA

    At December 31, 1998, approximately 43.6% (45.8 Bcfe) of the Company's
Proved Reserves were located in the Mid-Continent area in Oklahoma and Western
Arkansas which includes the Anadarko and Arkoma Basins.












                                       4
<PAGE>   6

    ANADARKO BASIN. The Anadarko Basin is considered a mature oil and natural
gas province characterized by multiple producing horizons and relatively long
reserve lives. Drilling a Producing Well on these locations can convert Proved
Undeveloped Reserves to Proved Developed Producing Reserves, and can provide
additional PUD locations on the Company's leasehold acreage.

    The Company's Anadarko Basin properties were initially drilled on 640 acre
producing units. Industry has successfully demonstrated to Oklahoma regulators
that deeper wells in the Anadarko Basin will not efficiently drain 640 acres and
have obtained authorization for increased density drilling on smaller acreage
units. Further, under the forced pooling rules in Oklahoma, even if the Company
is not the operator of the property for which increased density drilling has
been approved, the Company may propose to drill and operate additional wells on
the original production unit. Frequently this results in the proposing party
owning a larger portion of newly drilled wells because other Working Interest
owners may decline to participate.

    During the year ended December 31, 1998, the Company drilled 7 Gross (2.4
Net) Development Wells in the Anadarko Basin of which 5 Gross (1.6 Net)
Development Wells were completed as commercially productive. The Company's wells
typically are completed in horizons ranging in depth between 7,000 and 15,000
feet.

    ARKOMA BASIN. Most Arkoma Basin reserves are produced from formations at
depths ranging from approximately 3,000 to 8,000 feet.

    During 1998, the Company drilled 3 Gross (1.5 Net) Development Wells in the
Arkoma Basin of which 1 Gross (.2 Net) Development Well was completed as
commercially productive. The typical Arkoma Basin well is drilled to a total
depth of approximately 7,500 feet.

    EAST AND WEST TEXAS AREA

    At December 31, 1998, approximately 30.8% (32.2 Bcfe) of the Company's
Proved Reserves were located in the East and West Texas area, including East
Texas and the Goldsmith Adobe Unit in West Texas.

    EAST TEXAS. These reserves are found in the Cotton Valley formation and the
Travis Peak formation. The Cotton Valley formation is generally found at depths
of 8,500 to 10,500 feet in the Company's area of interest. These properties
produce from low permeability reservoirs that generally contain relatively long
life natural gas reserves. A significant portion of the cost to complete Cotton
Valley wells is incurred due to the low permeability of interbedded sandstones
and shales, which requires large hydraulic fracture stimulation, typically of
multiple zones of the producing formation, to obtain the increased production
levels necessary to make such wells commercially viable. The Travis Peak
formation is generally found at a depth of 7,200 feet and principally contains
oil reserves.

    During the year ended December 31, 1998, the Company drilled 2 Gross (2 Net)
Development Wells in the Travis Peak formation in East Texas both of which were
completed as commercially productive.

    GOLDSMITH ADOBE UNIT ("GAU"). The Goldsmith Adobe Unit is in the Permian
Basin in West Texas. The Company owns approximately a 95% Working Interest in
the GAU, which it operates.

    Originally the GAU was drilled on 40 acre spacing units. Previous operators
had drilled several wells on 20 acre spacing units and, based on the results of
this drilling and 20 acre spacing development on adjoining leases, the Company
began a drilling program in July 1994 to develop the GAU on 20 acre spacing
units. During 1998, the Company drilled and completed as commercially
productive, 4 Gross (3.8 Net) Development Wells on the GAU.

    Typically, wells drilled by the Company in the GAU in 1998 were drilled to
depths between 5,600 and 6,000 feet into the Clearfork formation.


                                       5
<PAGE>   7



    GULF COAST AREA

    At December 31, 1998, 25.6% (26.9 Bcfe) of the Company's Proved Reserves
were located in the Gulf Coast areas, principally in the Greater Bayou Sorrel
Area in Iberville Parish, Louisiana and at Mustang Island in offshore Gulf of
Mexico. The Company also has participated in exploratory activity in various
parishes throughout Southern Louisiana.

    GREATER BAYOU SORREL AREA. The Greater Bayou Sorrel Area is located
approximately eighty miles west of New Orleans, in Iberville Parish, Louisiana,
in the Atchafalaya River Basin. The target formations of the Company's
exploration prospects in this area range from approximately 11,000 to 14,000
feet and include the Marg Vag, Marg Howeii, Camerina, Cib Haz, and Marg Tex
zones. The topography of the surface is river swamp and all work must be done
with barge-mounted drilling rigs and boats. Production platforms are mounted on
pilings. The Company first participated in the successful exploratory test of
the Schwing #1 well in the Company's East Bayou Sorrel prospect in January 1996.
This discovery well was drilled to a total depth of approximately 14,000 feet on
the eastern flank of the old Bayou Sorrel Field, which was discovered by Shell
Oil Company in 1954. The old Bayou Sorrel Field was drilled in the 1950s and
1960s, with a total of 87 wells drilled and produced in twenty-eight different
horizons ranging in depths from 7,000 to 11,100 feet. During 1997, the Company
successfully drilled and completed a second test well, the Schwing #2.

    During 1998, the Company drilled 2 Gross (1.2 Net) Exploratory Wells in the
Greater Bayou Sorrel area both of which were determined to be dry holes. Also
during 1998, the Company successfully drilled and completed 1 Gross (.8 Net)
Development Well in the Greater Bayou Sorrel area.

    The Company has completed shooting, processing and interpreting, an
approximate 54 square mile 3-D seismic survey over the Greater Bayou Sorrel
Area. The Company has identified additional potential drilling locations for
prospects in this area through interpretation of the 3-D seismic data. The
Greater Bayou Sorrel Area has produced and continues to produce significant oil
and gas. Because of the difficult topography, very little seismic data had been
acquired prior to the Company's 3-D survey. The Company controls approximately
13,400 acres either by lease or option to lease, within the Greater Bayou Sorrel
Area.

    In March 1998, the Company acquired Fortune Natural Resources Corporation's
interests in the East Bayou Sorrel field for approximately $4.5 million in cash.

    MUSTANG ISLAND. The Mustang Island area is located offshore in shallow state
waters in Nueces County, Texas. The Company currently has approximately a 92%
working interest in approximately 16,000 gross acres of leases, majority
interests in 2 producing wells, 11 miles of pipeline, and an onshore tank
facility. In addition, the Company participated in a 3-D seismic survey over the
area, which provided approximately 90 square miles of data. Several exploratory
opportunities have been identified from this 3-D seismic data. The Company did
not drill any wells at Mustang Island during 1998.

    In June 1998, the Company acquired Germany Oil Company's interest in six
state leases and one producing well in the Mustang Island area for $.4 million
in cash.

    OTHER SOUTH LOUISIANA. The Company has also participated in exploratory
prospects outside of the Greater Bayou Sorrel area in various parishes in South
Louisiana. During 1998, the Company drilled 5 Gross (2.7 Net) Exploratory Wells
in various parishes located in South Louisiana, of which 1 Gross (.3 Net)
Exploratory Well was completed as commercially productive.

OIL AND NATURAL GAS RESERVES

    The estimated reserves and related future net revenues as of December 31,
1998, were prepared by the Company's in-house engineers. All of the Company's
reserves are located in the continental United States. This reserve report was
prepared using constant prices and costs in accordance with the published
guidelines of the SEC. The net weighted average prices used in the Company's
reserve report at December 31, 1998, were $10.46 per 








                                       6
<PAGE>   8



barrel of oil and $2.06 per Mcf of natural gas. The estimation of reserves and
future net revenues can be materially affected by the oil and gas prices used in
preparing the reserve report. Substantially all of the Company's oil and natural
gas properties are subject to liens, and the remaining oil and natural gas
properties are subject to a negative pledge pursuant to the Company's credit
facility.

    All reserves are evaluated at constant temperature and pressure which can
affect the measurement of natural gas reserves. Estimated operating costs,
development costs, abandonment costs and certain production-related and ad
valorem taxes were deducted in arriving at the estimated future net cash flows.
No provision was made for income taxes. The following estimates set forth
reserves considered to be economically recoverable under normal operating
methods and existing conditions at the prices and operating costs prevailing at
the dates indicated above. The estimates of the PV10% from future net cash flows
can differ from the Standardized Measure of discounted future net cash flows set
forth in the notes to the Financial Statements of the Company, which is
calculated after provision for future income taxes. There can be no assurance
that these estimates are accurate predictions of future net cash flows from oil
and natural gas reserves or their present value.

    Reservoir engineering is a subjective process of estimating the volumes of
underground accumulations of oil and natural gas that cannot be measured in an
exact way. The accuracy of any reserve estimates is a function of the quality of
available data and of engineering and geological interpretation and judgment.
Reserve estimates prepared by other engineers might differ from the estimates
contained herein. Results of drilling, testing, and production subsequent to the
date of the estimate may justify revision of such estimate. Future prices
received for the sale of oil and natural gas may be different from those used in
preparing these reports. The amounts and timing of future operating and
development costs may also differ from those used. Accordingly, reserve
estimates are often different from the quantities of oil and natural gas that
are ultimately recovered.

    No estimates of Proved Reserves of oil and natural gas have been filed by
the Company with, or included in any report to, any United States authority or
agency (other than the SEC) since December 31, 1997.

    The following table sets forth certain information for the Company's total
Proved Reserves of oil and natural gas and the PV10% of estimated future net
revenues from such reserves, at December 31, 1998. Also presented is the
Standardized Measure of the Company's total Proved Reserves of oil and natural
gas.

<TABLE>
<CAPTION>

                                                             AS OF DECEMBER 31, 1998
                                           ---------------------------------------------------------
                                                             NATURAL     NATURAL GAS       PV10%
                                               OIL             GAS        EQUIVALENT        (IN
                                             (MBBLS)         (MMCF)        (MMCFE)       THOUSANDS)
                                           ------------   ------------   ------------   ------------

<S>                                         <C>           <C>            <C>            <C>         
Proved Developed Reserves ..............          4,188         67,039         92,166   $     68,973
Proved Undeveloped Reserves ............            426         10,203         12,759          6,904
                                           ------------   ------------   ------------   ------------
Total Proved Reserves ..................          4,614         77,242        104,925   $     75,877
                                           ============   ============   ============   ============
Standardized Measure ...................                                                $     75,877
                                                                                        ============
</TABLE>

OIL AND NATURAL GAS PRODUCTION AND UNIT ECONOMICS

    The following table shows the approximate net production attributable to the
Company's oil and natural gas interests, the average sales price per barrel of
oil and Mcf of natural gas produced, and the average unit economics per Mcfe
related to the Company's oil and natural gas production for the periods
indicated. Information relating to


                                       7
<PAGE>   9
properties acquired or disposed of is reflected in this table only since or up
to the closing date of their respective acquisition or sale, and may affect the
comparability of the data between the periods presented.

<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31,
                                                     ------------------------------------
                                                        1996         1997         1998
                                                     ----------   ----------   ----------
<S>                                                  <C>          <C>          <C>       
Net production:
   Oil (Mbbls) ...................................          522        1,110        1,238
   Natural gas (Mmcf) ............................        5,681       13,146       11,255
   Natural gas equivalent (Mmcfe) ................        8,811       19,807       18,685
Average sales price:
   Oil (per Bbl) .................................   $    21.70   $    19.17   $    12.66
   Natural gas (per Mcf) .........................         2.26         2.37         2.02
Unit economics (per Mcfe):
   Average sales price ...........................   $     2.74   $     2.65   $     2.06
   Lease operating expenses ......................          .41          .34          .46
   Oil and gas production taxes ..................          .15          .16          .13
   Depletion rate (excluding writedowns) .........         1.10         1.11         1.06
   General and administrative expenses ...........          .24          .22          .33
</TABLE>

PRODUCTIVE WELL SUMMARY

    The Company's production of oil and natural gas is primarily derived from
wells located in Texas, Oklahoma, Louisiana, and Arkansas. The following table
sets forth the Company's interests in Productive Wells, by principal area of
operation, as of December 31, 1998:

<TABLE>
<CAPTION>
                                   OIL             NATURAL GAS            TOTAL
                            -----------------   -----------------   -----------------
                             GROSS      NET      GROSS      NET      GROSS      NET
                            -------   -------   -------   -------   -------   -------
                            <S>       <C>       <C>       <C>       <C>       <C>
Area:
   Mid-Continent .........        67      20.2       280     136.3       347     156.5
   East and West Texas ...       135     124.1        37      35.1       172     159.2
   Gulf Coast ............        22      18.0         9       4.9        31      22.9
                             =======   =======   =======   =======   =======   =======
     Total ...............       224     162.3       326     176.3       550     338.6
                             =======   =======   =======   =======   =======   =======
</TABLE>

LEASEHOLD ACREAGE

    The following table shows the approximate Gross and Net Acres in which the
Company had a leasehold interest as of December 31, 1998:

<TABLE>
<CAPTION>
                                            DEVELOPED ACREAGE    UNDEVELOPED ACREAGE
                                           -------------------   -------------------
                                            GROSS        NET      GROSS       NET
                                           --------   --------   --------   --------
<S>                                        <C>        <C>        <C>        <C>
Area:
   Mid-Continent .......................    104,654     53,900      3,700      2,494
   East and West Texas .................     17,863     14,315      6,374      3,656
   Gulf Coast ..........................     15,778     10,657     30,832     22,045
                                           ========   ========   ========   ========
     Totals ............................    138,295     78,872     40,906     28,195
                                           ========   ========   ========   ========
</TABLE>

    The Company generally acquires a leasehold interest in the properties to be
explored. The leases grant the lessee the right to explore for and extract oil
and natural gas from a specified area. Lease rentals usually consist of a fixed
annual charge made prior to obtaining production. Once production has been
established, a royalty is paid to the lessor based upon the gross proceeds from
the sale of oil and natural gas. Once wells are drilled, a lease generally
continues as long as production of oil and natural gas continues. In some cases,
leases may be acquired in exchange for a commitment to drill or finance the
drilling of a specified number of wells to predetermined depths.

    Substantially all of the Company's producing oil and natural gas properties
are located on leases held by the Company for an indeterminate number of years
as long as production is maintained. All of the Company's non-producing acreage
is held under leases from mineral owners or a government entity which expire at
varying dates. The Company is obligated to pay annual delay rentals to the
lessors of certain properties in order to prevent the 



                                       8
<PAGE>   10
leases from terminating. Delay rentals were approximately $1.0 million for the
year ended December 31, 1997 and were approximately $.9 million for the year
ended December 31, 1998, and could increase in future periods depending on the
Company's lease acquisition activities.

DRILLING ACTIVITY

    The following table sets forth exploration and development drilling results
for the years ended December 31, 1996, 1997, and 1998.

<TABLE>
<CAPTION>

                                                    YEAR ENDED DECEMBER 31,
                                 ---------------------------------------------------------------
                                        1996                  1997                   1998
                                 -------------------   -------------------   -------------------
                                   GROSS      NET       GROSS       NET       GROSS        NET
                                 --------   --------   --------   --------   --------   --------

<S>                              <C>        <C>        <C>        <C>        <C>        <C>
 Exploratory
   Productive ................          3        1.4          2        1.0          1         .3
   Non-productive ............          5        1.1          6        2.4          6        3.6
                                 --------   --------   --------   --------   --------   --------
     Total ...................          8        2.5          8        3.4          7        3.9
                                 --------   --------   --------   --------   --------   --------

Development
   Productive ................         28       25.6         67       58.5         13        8.4
   Non-productive ............          1         .2          2        1.5          4        2.1
                                 --------   --------   --------   --------   --------   --------
     Total ...................         29       25.8         69       60.0         17       10.5
                                 --------   --------   --------   --------   --------   --------
Combined Total ...............         37       28.3         77       63.4         24       14.4
                                 ========   ========   ========   ========   ========   ========
</TABLE>


TITLE TO OIL AND NATURAL GAS PROPERTIES

    The Company has acquired interests in producing wells and undeveloped
acreage in the form of Working Interests, Royalty Interests, and Overriding
Royalty Interests. To reduce the Company's financial exposure in any one
exploratory prospect, the Company often acquires less than 100% of the Working
Interest in a prospect. Working Interests held by the Company may, from time to
time, become subject to minor liens. Prior to an acquisition, due diligence
investigations are made in accordance with standard practices in the industry,
which may include securing an acquisition title opinion.

PRODUCTION AND SALES PRICES

    The Company produces oil and natural gas solely in the continental United
States. The Company has no obligations to provide a fixed and determinable
quantity of oil and/or natural gas in the future under existing contracts or
agreements. Nor does the Company refine or process the oil and natural gas it
produces, but sells the production to unaffiliated oil and natural gas
purchasing companies in the area in which it is produced. The Company expects to
sell crude oil on a market price basis and to sell natural gas under contracts
to both interstate and intrastate natural gas pipeline companies. The Company
currently sells a significant portion of oil pursuant to a contract with Plains
Marketing and Transportation. See "-- Markets and Customers."

CONTROL OVER PRODUCTION ACTIVITIES

    The Company operated 394 of the 550 producing wells in which it owned an
interest as of December 31, 1998. The non-operated properties are operated by
unrelated third parties pursuant to operating agreements which are generally
standard in the industry. Significant decisions about operations regarding
non-operated properties may be determined by the outside operator rather than by
the Company. If the Company declines to participate in additional activities
proposed by the outside operator under certain operating agreements, the Company
will not receive revenues from, and/or will lose its interest in the activity in
which it declined to participate.

MARKETS AND CUSTOMERS

    The availability of a ready market for any oil and natural gas produced by
the Company and the prices obtained for such oil and natural gas depend upon
numerous factors beyond its control, including the demand for and supply of oil
and natural gas; fluctuations in production and seasonal demand; the
availability of adequate pipeline and 








                                       9
<PAGE>   11



other transportation facilities; weather conditions; economic conditions;
imports of crude oil; production by and agreements among OPEC members; and the
effects of state and federal governmental regulations on the import, production,
transportation, sale and taxation of oil and natural gas. The occurrence of any
factor that affects a ready market for the Company's oil and natural gas or
reduces the price obtained for such oil and natural gas, may adversely affect
the Company.

    A large percentage of the Company's oil and natural gas sales are made to a
small number of purchasers. The Company normally sells its oil under six month
contracts. During 1996, Plains Marketing and Transportation accounted for 83% of
the Company's oil sales, while Crosstex Energy and GPM Natural Gas Corporation
each accounted for 22% of the Company's natural gas sales. For the year ended
December 31, 1997, Plains accounted for 84% of the Company's oil sales, and
Crosstex and GPM accounted for 20% and 14%, respectively, of the Company's
natural gas sales. For the year ended December 31, 1998, Plains accounted for
85% of the Company's oil sales, and Crosstex and Aquila Energy Marketing
accounted for 23% and 26%, respectively, of the Company's natural gas sales. The
agreement with Plains, entered into in 1993, provides for Plains to purchase the
Company's oil pursuant to West Texas Intermediate posted prices plus a premium.
The Company does not believe that the loss of any purchaser would have a
material adverse effect on its business because, under prevailing market
conditions, such purchaser could be replaced.

    A portion of the Company's natural gas production is sold pursuant to long
term netback contracts. Under netback contracts, gas purchasers buy gas from a
number of producers, process the gas for natural gas liquids, and sell the
liquids and residue gas. Each producer receives a fixed portion of the proceeds
from the sale of the liquids, and residue gas. The gas purchasers pay for
transportation, processing, and marketing of the gas and liquids, and assume the
risk of contracting pipelines and processing plants in return for a portion of
the proceeds of the sale of the gas and liquids. Generally, because the
purchasers are marketing large volumes of hydrocarbons gathered from multiple
producers, higher prices may be obtained for the gas and liquids. A portion of
the Company's natural gas production is also sold under forward sales contracts.
See Note 9 of Notes to Consolidated Financial Statements. Deliveries under these
contracts are priced based on NYMEX prices less a differential whereby the
Company may fix the price for deliveries under these contracts at any time three
days prior to the close of the then current contract based on the NYMEX prices
at that time. The Company pays the cost of transportation of the natural gas to
the delivery point specified in these contracts. The remainder of the Company's
natural gas is sold on the spot market under short-term contracts.

REGULATION

    GENERAL. The Company's oil and natural gas exploration, production, and
related operations are subject to extensive rules and regulations promulgated by
federal and state agencies. Failure to comply with such rules and regulations
can result in substantial penalties. The regulatory burden on the oil and gas
industry increases the Company's cost of doing business and affects its
profitability. Because such rules and regulations are frequently amended or
interpreted by federal and state agencies or jurisdictions, the Company is
unable to predict the future cost or impact of complying with such laws.

    EXPLORATION AND PRODUCTION. The Company's exploration and development
operations are subject to various types of regulation at the federal, state, and
local levels. Such regulation includes requiring permits for the drilling of
wells; maintaining bonding requirements in order to drill or operate wells; and
regulating the location of wells, the method of drilling and casing wells, the
surface use and restoration of properties upon which wells are drilled, and the
plugging and abandoning of wells. The Company's operations are also subject to
various conservation regulations and rules to protect the correlative rights of
mineral interest owners. These include the regulation of the size of drilling
and spacing units or proration units, the density of wells which may be drilled,
and the unitization or pooling of oil and natural gas properties. In this
regard, some states allow the forced pooling or integration of tracts to
facilitate exploration, while other states rely on voluntary pooling of land and
leases. In addition, some state conservation laws establish maximum rates of
production from oil and natural gas wells, generally prohibit the venting or
flaring of natural gas, and impose certain requirements regarding the ratability
of production. The effect of these regulations is to limit the amounts of oil
and natural gas the Company can produce from its wells and to limit the number
of wells or the locations at which the Company can drill. Legislation in
Oklahoma and regulatory 








                                       10
<PAGE>   12


action in Texas governs the methodology by which the regulatory agencies
establish permissible monthly production allowables. The Company cannot predict
what effect any change in prorationing regulations might have on its production
and sales of natural gas.

    Certain of the Company's Oil, Gas and Mineral Leases are granted by the
federal government and administered by various federal agencies. Such leases
require compliance with detailed federal regulations and orders which regulate,
among other matters, drilling and operations on these leases and calculation and
disbursement of royalty payments to the federal government. The Mineral Lands
Leasing Act of 1920 places limitations on the number of acres under federal
leases that may be owned in any one state.

    ENVIRONMENTAL PROTECTION AND OCCUPATIONAL SAFETY. The Company is subject to
numerous federal, state and local laws and regulations governing the release of
materials into the environment or otherwise relating to environmental
protection. These laws and regulations may require the acquisition of a permit
before drilling commences, restrict the types, quantities and concentration of
various substances that can be released into the environment in connection with
drilling and production activities, limit or prohibit drilling activities on
certain lands lying within wilderness, wetlands and other protected areas, and
impose substantial liabilities for pollution resulting from operations.
Moreover, the recent trend toward stricter standards in environmental
legislation and regulation is likely to continue. For instance, legislation has
been proposed in Congress from time to time that would reclassify certain oil
and natural gas production wastes as "hazardous wastes," which reclassification
would make such wastes subject to much more stringent handling, disposal, and
clean-up requirements. If such legislation were to be enacted, it could have a
significant impact on the operating costs of the Company, as well as the oil and
gas industry in general. It is not anticipated that the Company will be required
in the near future to expend amounts that are material in relation to its total
capital expenditure program by reason of environmental laws and regulations, but
because such laws and regulations are frequently changed, the Company is unable
to predict the ultimate cost and effects of such compliance.

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

    In addition, the U.S. Oil Pollution Act of 1990 (the "OPA") and regulations
promulgated pursuant thereto impose a variety of regulations on responsible
parties related to the prevention of oil spills and liability for damages
resulting from such spills. The OPA establishes strict liability for owners of
facilities that are the site of a release of oil into "waters of the United
States." While OPA liability more typically applies to facilities near
substantial bodies of water, at least one district court has held that OPA
liability can attach if the contamination could enter waters that may flow into
navigable waters.

    Stricter standards in environmental legislation may be imposed in the oil
and gas industry as the result of the reclassification of certain oil and
natural gas exploration and production wastes as "hazardous oil and gas wastes,"
which could make the reclassified wastes subject to more stringent and costly
handling, disposal and clean-up requirements. The impact of any such
requirements, however, would not likely be any more burdensome to the Company
than to any other similarly situated company involved in oil and natural gas
exploration and production.

    The Resource Conservation and Recovery Act ("RCRA") and regulations
promulgated thereunder govern the generation, storage, transfer and disposal of
hazardous wastes. RCRA, however, excludes from the definition of hazardous
wastes "drilling fluids, produced waters, and other wastes associated with the
exploration, development, or production of crude oil, natural gas, or geothermal
energy." Because of this exclusion, many of the Company's







                                       11
<PAGE>   13


operations are exempt from RCRA regulation. Nevertheless, the Company must
comply with RCRA regulations for any of its operations that do not fall within
the RCRA exclusion (such as painting activities or use of solvents).

    Because oil and natural gas exploration and production, and possibly other
activities, have been conducted at some of the Company's properties by previous
owners and operators, materials from these operations remain on some of the
properties and in some instances require remediation. In addition, the Company
has agreed to indemnify some sellers of producing properties from whom the
Company has acquired reserves against certain liabilities for environmental
claims associated with such properties. While the Company does not believe that
costs to be incurred by the Company for compliance and remediating previously or
currently owned or operated properties will be material, there can be no
guarantee that such costs will not result in material expenditures.

    Additionally, in the course of the Company's routine oil and natural gas
operations, surface spills and leaks, including casing leaks of oil or other
materials occur, and as a result, the Company incurs costs for waste handling
and environmental compliance. Moreover, the Company is able to control directly
the operations of only those wells for which it acts as the operator.
Notwithstanding the Company's lack of control over wells in which the Company
owns an interest but is operated by others, the failure of the operator to
comply with applicable environmental regulations may, in certain circumstances,
be attributable to the Company.

    The Company is also subject to laws and regulations concerning occupational
safety and health. While it is not anticipated that the Company will be required
in the near future to expend amounts that are material in the aggregate to the
Company's overall operations by reason of occupational safety and health laws
and regulations, the Company is unable to predict the ultimate cost of
compliance.

    MARKETING AND TRANSPORTATION. Federal legislation and regulatory controls in
the United States have historically affected the price of the natural gas
produced by the Company and the manner in which such production is marketed. The
transportation and sales for resale of natural gas in interstate commerce are
regulated pursuant to the Natural Gas Act of 1938 (the "NGA") and the Federal
Energy Regulatory Commission ("FERC") regulations promulgated thereunder.
Maximum selling prices of certain categories of natural gas, whether sold in
interstate or intrastate commerce, previously were regulated pursuant to The
Natural Gas Policy Act of 1978 ("NGPA"). The NGPA established various categories
of natural gas and provided for graduated deregulation of price controls of
several categories of natural gas and the deregulation of sales of certain
categories of natural gas. All price deregulation contemplated under the NGPA
has already taken place. Subsequently, the Natural Gas Wellhead Decontrol Act of
1989 (the "Decontrol Act") terminated all remaining NGA and NGPA price and
non-price controls on wellhead sales of domestic natural gas on January 1, 1993.
While natural gas producers may currently make sales at uncontrolled market
prices, Congress could re-enact price controls in the future.

    In April 1992, the FERC issued its restructuring rule, known as Order No.
636 ("Order No. 636"), that has had a major impact on pipeline operations,
services, and rates. The most significant provisions of Order No. 636: (i)
required interstate pipelines to provide firm and interruptible transportation
solely on an "unbundled" basis, separate from their sales service, and to
convert each pipeline's bundled firm sales service into unbundled firm
transportation service; (ii) provided for the issuance of blanket certificates
to pipelines to provide unbundled sales service giving all utility customers a
chance to purchase their firm supplies from non-pipeline merchants; (iii)
required that pipelines provide firm and interruptible transportation service on
a basis that is equal in quality for all natural gas supplies, whether purchased
from the pipeline or elsewhere; (iv) required that pipelines provide a new,
non-discriminatory "no-notice" transportation service that largely replicates
the "bundled" sales service previously provided by pipelines; (v) established
two new, generic programs for the reallocation of firm pipeline capacity; (vi)
required that all pipelines offer access to their storage facilities on a firm
and interruptible basis; (vii) provided for pregranted abandonment of pipeline
sales agreements, interruptible and firm short-term (defined as one year or
less) transportation agreements and conditional pregranted abandonment of firm
long-term transportation service; (viii) modified transportation rate design by
requiring that all fixed costs related to transportation be recovered through
the reservation charge; and (ix) provided mechanisms for the recovery by
pipelines of certain transition costs occurring from implementation of Order No.
636.





                                       12
<PAGE>   14

    The rules contained in Order No. 636, as amended by Order No. 636-A (issued
in August 1992) and Order No. 636-B (issued in November 1992) (collectively,
"Order No. 636"), are far-reaching and complex. While Order No. 636 does not
directly regulate natural gas producers such as the Company, the FERC has stated
that Order No. 636 is intended to foster increased competition within the gas
industry.

OPERATIONAL HAZARDS AND INSURANCE

    The Company's operations are subject to all of the risks inherent in oil and
natural gas exploration, drilling and production. These hazards can result in
substantial losses to the Company due to personal injury and loss of life,
severe damage to and destruction of property and equipment, pollution or
environmental damage, or suspension of operations. The Company maintains
insurance of various types customary in the industry to cover its operations.
The Company believes it is insured prudently against certain of these risks. In
addition, the Company maintains operator's extra expense coverage that provides
coverage for the care, custody and control of wells drilled by the Company. The
Company's insurance does not cover every potential risk associated with the
drilling and production of oil and natural gas. The Company does, however,
maintain levels of insurance customary in the industry to limit its financial
exposure in the event of a substantial environmental claim resulting from sudden
and accidental discharges. However, 100% coverage is not maintained. The
occurrence of a significant adverse event, the risks of which are not fully
covered by insurance, could have a material adverse effect on the Company's
financial condition and results of operations. Moreover, no assurance can be
given that the Company will be able to maintain adequate insurance in the future
at rates it considers reasonable. The Company believes that it operates in
compliance with government regulations and in accordance with safety standards
which meet or exceed industry standards.

COMPETITION

    The oil and gas industry is intensely competitive in all of its phases. With
the decline in prices, the reduction in exploratory drilling, the reduction in
available capital markets and debt financing becoming scarce for energy
activities, competition for the acquisition of desirable producing Oil, Gas and
Mineral Leases and oil and natural gas companies with production has increased.
The Company, which is a small competitive factor in the industry, encounters
strong competition from major oil companies, independent oil and natural gas
concerns, and individual producers and operators, many of which have financial
resources, staffs, facilities and experience substantially greater than those of
the Company. Depressed energy prices have caused many energy companies to seek
merger candidates resulting in the combination of many small energy companies
into larger and more competitive entities. Furthermore, in times of high
drilling activity, exploration for and production of oil and natural gas may be
affected by the availability of equipment, labor, supplies and by competition
for drilling rigs. The Company cannot predict the effect these factors will have
on its operations. The Company owns no drilling rigs, and it is anticipated that
its drilling will be conducted by third parties. Furthermore, the oil and gas
industry also competes with other industries in supplying the energy and fuel
requirements of industrial, commercial, and individual consumers.

OFFICE SPACE

    The Company leases approximately 25,000 square feet of office space in
Dallas, Texas. The Company also leases a small amount of office space in Odessa,
Texas, Fort Smith, Arkansas and Yukon, Oklahoma for its business activities.

EMPLOYEES

    At March 24, 1999, the Company had 54 full-time employees. Of these
employees, eight are field-related personnel. The Company does not have any
collective bargaining agreements with employees and believes that relations with
its employees are generally satisfactory.




                                       13
<PAGE>   15


ITEM 3. LEGAL PROCEEDINGS

    The Company filed suit against Mr. R. E. Steakley in August 1995 to enjoin
Mr. Steakley from interfering with the operations of the Company. Mr. Steakley
counterclaimed against the Company for surface damages, alleging certain
environmental claims. In February 1999, without admitting any liability, the
Company and Mr. R. E. Steakley entered into a Settlement and Release Agreement
which provided that each of the Company and Mr. Steakley release and discharge
the other from all claims and damages which may have occurred through January
31, 1999 and dismiss the pending lawsuits against each other. The Company
further agreed to pay Mr. Steakley an amount of $75,000, purchase certain
materials from Mr. Steakley at market value which the Company shall use to
maintain roads incidental to its operations on the Steakley property and limit
the Company's ingress and egress to specified entrances on the Steakley
property.

     Other than the Bankruptcy Court proceedings, the Company is not a defendant
in any additional material pending legal proceedings. While the ultimate results
of these proceedings cannot be predicted with certainty, the Company does not
believe that the outcome of these matters will have a material adverse effect on
the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1998.



                                       14
<PAGE>   16


                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

     The Company's Common Stock traded on the Nasdaq National Market since
September 1, 1995 under the symbol "NEGX". On November 9, 1998, Nasdaq notified
the Company that its common stock would be delisted effective at the close of
business that day for failing to meet the net tangible asset test and minimum
bid price requirements set forth in NASD Marketplace Rules 4450(a)(3) and
4450(a)(5). Nasdaq also advised the Company that its common stock was
immediately eligible for trading on the OTC Bulletin Board through authorized
broker-dealers who had been market makers in the Company's stock during the last
30-days. The Company contacted its OTC Market Makers to notify them of Nasdaq's
action and to facilitate future trading activity. The Company's common stock
currently trades on the OTC Bulletin Board under the symbol "NEGXQ". The
following table sets forth for the periods indicated, the high and low closing
sales prices for the Company's Common Stock, as reported on Nasdaq and/or the
OTC Bulletin Board. The quotations represent prices between dealers in
securities and may not include retail mark-up, mark-down, or commission and may
not represent actual transactions.

<TABLE>
<CAPTION>

                                             COMMON STOCK PRICE
                                           -----------------------
                                              HIGH          LOW
                                           ----------   ----------
<S>                                        <C>          <C>       
CALENDAR YEARS BY QUARTER
1998:
   First ...............................   $     4.13   $     2.31
   Second ..............................         2.78         1.38
   Third ...............................         1.50          .38
   Fourth ..............................          .38          .03
1997:
   First ...............................         4.56         3.13
   Second ..............................         3.69         2.88
   Third ...............................         5.63         2.94
   Fourth ..............................         6.56         3.44
</TABLE>

     On March 24, 1999, the latest practicable date for providing price
information, the last sales price for the Company's Common Stock was $.10.

HOLDERS

     As of March 24, 1999, the Company had approximately 4,500 record holders
of its shares of Common Stock, including multiple nominee holders for an
undetermined number of beneficial owners.

DIVIDENDS ON COMMON STOCK

     The Company has not paid cash dividends on its Common Stock and does not
expect to declare cash dividends in the foreseeable future. Payment of dividends
is prohibited under bankruptcy rules and regulations. Furthermore, any future
dividends on the Common Stock will be limited by the terms of the Preferred
Stock, which prohibits cash dividends on Common Stock unless all accrued and
unpaid dividends on the Preferred Stock have been paid, and the terms of the
Company's credit facility with Arnos, Inc., which does not permit dividends on
the Common Stock.



                                       15
<PAGE>   17



ITEM 6.  SELECTED FINANCIAL DATA

    The following table sets forth selected historical financial and operating
data with respect to the Company as of and for each of the five years in the
period ended December 31, 1998. The Company acquired significant producing oil
and natural gas properties during certain of the periods presented which affects
the comparability of the historical financial and operating data for the periods
presented. The financial data was derived from the historical financial
statements of the Company. This information is not necessarily indicative of the
Company's future performance. The financial data set forth below should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and the
related notes thereto of the Company included elsewhere herein.

<TABLE>
<CAPTION>

                                                                          YEAR ENDED DECEMBER 31,
                                                     ------------------------------------------------------------------
                                                        1994          1995          1996          1997         1998
                                                     ----------    ----------    ----------    ----------    ----------
                                                         (IN THOUSANDS, EXCEPT FOR RATIOS AND PER UNIT DATA)

<S>                                                  <C>           <C>           <C>           <C>           <C>       
STATEMENT OF OPERATIONS DATA:(1)
Oil and natural gas sales ........................   $    3,100    $    7,827    $   24,174    $   52,417    $   38,440
Costs and expenses:
   Lease operating ...............................        1,149         1,701         3,596         6,729         8,590
   Oil and natural gas production taxes ..........          176           416         1,285         3,139         2,504
   Depreciation, depletion and amortization ......        1,050         3,171         9,901        23,205        21,311
   Writedown of oil and natural gas
    properties(2) ................................           --            --        43,497        46,396       148,400
   Restructuring charges .........................           --            --            --            --         1,869
   General and administrative ....................          826         1,634         2,157         4,392         6,141
                                                     ----------    ----------    ----------    ----------    ----------
     Total costs and expenses ....................        3,201         6,922        60,436        83,861       188,815
                                                     ----------    ----------    ----------    ----------    ----------
Operating income (loss) ..........................         (101)          905       (36,262)      (31,444)     (150,375)
Interest expense .................................         (497)       (1,011)       (4,108)      (11,212)      (14,432)
Other income .....................................          109           312           308         1,032           293
                                                     ----------    ----------    ----------    ----------    ----------
Income (loss) before income taxes and
  extraordinary item .............................         (489)          206       (40,062)      (41,624)     (164,514)
Income tax benefit ...............................           --            --        14,504         7,286            --
                                                     ----------    ----------    ----------    ----------    ----------
Income (loss) before extraordinary item ..........         (489)          206       (25,558)      (34,338)     (164,514)
Extraordinary loss ...............................         (122)         (432)         (292)           --            --
                                                     ----------    ----------    ----------    ----------    ----------
Net loss .........................................   $     (611)   $     (226)   $  (25,850)   $  (34,338)   $ (164,514)
                                                     ==========    ==========    ==========    ==========    ==========
Loss per common share before
  extraordinary item .............................   $    (0.09)   $    (0.05)   $    (1.33)   $     (.94)   $    (4.08)
                                                     ==========    ==========    ==========    ==========    ==========
Net loss per common share ........................   $    (0.10)   $    (0.09)   $    (1.34)   $     (.94)   $    (4.08)
                                                     ==========    ==========    ==========    ==========    ==========

CASH FLOW DATA:
Net cash provided by operating activities ........   $      373    $    2,857    $   11,788    $   22,864    $    5,082
Net cash used in investing activities ............       (3,812)      (16,726)      (49,277)      (75,826)      (53,303)
Net cash provided by financing activities ........        5,871        17,352        45,595        64,734        24,809

OTHER FINANCIAL DATA:
EBITDA(3) ........................................   $    1,058    $    4,387    $   17,443    $   39,189    $   19,628
Ratio of EBITDA to interest expense ..............         2.1x          4.3x          4.2x          3.5x          1.4x
Ratio of earnings to fixed charges (4) ...........           --          1.2x            --            --            --

BALANCE SHEET DATA (AT PERIOD END):(1)
Cash and cash equivalents ........................   $    2,594    $    6,076    $   14,182    $   25,954    $    2,542
Working capital (deficit) ........................        3,561        (2,335)       (1,582)        8,387      (197,834)
Total assets .....................................       18,746        43,491       216,199       254,361        95,002
Long-term debt ...................................        6,000        13,475       100,000       166,397            --
Stockholders' equity/(deficit) ...................       11,328        17,775        80,426        47,893      (116,933)
</TABLE>







                                       16
<PAGE>   18


<TABLE>
<CAPTION>


                                                                          YEAR ENDED DECEMBER 31,
                                                     --------------------------------------------------------------
                                                        1994         1995         1996         1997         1998
                                                     ----------   ----------   ----------   ----------   ----------

<S>                                                  <C>          <C>          <C>          <C>          <C>       
OPERATING DATA:(1)
Production:
  Oil (Mbls) .....................................          116          283          522        1,110        1,238
  Natural gas (Mmcf) .............................          621        1,753        5,681       13,146       11,255
  Natural gas equivalent (Mmcfe) .................        1,315        3,454        8,811       19,807       18,685
Average sales price:
  Oil (per Bbl) ..................................   $    16.01   $    17.22   $    21.70   $    19.17   $    12.66
  Natural gas (per Mcf) ..........................         2.01         1.68         2.26         2.37         2.02
Unit economics (per Mcfe):
  Average sales price ............................         2.36   $     2.27   $     2.74   $     2.65   $     2.06
  Lease operating expenses .......................          .87          .49          .41          .34          .46
  Oil and natural gas production taxes ...........          .13          .12          .15          .16          .13
  Depreciation, depletion and amortization (5) ...          .80          .92         1.12         1.17         1.14
  General and administrative .....................          .63          .47          .24          .22          .33
</TABLE>

----------

(1)      Reflects the revenues, results of operations, and production subsequent
         to the dates of acquisitions of various oil and natural gas properties
         that affect the comparability of the data presented. The Company
         acquired a 17% Working Interest in the GAU during 1994. During 1995,
         the Company acquired interests in producing oil and natural gas
         properties in the Mustang Island area, the Oak Hill Field, and in Eddy
         County, New Mexico. In August 1996, the Company completed the Merger
         with Alexander. See Note 3 of Notes to Consolidated Financial
         Statements.

(2)      The results of operations for the year ended December 31, 1996 include
         a writedown of oil and natural gas properties of approximately $43.5
         million ($28.3 million net of deferred income taxes), in accordance
         with the full cost method of accounting, which resulted from the
         Merger. The results of operations for the year ended December 31, 1997,
         included a writedown of oil and natural gas properties of approximately
         $46.4 million ($37.5 million, net of deferred income taxes) in
         accordance with the full cost method of accounting. The results of
         operations for the year ended December 31, 1998, include a writedown of
         oil and natural gas properties of approximately $148.4 million in
         accordance with the full cost method of accounting. See Notes 3 and 12
         of Notes to Consolidated Financial Statements.

(3)      See the Glossary included elsewhere herein for the definition of
         EBITDA. EBITDA is not a measure of cash flow as determined by generally
         accepted accounting principles. The Company has included information
         concerning EBITDA because EBITDA is a measure used by certain investors
         in determining the Company's historical ability to service its
         indebtedness. However, this measure may not be comparable to similarly
         titled measures of other companies. EBITDA should not be considered as
         an alternative to, or more meaningful than, net income or cash flows as
         determined in accordance with generally accepted accounting principles
         as an indicator of the Company's operating performance or liquidity.

(4)      For the purposes of calculating the ratio of earnings to, or deficiency
         of earnings over, fixed charges, earnings consist of income before
         extraordinary items and income taxes plus fixed charges, excluding
         capitalized interest. Fixed charges consist of interest expense,
         capitalized interest, the interest component of rent expense, and
         amortization of debt premium, discount and financing costs. The
         deficiency of earnings over fixed charges for the years ended December
         31, 1994, 1996, 1997 and 1998, were approximately $.05 million, $40.0
         million, $44.2 million, and $167.9 million, respectively.

(5)      Excludes the full cost ceiling writedowns discussed in Note 2 above.






                                       17
<PAGE>   19

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

    The following discussion should be read in conjunction with the Company's
Financial Statements and "Selected Financial Data" and respective notes thereto,
included elsewhere herein. The information below should not be construed to
imply that the results discussed herein will necessarily continue into the
future or that any conclusion reached herein will necessarily be indicative of
actual operating results in the future. Such discussion only represents the best
present assessment by management of the Company. Because of the size and scope
of the Company's acquisitions during 1996 and the relatively small scale of the
Company's operations prior to those acquisitions, the results of operations from
1996 to 1997 are not necessarily comparative.

    On December 4, 1998 the Company's 10 3/4% Senior Note bondholders filed an
Involuntary Petition for an Order and Relief under Chapter 11 of Title 11 of the
United States Bankruptcy Code in the United States Bankruptcy Court for the
Northern District of Texas, Dallas Division, due to non-payment of interest due
December 2, 1998, after expiration of a 30-day grace period. On December 23,
1998, the Company filed in the Bankruptcy Court, an Answer to and Motion to
Dismiss the pending Involuntary Petition. The Company's Motion affirmed that it
(i) was meeting its obligations and generally paying its debts as they became
due, unless such debts were the basis of a bona fide dispute and (ii) had
arranged with the lender under its credit facility to borrow additional funds
sufficient to pay the interest due on the 10 3/4% Senior Notes, conditioned upon
the Court's dismissal of the Involuntary Petition. However, on February 8, 1999,
the Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary
Petition. An Order for Relief was entered by the Bankruptcy Court on February
11, 1999, effective February 8, 1999. The Order for Relief places the Company
under the protection of the Court and precludes payment of the interest on the
Senior Notes at this time. The Company will act as debtor-in-possession and will
continue to operate its business and manage its properties in the ordinary
course during its Chapter 11 proceeding. The Company anticipates proposing a
Plan of Reorganization within 120 days of February 11, 1999, or at such time as
may be extended by the Court. As of December 4, 1998, the Company discontinued
the accrual of interest on unsecured liabilities subject to compromise, which
primarily relates to the Senior Notes.

OVERVIEW

    The Company's current financial condition and 1998 operating results have
resulted from the significant decline in oil prices during 1998, coupled with
unfavorable revisions in estimates of oil and gas reserves during the year.

    The revenues generated by the Company's operations are highly dependent upon
the prices of, and demand for, oil and natural gas. The price received by the
Company for its oil and natural gas production depends on numerous factors
beyond the Company's control, including seasonal price fluctuation, the
condition of the U.S. economy, foreign imports, political conditions in other
oil and natural gas producing countries, the actions of the Organization of
Petroleum Exporting Countries and domestic governmental regulations, legislation
and policies. Declines during 1998 in the prices of oil and gas have had a
material adverse effect on the carrying value of the Company's oil and gas
properties and the Company's revenues, profitability and cash flows.



                                       18
<PAGE>   20



RESULTS OF OPERATIONS

OVERVIEW OF PRODUCTION, SALES AND UNIT ECONOMICS

    The following table sets forth certain information regarding the production
volumes, oil and natural gas sales, average sales prices, and unit economics per
Mcfe for revenues and costs and expenses related to the Company's oil and
natural gas production for the periods indicated.

<TABLE>
<CAPTION>

                                                             YEAR ENDED DECEMBER 31,
                                                     ------------------------------------
                                                         1996         1997         1998
                                                     ----------   ----------   ----------
<S>                                                  <C>          <C>          <C>       
Net production:
  Oil (Mbbls) ....................................          522        1,110        1,238
  Natural Gas (Mmcf) .............................        5,681       13,146       11,255
  Natural Gas Equivalent (Mmcfe) .................        8,811       19,807       18,685
Oil and natural gas sales (in thousands):
  Oil ............................................   $   11,320   $   21,276   $   15,673
  Natural gas ....................................       12,854       31,141       22,767
                                                     ----------   ----------   ----------
  Total ..........................................   $   24,174   $   52,417   $   38,440
                                                     ==========   ==========   ==========
Average sales price:
  Oil (per Bbl) ..................................   $    21.70   $    19.17   $    12.66
  Natural gas (per Mcf) ..........................         2.26         2.37         2.02
Unit economics (per Mcfe):
  Average sales price ............................         2.74         2.65         2.06
  LOE ............................................          .41          .34          .46
  Oil and gas production taxes ...................          .15          .16          .13
  Depletion rate (excluding writedowns) ..........         1.10         1.11         1.06
  General and administrative .....................          .24          .22          .33
</TABLE>


YEAR ENDED DECEMBER 31, 1998, COMPARED WITH YEAR ENDED DECEMBER 31, 1997

     Revenues. Total revenues decreased by $14.0 million (26.7%) to $38.4
million for 1998 from $52.4 million in 1997. The reduction in revenues is
primarily due to the decrease in commodity prices from the same period in 1997.
Average natural gas prices decreased $.35 per Mcf to $2.02 per Mcf for 1998 from
$2.37 for 1997, and average oil prices decreased $6.51 per barrel to $12.66 for
1998 from $19.17 for 1997. The decrease in average prices reduced 1998 revenues
by approximately $12.0 million compared to 1997.

    Also contributing to the decrease in revenues was the Mmcfe equivalent
decrease in production. In 1998, the Company produced 1,238 Mbbls of oil, an
increase of 11.5% over 1,110 Mbbls in 1997, and 11,255 Mmcf of natural gas, a
decrease of 14.4% over 13,146 Mmcf in the same period of 1997. The increase in
oil production is due primarily to the completion of four GAU wells in the first
quarter of 1998, the completion of the State Lease #2102 well (in the Greater
Bayou Sorrel area) in October of 1998 and the drilling activity on the Company's
Anadarko Basin properties. The decline in gas production is primarily due to the
flush production in 1997 from the drilling program on the East Texas and Arkoma
properties. The Company had limited drilling activity in these areas during
1998.

    Also affecting 1998 production was the temporary shut-in of the East Bayou
Sorrel field to allow for a pipeline repair, which reduced 1998 production by
291 Mmcfe, the 1997 sale of certain non-strategic properties and natural decline
of production not replaced by additional drilling activity. The East Bayou
Sorrel field was also shut-in for seven days to allow for the completion of the
State Lease #2102 and Hurricane George. The Company expects production to
continue to decline unless replaced through drilling, workovers, recompletions
and/or acquisitions.

    Costs and Expenses. Lease operating expenses increased $1.9 million (28.4%)
to $8.6 million for 1998 from $6.7 million for 1997 primarily due to additional
wells brought into production during 1998 and 1997. The Company also entered
into a saltwater disposal lease and $.4 million was paid for this lease during
the fourth Quarter of 1998. The increase in lease operating expenses was in part
offset by the 1997 sale of non-strategic properties and the Company's efforts to
reduce operating costs. Lease operating expenses per Mcfe 








                                       19
<PAGE>   21


increased to $.46 for 1998 from $.34 for 1997 due to increased costs combined
with the Mmcfe equivalent decline in production during the period.

    Production taxes decreased $.6 million (19.4%) to $2.5 million for 1998
compared to $3.1 million for 1997. This decrease principally resulted from the
decrease in total oil and natural gas revenues discussed above.

    Depreciation, depletion and amortization decreased $1.9 million (8.2%) to
$21.3 million for 1998 compared to $23.2 million for 1997. This decrease is due
to the decrease in the depletion rate per Mcfe from $1.11 in 1997 to $1.06 for
1998. This decrease in the depletion rate was primarily due to the effects on
depletion expense of the full cost ceiling writedowns discussed below in 1998.

    At March 31, June 30, September 30, and December 31, 1998, the net book
value of the Company's oil and natural gas properties exceeded the full cost
ceiling, resulting in non-cash writedowns of the oil and natural gas properties
totaling $148.4 million for the year. These writedowns resulted primarily from
the decline in oil and natural gas prices, costs incurred on unsuccessful
exploratory wells drilled during such period and unfavorable revisions to
estimates of oil and gas reserves. See Notes 3 and 12 of Notes to Financial
Statements.

    During 1998, the Company recorded non-recurring charges of approximately
$1.9 million for severance and related costs resulting from the restructuring of
its executive management team, other personnel changes and costs associated with
the Chapter 11 filing.

    General and administrative costs increased $1.7 million (38.6%) to $6.1
million compared to $4.4 million for 1997. The increase in general and
administrative expenses compared to 1997 was primarily due to increased
personnel and office space due to the increase in the scope of the Company's
operations. In an effort to reduce general and administrative costs the Company
has restructured its executive management team and other personnel. The Company
has also renegotiated its office lease and implemented other cost cutting
strategies that should help reduce these costs in the future. The Company's
capitalized general and administrative expenses totaled $ 1.6 million and $2.0
million for the years ended December 31, 1997 and 1998, respectively. General
and administrative costs per Mcfe increased 50.0% to $.33 for 1998 from $.22 for
1997. This increase per Mcfe is attributable to the decrease in production,
combined with additional general and administrative costs noted above.

    Other Income and Expenses. The increase of $3.2 million in interest expense
to $14.4 million for 1998 from $11.2 million for 1997, was due to the issuance
of the Series C Notes in August 1997, and interest on borrowings under the
credit facility, partially offset by an increase of $.8 million of interest
costs which were capitalized during 1998 related to the Company's unproved oil
and natural gas properties. The average balance of debt outstanding during 1998
was $180.6 million as compared to average debt outstanding of $133.4 million for
1997. The weighted average interest rate for 1998 was 9.9% compared to 10.3% for
1997. As of December 4, 1998, the Company discontinued the accrual of interest
on unsecured liabilities subject to compromise, which primarily consisted of the
Senior Notes, as a result of the Chapter 11 filing. Approximately $1.3 million
additional interest expense would have been recognized by the Company if not for
the discontinuation of the interest accrual on the Senior Notes.

    Net Loss. A net loss of $164.5 million was generated for 1998, compared with
net loss of $34.3 million for 1997. The net losses for 1998 and 1997 included
writedowns of oil and natural gas properties of $148.4 million and $37.5
million, respectively, net of deferred taxes. Excluding these charges, income
decreased $19.3 million in 1998 compared with 1997 due to the decrease in
operating income and increased interest expense.

YEAR ENDED DECEMBER 31, 1997, COMPARED WITH YEAR ENDED DECEMBER 31, 1996

     Revenues. Total revenues increased by $28.2 million (116.5%) to $52.4
million for 1997 from $24.2 million in 1996. In 1997, the Company produced 1,110
Mbbls of oil, an increase of 112.6% over 522 Mbbls in 1996, and 13,146 Mmcf of
natural gas, an increase of 131.4% over 5,681 Mmcf in the same period of 1996.
The increase in production primarily from the results of the Drilling Program
and the Merger with Alexander completed in August 1996. Also contributing to the
increased production is the UMC Acquisition, the CA Acquisition, the Lake Boeuf
Acquisition and the Bayou Sorrel Acquisition (collectively, the "1996
Acquisitions") completed during 1996.









                                       20
<PAGE>   22

    Also contributing to the increase in revenues was the increase in average
natural gas prices of $.11 per Mcf to $2.37 per Mcf for 1997 from $2.26 for
1996, offset by the decrease in average oil prices of $2.53 per barrel to $19.17
for 1997 from $21.70 for 1996.

    Costs and Expenses. Lease operating expenses increased $3.1 million (86.1%)
to $6.7 million for 1997 from $3.6 million for 1996 primarily due to the
increased production discussed above. Although total lease operating expenses
increased, lease operating expenses per Mcfe decreased to $.34 for 1997 from
$.41 for 1996.

    Production taxes increased $1.8 million (144.2%) to $3.1 million for 1997
compared to $1.3 million for 1996. This increase principally resulted from the
increase in total oil and natural gas revenues discussed above and increased
production in Louisiana, which has higher production tax rates than Texas,
Oklahoma and Arkansas.

    Depreciation, depletion and amortization increased $13.3 million (134.3%) to
$23.2 million for 1997 compared to $9.9 million for 1996. This increase is due
to the increased production. The depletion rate per Mcfe was $1.11 for 1997
compared to $1.10 for 1996. This increase in the depletion rate was primarily
due to the acquisition costs incurred in the Merger.

    At December 31, 1997, the net book value of the Company's oil and natural
gas properties exceeded the full cost ceiling, resulting in a non-cash writedown
of the oil and natural gas properties of $46.4 million ($37.5 million net of
deferred income taxes). This writedowns resulted primarily from the decline in
oil and natural gas prices in the fourth quarter of 1997, combined with the
costs incurred on unsuccessful exploratory wells drilled during such period. In
August, 1996, as a result of allocating the cost of the Merger with Alexander,
under the purchase method of accounting, to the proved oil and natural gas
properties acquired in connection with the Merger, the Company recognized a
writedown of the oil and natural gas properties, net of related deferred income
taxes of $28.3 million. See Notes 3 and 12 of Notes to Financial Statements.

    General and administrative costs increased $2.2 million (100.0%) to $4.4
million compared to $2.2 million for 1996, due to the Merger with Alexander,
although general and administrative costs per Mcfe decreased 8.3% to $.22 for
1997 from $.24 for 1996. This decrease per Mcfe is attributable to the increase
in production discussed above, without a proportionate increase in costs to the
Company.

    Other Income and Expenses. The increase of $7.1 million in interest expense
to $11.2 million for 1997 from $4.1 million for 1996, was due to the issuance of
the Notes, partially offset by $2.5 million of interest costs related to the
Company's unproved oil and natural gas properties which was capitalized in 1997.
The average balance of debt outstanding during 1997 was $133.4 million as
compared to average debt outstanding of $41.4 million for 1996. The weighted
average interest rate for 1997 was 10.34% compared to 8.64% for 1996.

    Net Loss. A net loss of $34.3 million was generated for 1997, compared with
net loss of $25.8 million for 1996. The net losses for 1997 and 1996 included
writedowns of oil and natural gas properties of $37.5 million and $28.3 million,
respectively, net of deferred taxes. Excluding these charges, income increased
$.8 million in 1997 compared with 1996 as the increase in 1997 operating income
more than offset the increase in interest expense.

LIQUIDITY AND CAPITAL RESOURCES

YEAR ENDED DECEMBER 31, 1998, COMPARED WITH YEAR ENDED DECEMBER 31, 1997

    Net cash provided by operating activities was $5.1 million for the year
ended December 31, 1998, compared to $22.9 million for the same period in 1997.
The decrease in cash flow from operating activities is primarily due to the
decrease in income from operations before non-cash charges, resulting from
depressed sales prices for oil and gas and reduced production at such prices.

    Net cash used by investing activities was $53.3 million for 1998 compared
with $75.8 million for 1997. The cash used by investing activities for 1998
included $52.0 million for exploration and development expenditures pursuant to
the Company's Drilling Program, including acquisitions of leasehold interests
and seismic costs.






                                       21
<PAGE>   23

    Net cash provided by financing activities was $24.8 million for 1998
compared with $64.7 million for the same period in 1997. The net cash provided
by financing activities during 1998 consisted primarily of proceeds from the
credit facility. In 1997, cash provided by financing activities consisted
primarily of proceeds from the issuance of the Series C Notes.

    The Company's working capital deficit at December 31, 1998, was $197.8
million compared to a working capital surplus at December 31, 1997 of $8.4
million. The decrease in working capital was due primarily to the classification
as a current liability of the $25.0 million due under the Arnos credit facility,
the $166.2 million due on the Senior Notes and the accrued interest on the
Senior Notes.

YEAR ENDED DECEMBER 31, 1997, COMPARED WITH YEAR ENDED DECEMBER 31, 1996

    Net cash provided by operating activities was $22.9 million for the year
ended December 31, 1997, compared to $11.8 million for the same period in 1996.
The increase in cash flow from operating activities is primarily due to the
increase in income from operations before non-cash charges.

    Net cash used by investing activities was $75.8 million for 1997 compared
with $49.3 million for 1996. The cash used by investing activities for 1997
included $77.9 million for exploration and development expenditures pursuant to
the Company's Drilling Program, including acquisitions of leasehold interests
and seismic costs. In December 1997, the Company sold its interests in 274
nonstrategic wells for approximately $5.4 million.

    Net cash provided by financing activities was $64.7 million for 1997
compared with $45.6 million for the same period in 1996. The net cash provided
by financing activities during 1997 consisted primarily of proceeds from the
issuance of the Series C Notes. In 1996, cash provided by financing activities
consisted primarily of proceeds from the issuance of the Series A Notes and
proceeds from the issuance of preferred stock, partially offset by repayments of
long-term debt.

    The Company's working capital surplus at December 31, 1997, was $8.4 million
compared to a working capital deficit at December 31, 1996, of $1.6 million. The
increase in working capital was due primarily to the issuance of the Series C
Notes, partially offset by the expenditures of cash for oil and gas exploration,
acquisition, and development activities.

FUTURE CAPITAL REQUIREMENTS

    The Company has made, and will continue to make, ordinary course capital
expenditures for the development, and exploitation of oil and natural gas
reserves, subject to economic conditions and in accordance with the rulings and
procedures set forth by the Court. Due to the Chapter 11 filing and severely
depressed oil prices, the Company has suspended its exploratory drilling
program. The Company will limit its capital expenditures to ordinary course
enhancement of current production through workovers, recompletions, and other
production enhancing activities deemed to be economic given current depressed
oil and gas prices. Development drilling is anticipated to be limited to (i)
ordinary course nonoperated wells in which we have limited working interests and
in which the failure to participate may result in drainage, depletion or loss of
current reserves and (ii) operated wells deemed to be economical given current
oil and gas prices. Large expenditures for developmental drilling may require
court approval and none are planned at this time.

    The Company has currently budgeted approximately $7.8 million for capital
expenditures related to its oil and gas properties in 1999, of which
approximately $6.0 million would be for development and exploitation activities,
and approximately $1.8 million would be for delay rentals, lease bonuses,
geological and geophysical costs. Actual amounts to be expended by the Company
for these activities will be dependent upon a number of factors, including Court
approval if necessary, oil and natural gas prices, the availability of capital,
seismic and contract service costs, availability of drilling rigs and future
drilling results. The Company is not contractually committed to expend the
budgeted funds.





                                       22
<PAGE>   24

    The Company currently expects that existing cash and cash flows from
operations will be sufficient to fund planned capital expenditures for its
existing properties through 1999. However, the Company would require additional
capital to fund any acquisitions and access to these markets could be limited
due to the Chapter 11 proceeding.

    Subject to Court approval, the Company may seek additional capital, if
required, from traditional reserve base borrowings, equity, and debt offerings
or joint ventures to further develop and explore its properties and to acquire
additional properties. There is no assurance, even if approved by the Court,
that the Company would be able to access additional capital or that, if
available, it will be at prices or on terms acceptable to the Company. In
addition, the Chapter 11 proceeding and restrictions from the Bankruptcy Court
could limit the Company's ability to access additional capital markets.

    Should the Company be unable to access the capital markets or should
sufficient capital not be available, the development and exploration of the
Company's properties could be delayed or reduced and, accordingly, oil and
natural gas revenues and operating results may be adversely affected.

10 3/4% SENIOR NOTES DUE 2006

    On December 4, 1998 the Company's 10 3/4% Senior Note bondholders filed an
Involuntary Petition for an Order for Relief under Chapter 11 of Title 11 of the
United States Bankruptcy Code in the United States Bankruptcy Court for the
Northern District of Texas, Dallas Division, due to non-payment of interest due
December 2, 1998, after expiration of a 30-day grace period. On December 23,
1998, the Company filed in the Bankruptcy Court, an Answer to and Motion to
Dismiss the pending Involuntary Petition. The Company's Motion affirmed that it
(i) was meeting its obligations and generally paying its debts as they became
due, unless such debts were the basis of a bona fide dispute and (ii) had
arranged with the lender under its credit facility to borrow additional funds
sufficient to pay the interest due on the 10 3/4% Senior Notes, conditioned upon
the Court's dismissal of the Involuntary Petition. However, on February 8, 1999,
the Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary
Petition. An Order for Relief was entered by the Bankruptcy Court on February
11, 1999. The Order for Relief places the Company under the protection of the
Court and precludes payment of the interest on the Senior Notes at this time.
The Company shall act as debtor-in-possession and will continue to operate its
business and manage its properties in the ordinary course of business during its
Chapter 11 proceeding. The Company anticipates proposing a Plan of
Reorganization within 120 days of February 11, 1999 or at such time as may be
extended by the Court. As of December 4, 1998, the Company discontinued the
accrual of interest related to unsecured liabilities subject to compromise, 
principally the Senior Notes.

    Due to the non-payment of interest due December 2, 1998, the Senior Notes 
were in default at December 31, 1998 and have been classified as a current 
liability.

    In November 1996, the Company issued $100 million aggregate principal amount
of unregistered 10 3/4% Series A Notes due 2006. The net proceeds of the Series
A Notes of approximately $96.1 million were used to repay approximately $62.0
million of borrowings under the predecessor to the credit facility and to
increase the Company's working capital. In 1997, the Series A Notes were
exchanged for the registered 10 3/4% Series B Notes due 2006 which are
substantially identical to the Series A Notes. Collectively, the Series A Notes
and Series B Notes are referred to as the "Series A/B Notes." In August 1997,
the Company issued $65.0 million aggregate principal amount of its unregistered
10 3/4% Series C Notes. The net proceeds of the Series C Notes of approximately
$64.8 million were used to repay approximately $23.0 million of borrowings under
the credit facility, to fund the Drilling Program, and to increase the Company's
working capital. In December 1997, the Company exchanged substantially all of
the Series A/B Notes and the Series C Notes for registered 10 3/4% Series D
Notes due 2006. The Series D Notes are substantially identical to the Series A/B
Notes and the Series C Notes. Collectively, the Series A/B Notes, the Series C
Notes, and the Series D Notes are referred to as the "Notes." The Notes bear
interest at 10 3/4% per annum, payable semi-annually on May 1 and November 1.
The Notes mature November 1, 2006, but may be redeemed after November 1, 2001,
at the Company's option. The Indentures governing the Notes contain certain
covenants, including, but not limited to covenants restricting the ability of
the Company and its Restricted Subsidiaries' (as defined), to incur additional
indebtedness. See Note 5 of Notes to Consolidated Financial Statements.

CREDIT FACILITIES

    On August 29, 1996, the Company, NEG-OK and Boomer Marketing, entered into a
credit facility with Bank One, as Bank and Administrative Agent, and the Credit
Lyonnais New York Branch, as Bank and Syndication Agent






                                       23
<PAGE>   25


(collectively, the "Banks"). The credit facility consisted of a $100.0 million
reducing revolving line of credit, with an initial borrowing base of $60.0
million and a $5.0 million term loan. Interest under the reducing revolving line
of credit was payable monthly at the Bank One base rate, as adjusted. The
proceeds from the credit facility were used to repay a prior credit facility and
the existing indebtedness of NEG-OK, resulting in an extraordinary charge of
$292,372 or $.01 per common share in 1996.

    In November 1996, the Company repaid the outstanding borrowings under the
credit facility with a portion of proceeds from the issuance of $100.0 million
principal amount of 10 3/4% Senior Notes due 2006 (the "Series A Notes"). See
Note 5.

    Also in November 1996, in connection with the issuance of the Series A
Notes, the Company revised the credit facility. The credit facility had a
borrowing base of $25.0 million. The borrowing base may be redetermined at least
semiannually and may require mandated monthly principal reductions from time to
time. The principal amount of any borrowings is due at maturity, August 29, 2000
and interest is payable monthly.

    The Company granted liens to the Banks on substantially all of the Company's
oil and natural gas properties, whether currently owned or hereafter acquired,
and a negative pledge on all other oil and natural gas properties. The credit
facility requires, among other things, semiannual engineering reports covering
oil and natural gas properties, and maintenance of certain financial ratios,
including the maintenance of a minimum interest coverage, a current ratio, and a
minimum tangible net worth.

    The credit facility contains other covenants prohibiting cash dividends,
distributions, loans, or advances to third parties, except that cash dividends
on preferred stock will be allowed so long as no event of default exists or
would exist as a result of the payment thereof. In addition, if the Company is
required to purchase or redeem any portion of the Notes, or if any portion of
the Notes become due, the borrowing base is subject to reduction.

    The Company is required to pay a commitment fee on the unused portion of the
borrowing base equal to 1% per annum.

    On December 7, 1998, Bank One and Credit Lyonnais gave notice to the Company
that all outstanding obligations under the credit facility were accelerated and
were immediately due and payable due to certain unspecified Events of Default as
defined in the loan agreement.

    Effective December 22, 1998, the credit facility and all associated liens
were assigned by the Banks to Arnos, Inc., an affiliated subsidiary of the
Company's Series D Preferred Stockholder. In a letter dated December 23, 1998,
Arnos (1) rescinded the acceleration of the loan, (2) waived all defaults
existing at that time and (3) made sufficient borrowings available to pay the
interest on the Senior Notes that was due on November 2, 1998 conditioned upon
the Bankruptcy Court's dismissal of the Involuntary Petition. To date, no fees
or interest have been paid to Arnos. The Company is accruing interest expense at
an estimated rate under the Arnos credit facility. The Company had $25,000,000
outstanding under the Arnos credit facility as of December 31, 1998. At December
31, 1998, the Company was in violation of the minimum interest coverage ratio
and current ratio covenants under the Arnos credit facility and as a result has 
classified the borrowings under the credit facility as a current liability. 

PREFERRED STOCK

    In June 1994, the Company consummated the sale of $5.0 million of the Series
B Preferred Stock. Fifty thousand shares of the Series B Preferred Stock were
sold by the Company at $100 per share. The Series B Preferred Stock is
convertible into shares of the Common Stock at a conversion price of $1.625 per
share. In October 1997, 13,813 shares of the Series B Preferred Stock were
converted into Common Stock, leaving 38,687 shares of the Series B Preferred
Stock outstanding. The board of directors declared dividends on the Series B in
December of 1998, which would be made in shares of Series B Preferred Stock.
This dividend-in-kind has not been made and is currently in arrears.

    In June 1995, the Company consummated the sale of $4.0 million of the Series
C Preferred Stock. Forty thousand shares of the Series C Preferred Stock were
sold by the Company at $100 per share. The Series C Preferred Stock is




                                       24
<PAGE>   26

convertible into shares of the Common Stock at a conversion rate of $2.00 per
share. The Series B Preferred Stock and Series C Preferred Stock require that
dividends be paid on the Series B Preferred Stock and Series C Preferred Stock
before any dividends are paid on the Common Stock. In October 1997, 17,000
shares of the Series C Preferred Stock were converted into Common Stock, leaving
23,000 shares of the Series C Preferred Stock outstanding. The board of
directors declared dividends on the Series C in December of 1998, which would be
made in shares of Series C Preferred Stock. This dividend-in-kind has not been
made and is currently in arrears.

    In August 1996, the Company completed the sale of 100,000 shares of the
Series D Preferred Stock for $10.0 million and 50,000 shares of the Series E
Preferred Stock for $5.0 million. The Series D Preferred Stock and Series E
Preferred Stock are convertible into shares of the Common Stock at a conversion
price of $2.25 per share. As part of such sale, the Company agreed to extend the
date at which it may first redeem the Series B Preferred Stock and Series C
Preferred Stock from June 14, 1997 to June 14, 1999. In October 1997, 40,500
shares of the Series E Preferred Stock were converted into Common Stock, leaving
9,500 shares of the Series E Preferred Stock outstanding.

    See Note 7 of Notes to Consolidated Financial Statements.

FINANCIAL REPORTING IMPACT OF FULL COST METHOD OF ACCOUNTING

    The Company follows the full cost method of accounting for oil and natural
gas properties. Under such method, the net book value of such properties, less
related deferred income taxes, may not exceed a calculated "ceiling." The
ceiling is the estimated after-tax future net revenues from proved oil and
natural gas properties, discounted at 10% per year. In calculating future net
revenues, prices and costs in effect at the time of the calculation are held
constant indefinitely, except for changes which are fixed and determinable by
existing contracts. The net book value is compared to the ceiling on a quarterly
and yearly basis. The excess, if any, of the net book value above the ceiling is
required to be written off as a non-cash expense. During 1996, as a result of
allocating additional cost, under the purchase method of accounting, to the oil
and natural gas properties in connection with the Merger, the Company recognized
a non-cash writedown of its oil and natural gas properties of approximately
$28.3 million, net of deferred taxes. During the years ended December 31, 1997
and 1998, the net book value of the Company's oil and natural gas properties
exceeded the ceiling based on the weighted average prices of crude oil and
natural gas received by the Company resulting in non-cash writedowns totaling
$37.5 million, net of deferred taxes and $148.4 million, respectively. There can
be no assurance that there will not be additional writedowns in future periods
under the full cost method of accounting as a result of sustained decreases in
oil and natural gas prices or other factors.

RECENT ACCOUNTING PRONOUNCEMENTS

    As of January 1, 1998, the Company adopted Financial Accounting Standards
Board Statement No. 130, Reporting Comprehensive Income. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources.
Statement 130 establishes rules for the reporting and display of comprehensive
income and its components. For 1996, 1997 and 1998, the differences between net
earnings and total comprehensive income were not material.

    In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities, which is required to be adopted in years beginning after
June 15, 1999. The Company expects to adopt the new Statement effective January
1, 2000. The Statement will require the Company to recognize all derivatives on
the balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value through income. If the derivative is a hedge, depending
on the nature of the hedge, changes in the fair value of derivatives will either
be offset against the change in fair value of the hedged assets, liabilities, or
firm commitments through earnings or recognized in other comprehensive income
until the hedged item is recognized in earnings. The ineffective portion of a
hedge's change in fair value will be immediately recognized in earnings.

CHANGES IN PRICES AND INFLATION

    The prices received by the Company for its oil and natural gas production
declined dramatically during 1998. The prices received for crude oil reached
their lowest level in 50 years and were the lowest inflation-adjusted oil prices
since 









                                       25
<PAGE>   27


the Depression. The Company's revenue and value of its oil and natural gas
properties have been and will continue to be adversely affected until such
prices recover. Oil and gas prices are subject to seasonal and other
fluctuations that are beyond the Company's ability to control or predict.

    During 1996, the Company hedged crude oil and natural gas prices through the
use of commodity swap agreements in an effort to reduce the effects of the
volatility of the price of crude oil and natural gas on the Company's
operations. These agreements involved the receipt of fixed-price amounts in
exchange for variable payments based on NYMEX prices and specific volumes. In
connection with the commodity swap agreements, the Company may also enter into
basis swap agreements to reduce the effects of unusual fluctuations between
prices actually received at the wellhead and NYMEX prices. Through the use of
commodity price and basis swap agreements, the Company can fix the price to be
received for specified volumes of production to the commodity swap price less
the basis swap price. The differential to be paid or received, under the swap
agreement, is accrued in the month of the related production and recognized as a
component of crude oil and natural gas sales. The Company does not hold or issue
financial instruments for trading purposes.

    While the use of hedging arrangements limits the downside risk of adverse
price movements, it may also limit future gains from favorable movements. All
hedging has been accomplished pursuant to swap agreements based upon standard
forms. The Company addresses market risk by selecting instruments whose value
fluctuations correlate strongly with the underlying commodity being hedged.
Credit risk related to hedging activities is managed by requiring minimum credit
standards for counter parties, periodic settlements, and market to market
valuations. The Company has not been required to provide collateral relating to
hedging activities. At December 31, 1998, the Company had no hedging or basis
swap agreements outstanding. During the years ended December 31, 1996, 1997 and
1998, the Company recognized a net gain of $20,315, $0, and $0 respectively,
related to hedging transactions.

    At December 31, 1998, the Company had entered into forward sales contracts
with two purchasers covering the future production of natural gas. Deliveries
under these contracts are priced based on NYMEX prices less a differential
whereby the Company may fix the price for deliveries under these contracts at
any time three days prior to the close of the then current contract based on the
NYMEX prices at that time. The Company pays the cost of transportation of the
natural gas to the delivery point specified in the contracts. See Note 9 of
Notes to Consolidated Financial Statements.

    Although certain of the Company's costs and expenses are affected by the
level of inflation, inflation has not had a significant effect on the Company's
results of operations during the three years ended December 31, 1998.

YEAR 2000

    The year 2000 ("Y2K") problem arises because of computer programs which use
two digits rather than four digits to define a year. This may result in
miscalculations or complete system failures in processing data with programs
using date sensitive information.

    The Company currently uses commercially available software for its
management information systems, including accounting, engineering, and word
processing applications. This software has either already been warranted by the
suppliers or publishers to be Y2K compliant or the suppliers and publishers have
represented such software will be compliant in upgrades the Company will receive
in 1999 at minimal or no cost to the Company.

    The Company has reviewed its internal computer systems and expects to be
compliant with Y2K by mid-year. The costs of compliance have been minimal and
management expects them to remain minimal since its management information
systems are warranted to be compliant or are represented to be compliant in
upgrades the Company will receive in 1999. Furthermore, the Company replaced its
former oil and gas system in 1996 with a Y2K compliant oil and gas package.

    Management is in the process of obtaining confirmation from its major
suppliers and purchasers that they also are or will be Y2K compliant. The costs
of seeking such confirmation are expected to be minimal. Management believes
that it will not be practical to independently verify the responses because it
does not believe that the Company would be given access to carry out such
verification or that the costs of doing so would be affordable. The cost of
replacing 







                                       26
<PAGE>   28


non-compliant or non-responsive suppliers and customers will not be possible to
determine until the review process has been completed. Any Y2K problems that do
occur will likely manifest themselves in reduced production through equipment
shut downs or impaired liquidity through inability of customers to take delivery
of production or process payments. The Company plans to establish contingency
plans by mid-year once its confirmation program is complete and the risks have
been more fully quantified.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

    The Company from time to time utilizes derivative instruments, principally
to hedge natural gas production, whereby gains and losses in the fair value of
the derivative instruments are generally offset by price changes in the
underlying commodity. Based on this approach, combined with risk assessment
procedures and internal controls, management believes that its use of derivative
instruments does not expose the Company to material risk, however, the use of
derivative instruments for the hedging activities could affect the Company's
results of operations in particular quarterly or annual periods. The use of such
instruments limits the downside risk of adverse price movements, but it may also
limit the Company's ability to benefit from favorable price movements.

    At December 31, 1998, the Company had entered into forward sales contracts
with two purchasers covering future production of natural gas. Deliveries under
these contracts are priced based on NYMEX prices less a differential whereby the
Company may fix the price for deliveries under these contracts at any time three
days prior to the close of the then current contract based on the NYMEX prices
at the time. Deliveries to be made under the forward sales contracts have not
been priced as of December 31, 1998.

    The Company's exposure to interest rates relates primarily to its borrowings
under its credit facility. The Company does not currently use derivatives to
manage interest rate risk. Interest is payable on borrowings under the credit
facility based on a floating rate. If short-term interest rates average 10%
higher in 1999 than they were in 1998, the Company's interest expense would
increase by approximately $225,000. This amount was determined by applying the
hypothetical interest rate change to the Company's outstanding borrowings under
the credit facility at December 31, 1998.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

    The Financial Statements of the Company required by this Item 8 are included
as part of Item 14(a)(1) hereof. These Financial Statements also serve as
financial statements required pursuant to Rule 15d-21 and Form 11-K of the
Exchange Act for the National Energy Group, Inc. Employee Stock Purchase Plan,
as such Plan invests solely in the Company's common stock.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

    None.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

    The information required by this Item 10 will be provided in the sections
entitled "Proposal 1 - Director Election Proposal", "Management" and "Certain
Relationships and Related Transactions" in the Company's definitive proxy
statement for its 1999 Annual Meeting of Shareholders (the "Proxy Statement") or
in Item 10 of a Form 10-KA, and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

    The information required by this Item 11 will be provided in the section
entitled, "Management" in the Company's Proxy Statement or in Item 11 of a Form
10-KA, and is incorporated herein by reference.





                                       27
<PAGE>   29

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

    The information required by this Item 12 will be provided in the section
entitled "Security Ownership of Certain Beneficial Owners and Management" in the
Company's Proxy Statement or in Item 12 of a Form 10-KA, and is incorporated
herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

    The information required by this Item 13 will be provided in the section
entitled "Certain Relationships and Related Transactions" in the Company's Proxy
Statement or in Item 13 of a Form 10-KA, and is incorporated herein by
reference.


                                       28
<PAGE>   30



                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)      The following documents are filed as part of this report.

         1.  Financial Statements: See Index to Financial Statements and
             Financial Statement Schedules on page F-1 of this report.

         2.  Financial Statement Schedules: See Index to Financial Statements
             and Financial Statement Schedules on page F-1 of this report.

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

             2.1   Agreement and Plan of Merger, dated June 6, 1996, among the
                   Company, NEG-OK, Inc. ("NEG OK"), and Alexander Energy
                   Corporation ("Alexander") (1)

             2.2   First Amendment to Agreement and Plan of Merger, dated as of
                   June 20, 1996, among the Company, NEG-OK and Alexander (2)

             2.3   Mutual Waiver Agreement dated as of August 29, 1996 by and
                   among the Company, NEG-OK and Alexander (3)

             3.1   Certificate of Incorporation of the Company, which includes
                   the Certificate of Incorporation of the Company filed with
                   the Secretary of State of Delaware on November 20, 1990 (4),
                   the Certificate of Elimination of the Redeemable Convertible
                   Preferred Stock, Series A of the Company, filed with the
                   office of the Secretary of State of the State of Delaware on
                   June 2, 1994 (3), the Certificate of Amendment of Certificate
                   of Incorporation of the Company, filed with the office of the
                   Secretary of State of the State of Delaware on August 29,
                   1996 (3) , the Certificate of Designations of the Company of
                   10% Cumulative Convertible Preferred Stock, Series B (5), the
                   Certificate of Designations of the Company of 10 1/2%
                   Cumulative Convertible Preferred Stock, Series C (6), the
                   Certificate of Designations of the Company of Convertible
                   Preferred Stock, Series D (3), and the Certificate of
                   Designations of the Company of Convertible Preferred Stock,
                   Series E (3)

             3.2   By-laws of the Company (4)

             4.1   Certificate of Designations of the Company of 10% Cumulative
                   Convertible Preferred Stock, Series B (5)

             4.2   Certificate of Designations of the Company of 10 1/2%
                   Cumulative Convertible Preferred Stock, Series C (6)

             4.3   Certificate of Designations of the Company of Convertible
                   Preferred Stock, Series D (3)

             4.4   Certificate of Designations of the Company of Convertible
                   Preferred Stock, Series E (3)

             4.5   Indenture dated as of November 1, 1996, among the Company,
                   National Energy Group of Oklahoma, Inc. (the "Guarantor"),
                   formerly NEG-OK, and Bank One, Columbus, N.A. (7)

             4.6   Indenture dated August 21, 1997, among the Company and Bank
                   One, N.A. (14)

             4.7   Instrument of Resignation, Appointment and Acceptance, dated
                   October 23, 1998, between the Company, Bank One, N.A., and
                   Norwest Bank Minnesota, N.A. (19)

             10.1  Crude Oil Purchase Contract, dated November 30, 1992, between
                   the Company and Plains Liquids Transport Inc. (8)



                                       29
<PAGE>   31

             10.2  Amendment to Crude Oil Purchase Contract, dated November 17,
                   1993, between the Company and Plains Liquids Transport, Inc.
                   (5)


             10.3  Crude Oil Purchase Contract, dated February 8, 1993, between
                   the Company and Plains Marketing and Transportation Inc. and
                   the predecessor contract, the Crude Oil Purchase Contract,
                   dated November 12, 1991, between Sunnybrook Transmission,
                   Inc. and TriSearch Inc. (8)

             10.4  Agreement for Purchase and Sale (Mustang Island) dated April
                   20, 1995, between the Company and Sierra Mineral Development,
                   L.C. (6)

             10.5  Agreement for Purchase and Sale (Oak Hill) dated April 12,
                   1995, between the Company and Sierra 1994 I Limited
                   Partnership (6)

             10.6  Stock Purchase Agreement, dated as of June 14, 1995, among
                   the Company, Arbco Associates L.P., Offense Group Associates
                   L.P., Kayne, Anderson Nontraditional Investments L.P., and
                   Opportunity Associates L.P. (6)

             10.7  High River Limited Partnership Warrant to purchase 700,000
                   Shares of Common Stock, dated August 29, 1996 (3)

             10.8  Form of Series E Investors' Warrants to purchase an aggregate
                   350,000 Shares of Common Stock, dated August 29, 1996 (3)

             10.9  Gascon Partners Warrant to Purchase 300,000 shares of the
                   Company's Common Stock (13)

             10.10 Prudential Securities Incorporated Warrant to Purchase
                   100,000 Shares of the Company's Common Stock (3)

             10.11 Gaines Berland, Inc. Warrant to Purchase 300,000 Shares of
                   the Company's Common Stock dated August 29, 1996 (3)

             10.12 Gaines Berland, Inc. Warrant to Purchase 700,000 Shares of
                   the Company's Common Stock dated August 29, 1996 (3) 10.13
                   Executive Employment Agreement, dated January 1, 1996,
                   between the Company and Miles D. Bender (9)

             10.13 Executive Employment Agreement, dated January 1, 1996,
                   between the Company and Miles D. Bender (9)

             10.14 Separation Agreement, dated November 24, 1998, between the
                   Company and Miles D. Bender (19)

             10.15 Executive Employment Agreement, dated January 1, 1996,
                   between the Company and Melissa Rutledge (9)

             10.16 Separation Agreement between the Company and Robert A. Imel
                   dated October 31, 1997 (15)

             10.17 Separation Agreement, dated May 18, 1998, between the Company
                   and William T. Jones (17)

             10.18 Executive Employment Agreement, dated June 6, 1996, between
                   the Company and Jim L. David (1)

             10.19 Executive Employment Agreement dated March 20, 1997, between
                   the Company and Philip D. Devlin (10)






                                       30
<PAGE>   32

             10.20 Separation Agreement, dated May 19, 1998, between the Company
                   and Gene W. Anderson (19)

             10.21 Executive Employment Agreement dated August 25, 1997, between
                   the Company and C. Dewayne Cravens (19)

             10.22 Separation Agreement, dated May 18, 1998, between the Company
                   and C. Dewayne Cravens (19)

             10.23 Executive Employment Agreement, dated January 29, 1998,
                   between the Company and Fred R. Miller (15)

             10.24 Executive Employment Agreement, dated March 5, 1998, between
                   the Company and Chuck Elsey (16)

             10.25 Termination Notice and Agreement, dated October 28, 1998,
                   between the Company and Chuck Elsey(19)

             10.26 Executive Employment Agreement, dated April 13, 1998, between
                   the Company and Kent Lueders(16)

             10.27 Executive Employment Agreement, dated June 1, 1998, between
                   the Company and Leslie Wylie(17)

             10.28 National Energy Group, Inc. 1996 Incentive Compensation Plan
                   (11)

             10.29 National Energy Group, Inc. Employee Stock Purchase Plan(12)

             10.30 National Energy Group, Inc. Employee Severance Policy(19)

             10.31 Agreement dated January 1, 1996 between the Company and
                   Sandefer Oil & Gas, Inc.(1)

             10.32 Consulting Agreement dated January 1, 1996 between Sandefer
                   Oil & Gas, Inc. and Potosky Oil & Gas, Inc. and Atocha
                   Exploration, Inc.(1)

             10.33 Memorandum of Amendment dated March 27, 1997 amending (i)
                   Agreement dated January 1, 1996 between the Company and
                   Sandefer Oil & Gas, Inc. and (ii) Consulting Agreement dated
                   January 1, 1996 between Sandefer Oil & Gas, Inc. and Potosky
                   Oil & Gas, Inc. and Atocha Exploration, Inc.(15)

             10.34 First Amendment dated April 15, 1997 to (i) Agreement dated
                   January 1, 1996 between the Company and Sandefer Oil & Gas,
                   Inc. and (ii) Consulting Agreement dated January 1, 1996
                   between Sandefer Oil & Gas, Inc. and Potosky Oil & Gas, Inc.
                   and Atocha Exploration, Inc.(15)

             10.35 Restated Loan Agreement dated August 29, 1996 among Bank One
                   and Credit Lyonnais New York Branch ("Credit Lyonnais") and
                   the Company, NEG-OK and Boomer Marketing Corporation
                   ("Boomer")(3)

             10.36 $50,000,000 Revolving Note dated August 29, 1996 payable to
                   Bank One(3)

             10.37 $50,000,000 Revolving Note dated August 29, 1996 payable to
                   Credit Lyonnais(3)

             10.38 Assignment of $50,000,000 Revolving Note to Arnos Corp. from
                   BankOne, Texas, N.A.(19)

             10.39 Assignment of $50,000,000 Revolving Note to Arnos Corp. from
                   Credit Lyonnais New York Branch(19)

             10.40 Unlimited Guaranty of NEG-OK dated August 29, 1996 for the
                   benefit of Bank One(3)





                                       31
<PAGE>   33
             10.41 Unlimited Guaranty of NEG-OK, dated August 29, 1996 for the
                   benefit of Credit Lyonnais(3)

             10.42 Unlimited Guaranty of Boomer dated August 29, 1996 for the
                   benefit of Bank One(3)

             10.43 Unlimited Guaranty of Boomer dated August 29, 1996 for the
                   benefit of Credit Lyonnais(3)

             10.44 First Amendment to Restated Loan Agreement dated October 31,
                   1996 among Bank One and Credit Lyonnais and the Company,
                   Guarantor and Boomer(9)

             10.45 Second Amendment to Restated Loan Agreement dated October 31,
                   1996, among Bank One and Credit Lyonnais and the Company,
                   Guarantor and Boomer(10)

             10.46 Third Amendment to Restated Loan Agreement dated October 31,
                   1996, among Bank One and Credit Lyonnais and the Company,
                   Guarantor and Boomer(10)

             10.47 Fourth Amendment to Restated Loan Agreement dated October 31,
                   1996, among Bank One and Credit Lyonnais and the Company,
                   Guarantor and Boomer(5)

             10.48 Multi-State Assignment Agreement dated December 22, 1998
                   between BankOne, Texas, NA, Credit Lyonnais New York Branch
                   and Arnos, Corp.(19)

             10.49 Multi-State Assignment Agreement, LaFourche Parish,
                   Louisiana, dated December 22, 1998, between BankOne, Texas,
                   NA, Credit Lyonnais New York Branch and Arnos Corp.(19)

             10.50 Multi-State Assignment Agreement, Iberville Parish,
                   Louisiana, dated December 22, 1998, between BankOne, Texas, 
                   NA, Credit Lyonnais New York Branch and Arnos Corp.(19)

             10.51 Oklahoma Assignment Agreement, dated December 22, 1998,
                   between BankOne, Texas, NA, Credit Lyonnais New York Branch
                   and Arnos, Corp.(19)

             10.52 Arnos Corporation Letter dated December 23, 1998(19)

             12.1  Computation of Ratio of Earnings to Fixed Charges(19)

             23.1  Consent of Ernst & Young LLP, Independent Auditors(19)

             24.1  Power of Attorney (included in signature pages to this Form
                   10-K)(19)

             27.1  Financial Data Schedule(19)

             99.1  Order of Bankruptcy Court Granting Relief on Involuntary
                   Petition(18)

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

             (1)      Incorporated by reference to the Company's Registration
                      Statement on Form S-4 (No. 333-9045), dated July 29, 1996.

             (2)      Incorporated by reference to Amendment No. 1 to the
                      Company's Registration Statement on Form S-4 (No.
                      333-9045), dated August 7, 1996.

             (3)      Incorporated by reference to the Company's Current Report
                      on Form 8-K, dated August 29, 1996.

             (4)      Incorporated by reference to the Company's Registration
                      Statement on Form S-4 (No. 33-38331), dated April 23,
                      1991.

             (5)      Incorporated by reference to the Company's Current Report
                      on Form 8-K, dated June 17, 1994.

             (6)      Incorporated by reference to the Company's Current Report
                      on Form 8-K, dated July 17, 1995.

             (7)      Incorporated by reference to the Company's Quarterly
                      Report on Form 10-Q for the quarter ended September 30,
                      1996.

             (8)      Incorporated by reference to the Company's Annual Report
                      on Form 10-KSB for the year ended December 31, 1992.

             (9)      Incorporated by reference to the Company's Annual Report
                      on Form 10-KSB for the year ended December 31, 1995.

             (10)     Incorporated by reference to the Company's Quarterly
                      Report on Form 10-Q for the quarter ended March 31, 1997.

             (11)     Incorporated by reference to the Company's Schedule 14A
                      filed April 25, 1997.


                                       32
<PAGE>   34

             (12)     Incorporated by reference to the Company's Form S-8 filed
                      December 23, 1997.

             (13)     Incorporated by reference to the Company's Quarterly
                      Report on Form 10-Q for the quarter ended September 30,
                      1997.

             (14)     Incorporated by reference to the Company's Form S-4 (No.
                      333-38075), filed October 16, 1997.

             (15)     Incorporated by reference to the Company's Annual Report
                      on Form 10-K for the year ended December 31, 1997.

             (16)     Incorporated by reference to the Company's Quarterly
                      Report on Form 10-Q for the quarter ended March 31, 1998.

             (17)     Incorporated by reference to the Company's Quarterly
                      Report on Form 10-Q for the quarter ended June 30, 1998.

             (18)     Incorporated by reference to the Company's Current Report
                      on Form 8-K, dated February 8, 1999.

             (19)     Filed herewith.

(b) The Company filed a report on Form 8-K, dated February 8, 1999, reporting
the entry of an Order for Relief Under Chapter 11 of the Bankruptcy Code by the
United States Bankruptcy Court for the Northern District of Texas, Dallas
Division. Under the Order, the Court assumed jurisdiction and supervision of the
Company and its assets and business.





                                       33
<PAGE>   35



                                    GLOSSARY

    Wherever used herein, the following terms shall have the meaning specified.

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

    Bcf -- One billion cubic feet.

    Bcfe -- One billion cubic feet of Natural Gas Equivalent.

    Behind the Pipe -- Hydrocarbons in a potentially producing horizon
penetrated by a well bore the production of which has been postponed pending the
production of hydrocarbons from another formation penetrated by the well bore.
The hydrocarbons are classified as proved but non-producing reserves.

    Developed Acreage -- Acres which are allocated or assignable to producing
wells or wells capable of production.

    Development Well -- A well drilled within the proved area of an oil and
natural gas reservoir to the depth of stratigraphic horizon known to be
productive.

    Dry Well -- A well found to be incapable of producing either oil or natural
gas in sufficient quantities to justify completion as an oil or natural gas
well.

    EBITDA -- Earnings (including interest income and excluding discontinued
operations, extraordinary items, charges resulting from changes in accounting
and significant nonrecurring revenues and expenses) before interest expense,
income taxes, depletion, depreciation and amortization, and the provision for
impairment of oil and natural gas properties. EBITDA is not a measure of cash
flow as determined by generally accepted accounting principles. EBITDA
information has been included in this document because EBITDA is a measure used
by certain investors in determining historical ability to service indebtedness.
EBITDA should not be considered as an alternative to, or more meaningful than,
net income or cash flows as determined in accordance with generally accepted
accounting principles as an indicator of operating performance or liquidity.

    Exploratory Well -- A well drilled to find and produce oil or natural gas in
an unproved area, to find a new reservoir in a field previously found to be
productive of oil or natural gas in another reservoir, or to extend a known
reservoir.

    Gross Acres or Gross Wells -- The total acres or wells, as the case may be,
in which a Working Interest is owned.

    Infill Well -- A well drilled between known producing wells.

    Mbbl -- One thousand Bbl.

    Mcf -- One thousand cubic feet.

    Mcfe -- One thousand cubic feet of Natural Gas Equivalent.

    Mmcf -- One million cubic feet.

    Mmcfe -- One million cubic feet of Natural Gas Equivalent.

    Natural Gas Equivalent -- The ratio of one Bbl of crude oil to six Mcf of
natural gas.

    Net Acres or Net Wells -- The sum of the fractional Working Interests owned
in Gross Acres or Gross Wells.








                                       34
<PAGE>   36

    NYMEX -- New York Mercantile Exchange.

    Oil and Natural Gas Lease -- An instrument by which a mineral fee owner
grants to a lessee the right for a specific period of time to explore for oil
and natural gas underlying the lands covered by the lease and the right to
produce any oil and natural gas so discovered generally for so long as there is
production in economic quantities from such lands.

    OPEC -- Organization of Petroleum Exporting Countries.

    Overriding Royalty Interest -- A fractional undivided interest in an oil and
natural gas property entitling the owner of a share of oil and natural gas
production, in addition to the usual royalty paid to the owner, free of costs of
production.

    PDNP -- Proved developed, nonproducing, or Behind the Pipe reserves.

    Productive Well -- A well that is producing oil or natural gas or that is
capable of production.

    Proved Developed Producing Reserves -- Proved reserves that can be expected
to be recovered from currently producing zones under the continuation of present
operating methods.

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

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

    Proved Undeveloped Reserves -- Reserves that are expected to be recovered
from new wells on undrilled acreage, or from existing wells where a relatively
major expenditure is required for completion.

    PUD -- See Proved Undeveloped Reserves.

    PV 10% -- The discounted future net cash flows for Proved Reserves of oil
and natural gas computed on the same basis as the Standardized Measure, but
without deducting income taxes, which is not in accordance with generally
accepted accounting principles. PV 10% is an important financial measure for
evaluating the relative significance of oil and natural gas properties and
acquisitions, but should not be construed as an alternative to the Standardized
Measure (as determined in accordance with generally accepted accounting
principles).

    Revenue Interest -- The interest in a lease or well that receives a
proportionate share of all revenues from that lease or well as identified in the
division order.

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

    Secondary Recovery -- A method of oil and natural gas extraction in which
energy sources extrinsic to the reservoir are utilized.

    Standardized Measure -- The estimated future net cash flows from Proved
Reserves of oil and natural gas computed using prices and costs, at the date
indicated, after income taxes and discounted at 10%.

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

    Working Interest -- The operating interest which gives the owner the right
to participate in the drilling, producing, and conducting operating activities
on the property and a share of all costs of exploration, development, and
operations and all risks in connection therewith.



                                       35
<PAGE>   37


                                   SIGNATURES

    Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

<TABLE>

<S>                                                                                <C>
                     NATIONAL ENERGY GROUP, INC.

                     By:          /s/ Bob G. Alexander                              March 31, 1999
                        ------------------------------------------------
                                      Bob G. Alexander
                             President and Chief Executive Officer

                     By:          /s/ Melissa H. Rutledge                           March 31, 1999
                        ------------------------------------------------
                                      Melissa H. Rutledge
                         Vice President, Principal Financial Officer and
                                          Controller
</TABLE>


                     POWER OF ATTORNEY AND SIGNATURES


    The undersigned directors and officers of National Energy Group, Inc. hereby
constitute and appoint Bob G. Alexander with full power to act and with full
power of substitution and resubstitution, our true and lawful attorney-in-fact
with full power to execute in our name and on our behalf in the capacities
indicated below any and all amendments to this Form 10-K and to file the same,
with all exhibits thereto and other documents in connection therewith with the
Commission, and hereby ratify and confirm all that such attorney-in-fact, which
he or his substitute shall lawfully do or cause to be done by virtue hereof.

    Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities on March 31, 1999.



             /s/ Bob G. Alexander                     President, Chief Executive
------------------------------------------------        Officer and Director
                 Bob G. Alexander                      

             /s/ Jim L. David                         Assistant to President
------------------------------------------------        and Director
                 Jim L. David                            

             /s/ Russell D. Glass                     Director
------------------------------------------------
                 Russell D. Glass

            /s/  Martin Hirsch                        Director
------------------------------------------------
                 Martin Hirsch

            /s/  Robert H. Kite                       Director
------------------------------------------------
                 Robert H. Kite

           /s/   Robert J. Mitchell                   Director
------------------------------------------------
                 Robert J. Mitchell

             /s/ Jack G. Wasserman                    Director
------------------------------------------------
                 Jack G. Wasserman




                                       36
<PAGE>   38


         INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES


<TABLE>
<CAPTION>

FINANCIAL STATEMENTS                                                                                    PAGE
                                                                                                        ----
<S>                                                                                                     <C> 
Report of Independent Auditors.......................................................................    F-2
Consolidated Balance Sheets as of December 31, 1997, and 1998........................................    F-3
Consolidated Statements of Operations for the years ended
   December 31, 1996, 1997, and 1998.................................................................    F-4
Consolidated Statements of Cash Flows for the years ended
   December 31, 1996, 1997, and 1998.................................................................    F-5
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended
   December 31, 1996, 1997, and 1998.................................................................    F-6
Notes to Consolidated Financial Statements...........................................................    F-8
</TABLE>

FINANCIAL STATEMENT SCHEDULES

    All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.


                                      F-1

<PAGE>   39


                         REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Shareholders
National Energy Group, Inc.

    We have audited the accompanying consolidated balance sheets of National
Energy Group, Inc., as of December 31, 1997 and 1998, and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

    In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of National Energy
Group, Inc., at December 31, 1997 and 1998, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.

    The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. The Company has
suffered recurring losses from operations. Additionally, as discussed in Note 1
of the Notes to the Consolidated Financial Statements, on February 11, 1999, the
United States Bankruptcy Court granted an Involuntary Petition for an Order for
Relief under Chapter 11 of Title 11 of the United States Bankruptcy Code. These
matters raise substantial doubt about the ability of the Company to continue as
a going concern. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets or the amounts and classification of liabilities that may result from the
outcome of this uncertainty.

                                                      ERNST & YOUNG LLP




Dallas, Texas
March 24, 1999







                                      F-2

<PAGE>   40



                           NATIONAL ENERGY GROUP, INC.
                           CONSOLIDATED BALANCE SHEETS
                                    (NOTE 1)


                                     ASSETS


<TABLE>
<CAPTION>


                                                                                              DECEMBER 31
                                                                                    ------------------------------
                                                                                         1997             1998
                                                                                    -------------    -------------

<S>                                                                                 <C>              <C>          
Current assets:
   Cash and cash equivalents ....................................................   $  25,954,479    $   2,542,235
   Marketable securities ........................................................         486,750          339,250
   Accounts receivable - oil and natural gas sales ..............................      10,145,739        5,030,155
   Accounts receivable - joint interest and other ...............................       7,278,436        1,918,411
   Other ........................................................................       2,678,029        1,905,050
                                                                                    -------------    -------------
     Total current assets .......................................................      46,543,433       11,735,101
Oil and natural gas properties, at cost (full cost method):
   Subject to ceiling limitation ................................................     245,228,081      327,459,034
   Excluded from ceiling limitation .............................................      35,698,549               --
                                                                                    -------------    -------------
                                                                                      280,926,630      327,459,034
Accumulated depreciation, depletion, and amortization ...........................     (83,478,971)    (251,712,879)
                                                                                    -------------    -------------
   Net oil and natural gas properties ...........................................     197,447,659       75,746,155
Other property and equipment ....................................................       4,797,737        2,601,163
Accumulated depreciation ........................................................        (799,136)        (989,905)
                                                                                    -------------    -------------
   Net other property and equipment .............................................       3,998,601        1,611,258
Other assets and deferred charges, net ..........................................       6,371,714        5,909,344
                                                                                    -------------    -------------
     Total assets ...............................................................   $ 254,361,407    $  95,001,858
                                                                                    =============    =============

                                   LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
   Accounts payable - trade .....................................................   $  21,725,575    $   2,299,274
   Accounts payable - revenue ...................................................       7,393,127        4,932,541
   Drilling advances ............................................................       5,282,467           99,961
   Debt in default:
    Senior Notes ................................................................              --      166,238,513
    Credit facility borrowings ..................................................              --       25,000,000
   Accrued interest .............................................................       2,956,250       10,537,601
   Other ........................................................................         798,983          461,088
                                                                                    -------------    -------------
     Total current liabilities ..................................................      38,156,402      209,568,978
Long-term liabilities ...........................................................       1,915,305        2,365,648
Senior Notes ....................................................................     166,396,622               --

Commitments and contingencies

Stockholders' equity (deficit): Convertible preferred stock, $1.00 par:
     Authorized shares - 1,000,000;
     Issued and outstanding shares 171,187 at both
         December 31, 1997 and 1998
     Aggregate liquidation preference $17,118,700
       and $17,433,300 at December 31, 1997 and 1998, respectively ..............         171,187          171,187
   Common stock, $.01 par value:
     Authorized shares - 100,000,000;
     Issued and outstanding shares - 40,456,320 and 40,527,482
       at December 31, 1997 and 1998, respectively ..............................         404,563          405,275
   Additional paid-in capital ...................................................     112,940,414      113,089,872
   Unrealized loss on marketable securities, net ................................         (28,594)        (176,094)
   Accumulated deficit ..........................................................     (65,594,492)    (230,423,008)
                                                                                    -------------    -------------
     Total stockholders' equity (deficit) .......................................      47,893,078     (116,932,768)
                                                                                    -------------    -------------
       Total liabilities and stockholders' equity (deficit) .....................   $ 254,361,407    $  95,001,858
                                                                                    =============    =============
</TABLE>



                             See accompanying notes.



                                      F-3

<PAGE>   41



                           NATIONAL ENERGY GROUP, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                    (NOTE 1)

<TABLE>
<CAPTION>


                                                                     YEAR ENDED DECEMBER 31,
                                                         -----------------------------------------------
                                                               1996             1997             1998
                                                         -------------    -------------    -------------

<S>                                                      <C>              <C>              <C>          
Revenues:
   Oil and natural gas sales .........................   $  24,174,410    $  52,417,108    $  38,440,260
Costs and expenses:
   Lease operating ...................................       3,595,537        6,728,684        8,589,663
   Oil and natural gas production taxes ..............       1,285,410        3,138,644        2,503,616
   Depreciation, depletion, and amortization .........       9,900,777       23,205,462       21,310,754
   Writedowns of oil and natural gas properties ......      43,497,000       46,396,334      148,400,000
   Restructuring charges .............................              --               --        1,869,169
   General and administrative ........................       2,157,899        4,392,469        6,141,837
                                                         -------------    -------------    -------------
                                                            60,436,623       83,861,593      188,815,039
                                                         -------------    -------------    -------------
Operating loss .......................................     (36,262,213)     (31,444,485)    (150,374,779)
Other income (expense):
   Interest expense ..................................      (4,107,070)     (11,211,607)     (14,431,794)
   Interest income and other, net ....................         426,021        1,031,980          292,242
   Loss on sale of marketable securities .............        (117,955)              --               --
                                                         -------------    -------------    -------------
Loss before income taxes .............................     (40,061,217)     (41,624,112)    (164,514,331)
Benefit for income taxes .............................      14,503,595        7,285,765               --
                                                         -------------    -------------    -------------
Loss before extraordinary item .......................     (25,557,622)     (34,338,347)    (164,514,331)
Extraordinary loss on early extinguishments of debt ..        (292,372)              --               --
                                                         -------------    -------------    -------------
Net loss .............................................     (25,849,994)     (34,338,347)    (164,514,331)
Preferred stock dividend requirements ................         945,000          883,435          628,380
                                                         -------------    -------------    -------------
Net loss applicable to common shareholders ...........   $ (26,794,994)   $ (35,221,782)   $(165,142,711)
                                                         =============    =============    =============
Loss per common share, basic and diluted:
   Loss before extraordinary item ....................   $       (1.33)   $        (.94)   $       (4.08)
                                                         =============    =============    =============
   Net loss ..........................................   $       (1.34)   $        (.94)   $       (4.08)
                                                         =============    =============    =============
   Weighted average number of common
     shares outstanding ..............................      19,939,975       37,380,343       40,499,911
                                                         =============    =============    =============
</TABLE>



                                        See accompanying notes.


                                      F-4

<PAGE>   42



                           NATIONAL ENERGY GROUP, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                    (NOTE 1)


<TABLE>
<CAPTION>

                                                                                                  YEAR ENDED DECEMBER 31,
                                                                                  -----------------------------------------------
                                                                                       1996             1997             1998
                                                                                  -------------    -------------    -------------

<S>                                                                               <C>              <C>              <C>           
OPERATING ACTIVITIES
Net loss ......................................................................   $ (25,849,994)   $ (34,338,347)   $(164,514,331)
Adjustments to reconcile net loss to net cash
   provided by operating activities:
Depreciation and depletion ....................................................       9,795,283       22,521,612       20,374,833
Writedowns of oil and natural gas properties ..................................      43,497,000       46,396,334      148,400,000
Amortization of loan costs and issuance premium ...............................         151,063          573,705          777,804
Amortization of deferred compensation .........................................          36,083           39,094           42,366
Benefit for deferred income taxes .............................................     (14,503,595)      (7,273,829)              --
Loss on sale of marketable securities .........................................         117,955               --               --
Extraordinary loss on early extinguishment of debt ............................         292,372               --               --
Common stock, options, and warrants issued for services .......................         216,206          151,365               --
Other .........................................................................              --               --          290,701
Changes in operating assets and liabilities excluding effects of business
   acquisitions:
   Accounts receivable ........................................................      (4,729,262)      (7,771,430)       8,581,932
   Other current assets .......................................................        (320,601)      (1,350,230)         194,926
   Accounts payable and accrued liabilities ...................................       3,085,455        3,915,896       (9,066,079)
                                                                                  -------------    -------------    -------------
   Net cash provided by operating activities ..................................      11,787,965       22,864,170        5,082,152
                                                                                  -------------    -------------    -------------
INVESTING ACTIVITIES
Purchases of marketable securities ............................................          (9,008)        (515,344)              --
Proceeds from sale of marketable securities ...................................       1,675,669               --               --
Purchases of other property and equipment .....................................      (1,553,355)      (1,910,904)        (687,613)
Oil and natural gas acquisition, exploration, and development expenditures ....     (46,945,872)     (77,902,861)     (51,999,775)
Acquisition of Alexander Energy Corporation, net of cash acquired of $1,332,444      (2,455,993)              --               --
Proceeds from sales of oil and gas properties .................................              --        5,419,581           50,881
Other .........................................................................          11,638         (916,639)        (666,956)
                                                                                  -------------    -------------    -------------
   Net cash used in investing activities ......................................     (49,276,921)     (75,826,167)     (53,303,463)
                                                                                  -------------    -------------    -------------
FINANCING ACTIVITIES
Proceeds from issuance of 103/4% Notes due 2006, net ..........................      96,059,119       64,483,206               --
Proceeds from issuance of other long-term debt, net ...........................      69,026,613       32,978,502       30,000,000
Proceeds from issuance of note payable ........................................       8,000,000               --               --
Repayments of other long-term debt ............................................    (130,510,233)     (33,000,000)      (5,000,000)
Repayments of note payable ....................................................     (11,000,000)              --               --
Repayments of other long-term liabilities .....................................        (534,815)        (776,034)         (26,918)
Proceeds from exercise of stock options and warrants ..........................         499,704        1,917,561           93,750
Proceeds from employee stock purchase plan ....................................              --               --           56,420
Proceeds from issuance of convertible preferred stock, net ....................      15,000,000               --               --
Preferred stock dividends .....................................................        (945,000)        (786,685)        (314,185)
Other .........................................................................            (385)         (82,320)              --
                                                                                  -------------    -------------    -------------
   Net cash provided by financing activities ..................................      45,595,003       64,734,230       24,809,067
                                                                                  -------------    -------------    -------------
Increase (decrease)  in cash and cash equivalents .............................       8,106,047       11,772,233      (23,411,244)
Cash and cash equivalents at beginning of period ..............................       6,076,199       14,182,246       25,954,479
                                                                                  -------------    -------------    -------------
Cash and cash equivalents at end of period ....................................   $  14,182,246    $  25,954,479    $   2,542,235
                                                                                  =============    =============    =============

SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid in cash .........................................................   $   2,549,835    $  12,403,910    $   9,940,420
                                                                                  =============    =============    =============
</TABLE>





                             See accompanying notes.

                                      F-5

<PAGE>   43
                           NATIONAL ENERGY GROUP, INC.
            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                    (NOTE 1)

<TABLE>
<CAPTION>
                                                      CONVERTIBLE                                             
                                                    PREFERRED STOCK                   COMMON STOCK            
                                           -------------------------------    ------------------------------ 
                                               SHARES            AMOUNT          SHARES           AMOUNT      
                                           --------------     ------------    -------------    -------------
<S>                                        <C>              <C>               <C>            <C>          
Balance at December 31, 1995 ...........          92,500    $      92,500       11,880,125    $     118,801
   Common stock issued upon
     exercise of options and ...........              --               --          351,242            3,513
     warrants
   Common stock, options, and
     warrants issued for services ......              --               --           50,000              500
   Common stock issued to acquire
     interests in oil and natural
     gas properties ....................              --               --        2,416,332           24,163
   Issuance of Series D and E
     Convertible Preferred Stock
     and related warrants to ...........         150,000          150,000               --               -- 
     purchase common stock
   Common stock, stock options,
     and warrants issued or
     assumed in acquisition of .........              --               --       21,279,441          212,794
     Alexander Energy Corporation
   Preferred stock dividends ...........              --               --               --               -- 
   Unrealized gain on marketable
     securities ........................              --               --               --               -- 
   Net loss ............................              --               --               --               -- 
                                           -------------    -------------    -------------    -------------
Balance at December 31, 1996 ...........         242,500    $     242,500       35,977,140    $     359,771
   Common stock issued upon
     exercise of options and ...........              --               --          920,300            9,203
     warrants
   Common stock and warrants
     issued for services and other .....              --               --           82,854              829
   Common stock issued upon
     conversion of Series B, C,
     and E convertible preferred .......         (71,313)         (71,313)       3,500,026           35,000
   Repurchase of common stock ..........              --               --          (24,000)            (240)
   Preferred stock dividends ...........              --               --               --               -- 
   Unrealized loss on marketable
     securities ........................              --               --               --               -- 
   Net loss ............................              --               --               --               -- 
                                           -------------    -------------    -------------    -------------
Balance at December 31, 1997 ...........         171,187    $     171,187       40,456,320    $     404,563
                                           =============    =============    =============    =============

<CAPTION>

                                                               GAIN                                                  
                                                             (LOSS) ON                           TOTAL               
                                             ADDITIONAL      AVAILABLE                        STOCKHOLDERS'                 
                                              PAID-IN         FOR SALE        ACCUMULATED          EQUITY        
                                              CAPITAL        SECURITIES         DEFICIT          (DEFICIT)
                                           -------------    -------------    -------------    -------------

<S>                                        <C>              <C>              <C>              <C>          
Balance at December 31, 1995 ...........   $  21,485,224    $    (247,492)   $  (3,674,466)   $  17,774,567
   Common stock issued upon
     exercise of options and ...........         496,191               --               --          499,704
     warrants
   Common stock, options, and
     warrants issued for services ......         215,706               --               --          216,206
   Common stock issued to acquire
     interests in oil and natural
     gas properties ....................       8,319,203               --               --        8,343,366
   Issuance of Series D and E
     Convertible Preferred Stock
     and related warrants to ...........      14,850,000               --               --       15,000,000
     purchase common stock
   Common stock, stock options,
     and warrants issued or
     assumed in acquisition of .........      64,927,062               --               --       65,139,856
     Alexander Energy Corporation
   Preferred stock dividends ...........              --               --         (945,000)        (945,000)
   Unrealized gain on marketable
     securities ........................              --          247,492               --          247,492
   Net loss ............................              --               --      (25,849,994)     (25,849,994)
                                           -------------    -------------    -------------    -------------
Balance at December 31, 1996 ...........   $ 110,293,386    $          --    $ (30,469,460)   $  80,426,197
   Common stock issued upon
     exercise of options and ...........       1,908,358               --               --        1,917,561
     warrants
   Common stock and warrants
     issued for services and other .....         782,489               --               --          783,318
   Common stock issued upon
     conversion of Series B, C,
     and E convertible preferred .......          36,313               --               --               --
   Repurchase of common stock ..........         (80,132)              --               --          (80,372)
   Preferred stock dividends ...........              --               --         (786,685)        (786,685)
   Unrealized loss on marketable
     securities ........................              --          (28,594)              --          (28,594)
   Net loss ............................              --               --      (34,338,347)     (34,338,347)
                                           -------------    -------------    -------------    -------------
Balance at December 31, 1997 ...........   $ 112,940,414    $     (28,594)   $ (65,594,492)   $  47,893,078
                                           =============    =============    =============    =============
</TABLE>


                             See accompanying notes.


                                      F-6
<PAGE>   44
                           NATIONAL ENERGY GROUP, INC.
      CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
                                    (NOTE 1)

<TABLE>
<CAPTION>

                                                CONVERTIBLE                                            
                                               PREFERRED STOCK                     COMMON STOCK        
                                         -----------------------------   -----------------------------
                                            SHARES          AMOUNT          SHARES           AMOUNT    
                                         -------------   -------------   -------------   -------------
<S>                                      <C>             <C>                <C>          <C>          
Balance at December 31, 1997 .........         171,187   $     171,187      40,456,320   $     404,563
   Common stock issued upon
     exercise of options and .........              --              --          25,000             250
     warrants
   Common stock issued under
     employee stock purchase plan ....              --              --          46,162             462
   Preferred stock dividends .........              --              --              --              -- 
   Unrealized loss on marketable
     securities ......................              --              --              --              -- 
   Net loss ..........................              --              --              --              -- 
                                         -------------   -------------   -------------   -------------
Balance at December 31, 1998 .........         171,187   $     171,187      40,527,482   $     405,275
                                         =============   =============   =============   =============

<CAPTION>
                                                            GAIN                                                       
                                                          (LOSS) ON                         TOTAL                         
                                           ADDITIONAL     AVAILABLE                       STOCKHOLDERS'    
                                            PAID-IN       FOR SALE        ACCUMULATED        EQUITY             
                                            CAPITAL       SECURITIES        DEFICIT        (DEFICIT)
                                         -------------   -------------   -------------   -------------
<S>                                     <C>             <C>              <C>              <C>          
Balance at December 31, 1997 .........   $ 112,940,414   $     (28,594)   $ (65,594,492)   $  47,893,078
   Common stock issued upon
     exercise of options and .........          93,500              --               --           93,750
     warrants
   Common stock issued under
     employee stock purchase plan ....          55,958              --               --           56,420
   Preferred stock dividends .........              --              --         (314,185)        (314,185)
   Unrealized loss on marketable
     securities ......................              --        (147,500)              --         (147,500)
   Net loss ..........................              --              --     (164,514,331)    (164,514,331)
                                         -------------   -------------    -------------    -------------
Balance at December 31, 1998 .........   $ 113,089,872   $    (176,094)   $(230,423,008)   $(116,932,768)
                                         =============   =============    =============    =============
</TABLE>




                             See accompanying notes.


                                      F-7

<PAGE>   45
                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998



1. SUBSEQUENT EVENT - BANKRUPTCY ORDER

     On December 4, 1998 the Company's 10 3/4% Senior Note bondholders filed an
Involuntary Petition for an Order for Relief under Chapter 11 of Title 11 of the
United States Bankruptcy Code in the United States Bankruptcy Court for the
Northern District of Texas, Dallas Division, due to non-payment of interest due
December 2, 1998, after expiration of a 30-day grace period. On December 23,
1998, the Company filed in the Bankruptcy Court, an Answer to and Motion to
Dismiss the pending Involuntary Petition. The Company's Motion affirmed that it
(i) was meeting its obligations and generally paying its debts as they become
due, unless such debts were the basis of a bona fide dispute and (ii) had
arranged with the lender under its credit facility to borrow additional funds
sufficient to pay the interest due on the 10 3/4% Senior Notes, conditioned upon
the Court's dismissal of the Involuntary Petition. However, on February 8, 1999,
the Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary
Petition. An Order for Relief was entered by the Bankruptcy Court on February
11, 1999. The Order for Relief places the Company under the protection of the
Court and precludes payment of the interest on the Senior Notes at this time.
Additionally, payment of liabilities existing as of February 11, 1999 to certain
unsecured creditors and dividends in arrears to holders of the Company's
Preferred Stock and any pending litigation are stayed during the Bankruptcy
proceeding. The Company shall act as debtor-in-possession and will continue to
operate its business and manage its properties in the ordinary course of
business during its Chapter 11 proceeding. The Company anticipates proposing a
Plan of Reorganization within 120 days of February 11, 1999 or at such time as
may be extended by the Court. As of December 4, 1998, the Company discontinued
the accrual of interest related to unsecured liabilities subject to compromise,
principally the Senior Notes, as a result of the Chapter 11 filing.
Approximately $1.3 million additional interest expense would have been
recognized by the Company if not for the discontinuation of the interest accrual
on the Senior Notes.

     The accompanying consolidated financial statements have been prepared on a
going concern basis of accounting and do not reflect any adjustments that might
result should the Company be unable to continue as a going concern. The
Company's recent losses from operations and the related Chapter 11 proceeding
raise concern about its ability to continue as a going concern. The
appropriateness of using the going concern basis is dependent upon, among other
things (i) confirmation of a plan of reorganization under the Bankruptcy Code,
(ii) the ability to achieve profitable operations after such confirmation and
(iii) the ability to generate sufficient cash from operations to meet its
obligations.

     The Company anticipates proposing a Plan of Reorganization in accordance
with the federal bankruptcy laws as administered by the Bankruptcy Court.
Confirmation of a Plan of Reorganization could materially change the amounts
currently recorded in the financial statements. The financial statements do not
give effect to any adjustment to the carrying value of assets, or amounts and
classifications of liabilities that might be necessary as a consequence of this
matter.

     Through December 31, 1998, the Company has incurred expenses of
approximately $.3 million relating to the bankruptcy proceedings. At December
31, 1998, substantially all of the Company's unsecured liabilities are subject
to compromise under the terms of the bankruptcy proceeding.

2. SIGNIFICANT ACCOUNTING POLICIES

Organization and Business

    National Energy Group, Inc. was incorporated under the laws of the State of
Delaware on November 20, 1990. The Company has historically engaged in the
exploration, acquisition, exploitation, development, and operation of crude oil
and natural gas properties in major producing basins onshore in Texas,
Louisiana, Oklahoma, Arkansas, and Mississippi and offshore in the Gulf of
Mexico.

Consolidation

     The consolidated financial statements include the accounts of National
Energy Group, Inc., and its subsidiaries. All significant intercompany
transactions and balances have been eliminated.


                                      F-8
<PAGE>   46


                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998



2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Accounting Estimates

    The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.

Cash and Cash Equivalents

    Cash and cash equivalents may include demand deposits, short-term commercial
paper, and/or money-market investments with maturities of three months or less
when purchased. At December 31, 1997, all cash and cash equivalents were
invested with Bank One, Texas, N.A. At December 31, 1998, all cash and cash
equivalents were invested with either Bank One or Chase Bank of Texas.

Oil and Natural Gas Properties

    The Company utilizes the full cost method of accounting for its crude oil
and natural gas properties. Under the full cost method, all productive and
nonproductive costs incurred in connection with the acquisition, exploration,
and development of crude oil and natural gas reserves are capitalized and
amortized on the units-of-production method based upon total proved reserves.
The costs of unproven properties are excluded from the amortization calculation
until the individual properties are evaluated and a determination is made as to
whether reserves exist. Conveyances of properties, including gains or losses on
abandonments of properties, are treated as adjustments to the cost of crude oil
and natural gas properties, with no gain or loss recognized.

    Under the full cost method, the net book value of oil and natural gas
properties, less related deferred income taxes, may not exceed the estimated
after-tax future net revenues from proved oil and natural gas properties,
discounted at 10% per year (the ceiling limitation). In arriving at estimated
future net revenues, estimated lease operating expenses, development costs,
abandonment costs, and certain production related and ad-valorem taxes are
deducted. In calculating future net revenues, prices and costs in effect at the
time of the calculation are held constant indefinitely, except for changes which
are fixed and determinable by existing contracts. The net book value is compared
to the ceiling limitation on a quarterly and yearly basis. The excess, if any,
of the net book value above the ceiling limitation is required to be written off
as a non-cash expense. During 1996, as a result of allocating additional cost,
under the purchase method of accounting, to the oil and natural gas properties
in connection with the Alexander Energy acquisition, the Company recognized a
non-cash writedown of its oil and natural gas properties of approximately $43.5
million. During the years ended December 31, 1997 and 1998, the net book value
of the Company's oil and natural gas properties exceeded the ceiling limitation
resulting in non-cash writedowns totaling $46.4 and $148.4 million,
respectively. There can be no assurance that there will not be additional
writedowns in future periods under the full cost method of accounting as a
result of sustained decreases in oil and natural gas prices or other factors.

    Oil and natural gas properties excluded from the ceiling limitation consist
primarily of unevaluated acreage, acquisition costs, and related seismic and
other geological and geophysical costs (unproven properties). During 1998,
unproven properties with a carrying value of approximately $32.0 million were
transferred to proved properties, largely as a result of drilling activities and
became subject to the full cost ceiling. At December 31, 1998, due to
uncertainty relating to the Company's ability to obtain Court approval for
exploration of its remaining portfolio of unproven properties and due to low oil
prices which make the projects uneconomical, the remaining carrying value of the
unproven properties, approximately $9.1 million, was transferred to proved
properties and became subject to the ceiling limitation.




                                      F-9
<PAGE>   47


                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998




2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    The Company has capitalized internal costs of $487,835, $1,582,021 and
$1,950,914 for the years ended December 31, 1996, 1997, and 1998, respectively.
Such capitalized costs include salaries and related benefits of individuals
directly involved in the Company's acquisition, exploration, and development
activities based on the percentage of their time devoted to such activities.
During the years ended December 31, 1997 and 1998, the Company capitalized
interest costs of $2,545,617 and $3,371,279 related to its unproved oil and gas
properties.

Other Property and Equipment

    Other property and equipment includes furniture, fixtures, and other
equipment. Such assets are recorded at cost and are depreciated over their
estimated useful lives using the straight-line method.

    Maintenance and repairs are charged against income when incurred; renewals
and betterments, which extend the useful lives of property and equipment, are
capitalized.

Income Taxes

    Deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using enacted tax rates. The effect on deferred tax assets and
liabilities of a change in tax rate is recognized in the period that includes
the enactment date. The measurement of deferred tax assets is adjusted by a
valuation allowance, if necessary, to recognize the extent to which, based on
available evidence, the future tax benefits more likely than not will be
realized.

Financial Instruments

    The Company does not hold or issue financial instruments for trading
purposes.

    See Notes 4 and 5 for disclosure of the fair value of borrowings under the
Company's credit facility and the 10 3/4% Senior Notes, respectively.

    The Company from time to time utilizes certain derivative financial
instruments to hedge future oil and gas prices. (Note 9). Gains and losses
arising from the use of these instruments are deferred until realized and are
reported as oil and natural gas sales.

    The Company's marketable securities are classified as available-for-sale.
Available-for-sale securities are carried at fair value, with the unrealized
gains and losses, net of tax, reported as a separate component of stockholders'
equity. Realized gains and losses and declines in value judged to be
other-than-temporary are included in interest income. The cost of securities
sold is based on the specific identification method.

    The following is a summary of available-for-sale securities at December 31,
1997 and 1998:

<TABLE>
<CAPTION>


                                                                    GROSS           GROSS        ESTIMATED
                                                                  UNREALIZED      UNREALIZED        FAIR 
                                                    COST            GAINS          LOSSES          VALUE
                                                =============   =============   =============   =============

<S>                                             <C>             <C>             <C>             <C>          
Common stocks at December 31, 1997 ..........   $     515,344   $          --   $      28,594   $     486,750

                                                =============   =============   =============   =============
Common stocks at December 31, 1998 ..........   $     515,344   $          --   $     176,094   $     339,250
                                                =============   =============   =============   =============
</TABLE>


    The Company had no sales of marketable securities in 1998.

    The Company's investment in marketable securities is comprised of securities
of another independent oil and gas company.


                                      F-10

<PAGE>   48

                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    The Company sells crude oil and natural gas to various customers. In
addition, the Company participates with other parties in the operation of crude
oil and natural gas wells. Substantially all of the Company's accounts
receivable are due from either purchasers of crude oil and natural gas or
participants in crude oil and natural gas wells for which the Company serves as
the operator. Generally, operators of crude oil and natural gas properties have
the right to offset future revenues against unpaid charges related to operated
wells. Crude oil and natural gas sales are generally unsecured.

    Allowances for bad debt totaled approximately $120,000 and $150,000 at
December 31, 1997 and 1998, respectively. At December 31, 1997 and 1998, the
carrying value of the Company's accounts receivable approximates fair value.

Natural Gas Production Imbalances

    The Company accounts for natural gas production imbalances using the sales
method, whereby the Company recognizes revenue on all natural gas sold to its
customers notwithstanding the fact that its ownership may be less than 100% of
the natural gas sold.

Stock Options

    The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, in accounting for its employee
stock options. Under APB 25, if the exercise price of an employee's stock
options equals or exceeds the market price of the underlying stock on the date
of grant, no compensation expense is recognized.

Earnings (Loss) Per Share

    Earnings (loss) per share is computed in accordance with Financial
Accounting Standards Board Statement No. 128, Earnings per Share. Basic earnings
per share data is computed by dividing net income (loss) applicable to common
shareholders by the weighted average number of common shares outstanding and
excludes any dilutive effects of options, warrants, and convertible securities.
Shares issuable upon exercise of options and warrants are included in the
computation of diluted earnings per common and common equivalent share to the
extent that they are dilutive. Diluted earnings per share computations also
assume the conversion of the Company's preferred stock (Note 7) if such
conversion has a dilutive effect. For the years ended December 31, 1996, 1997,
and 1998, neither the common equivalent shares nor the assumed conversion of the
preferred stock had a dilutive effect on the loss per share calculations.
Accordingly, both basic and diluted loss per share calculations for such periods
are based on the weighted average number of common shares outstanding during
each year.

Recent Accounting Pronouncements

    As of January 1, 1998, the Company adopted Financial Accounting Standards
Board Statement No. 130, Reporting Comprehensive Income. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources.
Statement 130 establishes rules for the reporting and display of comprehensive
income and its components. For 1996, 1997 and 1998, the differences between net
earnings and total comprehensive income were not material.

    In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities, which is required to be adopted in years beginning after
June 15, 1999. The Company expects to adopt the new Statement effective January
1, 2000. The Statement will require the Company to recognize all derivatives on
the balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value through income. If the derivative is a hedge, depending
on the nature of the hedge, changes in the fair value of derivatives will either
be offset against the change in fair value of the



                                      F-11

<PAGE>   49

                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

hedged assets, liabilities, or firm commitments through earnings or recognized
in other comprehensive income until the hedged item is recognized in earnings.
The ineffective portion of a hedge's change in fair value will be immediately
recognized in earnings.

Reclassifications

    Certain previously reported amounts have been reclassified to conform with
the current presentation.

3. ACQUISITIONS

    In January 1996, the Company completed the acquisition of oil and natural
gas properties in offshore Nueces County, Texas, adjacent to the Company's
Mustang Island property, from C/A Limited, Chartex Petroleum Company, and
Petrotex Engineering Company. The acquisition includes interests in five wells,
a pipeline and separation facility related to Mustang Island. The consideration
for this acquisition consisted of 140,857 shares of the Company's Common Stock
and $675,000 in cash.

    In February 1996, the Company completed the acquisition of two oil and gas
wells on one offshore block, interests in five other offshore blocks, and a
related production platform and equipment in offshore Nueces County, Texas,
adjacent to the Company's Mustang Island property, from UMC Petroleum
Corporation (the "UMC Acquisition"). The consideration for this acquisition
consisted of $1.5 million in cash, which was funded primarily from borrowings
under a credit agreement with Bank One.

    In April 1996, the Company won exploration rights on 16 offshore tracts
(covering 7,765 acres) in the Mustang Island area in offshore Nueces County,
Texas, through successful bids with the State of Texas ("Offshore Lease
Acquisition"). The Company paid $1.4 million in cash for these rights, and the
purchase was funded by borrowings under a credit facility with Bank One and
available cash.

    On August 29, 1996, the Company completed the acquisition of Alexander
Energy Corporation. The transaction consisted of a merger of Alexander with and
into National Energy Group of Oklahoma, Inc., formerly known as NEG-OK, Inc., a
wholly-owned subsidiary of the Company ("NEG-OK"). Pursuant to the Merger, (a)
the separate corporate existence of Alexander terminated, (b) each share of
Alexander common stock, par value $.03 per share ("Alexander Common Stock"),
together with certain rights associated with the Alexander Common Stock
outstanding immediately before the Merger, were converted into 1.7 shares of the
Company's Common Stock, and (c) all outstanding options and warrants to purchase
Alexander Common Stock were assumed by the Company and converted into options
and warrants to purchase Common Stock. In lieu of fractional shares, Alexander
shareholders otherwise entitled to receive fractional shares of Common Stock
were paid in cash an amount equal to $4.375 multiplied by the fraction of a
share of Common Stock to be received. On December 31, 1996, NEG-OK was merged
into and with the Company and its separate corporate existence ceased to exist.

    In connection with the Merger, on August 29, 1996, the Company, NEG-OK, and
Boomer Marketing Corporation, a wholly-owned subsidiary of NEG-OK, entered into
a new credit facility. See Note 4. On August 29, 1996, the Company also closed
the sale of 100,000 shares of its Convertible Preferred Stock, Series D, $1.00
par value per share, the sale of 50,000 shares of its Convertible Preferred
Stock, Series E, $1.00 par value per share, and warrants to purchase 1,050,000
shares of Common Stock. See Note 7.




                                      F-12

<PAGE>   50

                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998



3. ACQUISITIONS (CONTINUED)


    The cost of acquiring Alexander was approximately $69.4 million, consisting
of the following (in thousands):

<TABLE>

<S>                                                                                 <C>
Fair value of 21.1 million shares of the Company's Common
  Stock issued ...................................................................   $63,404
Cost of 105,740 shares of NEG-OK common stock owned by the
  Company ........................................................................       288
Alexander stock options and warrants assumed .....................................       340
Fair value of 122,324 shares of the Company's Common Stock and 800,000 warrants
  issued for services provided by
  investment advisors ............................................................     1,322
Other investment advisor, legal, and accounting professional
  fees and other Merger related costs ............................................     4,009
                                                                                     -------
                                                                                     $69,363
                                                                                     =======
</TABLE>


    The fair value of the securities issued in connection with the Merger was
calculated using the price of the Company's Common Stock at the time the Merger
was announced to the public of $3.00 per share.

    The Company's purchase price was allocated to the consolidated assets and
liabilities of NEG-OK based on preliminary estimates of fair values with the
remaining purchase price allocated to proved oil and gas properties. No goodwill
was recorded in this transaction.

    The allocation of the purchase price is summarized as follows (in
thousands):

<TABLE>

<S>                                                                      <C>
Working capital (deficit) assumed, excluding current portion
  of long-term debt ..................................................   $     (87)
Oil and natural gas properties:
  Proved .............................................................     132,756
  Unproved ...........................................................       6,319
Other property and equipment .........................................         970
Other non-current assets .............................................         198
Long-term debt assumed ...............................................     (45,853)
Other non-current liabilities assumed ................................      (3,163)
Deferred income taxes ................................................     (21,777)
                                                                         ---------
                                                                         $  69,363
                                                                         =========
</TABLE>


    Under the full cost method of accounting, the carrying value of oil and gas
properties (net of related deferred taxes) is generally not permitted to exceed
the sum of the present value (10% discount rate) of estimated future net cash
flows, after tax, from proved reserves, based on current prices and costs, plus
the lower of cost or estimated fair value of unproved properties (the "full cost
ceiling"). Based upon the combined full cost ceiling at August 29, 1996, and the
preliminary allocation of the Company's purchase price, the purchase price
allocated to oil and gas properties was in excess of the full cost ceiling using
oil and natural gas prices being received by the Company and NEG-OK in August
1996 of $20.75 per Bbl and $2.21 per Mcf. Such excess was written off at the
date of acquisition, resulting in a charge to the Company's results of
operations of $28.3 million as follows (in thousands):

<TABLE>

<S>                                                            <C>
Writedown of oil and natural gas properties ................   $ 43,497
Deferred income tax benefit ................................    (15,224)
                                                               --------
                                                               $ 28,273
                                                               ========
</TABLE>

    In September 1996, the Company acquired an approximate 87.5% working
interest in two wells and certain proved undeveloped reserves in the South Lake
Boeuf Field, La Fourche Parish, Louisiana (the "Lake Boeuf Acquisition") for
approximately $7.2 million, consisting of $1.5 million in cash and 1,758,460
shares of Common Stock.



                                      F-13



<PAGE>   51
                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


3. ACQUISITIONS (CONTINUED)

    The following pro forma data presents the results of the Company for the
year ended December 31, 1996, as if the acquisitions of Mustang Island, Oak
Hill, the Enron Properties, NEG-OK, and the Lake Boeuf Acquisition had occurred
on January 1, 1996. The pro forma results of operations are presented for
comparative purposes only and are not necessarily indicative of the results
which would have been obtained had the acquisitions been consummated as
presented. The following data reflect pro forma adjustments for oil and gas
revenues, production costs, depreciation, and depletion related to the
properties and businesses acquired, interest on borrowed funds, additional
preferred stock dividend requirements, and the related income tax effects, but
excluding the effect of the full cost ceiling writedown recorded in 1996 (in
thousands, except per share amounts).

<TABLE>
<CAPTION>

                                                                    PRO FORMA
                                                          YEAR ENDED DECEMBER 31, 1996
                                                          ----------------------------
                                                                    (UNAUDITED)


<S>                                                      <C>       
Total revenues ........................................             $   38,807
                                                                    ==========
Income (loss) before extraordinary item ...............             $    3,465
                                                                    ==========
Income (loss) before extraordinary item per share .....             $      .06
                                                                    ==========
</TABLE>

    In October 1996, the Company acquired certain leasehold interests located in
the East Bayou Sorrel Field, Iberville Parish, Louisiana from W&T Offshore, Inc.
The consideration paid by the Company consisted of $3,300,000 in cash. In
November 1996, the Company completed the acquisition of oil and natural gas
properties and related facilities located in the Bayou Sorrel Field, Iberville
Parish, Louisiana. The consideration paid by the Company consisted of $9.0
million cash, 477,612 shares of the Company's Common Stock and conveyance of 3%
overriding royalty interest in the property acquired, limited to production
below 11,000 feet. In December 1996, the Company acquired certain oil and
natural gas properties located in the East Bayou Sorrel Field, Iberville Parish,
Louisiana. The consideration paid by the Company consisted of $7.0 million in
cash. The Company funded the cash portion of these acquisitions from available
cash. These acquisitions consisted principally of proved developed nonproducing
and unproved properties and, accordingly, did not have a significant impact on
the Company's results of operations for 1996.

    In December 1996, the Company acquired, for $4.2 million in cash, John
Hancock Mutual Life Insurance Company's limited partnership interests in certain
limited partnerships in which the Company was the general partner. The limited
partnerships owned working interests in the Anadarko and Arkoma Basin areas of
Oklahoma and the Giddings area of Texas.

    In March 1998, the Company acquired Fortune Natural Resources Corporation's
interests in the East Bayou Sorrel field for approximately $4.5 million in cash.
In June 1998, the Company acquired Germany Oil Company's interest in six state
leases and one producing well in the Mustang Island area for $.4 million in
cash. These acquisitions did not have a significant impact on the Company's
results of operations for 1998.

4. CREDIT FACILITIES

    On August 29, 1996, the Company, NEG-OK and Boomer Marketing, entered into a
credit facility with Bank One, as Bank and Administrative Agent, and the Credit
Lyonnais New York Branch, as Bank and Syndication Agent (collectively, the
"Banks"). The credit facility consisted of a $100.0 million reducing revolving
line of credit, with an initial borrowing base of $60.0 million and a $5.0
million term loan. Interest under the reducing revolving line of credit was
payable monthly at the Bank One base rate, as adjusted. The proceeds from the
credit facility were used to repay a prior credit facility and the existing
indebtedness of NEG-OK, resulting in an extraordinary charge of $292,372 or $.01
per common share in 1996.

                                      F-14

<PAGE>   52

                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998



4. CREDIT FACILITIES (CONTINUED)

    In November 1996, the Company repaid the outstanding borrowings under the
credit facility with a portion of proceeds from the issuance of $100.0 million
principal amount of 10 3/4% Senior Notes due 2006 (the "Series A Notes"). See
Note 5.

    Also in November 1996, in connection with the issuance of the Series A
Notes, the Company revised the credit facility. The credit facility had a
borrowing base of $25.0 million. The borrowing base may be redetermined at least
semiannually and may require mandated monthly principal reductions from time to
time. The principal amount of any borrowings is due at maturity, August 29, 2000
and interest is payable monthly.

    The Company granted liens to the Banks on substantially all of the Company's
oil and natural gas properties, whether currently owned or hereafter acquired,
and a negative pledge on all other oil and natural gas properties. The credit
facility requires, among other things, semiannual engineering reports covering
oil and natural gas properties, and maintenance of certain financial ratios,
including the maintenance of a minimum interest coverage, a current ratio, and a
minimum tangible net worth.

    The credit facility contains other covenants prohibiting cash dividends,
distributions, loans, or advances to third parties, except that cash dividends
on preferred stock will be allowed so long as no event of default exists or
would exist as a result of the payment thereof. In addition, if the Company is
required to purchase or redeem any portion of the Notes, or if any portion of
the Notes become due, the borrowing base is subject to reduction.

    The Company is required to pay a commitment fee on the unused portion of the
borrowing base equal to 1% per annum.

    On December 7, 1998, Bank One and Credit Lyonnais gave notice to the Company
that all outstanding obligations under the credit facility were accelerated and
were immediately due and payable due to certain unspecified Events of Default as
defined in the loan agreement.

    Effective December 22, 1998, the credit facility and all associated liens
were assigned by the Banks to Arnos, Inc., an affiliated subsidiary of the
Company's Series D Preferred Stockholder. In a letter dated December 23, 1998,
Arnos (1) rescinded the acceleration of the loan, (2) waived all defaults
existing at that time and (3) made sufficient borrowings available to pay the
interest on the Senior Notes that was due on November 2, 1998, conditioned upon
the Bankruptcy Court's dismissal of the Involuntary Petition. To date, no fees
or interest have been paid to Arnos. The Company is currently accruing interest
expense at an estimated rate under the Arnos credit facility. The Company had
$25,000,000 outstanding under the Arnos credit facility as of December 31, 1998.
At December 31, 1998, the Company was in violation of the minimum interest
coverage ratio and current ratio covenants under the Arnos credit facility and
has classified borrowings under the facility as current liabilities.

    At December 31, 1998, the fair value of borrowings under the Arnos credit
facility approximates the carrying value of the liability.

                                      F-15

<PAGE>   53



5. 10 3/4 SENIOR NOTES DUE 2006

    On December 4, 1998 the Company's 10 3/4% Senior Note bondholders filed an
Involuntary Petition for an Order for Relief under Chapter 11 of Title 11 of the
United States Bankruptcy Code in the United States Bankruptcy Court for the
Northern District of Texas, Dallas Division due to non-payment of interest due
December 2, 1998, after expiration of 30 day grace period. On December 23, 1998,
the Company filed in the Bankruptcy Court, an Answer to and Motion to Dismiss
the pending Involuntary Petition. The Company's Motion affirmed that it (i) was
meeting its obligations and generally paying its debts as they become due,
unless such debts were the basis of a bona fide dispute and (ii) had arranged
with the lender under its credit facility to borrow additional funds sufficient
to pay the interest due on the 10 3/4% Senior Notes, conditioned upon the
Court's dismissal of the Involuntary Petition. However, on February 8, 1999, the
Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary
Petition. An Order for Relief was entered by the Bankruptcy Court on February
11, 1999. The Order for Relief places the Company under the protection of the
Court and precludes payment of the interest on the Senior Notes at this time.
The Company shall act as debtor-in-possession and will continue to operate its
business and manage its properties in the ordinary course of business during its
Chapter 11 proceeding. The Company anticipates proposing a Plan of
Reorganization within 120 days of February 11, 1999 as such time may be extended
by the Court. As a result of the Chapter 11 proceeding, the Company discontinued
accruing interest on the Notes as of December 4, 1998, principally the Senior
Notes, as a result of the Chapter 11 filing. Approximately $1.3 million
additional interest expense would have been recognized by the Company if not for
the discontinuation of the interest accrual on the Senior Notes.

    In November 1996, the Company issued $100 million aggregate principal amount
of unregistered 10 3/4% Senior Notes due 2006 (the "Series A Notes"). The net
proceeds of the Series A Notes of approximately $96.1 million were used to repay
approximately $62.0 million of borrowings under a prior facility and to increase
the Company's working capital. In 1997, the Series A Notes were exchanged for
registered 10 3/4% Senior Notes due 2006 (the "Series B Notes") which were
substantially identical to the Series A Notes. Collectively, the Series A Notes
and Series B Notes are referred to as the Series A/B Notes." In August 1997, the
Company issued $65.0 million aggregate principal amount of its unregistered 10
3/4% Senior Notes (the "Series C Notes"). The net proceeds of the Series C Notes
of approximately $64.8 million were used to repay approximately $23.0 million of
borrowings under the credit facility and to increase the Company's working
capital. In December 1997, the Company exchanged substantially all of the Series
A/B Notes and all of the Series C Notes for registered 10 3/4% Senior Notes due
2006 (the "Series D Notes"). The Series D Notes are substantially identical to
the Series A/B Notes and the Series C Notes. Collectively, the Series A/B Notes,
the Series C Notes and the Series D Notes are referred to as the "Notes." The
Notes bear interest at an annual rate of 10 3/4%, payable semiannually in
arrears on May 1 and November 1 of each year. The Notes are senior, unsecured
obligations of the Company, ranking pari passu with all existing and future
senior indebtedness of the Company, and senior in right of payment to all future
subordinated indebtedness of the Company. Subject to certain limitations set
forth in the indenture covering the Notes (the "Indenture"), the Company and its
subsidiaries may incur additional senior indebtedness and other indebtedness.

    At December 31, 1997 and 1998, unamortized issuance premiums associated with
the Notes totaled $1,396,622 and $1,238,513, respectively.

    The Indenture provides that the Notes will be unconditionally guaranteed
(the "Guarantee") by any subsidiary designated by the Company as a Restricted
Subsidiary (a "Guarantor"). As a result of the merger of NEG-OK into the Company
on December 31, 1996, the Company has no Restricted Subsidiaries.

    The Indenture contains certain covenants limiting the Company and any
Restricted Subsidiaries, with respect to the following: (i) assets sales; (ii)
restricted payments; (iii) the incurrence of additional indebtedness and the
issuance of certain redeemable preferred stock; (iv) liens; (v) sale and
leaseback transactions; (vi) lines of business; (vii) dividend and other payment
restrictions affecting subsidiaries; (viii) mergers and consolidations; and (ix)
transactions with affiliates.


                                      F-16
<PAGE>   54


                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998




    The Notes mature on November 1, 2006. At any time on or after November 1,
2001, the Company may, at its option, redeem all or any portion of the Notes at
the redemption prices expressed as percentages of the principal amount of the
Notes set forth below, plus, in each case, accrued and unpaid interest thereon
to the applicable redemption date, if redeemed during the 12-month period
beginning November 1 of the years indicated below:

<TABLE>
<CAPTION>

   YEAR                                                                                              PERCENTAGE
   ----                                                                                              ----------
<S>                                                                                                  <C>
   2001.............................................................................................  105.375%
   2002.............................................................................................  102.688%
   2003 and thereafter..............................................................................  100.000%
</TABLE>


Notwithstanding the foregoing, at any time prior to November 1, 2001, the
Company may, at its option, redeem all or any portion of the Notes at the
Make-Whole Price, as defined, plus accrued and unpaid interest to the date of
redemption. In addition, in the event the Company consummates one or more Equity
Offerings, as defined, on or prior to November 1, 1999, the Company, at its
option, may redeem up to $35.0 million of the aggregate principal amount of the
Notes with all or a portion of the aggregate net proceeds received by the
Company from such Equity Offering or Equity Offerings at a redemption price of
110.75% of the aggregate principal amount of the Notes so redeemed, plus accrued
and unpaid interest thereon to the redemption date; provided, however, that
following such redemption, at least $65.0 million of the aggregate principal
amount of the Notes remains outstanding.

    Upon a Change of Control, as defined, the Company will be required, subject
to certain conditions, to offer to repurchase all Notes at 101% of the principal
amount thereof, plus accrued and unpaid interest to the date of purchase.

    Due to the non-payment of interest due December 2, 1998, the Notes were in
default at December 31, 1998, and have been classified as a current liability.

    At December 31, 1998, the fair value of the Notes, as determined by quoted
market prices, was approximately $62.7 million.

6. COMMITMENTS AND CONTINGENCIES

    The Company leases office space under an operating lease. Rental expense
charged to operations was approximately $117,000, $275,000, and $364,000 during
the years ended December 31, 1996, 1997 and 1998, respectively. Minimum lease
payments under future operating lease commitments at December 31, 1998, are as
follows:

<TABLE>

<S>                                                                                             <C>
1999.......................................................................................     $   391,611
2000.......................................................................................         487,442
2001.......................................................................................         487,442
2002.......................................................................................         487,442
2003.......................................................................................         549,934
Thereafter.................................................................................       2,199,736
                                                                                                -----------
                                                                                                $ 4,603,607
                                                                                                ===========
</TABLE>

    The Company filed suit against Mr. R. E. Steakley in August 1995 to enjoin
Mr. Steakley from interfering with the operations of the Company. Mr. Steakley
counterclaimed against the Company for surface damages, alleging certain
environmental claims. In February 1999, without admitting any liability, the
Company and Mr. R. E. Steakley entered into a Settlement and Release Agreement
which provided that each of the Company and Mr. Steakley release and discharge
the other from all claims and damages which may have occurred through January
31, 1999 and dismiss the pending litigation against each other. The Company
further agreed to pay Mr. Steakley an amount of $75,000, purchase certain
materials from Mr. Steakley at market value which the Company shall use to
maintain roads incidental to its operations on the Steakley property and limit
the Company's ingress and egress to specified entrances on the Steakley
property.




                                      F-17

<PAGE>   55


                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998



6. COMMITMENTS AND CONTINGENCIES (CONTINUED)

     Other than the Bankruptcy Court proceeding, the Company is not a defendant
in any additional material pending legal proceedings. While the ultimate results
of these proceedings cannot be predicted with certainty, the Company does not
believe that the outcome of these matters will have a material adverse effect on
the Company.

7. STOCKHOLDERS' EQUITY

Preferred Stock

    At December 31, 1998, the Company has authorized 330,000 shares of $1.00 par
value convertible preferred stock designated in four series B through E:

<TABLE>
<CAPTION>
                                           SERIES B         SERIES C          SERIES D          SERIES E
                                        --------------   --------------    --------------    --------------

<S>                                     <C>              <C>               <C>               <C>                 
Number of authorized
   shares .........................           100,000           80,000           100,000             50,000
Number of shares issued and
   outstanding:
     December 31, 1996 ............            52,500           40,000           100,000             50,000
     December 31, 1997 ............            38,687           23,000           100,000              9,500
     December 31, 1998 ............            38,687           23,000           100,000              9,500
Conversion price per
   common share ...................     $       1.625       $     2.00      $       2.25       $       2.25
Liquidation preference
   value per share ................     $      100.00       $   100.00      $     100.00       $     100.00
Dividend rights....................      10% payable      101/2% payable    Participation      Participation
                                        semi-annually      semi-annually     with common        with common
                                        (cumulative)       (cumulative)         stock              stock
</TABLE>


     On June 3, 1994, the Company consummated the sale of $5,000,000 of the
Company's 10% Cumulative Convertible Preferred Stock, Series B. Fifty thousand
shares of Series B were sold by the Company at $100.00 per share. The Series B
is convertible into shares of Common Stock at a conversion price of $1.625 per
share. The Series B has a liquidation and dividend preference over the Common
Stock. The Series B has a 10% dividend, payable semi-annually. The Company has
the option to make six dividend payments in shares of Series B; after the sixth
such payment, the holders of Series B have the option to receive additional
dividends in shares of Series B or to accrue such dividends in cash. If the
Company makes four dividend payments in shares of Series B, the holders of
Series B have the right to appoint one-third of the members of the Company's
Board of Directors. In December 1998, the Board of Directors declared a dividend
on Series B to be made in shares of Series B. To date, the dividends have not
been paid and therefore there are $193,435 dividends in arrears at December 31,
1998. The Series B is redeemable by the Company beginning June 14, 1999, at
$100.00 per share, plus accrued and unpaid dividends; provided, however, that
the Company cannot redeem any shares of Series B unless and until all
outstanding shares of the Series C have been redeemed by the Company. The
holders of Series B currently have the right to appoint one member to the
Company's Board of Directors. The Series B requires that dividends be paid on
the Series B before any dividends are paid on Common Stock.

    The holders of Series B are entitled to one vote for each share as to
matters upon which by law they are entitled to vote as a class. The approval of
a majority of the Series B, voting separately as a class, is required to (i)
make changes to the Company's Certificate of Incorporation or By-Laws which
adversely affect the Series B, (ii) authorize or issue additional shares of
Series B, (iii) issue preferred stock equal to or senior to the Series B as to
dividends or liquidation, or (iv) subject to certain exceptions, to effect an
extraordinary transaction that requires a vote of the Company's stockholders. As
a result, a class vote of the holders of Series B would be required for the
Company to merge or be acquired and may therefore delay, deter, or prevent a
change in control of the Company.








                                      F-18
<PAGE>   56


                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


7. STOCKHOLDERS' EQUITY (CONTINUED)

    In June 1995, the Company consummated the sale of $4.0 million of the
Company's 10 1/2% Cumulative Convertible Preferred Stock, Series C. Forty
thousand shares of Series C were sold by the Company at $100.00 per share. The
Series C is convertible into shares of Common Stock at a conversion price of
$2.00 per share.

    The Series C has a liquidation and dividend preference over the Common Stock
and is parity stock to the previously issued Series B. The Series C has a 10
1/2% dividend, payable semi-annually. The Company has the option to make six
dividend payments in shares of Series C; after the sixth such payment, the
holders of Series C have the option to receive additional dividends in shares of
Series C or to accrue such dividends in cash.

    If the Company makes four dividend payments in shares of Series C, the
holders of Series C (voting as a class with other affected series of preferred
stock with similar voting rights) have the right to appoint one-third of the
members of the Company's Board of Directors; provided, however, that if the
holders of Series B are presently entitled to a similar right, then the holders
of Series C shall have no such right until the right of the holders of Series B
terminates. In December 1998, the Board of Directors declared a dividend on
Series C to be made in shares of Series C. To date, the dividend is unpaid and
therefore there are $120,750 dividends in arrears at December 31, 1998. The
Series C is redeemable by the Company beginning June 14, 1999, at $100.00 per
share, plus accrued and unpaid dividends. The holders of the Series C currently
have the right to appoint one member to the Company's Board of Directors. The
holders of Series C are entitled to one vote for each share as to matters upon
which by law they are entitled to vote as a class. The approval of a majority of
the Series C, voting separately as a class, is required to (i) make changes to
the Company's Certificate of Incorporation or By-Laws which adversely affect the
Series C, (ii) authorize or issue additional shares of Series C, (iii) issue
preferred stock equal to or senior to the Series C as to dividends or
liquidation, (iv) subject to certain exceptions, to effect an extraordinary
transaction that requires a vote of the Company stockholders. As a result, a
class vote of the holders of Series C, as well as the Series B, would be
required for the Company to merge or be acquired and may therefore delay, deter,
or prevent a change in control of the Company.

    On August 29, 1996, the Company closed the sale for $10.0 million to High
River Limited Partnership of 100,000 shares of its Convertible Preferred Stock,
Series D, $1.00 par value per share and warrants to purchase 700,000 shares of
Common Stock exercisable immediately at $2.50 per share, which warrants expire
five years from their date of issuance. The rights and preferences of the Series
D are described in the Certificate of Designations of the Series D and include
the immediate right to convert all the shares of the Series D into 4,444,444
shares of Common Stock, based upon the initial conversion price of $2.25 per
share.

    The holder of the Series D is entitled to one vote for each share when
entitled to vote as described below and as to matters upon which by law it is
entitled to vote as a class. The holder of Series D has the right to appoint one
member to the Board of Directors. The Company may not, without the consent of
the director appointed by the holder of Series D, voluntarily file for
protection under federal or other bankruptcy laws. In addition, the holder of
Series D currently has the right to choose to appoint one-half of the members of
the Board of Directors plus one member (including the member appointed by the
Series D) if it elects to exercise such right. Currently, the holder of the
Series D has appointed a total of three directors to the Board.

    On August 29, 1996, simultaneously with the closing of the sale for $10.0
million of the Series D to High River, the Company also closed the sale for $5.0
million to two insurance companies and four affiliates of Kayne, Anderson
Investment Management, Inc., a registered investment adviser, of 50,000 shares
of Convertible Preferred Stock, Series E, $1.00 par value per share and warrants
to purchase 350,000 shares of the Common Stock exercisable immediately at $2.50
per share, which warrants expire five years from their date of issuance. The
Series E has the rights and preferences described in the Certificate of
Designations of the Series E which include the immediate right to convert all of
the shares of the Series E into 2,222,222 shares of the Common Stock, based upon
the initial conversion price of $2.25 per share. The Series E will vote together
with the Common Stock on all matters submitted to the holders of Common Stock
and shall have that number of votes per share equal to the number of shares of
Common Stock into which such share is convertible as of the record date for the
vote.




                                      F-19

<PAGE>   57

                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


7. STOCKHOLDERS' EQUITY (CONTINUED)

    In October 1997, 13,813 shares of Series B Preferred Stock, 17,000 shares of
Series C Preferred Stock and 40,500 shares of Series E Preferred Stock were
converted into approximately 3.5 million shares of Common Stock.

Common Stock

    Holders of Common Stock are entitled to one vote for each share held of
record on all matters voted on by stockholders. The shares of the Common Stock
do not have cumulative voting rights, which means that the holders of more than
50% of the shares of the Common Stock voting for the election of the directors
can elect all of the directors to be elected by holders of the Common Stock, in
which event the holders of the remaining shares of Common Stock will not be able
to elect any director. Upon any liquidation, dissolution, or winding-up of the
affairs of the Company, holders of the Common Stock would be entitled to
receive, pro rata, all of the assets of the Company available for distribution
to stockholders, after payment of any liquidation preference of any Preferred
Stock that may be issued and outstanding at the time. Holders of the Common
Stock have no subscription, redemption, sinking fund, or preemptive rights.

Warrants

    In June 1994, in connection with the sale of the Series B Preferred Stock,
the Company issued warrants to purchase 307,692 shares of Common Stock at a
price of $1.625 per share. During 1995, 255,492 of these warrants were exercised
and the remainder was exercised in 1996. In 1995, the Company granted warrants
to purchase 300,000 shares of Common Stock at a price of $1.625 per share,
pursuant to a consulting agreement. The estimated fair value of the warrants was
determined at the date of grant and charged to general and administrative
expenses over the vesting period. During 1997, 300,000 of these warrants were
exercised. In June 1995, in connection with the acquisition of Oak Hill (Note
3), the Company issued warrants to purchase 200,000 shares of Common Stock at a
price of $2.00 per share. During 1996, 100,000 of these warrants were exercised.
During 1998, the remaining warrants expired.

     During 1996, the Company issued warrants to purchase 1,050,000 shares of
Common Stock with exercise prices of $2.50 per share to the purchasers of the
Series D and Series E and issued warrants to purchase 300,000 shares of Common
Stock with exercise prices of $2.875 per share to financial advisors in
connection with this transaction. In connection with the Merger, the Company
issued warrants to purchase 800,000 shares of Common Stock to two financial
advisors. Warrants to purchase 700,000 shares have an exercise price of $2.875
per share while warrants to purchase 100,000 shares have an exercise price of
$4.09 per share. The Company also assumed 396,015 warrants to purchase Common
Stock at prices ranging from $2.07 to $3.00 in the Merger. During 1997, 353,515
of these warrants were exercised and the remainder expired during 1998. During
1997, the Company issued warrants to purchase 300,000 shares of common stock
with exercise prices of $3.00 per share in connection with the formation of a
drilling joint venture.

    The following table summarizes warrants outstanding at December 31, 1998:

<TABLE>
<CAPTION>


 NUMBER OF SHARES                       EXPIRATION                   WARRANTS             EXERCISE
   UNDER WARRANT                           DATE                     EXERCISABLE           PRICES
------------------                  -----------------           -----------------         -------
<S>                                 <C>                         <C>                       <C>
    1,050,000                         August 29, 2001              1,050,000              $  2.50
      300,000                         August 29, 2001                300,000                2.875
      700,000                         August 29, 2001                700,000                2.875
      100,000                         August 29, 2001                100,000                 4.09
      300,000                           July 11, 2002                300,000                 3.00
    ---------                                                      ---------
    2,450,000                                                      2,450,000              
    =========                                                      =========
</TABLE>





                                      F-20

<PAGE>   58


                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998



7. STOCKHOLDERS' EQUITY (CONTINUED)

Stock Options

    A summary of the Company's stock option activity, and related information
for the years ended December 31, 1996, 1997, and 1998, follows:


<TABLE>
<CAPTION>


                                                       1996                         1997                           1998
                                           ----------------------------  ---------------------------    ---------------------------
                                                             WEIGHTED                     WEIGHTED                        WEIGHTED
                                                             AVERAGE                       AVERAGE                         AVERAGE
                                                             EXERCISE                      EXERCISE                       EXERCISE
                                             OPTIONS           PRICE        OPTIONS         PRICE         OPTIONS          PRICE  
                                           ------------    ------------  ------------    ------------   ------------     ----------
<S>                                        <C>             <C>           <C>             <C>            <C>            <C>       
Outstanding at beginning of
  year .................................        932,500    $       2.02        873,486    $       2.28      3,072,201    $     3.62
Granted ................................          5,000            3.00      2,707,500            3.92        415,000          2.65
Assumed in the Merger with
  Alexander ............................        135,028            2.25             --              --             --            --
Exercised ..............................       (199,042)           1.08       (266,785)           2.44        (25,000)         3.75
Canceled ...............................             --              --       (242,000)           3.52     (1,824,351)         3.58
                                           ------------                   ------------                   ------------
Outstanding at end of year .............        873,486            2.28      3,072,201            3.62      1,637,850          3.40
                                           ============                   ============                   ============

Exercisable at end of year .............        503,484            2.24        936,450            2.84      1,148,600          3.45
                                           ============                   ============                   ============

Weighted-average fair value of
  options granted or assumed
  during the year ......................   $       2.15                   $       1.46                   $       1.11
                                           ============                   ============                   ============
</TABLE>

Information related to options outstanding and exercisable at December 31, 1998,
is summarized below:

<TABLE>
<CAPTION>

                                   OPTIONS OUTSTANDING                     OPTIONS EXERCISABLE
                        ------------------------------------------    -----------------------------
                                           WEIGHTED
                                           AVERAGE       WEIGHTED                       WEIGHTED
                                          REMAINING       AVERAGE                        AVERAGE
      RANGE OF            OPTIONS        CONTRACTUAL     EXERCISE       OPTIONS         EXERCISE
  EXERCISE PRICES       OUTSTANDING          LIFE         PRICE       EXERCISABLE         PRICE
  ---------------       ------------     -----------   -----------    ------------     -----------

<S>                     <C>              <C>           <C>            <C>              <C>
   $1.31  -  $2.99           445,850         1.79      $     2.11        305,850        $    2.35
    
   $3.32  -  $4.13         1,183,500         3.51            3.88        838,500             3.84
    
        $5.75                  8,500         3.79            5.75          4,250             5.75
                        ------------                                  ----------
                           1,637,850         3.05      $     3.40        1,148,600      $    3.45
                        ============                                  ===========
</TABLE>

    Statement of Financial Accounting Standards No. 123, Accounting for Stock
Based Compensation, requires the disclosure of pro forma net income and earnings
per share information computed as if the Company had accounted for its employee
stock options granted subsequent to December 31, 1994, under the fair value
method set forth in SFAS 123. The fair value for these options was estimated at
the date of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions for 1996, 1997 and 1998, respectively: a risk-free
interest rates of 6%, 5.5% and 5.5%, a dividend yield of 0%, and volatility
factors of .54, .53 and .53. In addition, the fair value of these options was
estimated based on an expected life of three to five years for options granted
by the Company and one year for options assumed in the merger with Alexander.

    The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. In addition, because
SFAS 123 is applicable only to options granted subsequent to December 31, 1994,
the pro forma information does not reflect the pro forma effect of all



                                      F-21


<PAGE>   59

                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


7. STOCKHOLDERS' EQUITY (CONTINUED)

previous stock option grants of the Company, and thus the pro forma information
is not necessarily indicative of future amounts until SFAS 123 is applied to all
outstanding stock options.

    For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows (in thousands except for earnings per share
information):

<TABLE>
<CAPTION>

                                                            YEAR ENDED DECEMBER 31,
                                           -----------------------------------------------------
                                                1996               1997               1998
                                           ---------------    ---------------    ---------------

<S>                                        <C>                <C>                <C>             
Pro forma net loss .....................   $   (26,380,771)   $   (35,226,665)   $  (164,914,586)
                                           ===============    ===============    ===============
Pro forma net loss per common share ....   $         (1.37)   $          (.97)   $         (4.09)
                                           ===============    ===============    ===============
</TABLE>


Stock Purchase Plan

    During 1998, the Company's shareholders approved the Company's Employee
Stock Purchase Plan ("ESPP"). Pursuant to the ESPP, employees can purchase the
common stock of the Company at a specified price through payroll deductions
during an offering period, currently established on a semi-annual basis. In June
1998, approximately 46,000 shares were issued to employees under the ESPP.

8. INCOME TAXES

    The reconciliation of income taxes computed at the U.S. federal statutory
tax rates to the benefit for income taxes on the income (loss) before
extraordinary item is as follows:

<TABLE>
<CAPTION>

                                                                      YEAR ENDED DECEMBER 31,
                                                         -------------------------------------------
                                                             1996           1997            1998
                                                         ------------   ------------    ------------

<S>                                                      <C>            <C>             <C>         
Income tax benefit at statutory rate .................   $ 14,021,426   $ 14,568,439    $ 57,580,016
Utilization of net operating loss carryforward .......        414,177             --              --
Valuation allowance on deferred tax assets ...........             --     (7,294,578)    (57,560,222)
Other ................................................         67,992         11,904         (19,794)
                                                         ============   ============    ============
                                                         $ 14,503,595   $  7,285,765    $         --
                                                         ============   ============    ============
</TABLE>

The computation of the net deferred tax asset (liability) follows:

<TABLE>
<CAPTION>

                                                                                          DECEMBER 31,
                                                                                --------------------------------
                                                                                   1997               1998
                                                                                -------------      -------------
<S>                                                                             <C>                <C>          
   Deferred tax assets (liabilities):
   Property and equipment..................................................     $  (6,875,104)     $  36,718,003
   Net operating loss carryforwards........................................        15,790,102         29,766,440
   Statutory depletion carryforwards.......................................         1,340,763          1,340,763
   Other, net..............................................................         1,009,371          1,000,148
                                                                                -------------      ------------- 
                                                                                   11,265,132         68,825,354
   Less valuation allowance................................................       (11,265,132)       (68,825,354)
                                                                                -------------      -------------
                                                                                $          --      $          --
                                                                                =============      =============
</TABLE>


     At December 31, 1998, the Company had net operating loss carryforwards
available for federal income tax purposes of approximately $85.0 million which
expire beginning in 1999. Utilization of approximately $32.0 million of the net
operating loss carryforwards is subject to various limitations because of
previous changes in control of ownership (as defined in the Internal Revenue
Code) of the Company and Alexander. Additional net operating loss limitations
may be imposed as a result of subsequent changes in stock ownership of the
Company. Bankruptcy proceedings may eliminate all or a portion of the Company's
net operating loss carryforwards. For federal income tax purposes, the Company
also has statutory depletion carryforwards of $3.8 million, which do not expire.




                                      F-22
<PAGE>   60

                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


9. NATURAL GAS HEDGING ACTIVITIES AND FORWARD SALES CONTRACTS

    While the use of financial hedging arrangements limits the downside risk of
adverse price movements, it may also limit future gains from favorable
movements. All financial hedging is accomplished pursuant to swap agreements
based upon standard forms. The Company addresses market risk by selecting
instruments whose value fluctuations correlate strongly with the underlying
commodity being hedged. Credit risk related to hedging activities is managed by
requiring minimum credit standards for counterparties, periodic settlements, and
mark to market valuations. The Company has not been required to provide
collateral relating to its hedging activities.

    During the year ended December 31, 1996, the Company recognized a net gain
of $20,315 related to hedging transactions. At December 31, 1997 and 1998, the
Company had no financial hedging agreements outstanding.

    At December 31, 1998, the Company had entered into forward sales contracts
with two purchasers covering future production of natural gas as follows:

<TABLE>
<CAPTION>

VOLUME COMMITMENT
  (MMBTU PER DAY)                                         TERM
------------------                        ----------------------------------------

<S>                                       <C>
      9,250                                   January 1999 through March 1999
      1,750                                  January 1999 through October 1999
      4,500                                  January 1999 through December 1999
      4,000                                   April 1999 through October 1999
      2,000                                   April 1999 through December 1999
</TABLE>

    Deliveries under these contracts are priced based on NYMEX prices less a
differential whereby the Company may fix the price for deliveries under these
contracts at any time three days prior to the close of the then current contract
based on the NYMEX prices at the time. Deliveries to be made under the forward
sales contracts have not been priced as of December 31, 1998. The Company pays
the cost of transportation of the natural gas to the delivery point specified in
the contracts.

10. RESTRUCTURING CHARGES

    During 1998, the Company recorded non-recurring restructuring charges of
$1,869,169. These charges related primarily to severance and related costs
resulting from restructuring of the Company's executive management team, and
other personnel changes and costs associated with the Chapter 11 filing. The
components of the restructuring charges are as follows:


<TABLE>

<S>                                              <C>
Severance                                        $  1,401,537
Lease termination costs                               154,946
Cost associated with Chapter 11 filing                312,686
                                                 ------------
                                                 $  1,869,169
                                                 ============
</TABLE>

    Substantially all of the restructuring charges required cash outlays which
have been made as of December 31, 1998.

11. CRUDE OIL AND NATURAL GAS PRODUCING ACTIVITIES

     Costs incurred in connection with the exploration acquisition, development,
and exploitation of the Company's crude oil and natural gas properties for the
years ended December 31, 1996, 1997, and 1998, are as follows:

<TABLE>
<CAPTION>

                                                                          YEAR ENDED DECEMBER 31,
                                                            --------------------------------------------------
                                                                1996               1997               1998
                                                            -------------      ------------       ------------
<S>                                                         <C>                <C>                  <C>       
Acquisitions of properties:
   Proved.................................................  $ 155,675,254      $         --       $  5,093,000
   Unproved...............................................     24,534,610         2,074,339                 --
Exploration costs.........................................      4,406,015        31,126,227          9,012,942
Development costs.........................................     19,389,494        54,475,373         25,022,494
Amortization rate per Mcfe................................           1.10              1.11               1.06
</TABLE>








                                      F-23

<PAGE>   61

                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


     The acquisitions of properties in 1996 include $132.8 million of proved
properties and $6.3 million of unproved properties acquired in the Merger. See
Note 3.

     During 1996, as a result of allocating additional cost under the purchase
method of accounting, to the oil and natural gas properties in connection with
the Merger, the Company recognized a non-cash writedown of its oil and natural
gas properties of approximately $43.5 million. During 1997 and 1998, the net
book value of the Company's oil and natural gas properties exceeded the full
cost ceiling resulting in writedowns of the oil and natural gas properties of
$46.4 million and $148.4 million, respectively. There can be no assurance that
there will not be additional writedowns in future periods under the full cost
method of accounting as a result of sustained decreases in oil and natural gas
prices or other factors.

    Revenues from individual purchasers that exceed 10% of total crude oil and
natural gas sales are as follows:


<TABLE>
<CAPTION>

                                                                               YEAR ENDED DECEMBER 31,
                                                                ----------------------------------------------------
                                                                    1996               1997               1998
                                                                --------------     --------------     --------------

<S>                                                              <C>               <C>                 <C>        
    Plains Marketing and Transportation.......................   $9,382,466        $ 17,918,762        $13,291,379
    Crosstex Energy...........................................    2,919,944           6,471,157          5,140,693
    GPM Natural Gas Corporation...............................    2,832,049           4,547,352                 --
    Aquila Energy Corp........................................           --                  --          5,897,799
</TABLE>



    The Company believes that the loss of these purchasers would not have a
significant impact on the Company's results of operations or financial
condition.

12. SUPPLEMENTARY CRUDE OIL AND NATURAL GAS RESERVE INFORMATION (UNAUDITED)

    The revenues generated by the Company's operations are highly dependent upon
the prices of, and demand for, oil and natural gas. The price received by the
Company for its oil and natural gas production depends on numerous factors
beyond the Company's control, including seasonality, the condition of the U.S.
economy, foreign imports, political conditions in other oil and natural gas
producing countries, the actions of the Organization of Petroleum Exporting
Countries and domestic governmental regulations, legislation and policies.
Declines during 1998 in the prices of oil and gas have had an adverse effect on
the carrying value of the Company's oil and gas properties and the Company's
revenues, profitability and cash flows.

    The Company has made, and will continue to make, ordinary course capital
expenditures for the development, and exploitation of oil and natural gas
reserves, subject to economic conditions and in accordance with the rulings and
procedures set forth by the Court. Due to the Chapter 11 filing and severely
depressed oil prices, the Company has suspended its exploratory drilling
program. The Company will limit its capital expenditures to ordinary course
enhancement of current production through workovers, recompletions, and other
production enhancing activities deemed to be economic given current depressed
oil and gas prices. Development drilling is anticipated to be limited to (i)
ordinary course nonoperated wells in which the Company has limited working
interests and in which the failure to participate may result in drainage,
depletion or loss of current reserves and (ii) operated wells deemed to be
economical given current oil and gas prices. Large expenditures for
developmental drilling may require Court approval and none are planned at this
time.

    The Company has interests in crude oil and natural gas properties that are
principally located onshore in Texas, Louisiana, Oklahoma, Arkansas, and
offshore in the Gulf of Mexico. The Company does not own or lease any crude oil
and natural gas properties outside the United States.

    In 1995 and 1996, the Company retained independent petroleum engineering
firms to provide year-end estimates of the Company's future net recoverable
crude oil, natural gas, and natural gas liquids reserves. In 1997 and 1998, such
estimates were prepared by the Company's in-house reserve engineers. Estimated
proved net recoverable reserves as shown below include only those quantities
that can be expected to be commercially

                                      F-24
<PAGE>   62

                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


12. SUPPLEMENTARY CRUDE OIL AND NATURAL GAS RESERVE INFORMATION (UNAUDITED)
(CONTINUED)

recoverable at prices and costs in effect at the balance sheet dates under
existing regulatory practices and with conventional equipment and operating
methods.

    Proved developed reserves represent only those reserves expected to be
recovered through existing wells. Proved undeveloped reserves include those
reserves expected to be recovered from new wells on undrilled acreage or from
existing wells on which a relatively major expenditure is required for
recompletion.


     Net quantities of proved developed and undeveloped reserves of natural gas
and crude oil, including condensate and natural gas liquids, are summarized as
follows:

<TABLE>
<CAPTION>

                                                              NATURAL GAS
                                            CRUDE OIL       (THOUSAND CUBIC
                                            (BARRELS)            FEET)
                                           ------------    -----------------

<S>                                       <C>              <C>       
December 31, 1995 ......................      3,921,076           30,869,112
  Purchase of reserves in place ........      4,691,982           97,840,796
  Extensions and discoveries ...........         37,800              371,062
  Revisions of previous estimates ......        703,594            6,104,198
  Production ...........................       (521,701)          (5,680,904)
  Sales of reserves in place ...........        (29,880)            (634,386)
                                           ------------    -----------------
December 31, 1996 ......................      8,802,871          128,869,878
  Extensions and discoveries ...........      1,908,087            7,835,287
  Revisions of previous estimates ......        397,541           (7,685,884)
  Production ...........................     (1,110,105)         (13,146,251)
  Sales of reserves in place ...........       (220,190)          (5,391,799)
                                           ------------    -----------------
December 31, 1997 ......................      9,778,204          110,481,231
  Purchase of reserves in place ........        347,000              438,000
  Extensions and discoveries ...........         74,000            1,857,000
  Revisions of previous estimates ......     (4,346,951)         (24,279,454)
  Production ...........................     (1,238,379)         (11,254,797)
                                           ------------    -----------------
December 31, 1998 ......................      4,613,874           77,241,980
                                           ============    =================

Proved developed reserves:
   December 31, 1995 ...................      1,632,404           13,304,031
   December 31, 1996 ...................      4,383,926           77,496,645
   December 31, 1997 ...................      5,780,958           89,939,678
   December 31, 1998 ...................      4,187,831           67,039,255
</TABLE>


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

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



                                      F-25

<PAGE>   63

                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


12. SUPPLEMENTARY CRUDE OIL AND NATURAL GAS RESERVE INFORMATION (UNAUDITED)
(CONTINUED)

    The standardized measure of discounted future net cash flows relating to
proved crude oil and natural gas reserves are summarized as follows:

<TABLE>
<CAPTION>

                                                                          DECEMBER 31,
                                                               --------------------------------
                                                                    1997              1998
                                                               --------------    --------------

<S>                                                            <C>               <C>           
Future cash inflows ........................................   $  430,107,524    $  207,087,600
Future production and development costs ....................     (163,245,775)      (85,893,140)
Future income tax expenses .................................      (17,720,565)               --
                                                               --------------    --------------
Future net cash flows ......................................      249,141,184       121,194,460
10% annual discount for estimated timing of cash flows .....      (87,390,632)      (45,316,980)
                                                               --------------    --------------
Standardized measure of discounted future net cash flows ...   $  161,750,552    $   75,877,480
                                                               ==============    ==============
</TABLE>

    The following are the principal sources of change in the standardized
measure of discounted future net cash flows:

<TABLE>
<CAPTION>


                                                                            YEAR ENDED DECEMBER 31,
                                                                 -----------------------------------------------
                                                                      1996             1997             1998
                                                                 -------------    -------------    -------------
<S>                                                              <C>              <C>              <C>           
   Sales and transfers of crude oil and
      natural gas produced, net of production costs ..........   $ (19,293,463)   $ (42,549,780)   $ (27,705,832)
   Net changes in prices and production costs ................     131,330,518     (136,971,646)     (70,032,540)
   Development costs incurred during the
      period and changes in estimated future development .....       4,884,876       24,893,672       16,451,276
      costs
   Purchases of reserves in place ............................     117,893,900               --        4,783,270
   Sales of reserves in place ................................        (450,300)      (8,489,852)              --
   Extensions and discoveries, less related costs ............         850,200       24,388,228        1,663,986
   Revisions of previous quantity estimates ..................      16,576,531       (5,219,509)     (36,419,059)
   Accretion of discount .....................................       3,627,860       19,576,509       16,175,055
   Net change in income taxes ................................     (57,743,416)      54,258,990        7,633,978
   Changes in production rates (timing) and other ............         (24,175)       2,084,308        1,576,794
                                                                 -------------    -------------    -------------
   Net change ................................................   $ 197,652,531    $ (68,029,080)   $ (85,873,072)
                                                                 =============    =============    =============
</TABLE>

    During recent years, there have been significant fluctuations in the prices
paid for crude oil in the world markets. This situation has had a destabilizing
effect on crude oil posted prices in the United States, including the posted
prices paid by purchasers of the Company's crude oil. The net weighted average
prices of crude oil and natural gas at December 31, 1996, 1997, and 1998, used
in the above table were $25.36, $17.03 and $10.46 per barrel of crude oil,
respectively, and $3.72, $2.38 and $2.06 per thousand cubic feet of natural gas,
respectively.


                                      F-26

<PAGE>   64


                           NATIONAL ENERGY GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998



13. QUARTERLY FINANCIAL RESULTS (UNAUDITED)

The Company's operating results for each quarter of 1997 and 1998 are summarized
as follows (in thousands, except per share data):

<TABLE>
<CAPTION>

                                                                     THREE MONTHS ENDED
                                               ------------------------------------------------------------
                                                 MARCH 31        JUNE 30       SEPTEMBER 30    DECEMBER 31
                                               ------------    ------------    ------------    ------------

<S>                                            <C>             <C>             <C>             <C>         
YEAR ENDED DECEMBER 31, 1997:
   Total revenues ..........................   $     12,864    $     11,622    $     13,122    $     14,809
                                               ============    ============    ============    ============
   Writedowns of oil and gas properties ....   $         --    $         --    $         --    $    (46,396)
                                               ============    ============    ============    ============
   Operating income (loss) .................   $      4,623    $      2,752    $      3,100    $    (41,918)
                                               ============    ============    ============    ============
   Net income (loss) .......................   $      1,403    $        454    $        272    $    (36,467)
                                               ============    ============    ============    ============
   Income (loss) per common share ..........   $        .03    $        .00    $        .00    $       (.97)
                                               ============    ============    ============    ============

   Production:
     Oil (Bbl) .............................            237             261             292             320
     Natural gas (Mcf) .....................          2,884           3,389           3,580           3,293
     Natural gas equivalent (Mcfe)..........          4,308           4,956           5,329           5,213

YEAR ENDED DECEMBER 31, 1998:
   Total revenues ..........................   $     10,529    $     10,544    $      8,573    $      8,794
                                               ============    ============    ============    ============
   Writedowns of oil and gas properties ....   $    (26,500)   $    (24,800)   $    (38,650)   $    (58,450)
                                               ============    ============    ============    ============
   Operating loss ..........................   $    (25,757)   $    (25,280)   $    (39,690)   $    (59,289)
                                               ============    ============    ============    ============
   Net loss ................................   $    (29,044)   $    (28,968)   $    (43,592)   $    (62,910)
                                               ============    ============    ============    ============
   Income (loss) per common share ..........   $       (.72)   $       (.72)   $      (1.08)   $      (1.56)
                                               ============    ============    ============    ============

   Production:
     Oil (Bbl) .............................            293             335             278             332
     Natural gas (Mcf) .....................          3,080           2,913           2,682           2,580
     Natural gas equivalent (Mcfe) .........          4,835           4,925           4,350           4,575
</TABLE>

<PAGE>   65
                                EXHIBIT INDEX



<TABLE>
<CAPTION>
           EXHIBIT
           NUMBER                 DESCRIPTION
           -------                -----------
<S>                <C>
             2.1   Agreement and Plan of Merger, dated June 6, 1996, among the
                   Company, NEG-OK, Inc. ("NEG OK"), and Alexander Energy
                   Corporation ("Alexander") (1)

             2.2   First Amendment to Agreement and Plan of Merger, dated as of
                   June 20, 1996, among the Company, NEG-OK and Alexander (2)

             2.3   Mutual Waiver Agreement dated as of August 29, 1996 by and
                   among the Company, NEG-OK and Alexander (3)

             3.1   Certificate of Incorporation of the Company, which includes
                   the Certificate of Incorporation of the Company filed with
                   the Secretary of State of Delaware on November 20, 1990 (4),
                   the Certificate of Elimination of the Redeemable Convertible
                   Preferred Stock, Series A of the Company, filed with the
                   office of the Secretary of State of the State of Delaware on
                   June 2, 1994 (3), the Certificate of Amendment of Certificate
                   of Incorporation of the Company, filed with the office of the
                   Secretary of State of the State of Delaware on August 29,
                   1996 (3) , the Certificate of Designations of the Company of
                   10% Cumulative Convertible Preferred Stock, Series B (5), the
                   Certificate of Designations of the Company of 10 1/2%
                   Cumulative Convertible Preferred Stock, Series C (6), the
                   Certificate of Designations of the Company of Convertible
                   Preferred Stock, Series D (3), and the Certificate of
                   Designations of the Company of Convertible Preferred Stock,
                   Series E (3)

             3.2   By-laws of the Company (4)

             4.1   Certificate of Designations of the Company of 10% Cumulative
                   Convertible Preferred Stock, Series B (5)

             4.2   Certificate of Designations of the Company of 10 1/2%
                   Cumulative Convertible Preferred Stock, Series C (6)

             4.3   Certificate of Designations of the Company of Convertible
                   Preferred Stock, Series D (3)

             4.4   Certificate of Designations of the Company of Convertible
                   Preferred Stock, Series E (3)

             4.5   Indenture dated as of November 1, 1996, among the Company,
                   National Energy Group of Oklahoma, Inc. (the "Guarantor"),
                   formerly NEG-OK, and Bank One, Columbus, N.A. (7)

             4.6   Indenture dated August 21, 1997, among the Company and Bank
                   One, N.A. (14)

             4.7   Instrument of Resignation, Appointment and Acceptance, dated
                   October 23, 1998, between the Company, Bank One, N.A., and
                   Norwest Bank Minnesota, N.A. (19)

             10.1  Crude Oil Purchase Contract, dated November 30, 1992, between
                   the Company and Plains Liquids Transport Inc. (8)

</TABLE>



<PAGE>   66

<TABLE>
<S>                <C>
             10.2  Amendment to Crude Oil Purchase Contract, dated November 17,
                   1993, between the Company and Plains Liquids Transport, Inc.
                   (5)


             10.3  Crude Oil Purchase Contract, dated February 8, 1993, between
                   the Company and Plains Marketing and Transportation Inc. and
                   the predecessor contract, the Crude Oil Purchase Contract,
                   dated November 12, 1991, between Sunnybrook Transmission,
                   Inc. and TriSearch Inc. (8)

             10.4  Agreement for Purchase and Sale (Mustang Island) dated April
                   20, 1995, between the Company and Sierra Mineral Development,
                   L.C. (6)

             10.5  Agreement for Purchase and Sale (Oak Hill) dated April 12,
                   1995, between the Company and Sierra 1994 I Limited
                   Partnership (6)

             10.6  Stock Purchase Agreement, dated as of June 14, 1995, among
                   the Company, Arbco Associates L.P., Offense Group Associates
                   L.P., Kayne, Anderson Nontraditional Investments L.P., and
                   Opportunity Associates L.P. (6)

             10.7  High River Limited Partnership Warrant to purchase 700,000
                   Shares of Common Stock, dated August 29, 1996 (3)

             10.8  Form of Series E Investors' Warrants to purchase an aggregate
                   350,000 Shares of Common Stock, dated August 29, 1996 (3)

             10.9  Gascon Partners Warrant to Purchase 300,000 shares of the
                   Company's Common Stock (13)

             10.10 Prudential Securities Incorporated Warrant to Purchase
                   100,000 Shares of the Company's Common Stock (3)

             10.11 Gaines Berland, Inc. Warrant to Purchase 300,000 Shares of
                   the Company's Common Stock dated August 29, 1996 (3)

             10.12 Gaines Berland, Inc. Warrant to Purchase 700,000 Shares of
                   the Company's Common Stock dated August 29, 1996 (3) 10.13
                   Executive Employment Agreement, dated January 1, 1996,
                   between the Company and Miles D. Bender (9)

             10.13 Executive Employment Agreement, dated January 1, 1996,
                   between the Company and Miles D. Bender (9)

             10.14 Separation Agreement, dated November 24, 1998, between the
                   Company and Miles D. Bender (19)

             10.15 Executive Employment Agreement, dated January 1, 1996,
                   between the Company and Melissa Rutledge (9)

             10.16 Separation Agreement between the Company and Robert A. Imel
                   dated October 31, 1997 (15)

             10.17 Separation Agreement, dated May 18, 1998, between the Company
                   and William T. Jones (17)

             10.18 Executive Employment Agreement, dated June 6, 1996, between
                   the Company and Jim L. David (1)

             10.19 Executive Employment Agreement dated March 20, 1997, between
                   the Company and Philip D. Devlin (10)

</TABLE>
<PAGE>   67
<TABLE>
<S>                <C>
             10.20 Separation Agreement, dated May 19, 1998, between the Company
                   and Gene W. Anderson (19)

             10.21 Executive Employment Agreement dated August 25, 1997, between
                   the Company and C. Dewayne Cravens (19)

             10.22 Separation Agreement, dated May 18, 1998, between the Company
                   and C. Dewayne Cravens (19)

             10.23 Executive Employment Agreement, dated January 29, 1998,
                   between the Company and Fred R. Miller (15)

             10.24 Executive Employment Agreement, dated March 5, 1998, between
                   the Company and Chuck Elsey (16)

             10.25 Termination Notice and Agreement, dated October 28, 1998,
                   between the Company and Chuck Elsey(19)

             10.26 Executive Employment Agreement, dated April 13, 1998, between
                   the Company and Kent Lueders(16)

             10.27 Executive Employment Agreement, dated June 1, 1998, between
                   the Company and Leslie Wylie(17)

             10.28 National Energy Group, Inc. 1996 Incentive Compensation Plan
                   (11)

             10.29 National Energy Group, Inc. Employee Stock Purchase Plan(12)

             10.30 National Energy Group, Inc. Employee Severance Policy(19)

             10.31 Agreement dated January 1, 1996 between the Company and
                   Sandefer Oil & Gas, Inc.(1)

             10.32 Consulting Agreement dated January 1, 1996 between Sandefer
                   Oil & Gas, Inc. and Potosky Oil & Gas, Inc. and Atocha
                   Exploration, Inc.(1)

             10.33 Memorandum of Amendment dated March 27, 1997 amending (i)
                   Agreement dated January 1, 1996 between the Company and
                   Sandefer Oil & Gas, Inc. and (ii) Consulting Agreement dated
                   January 1, 1996 between Sandefer Oil & Gas, Inc. and Potosky
                   Oil & Gas, Inc. and Atocha Exploration, Inc.(15)

             10.34 First Amendment dated April 15, 1997 to (i) Agreement dated
                   January 1, 1996 between the Company and Sandefer Oil & Gas,
                   Inc. and (ii) Consulting Agreement dated January 1, 1996
                   between Sandefer Oil & Gas, Inc. and Potosky Oil & Gas, Inc.
                   and Atocha Exploration, Inc.(15)

             10.35 Restated Loan Agreement dated August 29, 1996 among Bank One
                   and Credit Lyonnais New York Branch ("Credit Lyonnais") and
                   the Company, NEG-OK and Boomer Marketing Corporation
                   ("Boomer")(3)

             10.36 $50,000,000 Revolving Note dated August 29, 1996 payable to
                   Bank One(3)

             10.37 $50,000,000 Revolving Note dated August 29, 1996 payable to
                   Credit Lyonnais(3)

             10.38 Assignment of $50,000,000 Revolving Note to Arnos Corp from
                   Bank One, Texas, N.A. (19)

             10.39 Assignment of $50,000,000 Revolving Note to Arnos Corp from
                   Credit Lyonnais New York Branch (19)

             10.40 Unlimited Guaranty of NEG-OK dated August 29, 1996 for the
                   benefit of Bank One(3)

</TABLE>
<PAGE>   68
<TABLE>
<S>                <C>
             10.41 Unlimited Guaranty of NEG-OK, dated August 29, 1996 for the
                   benefit of Credit Lyonnais(3)

             10.42 Unlimited Guaranty of Boomer dated August 29, 1996 for the
                   benefit of BankOne(3)

             10.43 Unlimited Guaranty of Boomer dated August 29, 1996 for the
                   benefit of Credit Lyonnais(3)

             10.44 First Amendment to Restated Loan Agreement dated October 31,
                   1996 among BankOne and Credit Lyonnais and the Company,
                   Guarantor and Boomer(9)

             10.45 Second Amendment to Restated Loan Agreement dated October 31,
                   1996, among BankOne and Credit Lyonnais and the Company,
                   Guarantor and Boomer(10)

             10.46 Third Amendment to Restated Loan Agreement dated October 31,
                   1996, among BankOne and Credit Lyonnais and the Company,
                   Guarantor and Boomer(10)

             10.47 Fourth Amendment to Restated Loan Agreement dated October 31,
                   1996, among BankOne and Credit Lyonnais and the Company,
                   Guarantor and Boomer(15)

             10.48 Multi-State Assignment Agreement dated December 22, 1998
                   between BankOne, Texas, NA, Credit Lyonnais New York Branch
                   and Arnos, Corp (19)

             10.49 Multi-State Assignment Agreement, LaFourche Parish,
                   Louisiana, dated December 22, 1998, between BankOne, Texas,
                   NA, Credit Lyonnais New York Branch and Arnos Corp (19)

             10.50 Multi-State Assignment Agreement, Iberville Parish,
                   Louisiana, dated December 22, 1998, between BankOne, Texas,
                   NA, Credit Lyonnais New York Branch and Arnos Corp (19)

             10.51 Oklahoma Assignment Agreement, dated December 22, 1998,
                   between BankOne, Texas, NA, Credit Lyonnais New York Branch
                   and Arnos, Corp (19)

             10.52 Arnos Corporation Letter dated December 23, 1998(19)

             12.1  Computation of Ratio of Earnings to Fixed Charges(19)

             23.1  Consent of Ernst & Young LLP, Independent Auditors(19)

             24.1  Power of Attorney (included in signature pages to this Form
                   10-K)(19)

             27.1  Financial Data Schedule(19)

             99.1  Order of Bankruptcy Court Granting Relief on Involuntary
                   Petition(18)

</TABLE>

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


             (1)      Incorporated by reference to the Company's Registration
                      Statement on Form S-4 (No. 333-9045), dated July 29, 1996.

             (2)      Incorporated by reference to Amendment No. 1 to the
                      Company's Registration Statement on Form S-4 (No.
                      333-9045), dated August 7, 1996.

             (3)      Incorporated by reference to the Company's Current Report
                      on Form 8-K, dated August 29, 1996.

             (4)      Incorporated by reference to the Company's Registration
                      Statement on Form S-4 (No. 33-38331), dated April 23,
                      1991.

             (5)      Incorporated by reference to the Company's Current Report
                      on Form 8-K, dated June 17, 1994.

             (6)      Incorporated by reference to the Company's Current Report
                      on Form 8-K, dated July 17, 1995.

             (7)      Incorporated by reference to the Company's Quarterly
                      Report on Form 10-Q for the quarter ended September 30,
                      1996.

             (8)      Incorporated by reference to the Company's Annual Report
                      on Form 10-KSB for the year ended December 31, 1992.

             (9)      Incorporated by reference to the Company's Annual Report
                      on Form 10-KSB for the year ended December 31, 1995.

             (10)     Incorporated by reference to the Company's Quarterly
                      Report on Form 10-Q for the quarter ended March 31, 1997.

             (11)     Incorporated by reference to the Company's Schedule 14A
                      filed April 25, 1997.


<PAGE>   69

             (12)     Incorporated by reference to the Company's Form S-8 filed
                      December 23, 1997.

             (13)     Incorporated by reference to the Company's Quarterly
                      Report on Form 10-Q for the quarter ended September 30,
                      1997.

             (14)     Incorporated by reference to the Company's Form S-4 (No.
                      333-38075), filed October 16, 1997.

             (15)     Incorporated by reference to the Company's Annual Report
                      on Form 10-K for the year ended December 31, 1997.

             (16)     Incorporated by reference to the Company's Quarterly
                      Report on Form 10-Q for the quarter ended March 31, 1998.

             (17)     Incorporated by reference to the Company's Quarterly
                      Report on Form 10-Q for the quarter ended June 30, 1998.

             (18)     Incorporated by reference to the Company's Current Report
                      on Form 8-K, dated February 8, 1999.

             (19)     Filed herewith.