<PAGE>   1


                                    FORM 10-Q                               

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549




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

                  For the quarterly period ended March 31, 1998

                                       OR

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

         For the transition period from _____________ to ______________

                         Commission file number 0-16621

                          GARNET RESOURCES CORPORATION
             (Exact name of registrant as specified in its charter)

              DELAWARE                                  74-2421851
  (State or other jurisdiction of                      (IRS Employer
    incorporation or organization)                  Identification No.)

   RR 2 BOX 4400, NACOGDOCHES, TEXAS                       75961
(Address of principal executive offices)                (Zip Code)

        Registrant's telephone number, including area code (409) 559-9959



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

As of May 15, 1998, 11,492,162 shares of Registrant's Common Stock, par value
$.01 per share, were outstanding.


                                       1
<PAGE>   2


        GARNET RESOURCES CORPORATION (the "Registrant" or the "Company")

                                    I N D E X



<TABLE>
<CAPTION>
      
PART I - FINANCIAL INFORMATION                                                   Page
                                                                                 ----

<S>                                                                            <C>                     
Item 1. Financial Statements

           Consolidated Balance Sheets -
            March 31, 1998 (unaudited)
            and December 31, 1997                                                 3-4


           Consolidated Statements of
            Operations for the Three Months Ended
            March 31, 1998 and 1997
            (unaudited)                                                             5


           Condensed Consolidated Statements of
            Cash Flows for the Three Months Ended
            March 31, 1998 and 1997  (unaudited)                                    6


           Notes to Condensed Consolidated Financial
            Statements- March 31, 1998  (unaudited)                              7-13



Item 2. Management's Discussion and Analysis of
             Financial Condition and Results of
             Operations                                                         13-16



PART II - OTHER INFORMATION

    
         Item 6. Exhibits and Reports on Form 8-K                               16-18
</TABLE>
    


                                       2
<PAGE>   3


PART I - FINANCIAL INFORMATION
Item 1.  Financial Statements.
------------------------------

                  GARNET RESOURCES CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                         -------------------------------

<TABLE>
<CAPTION>
                                                    March 31,       December 31
                                                      1998             1997
                                                 --------------   --------------
                                                   (unaudited)
<S>                                               <C>              <C>
         ASSETS

CURRENT ASSETS:         
         Cash and cash equivalents                $  2,411,699     $  2,124,250
         Accounts receivable                           835,866        1,476,485
         Inventories                                   380,325          736,899
         Prepaid expenses                              142,256          108,577
                                                --------------   --------------

                  Total current assets               3,770,146        4,446,211
                                                 -------------    -------------


PROPERTY AND EQUIPMENT, at cost:
     Oil and gas properties
          (full-cost method)-
           Proved                                   60,245,702       59,317,097
           Unproved (excluded from

            amortization)                              282,344          263,908
                                                --------------   --------------

                                                    60,528,046       59,581,005


         Other equipment                               134,409          134,598
                                                --------------   --------------


                                                    60,662,455       59,715,603

         Less - Accumulated depreciation,
          depletion and amortization               (52,225,469)     (48,213,229)
                                                  ------------      -----------

                                                     8,436,986       11,502,374
                                                 -------------     ------------


OTHER ASSETS                                           451,523          511,863
                                                 -------------   --------------


                                                  $ 12,658,655     $ 16,460,448
                                                   ===========      ===========
</TABLE>







The accompanying notes are an integral part of these condensed consolidated
financial statements.


                                       3
<PAGE>   4



                  GARNET RESOURCES CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                                    Continued

<TABLE>
<CAPTION>

                                                   March 31,     December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY                 1998            1997
                                                 ------------    ------------
                                                 (unaudited)
<S>                                              <C>             <C>
CURRENT LIABILITIES:         
     Current portion of long-term debt           $ 22,641,480    $ 22,641,480
     Accounts payable and accrued
      liabilities                                   1,701,683       1,123,104
                                                 ------------    ------------

         Total current liabilities                 24,343,163      23,764,584
                                                 ------------    ------------

LONG-TERM DEBT, net of current portion                   --              --
                                                 ------------    ------------

DEFERRED INCOME TAXES                                    --              --
                                                 ------------    ------------

OTHER LONG-TERM LIABILITIES                           274,462         279,200
                                                 ------------    ------------
STOCKHOLDERS' EQUITY:
     Common stock, $.01 par value, 75,000,000
        shares authorized, 11,492,162 shares
        issued and outstanding as of March 31,
        1998 and December 31, 1997                    114,922         114,922
     Capital in excess of par value                52,491,212      52,491,212
     Retained earnings (deficit)                  (64,565,104)    (60,189,470)
                                                 ------------    ------------

         Total stockholders' equity               (11,958,970)     (7,583,336)
                                                 ------------    ------------

                                                 $ 12,658,655    $ 16,460,448
                                                 ============    ============
</TABLE>
















The accompanying notes are an integral part of these condensed consolidated
financial statements.
                                       4
<PAGE>   5

                  GARNET RESOURCES CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)



<TABLE>
<CAPTION>

                                                    Three Months Ended
                                                          March 31,
                                                ----------------------------
                                                    1998            1997                               
                                                ------------    ------------
<S>                                             <C>             <C>
REVENUES:         
     Oil sales                                  $  1,124,154    $  3,044,001
     Interest and other                               57,578          69,759
                                                ------------    ------------
                                                   1,181,732       3,113,760
                                                ------------    ------------
COSTS AND EXPENSES:
     Production                                      606,451         943,776
     Exploration                                         760           1,752
     General and administrative                      282,321         204,908
     Interest                                        572,876         585,131
     Depreciation, depletion and amortization        530,543       2,092,572
     Write down of oil and gas properties          3,481,699       3,511,733
     Foreign currency translation (gain) loss        (29,437)        (80,086)
                                                ------------    ------------
                                                   5,445,213       7,259,786
                                                ------------    ------------

INCOME (LOSS) BEFORE  INCOME TAXES                (4,263,481)     (4,146,026)

PROVISION (BENEFIT) FOR  INCOME TAXES                112,153        (253,755)
                                                ------------    ------------

NET LOSS                                        $ (4,375,634)   $ (3,892,271)
                                                ============    ============ 


BASIC AND DILUTED NET LOSS PER SHARE            $       (.38)   $       (.34)
                                                ============    ============ 

WEIGHTED AVERAGE BASIC AND DILUTED

     SHARES OUTSTANDING                           11,492,162      11,492,162
                                                ============    ============
</TABLE>








The accompanying notes are an integral part of these condensed consolidated
financial statements.


                                       5
<PAGE>   6


                  GARNET RESOURCES CORPORATION AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
<TABLE>
<CAPTION>


                                                                    Three  Months Ended
                                                                         March 31,
                                                                --------------------------
                                                                    1998          1997
                                                                -----------    -----------             
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                             <C>            <C>         
     Net loss                                                   $(4,375,634)   $(3,892,271) 
     Exploration costs                                                  760          1,752
     Depreciation, depletion and amortization                       530,543      2,092,572
     Write down of oil and gas properties                         3,481,699      3,511,733
     Deferred income taxes                                             --         (489,254)
     Changes in components of working capital                     1,676,977        412,199
     Other                                                           60,390         59,591
                                                                -----------    -----------

         Net cash provided by operating activities                1,374,735      1,696,322
                                                                -----------    -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
     Capital expenditures                                        (1,102,749)    (3,008,123)
     (Increase) decrease in joint venture and
         contractor advances                                        (50,973)     1,005,540
     Other                                                            2,036        (57,562)
                                                                -----------    -----------
         Net cash used for investing activities                  (1,151,686)    (2,060,145)
                                                                -----------    -----------

CASH FLOWS FROM FINANCING ACTIVITIES:

     Short term borrowings                                           64,400           --
     Costs of debt issuances                                           --          (10,537)
                                                                -----------    -----------


         Net cash (used) for provided by financing activities        64,400        (10,537)
                                                                -----------    -----------

NET (DECREASE) INCREASE IN CASH
  AND CASH EQUIVALENTS                                              287,449       (374,360)

CASH AND CASH EQUIVALENTS
  AT BEGINNING OF PERIOD                                          2,124,250      4,107,364
                                                                -----------    -----------

CASH AND CASH EQUIVALENTS AT END OF PERIOD                      $ 2,411,699    $ 3,733,004
                                                                ===========    ===========


Supplemental disclosures of cash flow information:
 Cash paid for -

     Interest, net of amounts capitalized                       $   135,699    $   548,331
     Income taxes                                                    51,932        232,889

</TABLE>


The accompanying notes are an integral part of these condensed consolidated
financial statements.


                                       6
<PAGE>   7


              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 MARCH 31, 1998
                              -------------------
                                   (Unaudited)

(1)  FINANCIAL STATEMENT PRESENTATION-

       The condensed consolidated financial statements include the accounts of
Garnet Resources Corporation, a Delaware corporation ("Garnet"), and its wholly
owned subsidiaries. Garnet and its wholly owned subsidiaries are collectively
referred to as the "Company." These financial statements have been prepared by
the Company without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission, and include all adjustments (which consist
solely of normal recurring adjustments) which, in the opinion of management, are
necessary for a fair presentation of financial position and results of
operations. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are adequate to
make the information presented not misleading. It is suggested that these
condensed consolidated financial statements be read in conjunction with the
Company's audited consolidated financial statements and the notes thereto
included in its Form 10-K for the year ended December 31, 1997.

(2)  MERGER PLANS
     
       On April 16th, 1998, the Company signed a letter of intent to merge with
Aviva Petroleum, Inc.("Aviva"), a publicly traded international oil and gas
exploration and production company. Aviva, through its wholly owned subsidiary,
Neo Energy Corporation ("Neo") owns a 45% non-operated working interest in the
Colombian joint operations in which the Company owns 55% and is the operator.
Aviva also owns and operates properties offshore Gulf of Mexico in the United
States.

       The proposed arrangements include Aviva refinancing Garnet's outstanding
debt to Chase Bank of Texas ("Chase") which is guaranteed by the U. S. Overseas
Private Investment Corporation ("OPIC"), issuing approximately 1.1 million, 12.9
million and 0.1 million new Aviva commons shares to Garnet shareholders, Garnet
debenture holders and the minority interest owners of Argosy Energy
International , respectively. The Garnet debenture Holders will sell their $ 15
million of 9.5% subordinated debentures due December 21, 1998 to Aviva in
connection with the merger transaction.

       The merger transaction contemplates that Aviva will form a wholly owned
subsidiary which will then merge with and into Garnet. Garnet will become a
wholly owned subsidiary of Aviva upon consummation of the merger. The merger is
subject to various contingencies including negotiation, execution and delivery
of an Agreement and Plan of Merger, a Debenture Purchase Agreement and a Limited
Partnership Interest Purchase Agreement, approvals thereof by ING Capital
(Aviva's lender), OPIC, Chase, and shareholders of Garnet and Aviva. No
assurance can be given that the merger will be effected.


                                       7
<PAGE>   8
(3)   LIQUIDITY AND CAPITAL RESOURCES

       The Company is highly leveraged with $22,600,000 in current debt
consisting of (i) $15,000,000 of Debentures due December 21, 1998 and (ii)
$7,700,000 ($7,600,000 net to Garnet) in principal outstanding under the OPIC
Loan to Argosy. Based on Argosy's year-end financial statements, Argosy has
determined that it is no longer in compliance with certain covenants required by
the finance agreement governing the OPIC Loan. In the absence of a waiver of
such covenants, either OPIC or Chase would have the right to call a default
under the OPIC Loan, accelerate payment of all outstanding amounts due
thereunder and realize upon the collateral securing the OPIC Loan. Although
Argosy intends to apply for a waiver, given the Company's financial position and
negative working capital balance at March 31, 1998, no assurance can be given
that such waiver will be granted or continued. Under the terms of the OPIC Loan,
the 75% of proceeds from Argosy's oil sales, which are paid in U.S. dollars are
deposited into an escrow account with Chase to secure payment of the OPIC Loan.
Argosy is required to maintain a minimum balance in such escrow account equal to
six months of interest, principal and other fees due under the OPIC Loan. The
escrow account minimum required balance at April 15, 1998 was $1,700,000 and the
total account balance was $1,960,000. Any excess in the escrow account over the
minimum balance can be released to Argosy and used to pay operating expenses and
amounts due under the OPIC Loan. Even if OPIC grants a waiver of the loan
covenants with which Argosy is not in compliance, if the minimum balance
required in such escrow account increases, as a result of a change in the
amortization schedule or otherwise, sufficient funds may not be available to
fund the Company's operations.

The Company was unable to pay Debenture interest due March 31, 1998 and the
Company's financial forecasts indicate that, assuming no changes in its capital
structure, working capital and cash flow from operations, the Company will not
be able to pay Debenture interest due June 30, 1998, or pay principal and
interest due under the OPIC Loan on June 15, 1998 and continue to maintain the
minimum balance in the escrow account. The Company also does not expect working
capital and cash flow from operations to be sufficient to repay the principal
amount of the Debentures at maturity or earlier if the Debenture holders call a
default as a result of the non-payment of interest. The Company must complete a
restructuring transaction or renegotiate the terms of the Debentures in order to
avoid non-compliance with its obligations to pay the Debentures. As a result,
management believes there is substantial doubt about the Company's ability to
continue as a going concern. In the absence of a business transaction or a
restructuring of the Company's indebtedness, the Company may seek protection
from its creditors under the Federal Bankruptcy Code.

(4)  COLOMBIAN OPERATIONS-

      Through its ownership of interests in Argosy Energy International, a Utah
limited partnership ("Argosy"), the Company has an indirect interest in a risk
sharing contract in Colombia (the "Santana Contract") with Empresa Colombiana de
Petroleos, the Colombian national oil company ("Ecopetrol"). The Santana
Contract currently entitles Argosy and Neo to explore for oil and gas on
approximately 52,000 acres located in the Putumayo Region of Colombia (the
"Santana Block").The contract provided for a ten-year exploration period that
expired in 1997 and for a production period expiring in 2015. Argosy and Neo
also have two association contracts (the "Fragua Contract" and the "Yuruyaco
Contract") with Ecopetrol. The Fragua Contract covers an area of approximately
32,000 acres contiguous to the northern boundary of the Santana Block (the
"Fragua Block"), while the Yuruyaco Contract covers an area of approximately
39,000 acres contiguous to the eastern boundaries of the Santana Block and the
Fragua Block (the "Yuruyaco Block"). Work obligations under these two contracts
have been met and applications to relinquish 


                                       8
<PAGE>   9
the areas have been filed with Ecopetrol. Argosy and Neo also have the right
until 2003 to explore for and produce oil and gas from approximately 77,000
acres located in the Putumayo Region (the "Aporte Putumayo Block") pursuant to
other agreements with Ecopetrol. Argosy and Neo notified Ecopetrol in 1994 that
they intend to abandon the remaining wells and relinquish the Aporte Putumayo
Block because declining production rates made continued operation of the wells
economically unattractive.
  
      Argosy serves as the operator of the Colombian properties under joint
venture agreements. The Santana Contract provides that Ecopetrol will receive a
royalty equal to 20% of production on behalf of the Colombian government and, in
the event a discovery is deemed commercially feasible, Ecopetrol will acquire a
65% interest in the remaining production from the field, bear 50% of the
development costs, and reimburse the joint venture, from Ecopetrol's share of
future production from each well, for 50% of the joint venture's costs of
successful exploratory wells in the field. In June 1996, cumulative oil
production from the Santana Contract exceeded seven million barrels. Under the
terms of the Santana Contract, Ecopetrol continued to bear 50% of development
costs, but its interest in production revenues and operating costs applicable to
wells on the Santana Block increased to 65%. If a discovery is made and is not
deemed by Ecopetrol to be commercially feasible, the joint venture may continue
to develop the field at its own expense and will recover 200% of the costs
thereof, at which time Ecopetrol will acquire a 65% interest therein at no cost
to Ecopetrol or further reimbursement by Ecopetrol to Argosy.

      The Company's resulting net participation in revenues and costs for the  
Santana Contract Contract is as follows:

<TABLE>
<CAPTION>
                                          PRODUCTION      OPERATING    EXPLORATION     DEVELOPMENT
                                           REVENUES         COSTS         COSTS           COSTS
                                          ----------      ---------    -----------     ----------- 
<S>                                            <C>            <C>         <C>               <C>
Santana Contract:
 After seven million barrels  
   of accumulated production                   15.3%           19.1%       38.2%             27.3%
</TABLE>

      The joint venture has completed its seismic acquisition and drilling
obligations for the ten-year exploration period of the Santana Contract,
resulting in the discovery of four oil fields, all of which have been declared
commercial by Ecopetrol. The joint venture has the right to continue to explore
for additional oil and gas deposits on the remaining acreage in the block, which
is held under the commercial production provisions of the Santana Contract.

      Under the terms of a contract with Ecopetrol, all oil produced from the
Santana Block is sold to Ecopetrol. If Ecopetrol exports the oil, the price paid
is the export price received by Ecopetrol, adjusted for quality differences,
less a handling and commercialization fee of $.515 per barrel. If Ecopetrol does
not export the oil, the price paid is based on the price received from
Ecopetrol's Cartagena refinery, adjusted for quality differences, less
Ecopetrol's cost to transport the crude to Cartagena and a handling and
commercialization fee of $.415 per barrel. Under the terms of its contract with
Ecopetrol, 25% of all revenues from oil sold to Ecopetrol is paid in Colombian
pesos which may only be utilized in Colombia. To date, Argosy has experienced no
difficulty in repatriating the remaining 75% of such payments which are payable
in United States dollars.


                                       9
<PAGE>   10

      As general partner, the Company's subsidiary is contingently liable for
any obligations of Argosy and may be contingently liable for claims generally
related to the conduct of Argosy's business.


(5)  EXPLORATION LICENSES IN PAPUA NEW GUINEA-

      Garnet PNG Corporation, a wholly owned subsidiary of Garnet ("Garnet
PNG"), owned a 6% interest (the "PPL-181 Interest) in Petroleum Prospecting
License No. 181 ("PPL-181") which covered 952,000 acres (the "PPL-181 Area").
Garnet PNG also held a 7.73% interest in an adjoining license, Petroleum
Prospecting License No. 174, on which an exploratory dry hole was drilled in the
first quarter of 1996. This license was surrendered on April 25, 1997. In 1986,
oil was discovered approximately 10 miles from the northern border of the
PPL-181 Area in an adjoining license area.

      Under the terms of an agreement pertaining to PPL-181, Occidental
International Exploration and Production Company ("Occidental") agreed to drill
and complete at its cost, a test well on the PPL-181 Area by September 1997.
PPL-181 was owned by Occidental (88%), Garnet PNG (6%) and Niugini Energy Pty.
Limited (6%). The test well, Turama-1, was drilled in the first quarter of 1997,
reaching a total depth of 9,652 feet. The well encountered the objective sands
in the Jurassic-Cretaceous Imburu formation, but evaluations of samples and
electric logs indicated that the sands were water bearing; therefore, the well
was abandoned as a dry hole.

In an agreement dated November 24, 1997, among Occidental Kanau Ltd. ("Kanau"),
Occidental of Papua New Guinea Ltd. ("Occidental PNG"), Santos Niugini
Exploration Pty. Limited ("Santos"), Niugini Energy, Inc. and Garnet PNG ,
Garnet PNG agreed to exchange its 6% interest (the "PPL-181 Interest") in
PPL-181 for a 4% interest in a newly applied for but not yet issued petroleum
prospecting license (New PPL") covering the PPL-181 Area and Petroleum
Prospecting License No. 158 ("PPL-158") held by Occidental PNG and Santos. On
April 28, 1998, the Minister for Petroleum and Energy for the Government of
Papua New Guinea agreed in writing to the relinquishment of PPL-181 and PPL-158
and to the issuance of the New PPL to be designated Petroleum Prospecting
License No. 206 ("PPL-206). It is anticipated that PPL-206 will be formally
issued during the third quarter of this year.

      Upon presentation of a tax clearance certificate evidencing Garnet PNG's
compliance with the relevant provisions of Papua New Guinea's income tax lawns,
profits, dividends and certain other payments, if any, up to an amount of
500,000 kina (approximately US$ 290,000) per year may be fully remitted out of
Papua New Guinea. Amounts in excess of 500,000 kina may also be remitted,
subject to clearance from the Bank of Papua New Guinea.

(6)  LONG-TERM DEBT-

Long-term debt at March 31, 1998 and December 31, 1997 consisted of the
following:

                                                  1998           1997
                                             ------------    ------------

9 1/2% convertible subordinated debentures   $ 15,000,000    $ 15,000,000
Notes payable by Argosy to a U.S. bank          7,641,480       7,641,480
                                             ------------    ------------

                                               22,641,480      22,641,480
Less -- Current portion                       (22,641,480)    (22,641,480)
                                             ------------    ------------

                                             $               $
                                             ============    ============ 


                                       10
<PAGE>   11

      In 1993, Garnet issued $15,000,000 of convertible subordinated debentures
(the "Debentures") due December 21, 1998. The Debentures bear interest at 9 1/2%
per annum payable quarterly and are convertible at the option of the holders
into Garnet common stock at $5.50 per share. If the Company elects to prepay the
Debentures under certain circumstances, it will issue warrants under the same
economic terms as the Debentures. At the option of a holder, in the event of a
change of control of the Company, the Company will be required to prepay such
holder's Debenture at a 30% premium. The Debentures are secured by a pledge of
all of the common stock of Garnet's wholly owned subsidiary which serves as the
general partner of Argosy (see Note 2). Under the terms of an agreement with the
holders of its Debentures, Garnet has agreed that it will not pay dividends or
make distributions to the holders of its common stock. The Debentures mature
December 21, 1998; therefore, the entire balance has been classified as current
in the accompanying consolidated balance sheet. As of March 31, 1998, Garnet was
not in compliance with the minimum net worth required by the Debentures and did
not pay the quarterly interest payment due March 31, 1998. Additionally, the
Company does not expect working capital and cash flow from operations to be
sufficient to repay the principal amount of the debentures at maturity,
therefore the Company must consummate a restructuring transaction prior to their
maturity date in order to avoid non-compliance with its obligations to pay the
Debentures. If no restructuring transaction is consummated the Company will be
required to re-negotiate the terms of the debentures. In the absence of a
business transaction or a restructuring of the Company's indebtedness, the
Company may seek protection from its creditors under the Federal Bankruptcy
Code.

      In 1994, Argosy entered into a finance agreement with Overseas Private
Investment Corporation, an agency of the United States government ("OPIC"),
pursuant to which OPIC agreed to guarantee up to $9,200,000 in bank loans to
Argosy, the loans were funded in two stages of $4,400,000 in August 1994 and
$4,800,000 in October 1995. The Company used these funds to drill development
wells and complete the construction of its production facilities in Colombia.
OPIC's guaranty is secured by Argosy's interest in the Santana Contract and
related assets, as well as the pledge of Garnet's direct and indirect interests
in Argosy. The terms of the guaranty agreement also restrict Argosy's ability to
make distributions to its partners, including the Company, prior to the
repayment of the guaranteed loans. The maximum term of the loans is not to
exceed seven years, and the principal amortization schedule is based on
projected cash flows from wells on the Santana Block. The loans bear interest at
the lender's Eurodollar deposit rate plus .25% per annum for periods of two,
three or six months as selected by Argosy. The interest rate at March 31, 1998
was 6.125%. In consideration for OPIC's guaranty, Argosy pays OPIC a guaranty
fee of 2.4% per annum on the outstanding balance of the loans guaranteed. Argosy
is no longer in compliance with certain covenants required by the finance
agreement governing the OPIC Loan.

(7) Stock option plans-

      Garnet has adopted stock option plans (the "Employee Plans") pursuant to
which an aggregate of 1,473,000 shares of Garnet's common stock is authorized to
be issued upon 


                                       11
<PAGE>   12

exercise of options granted to officers, employees, and certain other persons or
entities performing substantial services for or on behalf of Garnet or its
subsidiaries.

      The Stock Option and Compensation Committee of Garnet's Board of Directors
(the "Committee") is vested with sole and exclusive authority to administer and
interpret the Employees' Plans, to determine the terms upon which options may be
granted, to prescribe, amend and rescind such interpretations and determinations
and to grant options to directors. Current Committee members are not eligible to
receive options under the Employees' Plans.

      The employee stock options are generally exercisable for a period of 10
years and 30 days from the date of grant. The purchase price of shares issuable
upon exercise of an option may be paid in cash or by delivery of shares with a
value equal to the exercise price of the option. The Committee has determined
that the right to exercise non-incentive options issued to employees vests over
a period of four years, so that 20% of the option becomes exercisable on each
anniversary of the date of grant.

      On May 22, 1997, Garnet adopted the 1997 Directors' Stock Option Plan
(the"1997 Directors' Plan") pursuant to which an aggregate of 470,000 shares of
Garnet's common stock is authorized to be issued upon exercise of options
granted to non-employee directors. An aggregate of 122,950 shares was issuable
as of March 31, 1998 upon exercise of options granted thereunder in exchange,
among other things, for the surrender of 265,000 options previously granted to
such directors under the 1990 Directors' Stock Option Plan that has since been
terminated. Director's stock options are exercisable for a period of 5 years
from the date of grant. The purchase price of shares issuable upon exercise of a
director's stock option must be paid in cash.

      The following is a summary of stock option activity in connection with the
Employees' Plans and the Directors' Plan:

                                              Shares      Price Range

Options outstanding at December 31, 1995    1,329,102    $2.50 -$13.83

Options granted                               480,000     4.00 - 11.75
Options expired                              (630,376)    2.87 -  4.05
                                            ---------    -------------

Options outstanding at December 31, 1996    1,178,726     1.19 - 13.83

Options granted                               698,956     0.38 -  0.56
Options cancelled                            (451,080)    4.00 - 11.75
Options expired                               (85,372)    2.87 -  4.05
                                            ---------    -------------

Options outstanding at December 31, 1997    1,341,230     0.38 -  2.50

Options expired                              (568,171)    0.38 -  2.50
                                            ---------    -------------

Options outstanding at March 31, 1998         773,059    $0.38 - $2.50
                                            =========    =============

       As of March 31, 1998, options for 370,118 shares were exercisable.

                                       12
<PAGE>   13

      In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 123, a new standard for
accounting for stock-based compensation. This standard established a fair-value
based method of accounting for stock options awarded after December 31, 1995 and
encourages companies to adopt SFAS No. 123 in place of the existing accounting
method, which requires expense recognition only in situations where stock
compensation plans award intrinsic value to recipients at the date of grant.
Companies that do not follow SFAS No. 123 for accounting purposes must make
annual pro forma disclosures of its effects. Adoption of the standard was
required in 1996, although earlier implementation was permitted. The Company did
not adopt SFAS No. 123 for accounting purposes; however it will make annual pro
forma disclosures of its effects.



(8)  INCOME TAXES-

      The provisions for income taxes and deferred income taxes payable relate
to the Colombian activities of Argosy. No deferred taxes were provided because
the tax bases of the Company's assets exceed the financial statement bases,
resulting in a deferred tax asset, which the Company has determined, is not
presently realizable.

      As of December 31, 1997, the Company had a regular U. S. tax net operating
loss carryforward and an alternative minimum tax loss carryforward of
approximately $30,900,000 and $ 30,600,000 respectively. These loss
carryforwards will expire beginning in 2001 if not utilized to reduce U.S.
income taxes otherwise payable in future years, and are limited as to
utilization because of the occurrences of "ownership changes" (as defined in
Section 382 of the Internal Revenue Code of 1986, as amended) in 1991 and
earlier years. Such loss carryforwards also exclude regular tax net operating
loss carryforwards aggregating approximately $4,500,000 attributable to certain
of Garnet's subsidiaries, which can be used in certain circumstances to offset
taxable income generated by such subsidiaries.

Item 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
          RESULTS OF OPERATIONS.

LIQUIDITY AND CAPITAL RESOURCES

      The Company is highly leveraged with $22,600,000 in current debt
consisting of (i) $15,000,000 of Debentures due December 21, 1998 and (ii)
$7,700,000 ($7,600,000 net to Garnet) in principal outstanding under the OPIC
Loan to Argosy. Based on Argosy's year-end financial statements, Argosy has
determined that it is no longer in compliance with certain covenants required by
the finance agreement governing the OPIC Loan. In the absence of a waiver of
such covenants, either OPIC or Chase would have the right to call a default
under the OPIC Loan, accelerate payment of all outstanding amounts due
thereunder and realize upon the collateral securing the OPIC Loan. Although
Argosy intends to apply for a waiver, given the Company's financial position and
negative working capital balance at March 31, 1998, no assurance can be given
that such waiver will be granted or continued. Under the terms of the OPIC Loan,
the 75% of proceeds from Argosy's oil sales, which are paid in U.S. dollars are
deposited into an escrow account with Chase to secure payment of the OPIC Loan.
Argosy is required to maintain a minimum balance in such escrow account equal to
six months of interest, principal and other fees due under the OPIC Loan. The
escrow account minimum required 


                                       13
<PAGE>   14

balance at April 15, 1998 was $1,700,000 and the total account balance was
$1,960,000. Any excess in the escrow account over the minimum balance can be
released to Argosy and used to pay operating expenses and amounts due under the
OPIC Loan. Even if OPIC grants a waiver of the loan covenants with which Argosy
is not in compliance, if the minimum balance required in such escrow account
increases, as a result of a change in the amortization schedule or otherwise,
sufficient funds may not be available to fund the Company's operations.

      The Company was unable to pay the Debenture interest due March 31, 1998
and the Company's financial forecasts indicate that, assuming no changes in its
capital structure, working capital and cash flow from operations, the Company
will not be able to pay Debenture interest due June 30, 1998 or pay principal
and interest due under the OPIC Loan on June 15, 1998 and continue to maintain
the minimum balance in the escrow account. The Company also does not expect
working capital and cash flow from operations to be sufficient to repay the
principal amount of the Debentures at maturity or earlier if the Debenture
holders call a default as a result of the non-payment of interest. The Company
must complete a restructuring transaction or renegotiate the terms of the
Debentures in order to avoid non-compliance with its obligations to pay the
Debentures. As a result, management believes there is substantial doubt about
the Company's ability to continue as a going concern. In the absence of a
business transaction or a restructuring of the Company's indebtedness, the
Company may seek protection from its creditors under the Federal Bankruptcy
Code.

      In view of its operating losses and financial condition, the Company
initiated further cost containment programs in 1997 and 1998 including a 28%
reduction in its Colombian personnel and the termination of all U.S. personnel
other than Douglas w. Fry, the Chief Executive Officer, and Edgar L. Dyes, the
Chief Financial Officer and the closing of the Company executive office in
Houston. The Company also engaged Rauscher Pierce Refsnes, Inc. ( now Dain
Rauscher) as a financial advisor to provide assistance in negotiating a business
combination or a debt restructuring transaction to address the Company's
liquidity issues. Although the Company engaged in comprehensive efforts,
including extensive negotiations with two separate candidates, the Company was
not successful in concluding a transaction. The Company is currently engaged in
negotiations to effect a business combination (see Note 2), although no
assurance can be given that such negotiations will result in a definitive
agreement or the consummation of a transaction.

      It is anticipated that any future foreign exploration and development
activities will require substantial amounts of capital. If the Company is unable
to conclude a business combination or a debt restructuring transaction, the
Company will not have the resources to finance any further exploration or
development activity. Accordingly, there can be no assurance that any additional
exploration or development activities will be conducted, other than those
activities required to deplete the Company's existing proved reserves. The
present environment for financing the ongoing obligations of an oil and gas
business is uncertain due, in part, to the substantial instability in oil and
gas prices in recent years and to the volatility of financial markets. In
addition, the Company's ability to continue its exploration and development
programs may be dependent upon its joint venture partners' financing their
portion of such costs and expenses. There can be no assurance that the Company's
partners will contribute, or be in a position to contribute, their costs and
expenses of the joint venture programs. If the Company's partners cannot finance
their obligations to the joint ventures, the Company may be required to accept
an assignment of the partners' interests therein and assume their financing



                                       14
<PAGE>   15

obligations. If sufficient funds cannot be raised to meet the Company's
obligations in connection with its properties, the interests in such properties
might be sold or forfeited.

      As described herein, the Company's operations are primarily located
outside the United States. Although certain of such operations are conducted in
foreign currencies, the Company considers the U.S. dollar to be the functional
currency in most of the countries in which it operates. In addition, the Company
has no significant operations in countries with highly inflationary economies.
As a result, the Company's foreign currency transaction gains and losses have
not been significant. Exchange controls exist for the repatriation of funds from
Colombia and Papua New Guinea. The Company believes that the continuing
viability of its operations in these countries will not be affected by such
restrictions.

      The foregoing discussion contains, in addition to historical information,
forward-looking statements. The forward-looking statements were prepared on the
basis of certain assumptions which relate, among other things, to costs expected
to be incurred in the development of the Company's properties, the receipt of
environmental and other necessary administrative permits required for such
development, future oil prices, future production rates, and the ability to
conclude a business combination or a debt restructuring transaction. Even if the
assumptions on which the projections are based prove accurate and appropriate,
the actual results of the Company's operations in the future may vary widely
from the financial projections due to unforeseen engineering, mechanical or
technological difficulties in drilling or working over wells, regional political
issues, general economic conditions, increased competition, changes in
government regulation or intervention in the oil and gas industry, and other
risks described herein. Accordingly, the actual results of the Company's
operations in the future may vary widely from the forward-looking statements
included herein.

RESULTS OF OPERATIONS
                        THREE MONTHS ENDED MARCH 31, 1998
                      COMPARED WITH THE SAME PERIOD IN 1997
                      -------------------------------------

      The Company reported net losses of $4,375,634 ($.38 per share) and
$3,892,271 ($.34 per share) for the three months ended March 31, 1998 and 1997,
respectively.

      The decrease in oil and gas revenues was attributable to lower production
volumes and lower average oil prices for the period. This decrease was partially
offset by decreased production expenses related to the expiration of Colombian
production taxes and lower transportation, handling and commercialization costs.
The Company's comparative average daily sales volumes in barrels of oil per day
("BOPD"), average sales prices and costs per barrel in Colombia for such periods
were as follows:

                                   THREE MONTHS ENDED
                                        MARCH 31,
                                    1998        1997
                                   ------      -----

Average oil sales (BOPD)            1,016       1,662
Average oil price per barrel       $12.29      $20.35
Production costs per barrel        $ 6.63      $ 6.31
Depreciation, depletion and
 amortization per barrel           $ 5.76      $13.96


                                       15
<PAGE>   16

      The net loss for the period increased partially by a cost center ceiling
write down of $3,482,000 which resulted from a decrease in world oil prices
during the first quarter compared to year-end December 31, 1997. Corporate
general and administrative expenses decreased by 12 % compared to the same
period in 1997 due to personnel reductions and austerity measures taken in the
last quarter of 1997. Net general and administrative expenses increased however,
due to reduced overhead recoveries from joint venture partners. The increase in
interest expense, net of amounts capitalized, resulted principally from
decreases in costs attributable to assets eligible for interest capitalization.
The provision for income taxes, all of which relates to Colombian operations,
was significantly lower due to revisions in Colombian presumptive income
calculations for tax purposes. The corporate tax rate in Colombia is currently
35 % and is applied to the greater of taxable or presumptive income.

  
                                       16
<PAGE>   17


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
         (a)  EXHIBITS
<TABLE>
<CAPTION>

              ITEM                                                                        EXHIBIT
               NO.                    ITEM TITLE                                          NO.
              ----                    ----------                                          ------- 
<S>           <C>          <C>                                                           <C>                  

                (2)        Plan of acquisition, reorganization,
                           arrangement, liquidation or succession:
                           Not Applicable

                (3)        Articles of Incorporation and By-Laws:
                           Not Applicable

                (4)        Instruments defining the rights of
                           security holders, including indentures:
                           Not Applicable

              (10)         Material contracts: Not Applicable

              (11)         Statement regarding computation of
                           share earnings is not required because the relevant
                           computations can be clearly determined from the
                           material contained in the Financial Statements
                           included
                           herein.


              (15)         Letter re unaudited interim financial
                           information:  Not Applicable

              (18)         Letter re change in accounting principles:
                           Not Applicable

              (19)         Report furnished to security holders:
                           Not Applicable

              (22)         Published report regarding matters
                           submitted to vote of security holders:
                           Not Applicable

              (23)         Consents of experts and counsel:
                           Not Applicable
              (24)         Power of attorney: Not Applicable

              (27)         Financial Data Schedule.                                         27

              (99)         Additional Exhibits:  Not Applicable
</TABLE>


                                       17
<PAGE>   18



         (b)  REPORTS ON FORM 8-K

              No Reports on Form 8-K were filed by Registrant during the three
months ended March 31, 1998.



































                                       18

<PAGE>   19




                                   SIGNATURES


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


                                          GARNET RESOURCES CORPORATION

Date:    May 15, 1998                     /s/ Edgar L. Dyes
                                          -----------------
                                          Edgar L. Dyes,
                                          Vice President and Treasurer
                                          (As both a duly authorized
                                           officer of Registrant and as
                                           principal financial officer
                                           of Registrant


                                       19
<PAGE>   20
                               INDEX TO EXHIBITS


   NO.                        DESCRIPTION
   ---                        -----------

   27                         Financial Data Schedule