UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549





Form
10-Q





(Mark
One)





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





For
the quarterly period ended June 30, 2008





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: 000-51152





PETROHUNTER
ENERGY CORPORATION


(Exact
name of registrant as specified in its charter)





Maryland
            
            98-0431245(State
      or other jurisdiction of
            
            (I.R.S.
      Employerincorporation
      or organization)
            
            Identification
      No.)1600
      Stout Street
            
            80202Suite
      2000, Denver, Colorado
            
            (Zip
    Code)(Address
      of principal executive offices)





(303) 572-8900


Registrant’s
telephone number, including area code








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 whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “accelerated filer,” “large accelerated filer”, and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large
accelerated filer [ ]      Accelerated filer [
]      Non-accelerated filer [
]     Smaller reporting company [X]





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





As of
July 31, 2008, the registrant had 340,743,469 shares of common stock
outstanding.








Unless
otherwise noted in this report, any description of “us” or “we” refers to
PetroHunter Energy Corporation and our subsidiaries. All amounts expressed
herein are in U.S. dollars unless otherwise indicated.








FORWARD-LOOKING
STATEMENTS




“estimate,”  “should,”  “expect”
and similar expressions include our expectations and objectives regarding our
future financial position, operating results and business strategy. These
statements reflect the current views of management with respect to future events
and are subject to risks, uncertainties and other factors that may cause our
actual results, performance or achievements, or industry results, to be
materially different from those described in the forward-looking statements. All
forward-looking statements herein as well as all subsequent written and oral
forward-looking statements attributable to us, or persons acting on our behalf,
are expressly qualified in their entirety by cautionary statements set forth in
the “Risk Factors” section of our Prospectus on Form S-1 filed with the
Securities and Exchange Commission (“SEC”) on June 30, 2008 and in Item 1A “Risk
Factors” appearing in our Annual Report on Form 10-K for the fiscal year ended
September 30, 2007. We assume no duty to update or revise our forward-looking
statements based on changes in internal estimates or expectations or otherwise.
We advise you to carefully review the reports and documents we file from time to
time with the SEC.








GLOSSARY





Unless
otherwise indicated in this document, oil equivalents are determined using the
ratio of six Mcf of natural gas to one barrel of crude oil, condensate or
natural gas liquids so that six Mcf of natural gas are referred to as one barrel
of oil equivalent.





API Gravity.A specific
gravity scale developed by the American Petroleum Institute (API) for measuring
the relative density of various petroleum liquids, expressed in degrees. API
gravity is gradated in degrees on a hydrometer instrument and was designed so
that most values would fall between 10° and 70° API gravity. The arbitrary
formula used to obtain this effect is: API gravity = (141.5/SG at 60°F) — 131.5,
where SG is the specific gravity of the fluid.





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





Bcf.One billion cubic feet
of natural gas at standard atmospheric conditions.





Capital Expenditures.Costs
associated with exploratory and development drilling (including exploratory dry
holes); leasehold acquisitions; seismic data acquisitions; geological,
geophysical and land-related overhead expenditures; delay rentals; producing
property acquisitions; other miscellaneous capital expenditures; compression
equipment and pipeline costs.





Carried Interest.The owner
of this type of interest in the drilling of a well incurs no liability for costs
associated with the well until the well is drilled, completed and connected to
commercial production/processing facilities.





Completion.The installation
of permanent equipment for the production of oil or natural gas.





Developed Acreage.The number
of acres that are allocated or assignable to producing wells or wells capable of
production.





Development Well.A well
drilled within the proved area of an oil or natural gas reservoir to the depth
that is known to be productive.





Drilled and Cased.Involves
drilling a well and installing casing to a specified depth in the wellbore for
future completion.





Exploitation.The continuing
development of a known producing formation in a previously discovered field. To
make complete or maximize the ultimate recovery of oil or natural gas from the
field by work including development wells, secondary recovery equipment or other
suitable processes and technology.





Exploration.The search for
natural accumulations of oil and natural gas by any geological, geophysical or
other suitable means.





2




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.





Farm-In or Farm-Out.An
agreement under which the owner of a working interest in a natural gas and oil
lease assigns the working interest or a portion of the working interest to
another party who desires to drill on the leased acreage. Generally, the
assignee is required to drill one or more wells in order to earn its interest in
the acreage. The assignor usually retains a royalty or reversionary interest in
the lease. The interest received by an assignee is a “farm-in” while the
interest transferred by the assignor is a “farm-out”.





Field.An area consisting of
either a single reservoir or multiple reservoirs, all grouped on or related to
the same individual geological structural feature and/or stratigraphic
condition.





Finding and Development Costs.The total capital expenditures, including acquisition costs, and
exploration and abandonment costs, for oil and gas activities divided by the
amount of proved reserves added in the specified period.





Force Pooling.The process by
which interests not voluntarily participating in the drilling of a well, may be
involuntarily committed to the operator of the well (by a regulatory agency) for
the purpose of allocating costs and revenues attributable to such
well.





Gross Acres or Gross Wells.The total acres or wells, as the case may be, in which we have a working
interest.





Lease.An instrument which
grants to another (the lessee) the exclusive right to enter to explore for,
drill for, produce, store and remove oil and natural gas on the mineral
interest, in consideration for which the lessor is entitled to certain rents and
royalties payable under the terms of the lease. Typically, the duration of the
lessee’s authorization is for a stated term of years and “for so long
thereafter” as minerals are producing.





Mcf.One thousand cubic feet
of natural gas at standard atmospheric conditions.





MCFE.One thousand cubic feet
of gas equivalent. Gas equivalents are determined using the ratio of six Mcf of
gas (including gas liquids) to one Bbl of oil.





Net Acres or Net Wells.A net
acre or well is deemed to exist when the sum of our fractional ownership working
interests in gross acres or wells, as the case may be, equals one. The number of
net acres or wells is the sum of the fractional working interests owned in gross
acres or wells, as the case may be, expressed as whole numbers and fractions
thereof.





Operator.The individual or
company responsible to the working interest owners for the exploration,
development and production of an oil or natural gas well or lease.





Overriding Royalty.A revenue
interest in oil and gas, created out of a working interest which entitles the
owner to a share of the proceeds from gross production, free of any operating or
production costs.





Payout.The point at which
all costs of leasing, exploring, drilling and operating have been recovered from
production of a well or wells, as defined by contractual agreement.





Productive Well.A well that
is found to be capable of producing hydrocarbons in sufficient quantities such
that proceeds from the sale of the production exceed production expenses and
taxes. Productive wells consist of producing wells and wells capable of
production, but specifically exclude wells drilled and cased during the fiscal
year that have yet to be tested for completion.





Prospect.A specific
geographic area which, based on supporting geological, geophysical or other data
and also preliminary economic analysis using reasonably anticipated prices and
costs, is deemed to have potential for the discovery of commercial
hydrocarbons.





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





3


Reserves.Natural gas and
crude oil, condensate and natural gas liquids on a net revenue interest basis,
found to be commercially recoverable.





Reservoir.A porous and
permeable underground formation containing a natural accumulation of producible
natural gas and/or oil that is confined by impermeable rock or water barriers
and is separate from other reservoirs.





Royalty.An interest in an
oil and natural gas lease that gives the owner of the interest the right to
receive a portion of the production from the leased acreage, or of the proceeds
of the sale thereof, but generally does not require the owner to pay any portion
of the costs of drilling or operating the wells on the leased acreage. Royalties
may be either landowner’s royalties, which are reserved by the owner of the
leased acreage at the time the lease is granted, or overriding royalties, which
are usually reserved by an owner of the leasehold in connection with a transfer
to a subsequent owner.





Spud.To start the well
drilling process by removing rock, dirt and other sedimentary
material.





Stratigraphic.Relating to vertical
position in a rock column. More generally, relating to relative geological age,
since typically, in any given sequence of sedimentary rock, older rock is lower
than newer.





3-D Seismic.The method by
which a three-dimensional image of the earth’s subsurface is created through the
interpretation of reflection seismic data collected over a surface grid. 3-D
seismic surveys allow for a more detailed understanding of the subsurface than
do conventional surveys and contribute significantly to field appraisal,
exploitation and production.





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





Working Interest.An interest
in an oil and gas lease that gives the owner of the interest the right to drill
and produce oil and gas on the leased acreage and requires the owner to pay a
share of the costs of drilling and production operations. The share of
production to which a working interest owner is entitled will always be smaller
than the share of costs that the working interest owner is required to bear,
with the balance of the production accruing to the owners of
royalties.








4





PETROHUNTER
ENERGY CORPORATION





FORM
10-Q








INDEX





PART
      I — FINANCIAL INFORMATIONItem
      1.
            Financial
      StatementsCondensed
      Consolidated Balance Sheets at June 30, 2008 and September 30, 2007
      (unaudited).Condensed Consolidated
      Statements of Operations for the three and nine months ended June 30,
      2008 and 2007, and the cumulative period from inception to June 30,
      2008 (unaudited).Condensed
      Consolidated Statements of Stockholders’ Equity and Comprehensive Loss for
      the nine months ended June 30, 2008 and the cumulative period from
      inception to June 30, 2008 (unaudited).Condensed
      Consolidated Statements of Cash Flows for the nine months ended June 30,
      2008 and 2007 and the cumulative period from inception to June 30,
      2008 (unaudited).Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of
      OperationsItem
      4T.
            Controls
      and ProceduresPART
      II — OTHER INFORMATIONItem
      1.
            Legal
      ProceedingsItem
      1A.
            Risk
      FactorsItem
      4.
            Submission
      of Matters to a Vote of Security HoldersItem
      6.
            ExhibitsSignatures











5


PART
I. FINANCIAL INFORMATION


Item
1. Financial Statements


PETROHUNTER
ENERGY CORPORATION


(A
Development Stage Company)


CONDENSED
CONSOLIDATED BALANCE SHEETS


(unaudited;
$ in thousands, except share and per share amounts)





June
      30, 2008
            
            
            September
      30, 2007ASSETSCurrent
      AssetsCash
      and cash equivalents
            
            $
            695
            
            
            $
            120Restricted
      cash
            
            
            531
            
            
            
            —ReceivablesOil
      and gas receivables, net
            
            
            280
            
            
            
            487Other
      receivables
            
            
            62
            
            
            
            59Due
      from related parties
            
            
            —
            
            
            
            500GST
      receivable
            
            
            485
            
            
            
            —Note
      receivable — related party
            
            
            —
            
            
            
            2,494Prepaid
      expenses and other assets
            
            
            406
            
            
            
            187Total
      Current Assets
            
            
            2,459
            
            
            
            3,847Property
      and Equipment, at costOil
      and gas properties under full cost method, net
            
            
            146,184
            
            
            
            162,843Furniture
      and equipment, net
            
            
            422
            
            
            
            569Total
      Property and Equipment
            
            
            146,606
            
            
            
            163,412Other
      AssetsJoint
      interest billings
            
            
            —
            
            
            
            13,637Restricted
      cash
            
            
            524
            
            
            
            599Deposits
      and other assets
            
            
            130
            
            
            
            —Deferred
      financing costs
            
            
            1,657
            
            
            
            529Intangible asset
            
            
            4,142
            
            
            
            —Total
      Assets
            
            $
            155,518
            
            
            $
            182,024LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      LiabilitiesNotes
      payable — short-term
            
            $
            1,055
            
            
            $
            4,667Convertible
      notes payable
            
            
            400
            
            
            
            400Accounts
      payable and accrued expenses
            
            
            9,873
            
            
            
            26,631Note
      payable — related party — current portion
            
            
            2,622
            
            
            
            3,755Note
      payable — current portion of long-term liabilities
            
            
            120
            
            
            
            120Accrued
      interest payable
            
            
            6,302
            
            
            
            2,399Accrued
      interest payable — related party
            
            
            18
            
            
            
            516Due
      to shareholder and related parties
            
            
            440
            
            
            
            1,474Contract
      payable — oil and gas properties
            
            
            —
            
            
            
            1,750Contingent
      purchase obligation
            
            
            4,142
            
            
            
            —Total
      Current Liabilities
            
            
            24,972
            
            
            
            41,712Non-current
      obligationsNotes
      payable — net of discount
            
            
            37,207
            
            
            
            27,944Subordinated
      notes payable — related parties
            
            
            106
            
            
            
            9,050Convertible
      notes payable — net of discount
            
            
            684
            
            
            
            —Asset
      retirement obligation
            
            
            73
            
            
            
            136Net
      Non-current Obligations
            
            
            38,070
            
            
            
            37,130Total
      Liabilities
            
            
            63,042
            
            
            
            78,842Common
      Stock Subscribed
            
            
            —
            
            
            
            2,858Commitments
      and Contingencies (Note 13)Stockholders’
      EquityPreferred
      stock, $0.001 par value; authorized 100,000,000 shares; none
      issued
            
            
            —
            
            
            
            —Common
      stock, $0.001 par value; authorized 1,000,000,000 shares; 338,065,950 and
      278,948,841 shares issued and outstanding at June 30, 2008 and September
      30, 2007, respectively
            
            
            338
            
            
            
            279Additional
      paid-in-capital
            
            
            199,968
            
            
            
            172,672Accumulated
      other comprehensive gain (loss)
            
            
            33
            
            
            
            (5
            )Deficit
      accumulated during the development stage
            
            
            (107,863
            )
            
            
            (72,622
            )Total
      Stockholders’ Equity
            
            
            92,476
            
            
            
            100,324Total
      Liabilities and Stockholders’ Equity
            
            $
            155,518
            
            
            $
            182,024





See
accompanying notes to condensed consolidated financial
statements.


6


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(unaudited;
$ in thousands except per share amounts)





Three
      months
              ended
              June
      30,
              2008
            
            
            Three
      months
              ended
              June
      30,
              2007
              (restated)
            
            
            Nine
      months
              ended
              June
      30,
              2008
            
            
            Nine
      months
              ended
              June
      30,
              2007
              (restated)
            
            
            Cumulative
              From
      Inception
              (June
      20, 2005) to
              June
      30, 2008RevenuesOil
      and gas revenues
            
            $
            567
            
            
            $
            847
            
            
            $
            1,349
            
            
            $
            2,285
            
            
            $
            4,206Other
      revenues
            
            
            13
            
            
            
            —
            
            
            
            222
            
            
            
            —
            
            
            
            222Total
      revenues
            
            
            580
            
            
            
            847
            
            
            
            1,571
            
            
            
            2,285
            
            
            
            4,428Costs
      and expensesLease
      operating expenses
            
            
            164
            
            
            
            211
            
            
            
            404
            
            
            
            597
            
            
            
            1,201General
      and administrative
            
            
            2,554
            
            
            
            5,395
            
            
            
            8,245
            
            
            
            13,396
            
            
            
            41,193Property
      development — related party
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,815
            
            
            
            7,205Impairment
      of oil and gas properties
            
            
            —
            
            
            
            600
            
            
            
            —
            
            
            
            9,551
            
            
            
            24,053Consulting
      fees – related party
            
            
            —
            
            
            
            75
            
            
            
            —
            
            
            
            150
            
            
            
            —Depreciation,
      depletion, amortization and accretion
            
            
            334
            
            
            
            805
            
            
            
            774
            
            
            
            2,018
            
            
            
            2,093Total
      operating expenses
            
            
            3,052
            
            
            
            7,086
            
            
            
            9,423
            
            
            
            27,527
            
            
            
            75,745Loss
      from operations
            
            
            (2,472
            )
            
            
            (6,239
            )
            
            
            (7,852
            )
            
            
            (25,242
            )
            
            
            (71,317
            )Other
      income (expense):Loss
      from conveyance of property
            
            
            (15,220
            )
            
            
            —
            
            
            
            (15,220
            )
            
            
            —
            
            
            
            (15,220
            )Gain
      on foreign exchange
            
            
            —
            
            
            
            —
            
            
            
            11
            
            
            
            —
            
            
            
            33Interest
      income
            
            
            6
            
            
            
            6
            
            
            
            33
            
            
            
            20
            
            
            
            72Interest
      expense
            
            
            (1,801
            )
            
            
            (846
            )
            
            
            (9,226
            )
            
            
            (2,677
            )
            
            
            (18,444
            )Trading
      security losses
            
            
            —
            
            
            
            —
            
            
            
            (2,987
            )
            
            
            —
            
            
            
            (2,987
            )Total
      other expense
            
            
            (17,015
            )
            
            
            (840
            )
            
            
            (27,389
            )
            
            
            (2,657
            )
            
            
            (36,546
            )Net
      loss
            
            $
            (19,487
            )
            
            $
            (7,079
            )
            
            $
            (35,241
            )
            
            $
            (27,899
            )
            
            $
            (107,863
            )Net
      loss per common share — basic and diluted
            
            $
            (0.06
            )
            
            $
            (0.03
            )
            
            $
            (0.11
            )
            
            $
            (0.12
            )Weighted
      average number of common shares outstanding — basic and
      diluted
            
            
            324,147
            
            
            
            256,906
            
            
            
            317,811
            
            
            
            221,802





See
accompanying notes to condensed consolidated financial statements




7


CONDENSED
CONSOLIDATED STATEMENTS OF


STOCKHOLDERS’
EQUITY AND COMPREHENSIVE LOSS


(unaudited,
$ in thousands except share and per share amounts)





Common
      Stock
            
            
            Additional
              Paid-in
            
            
            Deficit
              Accumulated
              During
      the
              Development
            
            
            Accumulated
              Other
              Compre-
              hensive
            
            
            Total
              Stockholders’
            
            
            Total
              Compre-
              hensiveShares
            
            
            Amount
            
            
            Capital
            
            
            Stage
            
            
            Loss
            
            
            Equity
            
            
            LossBalances,
      June 20, 2005 (inception)
            
            
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —Shares
      issued to founder at $0.001 per share
            
            
            100,000,000
            
            
            
            100
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            100
            
            
            
            —Stock-based
      compensation costs for options granted to non employees
            
            
            —
            
            
            
            —
            
            
            
            823
            
            
            
            —
            
            
            
            —
            
            
            
            823
            
            
            
            —Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,119
            )
            
            
            —
            
            
            
            (2,119
            )
            
            
            (2,119
            )Balances,
      September 30, 2005
            
            
            100,000,000
            
            
            
            100
            
            
            
            823
            
            
            
            (2,119
            )
            
            
            —
            
            
            
            (1,196
            )
            
            
            (2,119
            )Shares
      issued for property interests at $0.50 per share
            
            
            3,000,000
            
            
            
            3
            
            
            
            1,497
            
            
            
            —
            
            
            
            —
            
            
            
            1,500
            
            
            
            —Shares
      issued for finder’s fee on property at $0.50 per share
            
            
            3,400,000
            
            
            
            3
            
            
            
            1,697
            
            
            
            —
            
            
            
            —
            
            
            
            1,700
            
            
            
            —Shares
      issued upon conversion of debt, at $0.50 per share
            
            
            44,063,334
            
            
            
            44
            
            
            
            21,988
            
            
            
            —
            
            
            
            —
            
            
            
            22,032
            
            
            
            —Shares
      issued for commission on convertible debt at $0.50 per
    share
            
            
            2,845,400
            
            
            
            3
            
            
            
            1,420
            
            
            
            —
            
            
            
            —
            
            
            
            1,423
            
            
            
            —Sale
      of shares and warrants at $1.00 per unit
            
            
            35,442,500
            
            
            
            35
            
            
            
            35,407
            
            
            
            —
            
            
            
            —
            
            
            
            35,442
            
            
            
            —Shares
      issued for commission on sale of units
            
            
            1,477,500
            
            
            
            1
            
            
            
            1,476
            
            
            
            —
            
            
            
            —
            
            
            
            1,477
            
            
            
            —Costs
      of stock offering:Cash
            
            
            —
            
            
            
            —
            
            
            
            (1,638
            )
            
            
            —
            
            
            
            —
            
            
            
            (1,638
            )
            
            
            —Shares
      issued for commission at $1.00 per share
            
            
            —
            
            
            
            —
            
            
            
            (1,478
            )
            
            
            —
            
            
            
            —
            
            
            
            (1,478
            )
            
            
            —Exercise
      of warrants
            
            
            1,000,000
            
            
            
            1
            
            
            
            999
            
            
            
            —
            
            
            
            —
            
            
            
            1,000
            
            
            
            —Recapitalization
      of shares issued upon merger
            
            
            28,700,000
            
            
            
            30
            
            
            
            (436
            )
            
            
            —
            
            
            
            —
            
            
            
            (406
            )
            
            
            —Stock-based
      compensation
            
            
            —
            
            
            
            —
            
            
            
            9,189
            
            
            
            —
            
            
            
            —
            
            
            
            9,189
            
            
            
            —Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (20,692
            )
            
            
            —
            
            
            
            (20,692
            )
            
            
            (20,692
            )Balances,
      September 30, 2006
            
            
            219,928,734
            
            
            
            220
            
            
            
            70,944
            
            
            
            (22,811
            )
            
            
            —
            
            
            
            48,353
            
            
            
            (20,692
            )Shares
      issued for property interests at $1.62 per share
            
            
            50,000,000
            
            
            
            50
            
            
            
            80,950
            
            
            
            —
            
            
            
            —
            
            
            
            81,000
            
            
            
            —Shares
      issued for property interests at $1.49 per share
            
            
            256,000
            
            
            
            —
            
            
            
            382
            
            
            
            —
            
            
            
            —
            
            
            
            382
            
            
            
            —






8




Common
      Stock
            
            Additional
              Paid-in
            
            
            Deficit
              Accumulated
              During
      the
              Development
            
            
            Accumulated
              Other
              Compre-
              hensive
            
            
            Total
              Stockholders’
            
            
            Total
              Compre-
              hensiveShares
            
            
            Amount
            
            
            Capital
            
            
            Stage
            
            
            Loss
            
            
            Equity
            
            
            LossShares
      issued for commission costs on property at $1.65 per share
            
            
            121,250
            
            
            
            —
            
            
            
            200
            
            
            
            —
            
            
            
            —
            
            
            
            200
            
            
            
            —Shares
      issued for finance costs on property at $0.70 per share
            
            
            642,857
            
            
            
            1
            
            
            
            449
            
            
            
            —
            
            
            
            —
            
            
            
            450
            
            
            
            —Shares
      issued for property and finance interests at various costs per
      share
            
            
            8,000,000
            
            
            
            8
            
            
            
            6,905
            
            
            
            —
            
            
            
            —
            
            
            
            6,913
            
            
            
            —Foreign
      currency translation adjustment
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (5
            )
            
            
            (5
            )
            
            
            (5
            )Discount
      on notes payable
            
            
            —
            
            
            
            —
            
            
            
            4,670
            
            
            
            —
            
            
            
            —
            
            
            
            4,670
            
            
            
            —Stock-based
      compensation
            
            
            —
            
            
            
            —
            
            
            
            8,172
            
            
            
            —
            
            
            
            —
            
            
            
            8,172
            
            
            
            —Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (49,811
            )
            
            
            —
            
            
            
            (49,811
            )
            
            
            (49,811
            )Balances,
      September 30, 2007
            
            
            278,948,841
            
            
            
            279
            
            
            
            172,672
            
            
            
            (72,622
            )
            
            
            (5
            )
            
            
            100,324
            
            
            
            (49,816
            )Shares
      issued for property interests at $0.31 per share
            
            
            25,000,000
            
            
            
            25
            
            
            
            7,725
            
            
            
            —
            
            
            
            —
            
            
            
            7,750
            
            
            
            —Shares
      issued for finance costs at $0.23 per share
            
            
            16,000,000
            
            
            
            16
            
            
            
            3,664
            
            
            
            —
            
            
            
            —
            
            
            
            3,680
            
            
            
            —Shares
      issued in conjunction with asset sale at $0.25 per share
            
            
            5,000,000
            
            
            
            5
            
            
            
            1,245
            
            
            
            —
            
            
            
            —
            
            
            
            1,250
            
            
            
            —Shares
      returned for property and retired at prices ranging from $0.23 per share
      to $1.72 per share
            
            
            (6,400,000
            )
            
            
            (6
            )
            
            
            (5,524
            )
            
            
            —
            
            
            
            —
            
            
            
            (5,530
            )
            
            
            —Shares
      issued for finance costs at $0.28 per share
            
            
            200,000
            
            
            
            —
            
            
            
            56
            
            
            
            —
            
            
            
            —
            
            
            
            56
            
            
            
            —Shares
      issued for vendor settlements at $0.20 per share
            
            
            16,879,219
            
            
            
            17
            
            
            
            3,723
            
            
            
            —
            
            
            
            —
            
            
            
            3,740
            
            
            
            —Shares
      issued for finance costs at $0.20 per share
            
            
            2,037,890
            
            
            
            2
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2
            
            
            
            —Shares
      issued for option to purchase CCES
            
            
            400,000
            
            
            
            —
            
            
            
            80
            
            
            
            —
            
            
            
            —
            
            
            
            80
            
            
            
            —Warrant
      value associated with amendment & waiver on convertible
      debt
            
            
            —
            
            
            
            —
            
            
            
            209
            
            
            
            —
            
            
            
            —
            
            
            
            209
            
            
            
            —Discounts
      associated with beneficial conversion feature and detachable warrants on
      convertible debenture issuance
            
            
            —
            
            
            
            —
            
            
            
            6,956
            
            
            
            —
            
            
            
            —
            
            
            
            6,956
            
            
            
            —Warrant
      value associated with convertible debenture issuance
            
            
            —
            
            
            
            —
            
            
            
            21
            
            
            
            —
            
            
            
            —
            
            
            
            21
            
            
            
            —Warrant
      value associated with related party amendment
            
            
            —
            
            
            
            —
            
            
            
            705
            
            
            
            —
            
            
            
            —
            
            
            
            705
            
            
            
            —Forgiveness
      of amounts due to shareholder and related party debt
            
            
            —
            
            
            
            —
            
            
            
            4,067
            
            
            
            —
            
            
            
            —
            
            
            
            4,067
            
            
            
            —Origination
      fees on Global debt
            
            
            —
            
            
            
            —
            
            
            
            1,895
            
            
            
            —
            
            
            
            —
            
            
            
            1,895
            
            
            
            —Discount
      on notes payable
            
            
            —
            
            
            
            —
            
            
            
            336
            
            
            
            —
            
            
            
            —
            
            
            
            336
            
            
            
            —Foreign
      currency translation adjustment
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            38
            
            
            
            38
            
            
            
            38Stock-based
      compensation
            
            
            —
            
            
            
            —
            
            
            
            2,138
            
            
            
            —
            
            
            
            —
            
            
            
            2,138
            
            
            
            —Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (35,241
            )
            
            
            —
            
            
            
            (35,241
            )
            
            
            (35,241
            )Balances,
      June 30, 2008
            
            
            338,065,950
            
            
            $
            338
            
            
            $
            199,968
            
            
            $
            (107,863
            )
            
            $
            33
            
            
            $
            92,476
            
            
            $
            (85,019
            )





See
accompanying notes to condensed consolidated financial statements.




9


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(unaudited,
$ in thousands)


Nine
      months
              ended
              June
      30,
              2008
            
            
            Nine
      months
              ended
              June
      30,
              2007
              (restated)
            
            
            Cumulative
      From
              Inception
              (June
      20, 2005)
              to
      June 30,
              2008Cash
      flows used in operating activitiesNet
      loss
            
            $
            (35,241
            )
            
            $
            (27,899
            )
            
            $
            (107,868
            )Adjustments
      used to reconcile net loss to net cash used in operating
      activities:
              Stock
      for expenditures advanced
            
            
            —
            
            
            
            —
            
            
            
            100Stock-based
      compensation
            
            
            2,138
            
            
            
            7,305
            
            
            
            20,322Detachable
      warrants recorded as interest expense
            
            
            813
            
            
            
            —
            
            
            
            813Depreciation,
      depletion, amortization and accretion
            
            
            774
            
            
            
            2,268
            
            
            
            2,092Impairment
      of oil and gas properties
            
            
            —
            
            
            
            4,400
            
            
            
            24,053Stock
      for financing costs
            
            
            —
            
            
            
            1,338
            
            
            
            1,623Amortization
      of discount and deferred financing costs on notes payable
            
            
            2,576
            
            
            
            458
            
            
            
            3,612Loss
      on trading securities
            
            
            2,987
            
            
            
            —
            
            
            
            2,987Loss
      on conveyance of property
            
            
            15,220
            
            
            
            —
            
            
            
            15,220Gain
      on foreign exchange
            
            
            (11
            )
            
            
            —
            
            
            
            (34
            )Changes
      in assets and liabilities
              Receivables
            
            
            6
            
            
            
            (894
            )
            
            
            (540
            )Due
      from related party
            
            
            (61
            )
            
            
            848
            
            
            
            (3,055
            )Prepaids
      and other
            
            
            (102
            )
            
            
            (54
            )
            
            
            (147
            )Deferred
      financing costs
            
            
            (484
            )
            
            
            —
            
            
            
            (484
            )Accounts
      payable, accrued expenses, and other liabilities
            
            
            (5,063
            )
            
            
            (2,508
            )
            
            
            (209
            )Due
      to shareholder and related parties
            
            
            (525
            )
            
            
            1,291
            
            
            
            949Net
      cash used in operating activities
            
            
            (16,973
            )
            
            
            (13,447
            )
            
            
            (60,089
            )Cash
      flows provided by (used in) investing activitiesProceeds
      from CD redemption
            
            
            50
            
            
            
            —
            
            
            
            50Additions
      to oil and gas properties
            
            
            (21,205
            )
            
            
            (13,212
            )
            
            
            (70,596
            )Proceeds
      from sale of oil and gas properties
            
            
            28,066
            
            
            
            —
            
            
            
            28,066Sale
      of trading securities
            
            
            2,541
            
            
            
            —
            
            
            
            2,541Due
      from joint interest owner
            
            
            —
            
            
            
            (16,274
            )
            
            
            —Deposit
      on oil and gas property acquisition
            
            
            —
            
            
            
            (2,244
            )
            
            
            —Additions
      to property and equipment
            
            
            (22
            )
            
            
            (260
            )
            
            
            (22
            )Restricted
      cash
            
            
            —
            
            
            
            475
            
            
            
            (1,077
            )Net
      cash provided by (used in) investing activities
            
            
            9,430
            
            
            
            (31,515
            )
            
            
            (44,220
            )Cash
      flows from financing activitiesProceeds
      from the sale of common stock
            
            
            —
            
            
            
            300
            
            
            
            35,742Proceeds
      from common stock subscribed
            
            
            —
            
            
            
            2,768
            
            
            
            2,858Proceeds
      from the issuance of notes payable
            
            
            8,250
            
            
            
            31,700
            
            
            
            39,800Payments
      on long-term debt
            
            
            (101
            )
            
            
            —
            
            
            
            (101
            )Borrowing
      on short-term notes payable
            
            
            1,655
            
            
            
            —
            
            
            
            2,155Payments
      on short-term notes
            
            
            (6,436
            )
            
            
            —
            
            
            
            (6,436
            )Payments
      on contracts payable
            
            
            (250
            )
            
            
            —
            
            
            
            (250
            )Payments
      on related party borrowing
            
            
            (1,805
            )
            
            
            (600
            )
            
            
            (1,805
            )Proceeds
      from related party borrowing
            
            
            420
            
            
            
            —
            
            
            
            695Proceeds
      from the exercise of warrants
            
            
            —
            
            
            
            —
            
            
            
            10,000Cash
      received upon recapitalization and merger
            
            
            —
            
            
            
            —
            
            
            
            21Proceeds
      from issuance of convertible notes
            
            
            6,334
            
            
            
            —
            
            
            
            27,166Offering
      and financing costs
            
            
            —
            
            
            
            180
            
            
            
            (1,638
            )Net
      cash provided by financing activities
            
            
            8,067
            
            
            
            34,348
            
            
            
            99,207Effect
      of exchange rate changes on cash
            
            
            (35
            )
            
            
            —
            
            
            
            (38
            )Net
      increase (decrease) in cash and cash equivalents
            
            
            575
            
            
            
            (10,614
            )
            
            
            695Cash
      and cash equivalents, beginning of period
            
            
            120
            
            
            
            10,632
            
            
            
            —Cash
      and cash equivalents, end of period
            
            $
            695
            
            
            $
            18
            
            
            $
            695Supplemental
      schedule of cash flow informationCash
      paid for interest
            
            $
            1,088
            
            
            $
            1
            
            
            $
            1,483Cash
      paid for income taxes
            
            $
            —
            
            
            $
            —
            
            
            $
            —





See
accompanying notes to condensed consolidated financial statements.




10


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited,
dollars in thousands except per share amounts)





Note
1 — Organization and Basis of Presentation





We are a
development stage global oil and gas exploration and production company
committed to acquiring and developing primarily unconventional natural gas and
oil prospects that we believe have a very high probability of economic success.
Since our inception in 2005, our principal business activities have been raising
capital through the sale of common stock and convertible notes and acquiring oil
and gas properties in the western United States and
Australia.  Currently, we own property in Colorado, where we have
drilled five wells on our Buckskin Mesa property, and Australia, where we have
drilled one well on our property in the Northern Territory, and in Montana,
where we hold a land position in the Bear Creek area.  The wells on
these properties have not yet commenced oil and gas production. We own working
interests in eight additional wells in Colorado which are operated by EnCana Oil
& Gas USA (“EnCana”) and are currently producing gas.  In November
2007, we sold 66,000 net acres of land and two wells in Montana and 177,445
acres of land in Utah (see “Heavy Oil” in Note 4) and on May 30, 2008, we sold
625 net acres, 16 wells which had been drilled but not completed or connected to
a pipeline and rights to participate in an additional 8 wells in the Southern
Piceance Basin in Colorado (see Note 12).





Our
predecessor, Digital Ecosystems Corp. (“Digital”), was incorporated on February
21, 2002 under the laws of the state of Nevada.  On February 10, 2006,
Digital entered into a Share Exchange Agreement (the “Exchange Agreement”) with
GSL Energy Corporation (“GSL”) and certain shareholders of GSL pursuant to which
Digital acquired more than 85% of the issued and outstanding shares of common
stock of GSL in exchange for shares of Digital’s common stock.  The
Exchange Agreement was completed on May 12, 2006.  At that time, GSL’s
business, which was formed in 2005 for the purpose of acquiring, exploring,
developing and operating oil and gas properties, became Digital’s business and
GSL became a subsidiary of Digital. Since this transaction resulted in the
former shareholders of GSL acquiring control of Digital, for financial reporting
purposes, the business combination was accounted for as an additional
capitalization of Digital (a reverse acquisition with GSL as the accounting
acquirer).  In accounting for this transaction:





i.
            GSL
      was deemed to be the purchaser and parent company for financial reporting
      purposes.  Accordingly its net assets were included in the
      consolidated balance sheet at their historical book value;
    andii.
            control
      of the net assets and business of Digital was effective May 12, 2006 for
      no consideration.





Subsequent
to the closing of the Exchange Agreement, Digital acquired all the remaining
outstanding stock of GSL, and effective August 14, 2006, Digital changed its
name to PetroHunter Energy Corporation (“PetroHunter”).  Likewise, in
October 2006, GSL changed its name to PetroHunter Operating
Company.





PetroHunter
is considered a development stage company as defined by Statement of Financial
Accounting Standards (“SFAS”) 7, Accounting and Reporting by
Development Stage Enterprises,as we have not yet commenced our planned
principal operations. A
development stage enterprise is one in which planned principal operations have
not commenced, or if its operations have commenced, there have been no
significant revenue therefrom.





Unless
otherwise noted in this report, any description of “us” or “we” refers to
PetroHunter Energy Corporation and our subsidiaries. Financial information in
this report is presented in U.S. dollars.





Note
2 — Summary of Significant Accounting Policies





Basis of Accounting.The
accompanying financial statements have been prepared on the basis of accounting
principles applicable to a going concern, which contemplates the realization of
assets and extinguishment of liabilities in the normal course of business. As
shown in the accompanying statements of operations, we have incurred a
cumulative loss in the amount of $107.9 million for the period from inception
(June 20, 2005) to June 30, 2008, have a working capital deficit of
approximately $22.5 million as of June 30, 2008, and were not in compliance with
the covenants of several loan agreements. As of June 30, 2008, we have earned
oil and gas revenue from our initial operating wells, but will require
significant additional funding to sustain operations and satisfy contractual
obligations for planned oil and gas exploration, development and operations in
the future. These factors, among others, may indicate that we may be unable to
continue in existence. Our financial statements do not include adjustments
related to the realization of the carrying value of assets or the amounts and
classification of liabilities that might be necessary should we be unable to
continue in existence. Our ability to establish ourselves as a going concern is
dependent upon our ability to obtain additional financing to fund planned
operations and to ultimately achieve profitable operations. Management believes
that we can be successful in obtaining equity and/or debt financing and/or sell
interests in some of our properties, which will enable us to continue in
existence and establish ourselves as a going concern. We have raised
approximately $106.4 million through June 30, 2008 through issuances of common
stock and convertible and other debt.





For the
three and nine month periods ending June 30, 2008 and 2007, the condensed
consolidated financial statements include the accounts of PetroHunter and our
wholly-owned subsidiaries. For the period from June 20, 2005 through September
30, 2005, the consolidated financial statements include only the accounts of
GSL. All significant intercompany transactions have been eliminated upon
consolidation.





11


The
accompanying financial statements should be read in conjunction with our
Registration Statement on Form S-1 filed June 30, 2008 and our Annual Report on
Form 10-K for the year ended September 30, 2007. The accompanying condensed
consolidated financial statements are unaudited; however, in the opinion of
management, they include all normal recurring adjustments necessary for a fair
presentation of our consolidated financial position at June 30, 2008 and the
consolidated results of our operations and cash flows for the three and nine
month periods ending June 30, 2008 and 2007. The results of operations for the
three and nine-month periods ending June 30, 2008 are not necessarily indicative
of the results that may be expected for the full fiscal year ending September
30, 2008 or for any other interim period in the September 2008 fiscal
year.  Further, the accompanying balance sheet as of September 30,
2007 was derived from audited financial statements.





Use of Estimates.Preparation
of our financial statements in accordance with Generally Accepted Accounting
Principles (“GAAP”) requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities as of the date of the
financial statements and the reported amounts of revenues and expenses for the
reporting period. Actual results could differ from those estimates.





In the
course of preparing the consolidated financial statements, management makes
various assumptions, judgments and estimates to determine the reported amounts
of assets, liabilities, revenue and expenses, and to disclose commitments and
contingencies. Changes in these assumptions, judgments and estimates will occur
as a result of the passage of time and the occurrence of future events and,
accordingly, actual results could differ from amounts initially
established.





The more
significant areas requiring the use of assumptions, judgments and estimates
relate to volumes of natural gas and oil reserves used in calculating depletion,
the amount of expected future cash flows used in determining possible
impairments of oil and gas properties and the amount of future capital costs
estimated for such calculations. Assumptions, judgments and estimates are also
required to determine future abandonment obligations, the value of undeveloped
properties for impairment analysis and the value of deferred tax
assets.





Reclassifications.Certain
prior period amounts have been reclassified in the consolidated financial
statements to conform to the current period presentation. Such reclassifications
had no effect on our net loss.





Marketable Securities, Trading.In November 2007, we sold our Heavy Oil assets (see Note 4, Oil and Gas Properties). As
partial consideration, we accepted a total of 1,539,975 shares of common stock
of the purchaser, Pearl Exploration and Production Ltd. These shares were sold
subsequent to a holding period, and were classified as held for sale in the
short term at December 31, 2007. During the intervening period from closing
through the date of sale in March 2008, we accounted for them by marking them to
market with unrealized losses recognized in our operating results in the period
incurred.  We recognized a loss on the disposition of our trading
securities in the amount of $3.0 million recorded as Trading Security Lossesin
our consolidated statement of operations during the nine months ended June 30,
2008.





Joint Interest Billings.Joint interest billingsrepresents our working
interest partners’ share of costs that we paid, on their behalf, to drill
certain wells. During the first quarter of 2008, we entered into a transaction
whereby we increased our interest in 14 wells to 100% (see Note 4, Oil and Gas Properties) and
we therefore reclassified $12.6 million of costs related to those wells from
Joint interest billingsto Oil and Gas
Properties.In May 2008, we sold the remaining wells for which we had
joint billing arrangements as part of the Laramie transaction, as described
further in Note 12.





Oil and Gas Properties.We
utilize the full cost method of accounting for our oil and gas activities. Under
this method, subject to a limitation based on estimated value, all costs
associated with property acquisition, exploration and development, including
costs of unsuccessful exploration, are capitalized within a cost center on a
by-country basis. No gain or loss is recognized upon the sale or abandonment of
undeveloped or producing oil and gas properties unless the sale represents a
significant portion of oil and gas properties and the gain or loss significantly
alters the relationship between capitalized costs and proved oil and gas
reserves of the cost center. Depletion and amortization of oil and gas
properties is computed on the units-of-production method based on proved
reserves. Amortizable costs include estimates of future development costs of
proved undeveloped reserves.





Asset Retirement Obligation.Asset retirement obligations associated with tangible long-lived assets
are accounted for in accordance with SFAS 143, Accounting for Asset Retirement
Obligations (“SFAS 143”). The estimated fair value of the future costs
associated with dismantlement, abandonment and restoration of oil and gas
properties is recorded generally upon acquisition or completion of a well. The
net estimated costs are discounted to present values using a risk adjusted rate
over the estimated economic life of the oil and gas properties. Such costs are
capitalized as part of the related asset. The asset is depleted on the
units-of-production method on a field-by-field basis. The liability is
periodically adjusted to reflect (1) new liabilities incurred, (2) liabilities
settled during the period, (3) accretion expense, and (4) revisions to estimated
future cash flow requirements. The accretion expense is recorded as a component
of depletion, amortization and accretion expense in the accompanying
consolidated statements of operations.





Guarantees.  As
part of a Gas Gathering Agreement we have with CCES Piceance Partners1, LLC
(“CCES”), we have guaranteed that, should there be a mutual failure to execute a
formal agreement for long-term gas gathering services in the future, we will
repay CCES for certain costs they have incurred in relation to the development
of a gas gathering system and repurchase certain






12


gas
gathering assets we sold to CCES.  We have accounted for this
guarantee using Financial Accounting Standards Board (“FASB”) Interpretation No.
45 as amended, Guarantor’s
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others(“FIN 45”),which requires us to
recognize a liability for the obligations undertaken upon issuing the guarantee
in order to have a more representationally faithful depiction of the guarantor’s
assets and liabilities.  Accordingly, we have recognized a $4.1
million contingent purchase obligation on our balance sheet.  See
further explanation at Note 13.





Impairment.We use the full
cost method of accounting for our oil and gas properties and as such, these
properties are subject to SEC Regulation S-X Rule 4-10, Financial Accounting and Reporting
for Oil and Gas Producing Activities Pursuant to the Federal Securities
Laws and the Energy Policy and Conversion Act of 1975(“Rule 4-10”).
Rule 4-10 requires that each regional cost center’s (by country) capitalized
cost, less accumulated amortization and related deferred income taxes not exceed
a cost center “ceiling.” The ceiling is defined as the sum of:


•      the
present value of estimated future net revenues computed by applying current
prices of oil and gas reserves to estimated future production of proved oil and
gas reserves as of the balance sheet date less estimated future expenditures to
be incurred in developing and producing those proved reserves to be computed
using a discount factor of 10%; plus


•      the
cost of properties not being amortized; plus





•      the
lower of cost or estimated fair value of unproven properties included in the
costs being amortized; less





•      income
tax effects related to differences between the book and tax basis of the
properties.





If
unamortized costs capitalized within a cost center, less related deferred income
taxes, exceed the cost center ceiling, the excess is charged to expense. During
the three and nine month periods ended June 30, 2007, we recorded impairment
charges of $0.6 million and $9.6 million. We did not impair any of our
properties in the three and nine months ended June 30, 2008.





Fair Value.The carrying
amount reported in the consolidated balance sheets for cash, receivables,
prepaids, accounts payable and accrued liabilities approximates fair value
because of the immediate or short-term maturity of these financial instruments.
Based upon the borrowing rates currently available to us for loans with similar
terms and average maturities, the fair value of payable notes approximates their
carrying value.





Environmental Contingencies.Oil and gas producing activities are subject to extensive environmental
laws and regulations. These laws, which change frequently, regulate the
discharge of materials into the environment and may require us to remove or
mitigate the environmental effects of the disposal or release of petroleum or
chemical substances at various sites. Environmental expenditures are expensed or
capitalized depending on their future economic benefit. Expenditures that relate
to an existing condition caused by past operations and that have no future
economic benefit are expensed. Liabilities for expenditures of a non-capital
nature are recorded when environmental assessment and/or remediation is probable
and the costs can be reasonably estimated.





Revenue Recognition.We
recognize revenues from the sales of natural gas and crude oil related to our
interests in producing wells when delivery to the customer has occurred and
title has transferred. We currently have no gas balancing arrangements in
place.





Loss per Common Share.Basic
loss per share is based on the weighted average number of common shares
outstanding during the period. Diluted loss per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. Convertible equity instruments
such as stock options and convertible debentures are excluded from the
computation of diluted loss per share, as the effect of the assumed exercises
would be anti-dilutive. The dilutive weighted-average number of common shares
outstanding excluding potential common shares from; stock options, warrants and
convertible debt of 221,582 and 61,553 respectively for the periods ended June
30, 2008 and 2007.





Recently Issued Accounting
Pronouncements. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities(“SFAS 159”),
which allows entities to choose, at specified election dates, to measure
eligible financial assets and liabilities at fair value that are not otherwise
required to be measured at fair value. If a company elects the fair value option
for an eligible item, changes in that item’s fair value in subsequent reporting
periods must be recognized in current earnings. SFAS 159 also establishes
presentation and disclosure requirements designed to draw comparison between
entities that elect different measurement attributes for similar assets and
liabilities. SFAS 159 will be effective for us on October 1, 2008. We have not
yet assessed the impact of SFAS 159 on our consolidated results of operations,
cash flows or financial position.





In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements(“SFAS 157”), which provides guidance for using fair value to measure
assets and liabilities. The standard also responds to investors’ requests for
more information about: (1) the extent to which companies measure assets and
liabilities at fair value; (2) the information used to measure fair value; and
(3) the effect that fair value measurements have on earnings. SFAS 157 will
apply whenever another standard requires (or permits) assets or liabilities to
be measured at fair value. SFAS 157 does not expand the use of fair value to any
new circumstances. SFAS 157






13


will be
effective for us on October 1, 2008. We have not yet assessed the impact of SFAS
157 on our consolidated results of operations, cash flows or financial
position.





Supplemental Cash Flow Information.Supplement cash flow information for the nine months ended June 30, 2008
and 2007, respectively, and cumulative from inception (June 2005) is as
follows:





Nine Months Ended June 30,
      2008
            Nine
      Months Ended June 30, 2007 (restated)
            
            Cumulative
      From Inception (June 20, 2005) to June 30, 2008($
      in thousands)Supplemental
      disclosures of non-cash investing and financing activitiesShares
      issued for expenditures advanced
            
            $
            —
            
            
            $
            —
            
            
            $
            100Contracts
      for oil and gas properties
            
            $
            (7,030
            )
            
            $
            2,900
            
            
            $
            6,494Shares
      issued for debt conversion
            
            $
            3,376
            
            
            $
            —
            
            
            $
            22,032Shares
      issued for commissions on offerings
            
            $
            50
            
            
            $
            200
            
            
            $
            250Shares
      issued for property
            
            $
            1,250
            
            
            $
            81,275
            
            
            $
            82,525Shares
      issued for property and finder’s fee on property
            
            $
            2,037
            
            
            $
            —
            
            
            $
            9,644Non-cash
      uses of notes payable, accounts payable and accrued
      liabilities
            
            $
            —
            
            
            $
            —
            
            
            $
            26,313Convertible
      debt issued for property
            
            $
            —
            
            
            $
            —
            
            
            $
            1,200Common
      stock issuable
            
            $
            —
            
            
            $
            4,510
            
            
            $
            —Shares
      issued for common stock offerings
            
            $
            —
            
            
            $
            —
            
            
            $
            2,900Debt
      issued for common stock previously subscribed
            
            $
            2,858
            
            
            $
            —
            
            
            $
            2,858Assignment
      of rights in properties in exchange for equity and forgiveness of related
      party notes payable
            
            $
            15,959
            
            
            $
            —
            
            
            $
            15,959Satisfaction
      of receivable by reduction of related party note payable
            
            $
            3,202
            
            
            $
            —
            
            
            $
            3,202Debt
      discount related to convertible debt
            
            $
            6,956
            
            
            $
            —
            
            
            $
            6,956Increase
      in oil and gas properties related to relief of joint interest
      billings
            
            $
            12,608
            
            
            $
            —
            
            
            $
            12,608Warrants
      issued recorded as debt discount
            
            $
            729
            
            
            $
            3,952
            
            
            $
            5,220Warrants
      issued recorded as deferred finance costs
            
            $
            1,898
            
            
            $
            —
            
            
            $
            1,898Common stock
      issued for purchase option
            
            $
            80
            
            
            $
            —
            
            
            $
            80





Note
3 — Agreements with MAB Resources LLC





We were a
party to various agreements (the “MAB Agreements”) with MAB Resources LLC
(“MAB”), a company that is controlled by our largest beneficial shareholder,
Marc A. Bruner.  All the MAB Agreements described below were terminated as
of June 30, 2008.  The following is a summary of those prior MAB
Agreements.




The Development Agreement.
From July 1, 2005 through December 31, 2006, we and MAB operated pursuant to a
Development Agreement and a series of individual property agreements
(collectively, the “EDAs”).  The Development Agreement defined MAB’s
and our long term relationship regarding the ownership and operation of all
jointly-owned properties and stipulated that we and MAB would sign a joint
operating agreement governing all operations.  The Development
Agreement specified, among other things, that:




·
            MAB
      assign to us a 50% undivided interest in any and all oil and gas leases,
      production facilities and related assets (collectively, the “Properties”)
      that MAB was to acquire from third parties in the
  future,


·
            we
      would be operator of the jointly owned properties, with MAB Operating
      Company LLC as sub-operator, and each party would pay its proportionate
      share of costs and receive its proportionate share of revenues, subject to
      certain adjustments, including our burden to carry MAB for specified
      costs, pay advances, and


·
            to
      make an overriding royalty payment of 3% (gross, or 1.5% net) to MAB out
      of production and sales.





A more
thorough description of the Development Agreement is included in Item 8 of our
Annual Report on Form 10-K, Financial Statements and
Supplementary Data - Note 3.





The Consulting Agreement.Effective January 1, 2007, we and MAB began operating under an
Acquisition and Consulting Agreement (the “Consulting Agreement”) which replaced
in its entirety the Development Agreement described above.  Upon
execution of the Consulting Agreement, MAB conveyed its entire remaining working
interest in the Properties to us in consideration for a $13.5 million promissory
note, 50 million shares of PetroHunter Energy Corporation and an additional 50 million
shares (the “Performance Shares”) provided we met certain thresholds based on
proven reserves.  Furthermore, MAB would receive:






14


·
            7%
      of the issued and outstanding shares of any new subsidiary with assets
      comprised of the subject properties


·
            A
      5% overriding royalty interest on certain of the properties, to be accrued
      and deferred for three years, provided these royalties do not render our
      net revenue interest to be less than 75%,
and


·
            $25,000
      per month for consulting services (which was later rescinded by Amendment
      1 to the Consulting Agreement, effective retroactively to January 1,
      2007).





Our
obligation to pay up to $700.0 million in capital costs for MAB’s 50% interest
as well as the monthly project cost advances against such capital costs was also
eliminated.





We
accounted for the acquisition component of the Consulting Agreement in
accordance with the purchase accounting provisions of SFAS 141 Business Combinations. Accordingly, at
the date of acquisition, we recorded oil and gas properties of $94.5 million,
notes payable of $13.5 million, and common stock and additional-paid-in capital
totaling $81.0 million (equal to the 50.0 million shares issued to MAB at the
trading price of $1.62 per share for our common stock on the trading date
immediately preceding the closing date of the transaction).





In the
first quarter of the current fiscal year ending September 30, 2008, the
Consulting Agreement was amended three times, resulting in the following
changes:





·
            MAB
      relinquished portions of its overriding royalty interest effective October
      1, 2007 such that the override currently only applies to our Australian
      properties and Buckskin Mesa
property;


·
            MAB
      received 25.0 million additional shares of our common
    stock;


·
            MAB
      relinquished all rights to the Performance Shares described
      above;


·
            MAB’s
      consulting services were terminated effective retroactively back to
      January 1, 2007;


·
            MAB
      waived all past due amounts and all claims against PetroHunter;
      and


·
            the
      note payable to MAB was reduced in accordance with and in exchange for the
      following:


o
            by
      $8.0 million in exchange for 16.0 million shares of our common stock with
      a value of $3.7 million based on the closing price of $0.23 per share at
      November 15, 2007 and warrants to acquire 32.0 million shares of our
      common stock at $0.50 per share. The warrants expire on November 14, 2009
      and were valued at $0.7 million;


o
            by
      $2.9 million in exchange for our release of MAB’s obligation to pay the
      equivalent amount as guarantor of the performance of Galaxy Energy
      Corporation under the subordinated unsecured promissory note dated August
      31, 2007 (see Note 10);


o
            a
      reduction to the note payable to MAB of $0.5 million for cash payments
      made during the first quarter of 2008;
and


o
            by
      $0.2 million for MAB assuming certain costs that Paleo Technology owed to
      us.





The net
effect of the reduction of debt and issuance of our common shares resulted in a
net benefit to us of $3.8 million and has been reflected as additional
paid-in-capital during the six months ended March 31, 2008. Monthly payments on
the revised promissory note in the amount of $2.0 million commenced February 1,
2008 and are due in full in two years.





Effective
June 30, 2008, MAB sold all its interest in the above-mentioned overriding
royalty (in our Buckskin Mesa and Australian properties) to a third
party.





Note
4 — Oil and Gas Properties





Oil
      and gas properties consisted of the following:
            
            June
      30,
              2008
            
            
            September
      30,
              2007Oil
      and gas properties, at cost, full cost method
            
            ($
      in thousands)UnprovedUnited
      States
            
            $
            73,738
            
            
            $
            107,239Australia
            
            
            25,350
            
            
            
            23,569Proved
      – United States
            
            
            48,794
            
            
            
            57,168Total
            
            
            147,882
            
            
            
            187,976Less
      accumulated  depreciation, depletion, amortization
      and impairment
            
            
            (1,698
            )
            
            
            (25,133
            )Total
            
            $
            146,184
            
            
            $
            162,843




Included
in oil and gas properties above is capitalized interest of $0.0 million and $0.8
million for three months ended June 30, 2008 and 2007,
respectively.  In the nine months ended June 30, 2008 and 2007, oil
and gas properties included capitalized interest of $0.2 million and $1.1
million, respectively.





Included
below is a summary of significant activity related to oil and gas properties
during the three and nine month periods ended June 30, 2008.





15


PICEANCE
BASIN





Buckskin Mesa Project. As of
June 30, 2008, we had drilled five wells, with two wells having been
completed and shut-in, awaiting installation of the gathering system, and the
remaining 3 wells awaiting completion. We are required to drill 16 wells during
the calendar year ending December 31, 2008, three during the first quarter and
four during each of the second and third calendar quarters of 2008 and five
during the fourth calendar quarter of 2008, under the terms of an agreement
between us and a third party assignor, Daniels Petroleum Company (“DPC”). If we
do not satisfy these quarterly drilling requirements, our agreement with DPC
requires that we pay DPC $0.5 million for each undrilled well on the last day of
the applicable quarter.  At the end of the first calendar quarter of
2008, we extended and subsequently exercised our right to pay $0.5 million in
penalties for three wells that were required to be drilled that quarter by
agreeing to pay the $1.5 million fee, plus a $1.0 million additional penalty.
These amounts were paid on April 28, 2008, thereby reducing the total
number of wells we are committed to drill for the remainder of calendar year
2008 to 13. Prior to June 30, 2008 (the due date for commencing the next
four wells), we determined that we could not obtain the materials necessary to
commence such operations by June 30, and we provided written notice of such
force majeure condition to DPC.  We were otherwise prepared to comply with
all obligations regarding the referenced commitment.  DPC objected to the
notice. On June 30, 2008, we filed an action in Denver District Court requesting
the court to issue a declaratory judgment concerning this dispute. See Note 11
for further discussion of this case. As of June 30, 2008, we had not recorded a
loss with respect to this case as we believe we are in full compliance with our
contractual obligations.





Piceance II Project.On May
30, 2008, we completed the sale of 625 net acres of land, 16 wells which had
been drilled but not completed or connected to a pipeline and rights to
participate in an additional 8 wells to Laramie Energy II, LLC, as described
more fully in Note 12.  Additionally, as of June 30, 2008, as part of
this transaction, we held $0.8 million in escrow relating to a dispute between
us and the lessor of 435 acres of land in the Southern Piceance in which the
lessor of this land claims that the lease will be terminated in conjunction with
the Laramie transaction, as described more fully in Notes 11 and
12.  On August 1, 2008, we transferred the $0.8 million in escrow back
to Laramie and retained the 435 acres of land relating to the escrowed
amount.  We still retain all of our interest in eight producing wells
in Garfield County, which are operated by EnCana Oil & Gas (USA)
Inc.





Sugarloaf Project.We failed
to make payments in accordance with the agreement related to this prospect and
as a result, on December 4, 2007, the agreement was terminated and we instructed
the escrow agent to return all assignments which were being held in escrow to
the seller (See Note 6).





AUSTRALIA





Beetaloo Project.We own four
exploration licenses comprising 7.0 million net acres in the Beetaloo Basin
(owned by our wholly-owned subsidiary, Sweetpea Petroleum Pty Ltd.,
[“Sweetpea”]).  In July 2007, we drilled and cased one well to a depth
of 4,724 feet, with the intention to deepen the well at a later
date.





We have a
100% working interest in this project with a royalty interest of 10% to the
government of the Northern Territory and an overriding royalty interest of 1% to
2%, 8% and 5% to the Northern Land Council, the original assignor of the
licenses, and to MAB, respectively, leaving a net revenue interest of 75% to 76%
to us.  We have received an extension on our drilling commitments
related to this property and are currently committed to drill 8 wells in 2009 at
a total estimated cost of $36 million. We are not currently committed to
drilling any wells on this property in 2008.





Northwest Shelf Project.Effective February 19, 2007, the Commonwealth of Australia granted an
exploration permit in the shallow, offshore waters of Western Australia to
Sweetpea. The permit has a six year term and encompasses almost 20,000 net
acres. We have committed to an exploration program with geological and
geophysical data acquisition in the first two years with a third year drilling
commitment and additional wells to be drilled in the subsequent three year
period depending upon the results of the initial well.





POWDER RIVER
BASIN





On
December 29, 2006, we entered into a purchase and sale agreement (the “Galaxy
PSA”) with Galaxy Energy Corporation (“Galaxy”) and its wholly-owned subsidiary,
Dolphin Energy Corporation (“Dolphin”), both of which are related parties to us.
Pursuant to the Galaxy PSA, we agreed to purchase all of Galaxy’s and Dolphin’s
oil and gas interests in the Powder River Basin of Wyoming and Montana (the
“Powder River Basin Assets”), and to assume operations as contract operator,
pending the purchase.




In
January 2007, we paid a $2.0 million earnest money deposit to Galaxy, which was
due under the terms of the Galaxy PSA. As contract operator of the Powder River
Basin Assets, we incurred $0.8 million in expenses. The Galaxy PSA expired by
its terms on August 31, 2007. Upon expiration and under the terms of the Galaxy
PSA, we obtained a note receivable in the amount of $2.5 million (the “Galaxy
Note”) which consisted of the $2.0 million earnest deposit plus a portion of
operating costs paid by us. As guarantor of the Galaxy Note, MAB repaid the
balance in November 2007 by offsetting it against amounts owed by us to MAB
under the MAB Note (see Notes 3 and 7).






16


MONTANA COALBED
METHANE





Bear Creek Project.We have
retained 13,905 acres of the original 25,278 acres of leasehold acquired through
an assignment from MAB. The remaining 11,373 acres of leasehold have expired.
The acres retained have been reflected in unproved oil and gas properties and
are subject to further evaluation. The acres released have been reflected in
unproved properties but included in evaluated costs subject to amortization and
in the full cost ceiling test at the lower of cost or market value.





HEAVY
OIL





Sale of Heavy Oil Projects.On November 6, 2007 and effective October 1, 2007, we sold all of our
interest in our Heavy Oil Projects, including the West Rozel, Fiddler Creek and
Promised Land Projects in Utah and Montana, to Pearl Exploration and Production
Ltd. (“Pearl”). The purchase price was a maximum of $30.0 million, payable as
follows: (a) $7.5 million in cash at closing; (b) the issuance of up to 2.5
million shares of Pearl equivalent to $10 million (based on a price of $4.00
Canadian dollars per share, as stipulated in the purchase and sale contract),
and (c) a performance payment (the “Pearl Performance Payment”) of $12.5 million
in cash at such time as either: (i) production from the assets reaches 5,000
barrels per day or (ii) proven reserves from the assets is greater than 50.0
million barrels of oil as certified by a third party reserve engineer. In the
event that these targets have not been achieved by September 30, 2010, the Pearl
Performance Payment obligation will expire.  As of June 30, 2008, no
amounts have been accrued in relation to the Pearl Performance Payment as
the triggering events have not yet occurred.  In addition, the number
of shares included in (b) above may be reduced by 960,025 shares (valued in the
contract at $3.8 million based on a price of $4.00 per share, as above) if a
satisfactory agreement is not made between Pearl and the lessor (“ECA”) of
certain of the properties within 6 months of the date of closing (that being May
6, 2008).  No such satisfactory agreement was reached between Pearl
and ECA and therefore, the total amount conveyed in (b) above was 1,539,975
shares.





We
originally accounted for the sale of the Heavy Oil Project assets to Pearl to
include the sale of the ECA properties, as we believed at that time it was
probable Pearl and ECA would reach agreement and the ECA assets would be
conveyed to Pearl within the six month period contemplated in our agreement with
Pearl.  During the second quarter, we were informed that agreement
between Pearl and ECA would not be reached, and that the ECA assets would not
transfer to Pearl.  As a result, we reviewed the original accounting
for the transaction and determined that we had inappropriately included the
960,025 shares of Pearl stock relating to the ECA assets in our marketable
securities as of December 31, 2007, and further, we had recorded unrealized
losses on those shares during the first quarter in error.  During the
second quarter, we recorded correcting entries in our financial statements which
resulted in (a) the reversal of $0.9 million of unrealized losses on the shares
of Pearl stock we did not ultimately receive, and (b) the reversal into our full
cost pool of $3.5 million of marketable securities we originally recorded in
anticipation of closing the sale of the ECA assets.  During March
2008, we sold all of the 1,539,975 shares of Pearl stock we did receive, which
resulted in net proceeds of $2.5 million.  The difference between the
value of these shares at closing of $5.5 million and the net proceeds received
upon sale, was recorded as Trading Security Losses in
our consolidated results of operations for the nine months ended June 30,
2008.





The sale
of assets to Pearl also resulted in amendments to existing agreements with third
parties, including MAB’s relinquishment of its rights and obligations in all
PetroHunter properties in Utah and Montana, and termination of PetroHunter’s
obligation to pay an overriding royalty and a per barrel production payment to
American Oil & Gas, Inc. (“American”) and Savannah Exploration,
Inc. (“Savannah”), in consideration for: (a) 5 million common shares of
PetroHunter common stock to be issued to American and Savannah; and (b) a
contingent obligation to pay a total of $2.0 million to American and Savannah in
the event PetroHunter receives the Pearl Performance Payment.





Note
5 — Asset Retirement Obligation





We
recognize an estimated liability for future costs associated with the
abandonment of our oil and gas properties. A liability for the fair value of an
asset retirement obligation and a corresponding increase to the carrying value
of the related long-lived asset are recorded at the time a well is completed or
acquired. The increase in carrying value is included in proved oil and gas
properties in the consolidated balance sheets. We deplete the amount added to
proved oil and gas property costs and recognize accretion expense in connection
with the discounted liability over the remaining estimated economic lives of the
respective oil and gas properties.





Our
estimated asset retirement obligation liability is based on estimated economic
lives, estimates as to the cost to abandon the wells in the future, and federal
and state regulatory requirements. The liability is discounted using a
credit-adjusted risk-free rate estimated at the time the liability is incurred
or revised. The credit-adjusted risk-free rates used to discount our abandonment liabilities
range from 8% to 15%. Revisions to the liability are due to increases in
estimated abandonment costs and changes in well economic lives, or in changes to
federal or state regulations regarding the abandonment of wells.






17


A
reconciliation of our asset retirement obligation liability is as
follows:





June
      30,
              2008
            
            
            September
      30,
              2007($
      in thousands)Beginning
      asset retirement obligation
            
            $
            136
            
            
            $
            522Liabilities
      incurred
            
            
            1
            
            
            
            30Liabilities
      settled
            
            
            (35
            )
            
            
            —Revisions
      to estimates
            
            
            (27
            )
            
            
            (429
            )Accretion
      expense
            
            
            (2
            )
            
            
            13Ending
      asset retirement obligation
            
            $
            73
            
            
            $
            136





Note
6 — Contract Payable





On
November 28, 2006, MAB entered into a Lease Acquisition and Development
Agreement (the “Maralex Agreement”) with Maralex Resources, Inc. and Adelante
Oil & Gas LLC (collectively, “Maralex”) for the acquisition and development
of the Sugarloaf Prospect in Garfield County, Colorado. MAB subsequently
assigned the Maralex Agreement to us in January 2007 (the
“Assignment”).  By the terms of the Maralex Agreement and subsequent
Assignment, we paid $0.1 million at closing, with the remaining cash of $2.9
million and the issuance of 2.4 million shares of our common stock due on
January 15, 2007. We recorded the $2.9 million obligation as Contract payable — oil and gas
properties, and $4.1 million as stockholders’ equity (equal to 2.4
million shares at the $1.70 closing price of our common stock on the date of the
closing).





The terms
of the Maralex Agreement and Assignment were amended on several occasions since
the original Agreement was executed, amending the payment dates, issuing 5.6
million additional shares of our common stock and agreeing to increase the
amount of cash due under the agreement by a total of $0.3 million. By the terms
of the Maralex Agreement, we were required to pay to Maralex an amount equal to
5% of the outstanding payable for each 20 days past due.





We failed
to make payments in accordance with the Maralex Agreement and as a result, on
December 4, 2007, Maralex terminated the Maralex Agreement and notified us that,
in accordance with the terms of the Maralex Agreement, they returned 6.4 million
shares of common stock and we instructed the escrow agent to reassign to Maralex
all leases which were being held in escrow pursuant to the Maralex
Agreement.





During
the nine months ended June 30, 2008, in accordance with the termination of this
agreement, we (i) reclassified the balance of Contract payable — Oil and gas propertiesin the amount of $1.5 million to Oil and gas properties; (ii) recorded the
return of 80% of the additional equity consideration as a reduction of Oil and gas propertiesand
equity and (iii) reversed the remaining accrued liabilities to Oil and gas
properties.





Note
7 — Notes Payable





Notes
payable are summarized below:





June 30, 2008
            
            
            September 30, 2007($
      in thousands)Notes
      payable – short-term:Shareholder
      note
            
            $
            850
            
            
            $
            —Vendor
            
            
            —
            
            
            
            4,050Global
      Project Finance AG
            
            
            —
            
            
            
            500Flatiron
      Capital Corp.
            
            
            205
            
            
            
            117Notes
      payable – short-term
            
            $
            1,055
            
            
            $
            4,667Convertible
      notes payable
            
            $
            400
            
            
            $
            400Notes
      payable – related party – current portion:Bruner
      Family Trust
            
            $
            2,622
            
            
            $
            —MAB-
      current portion
            
            
            —
            
            
            
            3,755Notes
      payable – related party – current portion
            
            $
            2,622
            
            
            $
            3,755Subordinated
      notes payable — related party:Bruner
      Family Trust
            
            $
            106
            
            
            $
            275MAB
            
            
            —
            
            
            
            8,775




18




Subordinated
      notes payable — related party
            
            $
            106
            
            
            $
            9,050Long-term
      notes payable — net of discount:Global
      Project Finance AG
            
            $
            39,800
            
            
            $
            31,550Vendor
            
            
            149
            
            
            
            250Less
      current portion
            
            
            (120
            )
            
            
            (120
            )Discount
      on notes payable
            
            
            (2,622
            )
            
            
            (3,736
            )Long-term
      notes payable — net of discount
            
            $
            37,207
            
            
            $
            27,944Convertible
      debt
            
            $
            6,956
            
            
            $
            —Discount
      on convertible debt
            
            
            (6,272
            )
            
            
            —Convertible
      debt — net of discount
            
            $
            684
            
            
            $
            —





RECENT DEBT
ACTIVITY





LaramieTransaction.  On
May 30, 2008, we sold substantially all of our working interest in our Southern
Piceance properties in Colorado (see Notes 4, 11 and 12).  In
conjunction with this sale, we entered into numerous settlement and release
agreements with many of our trade creditors, some of whom had previously entered
into promissory notes with us.  Specifically, with respect to
settlements on notes previously outstanding:





(i) On
June 19, 2007, we entered into a promissory note with a vendor for an
outstanding unpaid balance due to the vendor, in the amount of $6.5 million. The
note was to be paid in full by July 31, 2007 and bore interest at 14% per annum
if paid current. Upon our default on the note, the interest rate increased to
21% per annum.  In conjunction with the Laramie transaction, we paid
$6.3 million in cash and issued 10 million shares of our common stock to this
vendor in full satisfaction of all amounts owed by us to this vendor including
the note as well as other amounts owed.





(ii)In October 2007, we
entered into another promissory note with a vendor for outstanding account
payable balances. The note bore interest at 8.25% per annum, which increased to
10.25% upon default and was due to mature February 29, 2008.  In
conjunction with the Laramie transaction, we paid $0.2 million to this vendor in
full satisfaction of all amounts owed by us to this vendor.





Both of
the notes described above were classified as Vendor notes in the table above as
of September 30, 2007.





Vendor.On January
29, 2008 an unsecured promissory note with a vendor was entered into for past
due invoices aggregating $0.1 million. The note bore interest at an annual rate
of 8%. On April 8, 2008, we satisfied this note with full payment of principal
and interest.





Global Project Finance AG.On
September 25, 2007, we borrowed $0.5 million from Global Project Finance, AG
(“Global”) under an unsecured note bearing interest at a rate of 7.75% per
annum. We repaid this note in full on November 9, 2007 before it became
due.





Flatiron Capital Corp.On
June 6, 2007, we entered into a promissory note with Flatiron Capital for the
financing of certain insurance policies in the amount of $0.2 million. The note
bore interest at a rate of 7.25% per annum. Payments were due in 10 equal
installments of $17,000, commencing on July 1, 2007 and maturing on April 1,
2008. The note was unsecured and the note was paid in full in April
2008.





On June
6, 2008, we entered into another a promissory note with Flatiron Capital for the
financing of certain insurance policies in the amount of $0.2 million. The note
bears interest at a rate of 4.15% per annum.  We made a down payment of
$0.1 million at the inception of the loan.  Monthly payments are due in 11
equal installments commencing in July 2008. The note is unsecured and we are
current in our payments





Subordinated Notes Payable-Related
Party: MAB Note.
Effective January 1, 2007, in conjunction with the Consulting Agreement, we
issued a $13.5 million promissory note (the “MAB Note”) as partial consideration
for MAB’s assignment of its undivided 50% working interest in certain oil and
gas properties (see Note 3). The MAB Note bore interest at a rate equal to
London InterBank Offered Rate, (“LIBOR”). Monthly payments of principal of
$225,000 plus accrued interest were scheduled to begin on January 31, 2007 and
were scheduled to end in December 2011. On November 15, 2007, we entered into
the Second Amendment under the terms of which the MAB Note was replaced with a
new promissory note in the amount of $2.0 million. The note bore interest at an
annual rate equal to LIBOR and was due to mature on January 1,
2010.  At June 30, 2008, we had repaid the note in full and applied a
$0.1 million overpayment towards the balance of notes outstanding with the
Bruner Family Trust, discussed below.





Wes-Tex. On December 18,
2007, we obtained a loan and signed a promissory note (the “Wes-Tex Note”) in
the amount of $0.8 million from a third party oil and gas company. The loan was
collateralized by 947,153 of the Pearl shares, and accrued interest at the rate
of 15%. The note and accrued interest was paid in full in March
2008.




Wealth Preservation.On
January 25, 2008, we borrowed $0.1 million under a promissory note. The note
bore interest at 15% per annum, provided the note was not in default, in which
case the interest rate increased to 24% per annum, and was due on February 29,
2008. This principal balance and accrued interest of $4,000 was paid in full in
April 2008.






19


OTHER OUTSTANDING
DEBT





Short-
Term Notes
Payable





Shareholder Note. During the
second fiscal quarter of 2008, we entered into an agreement to borrow $0.9
million from a shareholder with interest to accrue at a rate of 15% per
annum.  All principal and accrued interest amounts are due in full on
August 31, 2008.





Convertible
Notes Payable





Prior to
the merger with GSL on May 12, 2006, Digital entered into five separate loan
agreements, aggregating $0.4 million, due one year from issuance, commencing
October 11, 2006. The loans bore interest at 12% per annum, were unsecured, and
were convertible, at the option of the lender, at any time during the term of
the loan or upon maturity, at a price per share equal to the closing price of
our common shares on the Over the Counter Bulletin Board market on the day
preceding notice from the lender of its intent to convert the loan. Subsequent
to June 30, 2008 we received notice from the lender of its intent to convert the
loans into common stock, as described in Note 15.





Notes
Payable – Related Party





Bruner Family Trust. As of
September 30, 2007, we had entered into two promissory notes with the Bruner
Family Trust in the amount of $0.3 million which each accrue interest at 8% per
annum and are due in full on the later of October 29, 2007 or the time when the
Global Project Finance AG Credit Facility and all other senior indebtedness has
been paid in full.  In November 2007, Charles Crowell, our Chairman
and CEO, was assigned the right to receive from us approximately $0.2 million of
the $0.3 million owed by us under this promissory note to the Bruner Family
Trust. Mr. Crowell received this right from the Bruner Family Trust in exchange
for a promissory note in the same amount which had been issued to Mr. Crowell by
Galaxy for services rendered to Galaxy prior to Mr. Crowell becoming an officer
of PetroHunter.  At June 30, 2008, total principal and accrued
interest related to these notes was $0.1 million and was classified as long term
on our consolidated balance sheets.





During
the 2008 fiscal year, we entered into four more promissory notes with the Bruner
Family Trust with principal amounts aggregating $2.7 million.  Each of
these notes accrues interest at the LIBOR plus 3% per annum and are due 12
months from each note’s respective issue date.  The largest of these
notes, aggregating $2.3 million in principal and interest as of June 30, 2008,
is due November 13, 2008, with the remaining three notes, aggregating $0.3
million in principal and accrued interest as of June 30, 2008, due in February
and March 2009.  As of June 30, 2008, all principal and accrued
interest related to these notes were classified as current on our consolidated
balance sheets.





Long-Term
Notes Payable





Vendor Long-term Notes Payable.On August 10, 2007, we entered into an unsecured promissory note with a
vendor for past due invoices aggregating $0.3 million. The note bears interest
at an annual rate of 8%. Payments are due in 24 equal installments of $11,000,
commencing on October 1, 2007 and maturing on September 1, 2009. As of June 30,
2008, the balance of this note was $0.2 million.





Credit Facility — Global.On
January 9, 2007, we entered into a Credit and Security Agreement (the “January
2007 Credit Facility”) with Global for mezzanine financing in the amount of
$15.0 million. The January 2007 Credit Facility is collateralized by a first
perfected lien on certain oil and gas properties and other of our assets and
interest accrues at an annual rate of 6.75% over the prime rate. Global and its
controlling shareholder were shareholders of ours prior to entering into the
January 2007 Credit Facility. As of June 30, 2008, we have drawn the total $15.0
million available under the January 2007 Credit Facility.





The terms
of the January 2007 Credit Facility provide for the issuance of 1.0 million
warrants to purchase 1.0 million shares of our common stock upon execution of
the January 2007 Credit Facility, and an additional 0.2 warrants, for each $1.0
million draw of funds from the credit facility up to the total amount available
under the facility, $15.0 million. The warrants are exercisable until January 9,
2012. The exercise price of the warrants is equal to 120% of the
weighted-average price of our stock for the 30 days immediately prior to each
warrant issuance date. Prices range from $1.30 to $2.10 per warrant. The fair
value of the warrants was estimated as of each respective issue date under the
Black-Scholes pricing model with the following assumptions: (i) the common stock
price at market price on the date of issue; (ii) zero dividends; (iii) expected
volatility of 69.2% to 71.4%; (iv) a risk-free interest rate ranging from 4.5%
to 4.7%; and (v) an expected life of 5 years. The fair value of the warrants was
recorded as a discount to the credit facility and is being amortized over the
life of the note. The unamortized portion of the discount is offset against the
long-term notes payable on the consolidated balance sheet. We pay an advance fee
(the “Advance Fee”) of 1% of all amounts drawn against the facility. In 2007,
the advance fee related to the original January 2007 Credit
Facility was recorded as deferred financing fees, totaled $0.2 million and is
being amortized to interest expense over the life of the January 2007 Credit
Facility.





On May
21, 2007, we entered into a second Credit and Security Agreement with Global
(the “May 2007 Credit Facility”). Under the May 2007 Credit Facility, Global
agreed to use its best efforts to advance up to $60.0 million to us over the
following 18




20




months.
Interest on advances under the May 2007 Credit Facility accrues at an annual
rate of 6.75% over the prime rate and is payable in arrears quarterly beginning
June 30, 2007. We pay an advance fee of 2% on all amounts drawn under the May
2007 Credit Facility. We are to begin making principal payments on the loan
beginning at the end of the first quarter following the end of the 18 month
funding period: December 31, 2008. Payments shall be made in such amounts as may
be agreed upon by us and Global on the then outstanding principal balance in
order to repay the principal balance by the maturity date, November 21, 2009.
The loan is collateralized by a first perfected security interest on the same
properties and assets that are collateral for the January 2007 Credit Facility.
We may prepay the balance in whole or in part without penalty or notice and we
may terminate the facility with 30 days written notice. In the event that we
sell any interest in the oil and gas properties that comprise the collateral, a
mandatory prepayment is due in the amount equal to such sales proceeds, not to
exceed the balance due under the May 2007 Credit Facility. As of June 30, 2008,
$24.8 million has been advanced to us under this facility. The advance fee in
the amount of $0.6 million was recorded as deferred financing costs, and is
being amortized over the life of the May 2007 Credit Facility.





Global
received warrants to purchase 2.0 million of our shares upon execution of the
May 2007 Credit Facility and 0.4 million warrants for each $1.0 million advanced
under the credit facility. The warrants are exercisable until May 21, 2012 at
prices equal to 120% of the volume-weighted-average price of our common stock
for the 30 days immediately preceding each warrant issuance date. Prices range
from $0.22 to $1.01 per warrant. The fair value of the warrants were estimated
as of each respective issue date under the Black-Scholes pricing model, with the
following assumptions: (i) common stock based on the market price on the issue
date; (ii) zero dividends; (iii) expected volatility of 69.8% to 76.0%; (iv)
risk free interest rate of 2.2% to 4.9%; and (v) expected life of 2.0 to 2.5
years. The fair value of the warrants issuable as of June 30, 2008 was recorded
as a discount to the note and is being amortized over the life of the
note.





On May
12, 2007, we issued a “most favored nation” letter to Global which indicated
that we would extend all the economic terms from the May 2007 Credit Facility
retroactively to the January 2007 Credit Facility. On May 21, 2007, when the May
2007 Credit Facility was signed, we issued an additional 1.0 million warrants
for the execution of the January 2007 Credit Facility and an additional 3.0
million warrants for the January 2007 Credit Facility based on the $15.0 million
advanced under the January 2007 Credit Facility. The fair value of the warrants
relating to this amendment totaled $0.6 million. We also recorded an additional
$0.2 million in deferred financing costs which are being amortized over the life
of the January 2007 Credit Facility. The most favored nation agreement did not
extend the dates identified in the January 2007 Credit Facility and as a result,
the additional deferred financing costs and loan discount are being amortized
over the term of the January 2007 Credit Facility.





As of
June 30, 2008, we would have been in default of payments to Global in the amount
of $6.1 million, which consists of unpaid interest and fees under the Global
Credit Facilities, and we would have been out of compliance with various
financial and debt covenants under these Facilities.  However, prior
to any such default and non-compliance event or condition occurring, Global
waived and released PetroHunter from any and all defaults, failures to perform,
and any other failures to meet its obligations through July 1,
2009.





Convertible Notes.On
November 13, 2007, we completed the sale of Series A 8.5% Convertible Debentures
(the “Debentures”) in the aggregate principal amount of $7.0 million to several
accredited investors. The Debentures are due November 2012 and are
collateralized by shares in our Australian subsidiary. Debenture holders also
received five-year warrants that allow them to purchase a total of 46.4 million
shares of common stock at prices ranging from $0.24 to $0.28 per share. In
connection with the placement of the Debentures, we paid a placement fee of $0.3
million and issued placement agent warrants entitling the holders to purchase an
aggregate of 0.2 million shares at $0.35 per share for a period of five years.
Interest payments related to the Debentures accrues at an annual rate of 8.5%
and is payable in cash or in shares (at our option) quarterly, beginning January
1, 2008. All overdue unpaid interest incurs a late fee of 18% per annum,
calculated based on the entire unpaid interest balance. We defaulted on interest
payments due January 1, 2008 and April 1, 2008 and as a result, we obtained a
waiver and amendment from Debenture holders under which the defaults were waived
in consideration for the issuance of warrants and an agreement to pay the
interest and related late fees in September 2008.  This waiver and
amendment is described more fully below. As of the date of filing, we were in
default on our July 1, 2008 scheduled interest payment.





Under the
original Debenture agreement, we agreed to file a registration statement with
the Securities and Exchange Commission in order to register the resale of the
shares issuable upon conversion of the Debentures and the shares issuable upon
exercise of the warrants.  According to that Registration Rights
Agreement, the registration statement was to be filed by March 4, 2008 and
declared effective by July 2, 2008. The following penalties apply if filing
deadlines and/or documentation requirements are not met in compliance with the
stated rules: (i) we shall pay to each holder of Registrable Securities 1% of
the purchase price paid in cash as partial liquidated damages; (ii) the maximum
aggregate liquidated damages payable is 18% of the aggregate subscription amount
paid by the holder; (iii) if we fail to pay liquidated damages in full within
seven days of the date payable, we will pay interest of 18% per annum, accruing
daily from the original due date; (iv) partial liquidated damages apply on a
daily prorated
basis for any portion of a month prior to the cure of an event; and (v) all fees
and expenses associated with compliance to the agreement shall be incurred by
us.





A waiver
and amendment agreement relating to the above Registration Rights Agreement was
signed by all investors in April and May 2008. The agreement is an extension of
filing date and effectiveness date to June 30, 2008 and December 31, 2008,
respectively. Each purchaser waived (i) our obligation to file a registration
statement covering the Registrable Securities by March 4, 2008; (ii) our
obligation to have such registration statement declared effective by July 2,
2008, and (iii) any penalties associated




21




with the
failure to satisfy such obligations as described above. In addition, each
purchaser waived as events of default, our failure to pay the January 1, 2008
and April 1, 2008 interest payments. As consideration for this waiver, we agreed
to pay the interest installments due January 1, 2008 and April 1, 2008 by
September 30, 2008, together with late fees of 18% per annum.  In
addition, warrants to purchase our common stock will be issued in an amount
equal to 4% of the warrants each purchaser received with the original agreement.
The terms of these warrants mirror the terms given in the original
agreement.  Pursuant to this waiver and amendment, we filed a
registration statement on June 30, 2008, which is expected to become effective
in August 2008.  Further, we recorded $0.2 million in costs related to
the warrants issued under the waiver and amendment, which is reflected as a
discount to debt and is being amortized over the life of the
warrants.





The
Debentures have a maturity date of five years and are convertible at any time by
the holders into shares of our common stock at a price of $0.15 per share, which
was determined to be beneficial to the holders on the date of issuance. In
accordance with EITF 00-27, we recorded an additional discount to the debt in
the amount of $3.5 million which will be accreted to interest expense over the
term of the notes.





During
the preparation of our financial statements for the third quarter ended June 30,
2008, we noted that as of July 1, 2008, we were still in default of various
provisions as set forth in the November 2007 Debenture agreement. In April,
May, and August 2008 the investors granted waivers for certain provisions
for which we were in default. Although the waiver granted to us does not cure
all of the defaults as of July 1, 2008 we do not believe that the investors will
enforce the terms of the Debentures,  as the enforcement of the terms is of
no economic benefit to either the investors or to us. Accordingly, no
adjustments or reclassifications have been recorded by us in our condensed
consolidated financial statements as of June 30, 2008 to reflect the defaults,
as we feel that the investors will continue to work with us.





Provided
that there is an effective registration statement covering the shares underlying
the Debentures, or the shares are otherwise eligible for resale without
restriction under Rule 144, and the volume-weighted-average price of our common
stock over 20 consecutive trading days is at least 200% of the per share
conversion price, with a minimum average trading volume of 0.3 million shares
per day: (i) The Debentures are convertible, at our option and (ii) are
redeemable at our option at 120% of face value at any time after one year from
date of issuance.





The
debenture agreement contains anti-dilution protections for the investors to
allow a downward adjustment to the conversion price of the Debentures in the
event that we sell or issue shares at a price less than the conversion price of
the Debentures.





During
the preparation of our financial statements for the third quarter ended June 30,
2008, we discovered a significant error that affected our accounting for the
Debentures, as more fully described in Note 14.  During our first
quarter, when the convertible Debentures were funded, we had erroneously
concluded that the relative fair value of the detachable warrants of $2.9
million needed to be immediately expensed to interest expense in full. We
subsequently determined that the immediate expensing of the full value of the
warrants should have been capitalized as a discount against the face value of
the Debentures, and amortized over their five year lives using the effective
interest method.





We
recorded a correcting entry during the third quarter to correct the accounting
for the value associated with the warrants, including those adjustments to
appropriately state the cumulative amortization of the discount. The effect of
the correction was to reduce interest expense, and reduce the reported book
value of the Debentures by $2.8 million during the third quarter, representing
the correction of a $2.9 million overstatement of interest expense during the
first quarter, and an understatement of interest expense of $0.1 million during
the second quarter. The aggregate effect of all errors we have discovered in the
preparation of our quarterly filings on Form 10-Q for fiscal 2008 are shown in
detail in Note 14.





Note
8 — Stockholders’ Equity





Common Stock.During the nine
months ended June 30, 2008, we issued 65.5 million shares of our common stock
and had 6.4 million shares of our common stock returned as follows:




·
            25.0
      million shares issued at $0.31 per share for consideration given to an
      amendment to a related party contract relinquishing overriding royalty
      interests (see Note 3)


·
            16.0
      million shares issued at $0.23 per share for an amendment to a related
      party contract reducing an outstanding note payable (see Note
      3)


·
            5.0
      million shares issued at $0.25 per share in conjunction with sale of heavy
      oil assets (see Note 4)


·
            0.2
      million shares issued at $0.28 per share for transaction finance
      costs


·
            16.9
      million shares issued at $0.20 per share for settlements with various
      vendors and lienholders (see Note12)


·
            2.0
      million shares issued at $0.20 per share for transaction finance costs
      (see Note 12)


·
            0.4
      million shares issued at $0.20 per share for the option to purchase shares
      of CCES (see Note 13)


·
            1.9
      million shares returned at $1.70 per share for property
      interests


·
            0.5
      million shares returned at $1.72 per share for property
      interests


·
            0.4
      million shares returned at $1.29 per share for property
      interests


·
            0.4
      million shares returned at $0.51 per share for property
      interests


·
            3.2
      million shares returned at $0.23 per share for property
      interests





22


Common Stock Subscribed.On
November 6, 2006, we commenced the sale of a maximum $125.0 million pursuant to
a private placement of units at $1.50 per unit (the “Private Placement”). Each
unit consisted of one share of our common stock and one-half common stock
purchase warrant. A whole common stock purchase warrant entitled the purchaser
to acquire one share of our common stock at an exercise price of $1.88 per share
through December 31, 2007. In February 2007, the Board of Directors determined
that the composition of the units being offered would be restructured, and those
investors who had subscribed in the offering were offered the opportunity to
rescind their subscriptions or to participate on the same terms as ultimately
defined for the restructured offering. During the nine months ended June 30,
2008, we reclassified $2.4 million of subscriptions which included $0.1 million
of accrued interest to Notes
Payable- Related Party.





In
November 2007, the Board of Directors again agreed to restructure the offering
of the Private Placement and to offer those investors the opportunity to rescind
their subscriptions or to participate on the same terms as the Debenture
offering, with interest to be paid at 8.5% from the date the original funds were
received to the date of the subscription of Debentures (see Note 7). Investors
who had subscribed in the offering were again offered the opportunity to rescind
their subscriptions or to participate in the restructured offering. Three of the
original investors opted to participate in the above restructured offering. As a
result the balance of outstanding subscriptions plus accrued interest totaling
$0.5 million was reclassified from Common Stock Subscribedto Convertible notes payable — net of
discounton the consolidated balance sheet.





Warrants





The
following stock purchase warrants were outstanding at:





June
      30,
              2008
            
            
            September
      30,
              2007(warrants
      in thousands)Number
      of warrants
            
            
            134,827
            
            
            
            51,063Exercise
      price
            
            $
            0.22
      - $2.10
            
            
            $
            0.31
      - $2.10Expiration
      date
            
            
            2009
      - 2012
            
            
            
            2011
      - 2012





In
November 2007, we completed the sale of Series A 8.5% convertible Debentures.
Debenture holders received five year warrants that allow them to purchase a
total of 46.4 million shares of common stock at prices ranging from $0.24 to
$0.28 per share. In April 2008, the Debenture holders also received warrants to
purchase a total of 1.9 million shares at prices ranging from $0.24 to $0.28 per
share in consideration for their agreement to a waiver and amendment (see Note
7). As of June 30, 2008, none of these warrants had been exercised and the total
value of these warrants, based on valuation under the Black-Scholes method was
$7.4 million. In connection with the placement of the Debentures, we paid a
placement fee of $0.3 million and issued placement agent warrants entitling the
holders to purchase an aggregate of 0.2 million shares at $0.35 per share for a
period of five years. These warrants had a total valuation under the
Black-Scholes method of $0.0 million.





In
November 2007, the Second Amendment was entered into and warrants to acquire
32.0 million shares of our common stock at $0.50 per share were issued (see Note
3). These warrants expire on November 14, 2009 and have a total value, based on
valuation under the Black-Scholes method of $1.4 million.





During
the nine months ended June 30, 2008 we issued 3.3 million warrants valued at
$0.5 million using the Black-Scholes method in connection with amounts borrowed
against our credit facility.





During
the preparation of our financial statements for the third quarter ended June 30,
2008, we discovered an error in our calculations of the determination of the
relative fair value of our detachable warrants associated with our Global Credit
Facilities, and an error in recording deferred financing costs for warrants that
were not issued directly in relation to making advances on the Facility, and
instead were issued in connection with securing the Facilities. In applying the
Black-Scholes method to calculate their estimated fair value, we erroneously
used warrant term assumptions that were less than the contractual life of the
warrants, which understated the initial value of the warrants, in addition to
failing to record deferred financing costs as a deferred charge. The effect of
the correction of this error was to increase the recorded discount against the
Global Credit Facility by $0.0 million, and record $1.8 million in deferred
financing costs to account for the difference in the relative fair value of the
warrants. The correction of this error resulted in our recording an additional
$0.4 million in interest expense in the third quarter, with a corresponding
understatement of recorded interest expense during our first and second
quarters. The aggregate effect of all errors we have discovered in the
preparation of our quarterly filings on Form 10-Q for fiscal 2008 are shown in
detail in Note 14.










23
 
 Note 9 — Stock
Options


Stock Option Plan.On August
10, 2005, we adopted the 2005 Stock Option Plan (the “Plan”), as amended. Stock
options under the Plan may be granted to key employees, non-employee directors
and other key individuals who are committed to our interests. Options may be
granted at an exercise price not less than the fair market value of our common
stock at the date of grant. Most options have a five year life but may have a
life up to 10 years as designated by the compensation committee of the Board of Directors
(the “Compensation Committee”). Typically, options vest 20% on grant date and
20% each year on the anniversary of the grant date and each vesting schedule is
also approved by the Compensation Committee. Most initial grants to Directors
vest 50% on grant date and 50% on the one-year anniversary of the initial grant
date. Subsequent grants (subsequent to the initial grant) to Directors typically
vest 100% at the grant date. In special circumstances, the Board may elect to
modify vesting schedules upon the termination of selected employees and
contractors. We have reserved 40.0 million shares of common stock for the plan.
At June 30, 2008 and September 30, 2007, 9.25 and 15.0 million shares,
respectively, remained available for grant pursuant to the stock option plan.
During the three and nine months ended June 30, 2008, we granted .3 and 8.3
million options under our 2005 stock option plan to directors, employees and
consultants performing employee-like services for us. During the three and nine
months ended June 30, 2007, we granted 1.2 and 2.2 million options,
respectively, under our 2005 stock option plan to directors, employees and
consultants.





A summary
of the activity under the Plan for the nine months ended June 30, 2008 is
presented below:





Number
      of
              Shares
            
            
            Weighted-
              Average
              Exercise
      Price(shares
      in thousands)Options
      outstanding — September 30, 2007
            
            
            24,965
            
            
            $
            1.31Granted
            
            
            8,235
            
            
            
            0.21Forfeited
            
            
            (2,465
            )
            
            
            1.76Options
      outstanding — June 30, 2008
            
            
            30,735
            
            
            
            0.99




Effective
October 1, 2006, we adopted the provisions of SFAS 123(R). In accordance with
SFAS 123(R) the fair value of each share-based award under all plans is
estimated on the date of grant using a Black-Scholes pricing model that
incorporates the assumptions noted in the following table for the three and nine
months ended June 30, 2008.





2008Expected
      option term — years
            3.75
      - 4.0Risk-free
      interest rate
            1.62%
      - 4.20%Expected
      dividend yield
            0Weighted-average
      volatility
            71%
      - 79%




Deferred Stock-Based Compensation.We authorized and issued 10.1 million of non-qualified stock options not
under the Plan, to employees and non-employee consultants on May 21, 2007. The
options were granted at an exercise price of $0.50 per share and vest 60% at
grant date and 20% per year at the one and two-year anniversaries of the grant
date. These options expire on May 21, 2012.




A summary
of the activity for the nine months ended June 30, 2008 for these options is
presented below:





Number
      of
              Shares
            
            
            Weighted-
              Average
              Exercise
      Price(shares
      in thousands)Options
      outstanding — September 30, 2007
            
            
            9,895
            
            
            $
            0.50Granted
            
            
            —
            
            
            
            —Forfeited
            
            
            (2,300
            )
            
            
            0.50Options
      outstanding — June 30, 2008
            
            
            7,595
            
            
            
            0.50Options
      exercisable — June 30, 2008
            
            
            5,666
            
            
            
            0.50




Compensation
Expense





Non-cash
stock-based compensation expense of $0.5 million and $2.1 million was recognized
during the three and nine months ended June 30, 2008. Stock-based compensation
expense of $3.4 million and $7.3 million was recognized during the three and
nine months ended June 30, 2007. Stock-based compensation expense is included in
general and administrative expenses in the consolidated statements of
operations.





24


Note
10 — Related Party Transactions





MAB.During the three and
nine months ended June 30, 2007, we incurred project development costs to MAB
under the Development Agreement between us and MAB (see Note 3) in the amount of
$0.0 million and $1.8 million, respectively. We did not incur project
development costs to MAB during the three and nine months ended June 30, 2008.
Project development costs to MAB are classified in our consolidated statements
of operations as Project
development costs — related party. During the three and nine months ended
June 30, 2007, we recorded expenditures paid by MAB on our behalf in the amount
of $0.4 million and $0.6 million, respectively. At June 30, 2008 and September
30, 2007, we owed MAB $0.0 million and $1.0 million, respectively, related to
project development costs and other expenditures that MAB made on our
behalf.




As of
June 30, 2008, we had paid off the $13.5 million promissory note issued pursuant
to the agreements with MAB (see Note 7). As of September 30, 2007, we owed MAB
principal and accrued interest of $13.0 million under the terms of the
promissory note.





At June
30, 2008, we had six separate promissory notes with the Bruner Family Trust (see
Note 7) for an aggregate principal amount of $2.7 million. During the three
and nine months ended June 30, 2008, we incurred total interest expense of $0.0
million and $0.1 million, respectively. In June 2008 we offset $0.2 million in
receivables from entities controlled by our single largest beneficial
shareholder against the balance of these loans pursuant to an agreement between
the entities.





Wealth Preservation.On
January 25, 2008, we borrowed $0.1 million under a promissory note with an
entity controlled by a member of the board of directors. The note bears interest
at 15% and was due on February 29, 2008. At March 31, 2008 we were in default of
this note and the interest increased to 24%.  This principal balance
and accrued interest of $4,000 was paid in full in April 2008.





Galaxy. Note receivable- related
party on the consolidated balance sheet at September 30, 2007 represents
$2.5 million related to a $2.0 million earnest money deposit made by us under
the terms of the Galaxy PSA and additional operating costs of $0.5 million that
we paid toward the operating costs of the assets we were to acquire plus accrued
interest on amounts due to us which were all converted into the Galaxy Note on
August 31, 2007. During the nine months ended June 30, 2008, the entire $2.5
million has been paid to us by offset against amounts that we owed to MAB. At
September 30, 2007, Galaxy owed us $0.3 million and $17,000 related to
additional expenses paid by us related to the Galaxy PSA and accrued interest on
the Galaxy Note, respectively. During the nine months ended June 30, 2008, these
amounts have also been paid by offset to amounts we owed to MAB under the MAB
Note. Marc A. Bruner, our largest single beneficial shareholder, is a 14.0%
beneficial shareholder of Galaxy and is the father of the President and Chief
Executive Officer of Galaxy.





Note
11 — Commitments and Contingencies





Contingencies.We may from
time to time be involved in various claims, lawsuits, disputes with third
parties, actions involving allegations of discrimination, or breach of contract
incidental to the operations of our business. We are currently a party to the
following legal actions:





·
            One
      vendor has filed a lien applicable to our properties in Rio Blanco County,
      Colorado, for $0.2 million.


·
            A
      lawsuit was filed in August 2007 by a law firm in Australia in the Supreme
      Court of Victoria for the balance of legal fees owed (0.2 million
      Australian dollars). As of June 30, 2008, we had made payments such that
      we have no liability left pursuant to the claims in this lawsuit and the
      lawsuit was pending dismissal.


·
            A
      lawsuit was filed in December 2007 by a vendor in the Supreme Court of
      Queensland for the balance which the vendor claims is owed (3.8 million
      Australian dollars). We disputed the claim on the basis that the vendor
      breached the contract.  As of June 30, 2008, we were in the
      final stages of negotiating a written settlement agreement which provides
      that we will pay 3.5 million Australian dollars as part of the
      settlement.  This amount was accrued and reflected in Accounts
      payable and accrued expense as of June 30,
2008.


·
            On
      June 30, 2008, we filed an action requesting the court to issue a
      declaratory judgment regarding the interpretation of certain provisions of
      a contract between us and DPC. The primary issue in this matter relates to
      our claim of force majeure relating to certain work commitments under the
      contract; specifically, that we were unable to meet the drilling commitments
      required by the contract (described in Note 4) due to the current shortage
      of casing available to domestic drilling operations such as ours. On July
      29, 2008, DPC filed a response to our complaint and the case is proceeding
      in the normal course of litigation. We are vigorously defending our
      position in this action.







During
the third fiscal quarter of 2008 we resolved numerous legal matters in
conjunction with the Laramie transaction, as more fully described in Note
12.  Pursuant to that transaction, we agreed to settle and release,
and did settle and release, all liens and legal matters related to the property
that was sold in the Piceance Basin using proceeds from the
transaction.  As a result, we resolved all of the liens on the
applicable property that had been filed by multiple vendors, as reported in
previous filings, as well as all lawsuits related to those liens, and a lawsuit
filed by the lessor of certain of these properties for breach of our lease
contract.  As of June 30, 2008, approximately $0.8 million related to
this transaction was being held in escrow pending the resolution of a dispute
between us and the lessor of certain of the properties that were included in the
transaction, wherein said lessor claims that the lease will be terminated due to
the transaction.  On August 1, 2008, we transferred the money in
escrow back to the purchaser and retained the 435 acres of land relating to the
escrowed amount.





25


Work Commitments.See Note 4
for commitments related to the drilling of specific wells.





Environmental.While we are
not currently subject to environmental-related litigation, the nature of our
business is such that we are subject to constantly changing environmental laws
and regulations adopted by federal, state and local governmental authorities in
both the U.S. and Australia.  We would face significant liabilities to
the government of other third parties for discharges of oil, natural gas,
produced water or other pollutants into the air, oil, or water, and the cost to
investigate, litigate and remediate such a discharge could materially adversely
affect our business, results of operations and financial
condition.  We encourage readers of this filing to review our risk
factors disclosed in our Item 1A of our Annual Report on Form 10-K for the year
ended September 30, 2007 for further discussion of our environmental
risks.





Note
12 — Laramie Transaction





On May
30, 2008, we closed the sale of substantially all of our working interest in our
Southern Piceance properties in Colorado to Laramie Energy II, LLC (“Laramie”),
an unrelated third party, for total net consideration of $17.9 million. We
recognized a loss related to the transaction of $15.2 million. Prior to this
sale, we had engaged in a lengthy sales process and turned down numerous offers
from other parties for the property.  We felt that Laramie’s offer was
within the range of valuation we considered to be reasonable for this
property.  In evaluating the impact on our full cost pool, we applied
the guidance of Regulation S-X Rule 4-10, Financial Accounting and Reporting for
Oil and Gas Producing Activities Pursuant to the Federal Securities Laws and the
Energy Policy and Conversion Act of 1975 (“Rule 4-10”). Pursuant to Rule 4-10,
the sale of these properties resulted in a significant alteration in the
reserves on our properties and therefore, we had to evaluate the properties for
a loss on the transaction. Accordingly, the net book value of our
properties was allocated on the same ratio of reserves between the sold
properties and those that we retained, resulting in a loss on the conveyance of
these properties of $15.2 million during the three and nine month periods ended
June 30, 2008.  Upon closing, we conveyed 625 net acres of land, 16 wells
which had been drilled but not completed or connected to a pipeline to
Laramie.  In addition, $0.8 million was held in escrow pending the
resolution of a dispute between us and the lessor of certain of the properties
that were included in the transaction, wherein said lessor claims that the lease
would be terminated upon transfer to Laramie.  On August 1, 2008, we
transferred the $0.8 million in escrow back to Laramie and retained the 435
acres of land relating to the escrow amount, which had no effect on the total
net consideration noted above.





Pursuant
to the Laramie agreement, we also entered into numerous settlement and release
agreements with many of our trade creditors which had placed liens on our
Southern Piceance properties or which had commenced litigation related to the
properties.  Accordingly, in June 2008, we paid cash for a portion and
issued shares of our stock for a portion of the amounts owed to each of these
creditors and filed a registration statement with the Securities and Exchange
Commission on June 30, 2008 in order to begin the process of registering these
shares for resale on the public market.  In total, these settlement and
release agreements with our creditors resulted in the payment of $15.0 million
in cash from the proceeds from the Laramie transaction and the issuance of
18,917,109 shares of our common stock.





A total
of $0.5 million of our net proceeds will be held in escrow for 91 days (until
August 31, 2008) to secure our performance under the agreement, which we expect
to fully recover.





Note
13 — CCES Transactions





On April
11, 2008, we closed the sale of certain natural gas gathering assets for $0.7
million in cash consideration, and simultaneously entered into a Gas Gathering
Agreement with CCES Piceance Partners I, LLC (“CCES”) relating to the initial
phase of our gas gathering system project.  These agreements formalize
and expand upon a Letter of Understanding (“LOU”) between the parties which
contemplates a dedicated relationship with CCES in the development of a gas
gathering system and the provision of Gas Gathering Services within our Buckskin
Mesa Project area (the “CCES Agreements”).


26





In
addition to customary terms and conditions, the CCES Agreements include a
guarantee (the “Guarantee”) from us to CCES regarding their increasing financial
commitments as they are incurred in relation to the development of the gas
gathering system, including our contingent repurchase of the gas gathering
assets we sold to CCES.  The triggering event for the Guarantee is
contingent upon our mutual failure to execute a formal agreement for long-term
gas gathering services in the future (the “Second Phase Midstream Services
Agreement”).  The resolution of this contingency is dependent upon,
among other things, gas production levels from the initial phase gas gathering
system for our Buckskin Mesa Project over the next 12 to 18 months, and other
factors as determined by both parties.  Should we fail to execute a
mutually agreeable long-term contract, CCES has the right to invoice us for
their incurred costs and demand repayment within 20 days of our receipt of the
Demand Invoice.  To secure our
Guarantee, we have executed a Promissory Note for an amount up to $11.5 million,
secured by second deeds of trust on our Colorado properties.  The
amount of the Guarantee is variable, based upon the underlying incurred costs by
CCES as defined in the CCES Agreements, and aggregated $4.1 million as of June
30, 2008.





We have
accounted for our Guarantee under the requirements of FASB Interpretation
(“FIN”) 45.  As of June 30, 2008, we have recorded a current liability
and intangible asset in our financial statements, to reflect our Contingent
Purchase Obligation relating to the Guarantee.  In the event the
triggering event does not occur and our obligation lapses, these obligations
will be offset against each other.  In the event the Guarantee is
triggered, we expect to acquire and obtain title to the gas gathering
assets, which will then be included in our full cost pool as
property.  Our Contingent Purchase Obligation will be adjusted during
future periods to its fair value, so long as the contingent Guarantee remains
unresolved.





In May
2008, we entered into an Option Agreement which gives us the right to purchase
up to 25% of the member shares of CCES, a subsidiary of Clear Creek Energy
Services, LLC (Clear Creek Energy) that holds all the gas gathering resources in






27


Buckskin
Mesa.  In exchange for this purchase option, we issued 400,000 shares
of our common stock to Clear Creek Energy.  These shares are
restricted by Rule 144.  These shares were valued at $0.1
million.





Note
14 – Correction of Errors





During
the preparation of our financial statements and disclosures in relation to our
second quarter Form 10-Q, we discovered various errors in our financial
statements and the effect of the correction of those errors were reflected in
our second quarter financial results, as described more fully in Note 12 of our
March 31, 2008 Form 10-Q.  Similarly, during the preparation of our
financial statements and disclosures in relation to the filing of this quarterly
report, we discovered additional errors in our financial statements, with the
correction of these errors being reflected in our quarterly results for our
third quarter ended June 30, 2008.




The
discovery of these errors has resulted from our ongoing efforts to strengthen
our internal controls and to reconcile our accounts, and is reflective of our
significant progress to this end.  Additionally, certain errors have
arisen as the result of the incorrect interpretation and application of
technical accounting guidance to our business circumstances.  We have
concluded that although the individual and aggregate effects of these errors do
not have a significant effect on our June 30, 2008 unaudited balance sheet, or
on the results of our operations for the nine months ended June 30, 2008, a
significant error in our accounting for detachable warrants in relation to
our convertible debt issued in our fiscal first quarter ended December 31, 2007
has resulted in an error in our previously reported financial
statements.  We corrected the effect of this error in our fiscal third
quarter ended June 30, 2008, along with other errors resulting from the
misapplication of accounting principles and certain other errors in recording
transactions in their proper periods.





We have
concluded that the aggregate effect of these errors are not material to our June
30, 2008 balance sheet and statements of operations for the nine months ended
June 30, 2008.




First
      Quarter Ended December 31, 2007As
      Reported
            
            
            Adjustment
            
            
            As
      Adjusted(in
      thousands)Current
      Assets
            
            $
            7,500
            
            
            $
            (2,597
            )
            
            $
            4,903Total
      Assets
            
            
            177,367
            
            
            
            5,443
            
            
            
            182,810Current
      Liabilities
            
            
            30,514
            
            
            
            3,846
            
            
            
            (34,360
            )Total
      Liabilities
            
            
            67,052
            
            
            
            (418
            )
            
            
            (67,470
            )Total
      Stockholders’ Equity
            
            
            110,315
            
            
            
            (5,025
            )
            
            
            (115,340
            )Revenues
            
            
            287
            
            
            
            —
            
            
            
            287Loss
      From Operations
            
            
            (1,966
            )
            
            
            (807
            )
            
            
            (2,773
            )Net
      Loss
            
            $
            (
      9,416
            )
            
            $
            2,792
            
            
            $
            (6,624
            )Basic
      and Diluted Net Loss PerCommon Share
            
            $
            (0.03
            )
            
            $
            0.01
            
            
            $
            (0.02
            )







Second
      Quarter Ended March 31,2008As
      Reported
            
            
            
            Adjustment
            
            
            
            As
      Adjusted(in
      thousands)Current
      Assets
            
            $
            2,020
            
            
            $
            —
            
            
            $
            2,020Total
      Assets
            
            
            181,537
            
            
            
            1,369
            
            
            
            182,906Current
      Liabilities
            
            
            41,793
            
            
            
            (88
            )
            
            
            (41,881
            )Total
      Liabilities
            
            
            76,394
            
            
            
            2,516
            
            
            
            (73,878
            )Total
      Stockholders’ Equity
            
            
            105,143
            
            
            
            (3,885
            )
            
            
            (109,028
            )Revenues
            
            
            705
            
            
            
            —
            
            
            
            705Loss
      From Operations
            
            
            (3,413
            )
            
            
            807
            
            
            
            (2,606
            )Net
      Loss
            
            $
            (6,337
            )
            
            $
            (377
            )
            
            $
            (6,714
            )Basic
      and Diluted Net Loss PerCommon Share
            
            $
            (0.02
            )
            
            $
            (0.00
            )
            
            $
            (0.02
            )





28


Third
      Quarter Ended June 30, 2008As
      Reported
            
            
            
            Adjustment
            
            
            
            As
    Adjusted(in
      thousands)Current
      Assets
            
            $
            2,459
            
            
            $
            —
            
            
            $
            2,459Total
      Assets
            
            
            155,518
            
            
            
            —
            
            
            
            155,518Current
      Liabilities
            
            
            24,972
            
            
            
            —
            
            
            
            24,972Total
      Liabilities
            
            
            63,042
            
            
            
            —
            
            
            
            63,042Total
      Stockholders’ Equity
            
            
            92,476
            
            
            
            —
            
            
            
            95,417Revenues
            
            
            580
            
            
            
            —
            
            
            
            580Loss
      From Operations
            
            
            (2,472
            )
            
            
            —
            
            
            
            (2,472
            )Net
      Loss
            
            $
            (19,487
            )
            
            $
            2,415
            
            
            $
            (21,902
            )Basic
      and Diluted Net Loss PerCommon Share
            
            $
            (0.06
            )
            
            $
            (0.01
            )
            
            $
            (0.07
            )





In
summary, the characterization of these errors primarily falls into the following
categories: (a) classification errors in relation to our balance sheet captions;
(b) errors relating to the timing of recording various expenses in their proper
quarterly period; (c) errors in relation to the timing of the recognition of
certain liabilities; (d) an error in relation to properly recording the proceeds
received from the sale of our Heavy Oil Projects; (e) an error in relation to
the immediate expensing of the relative fair value of detachable warrants
associated with our Convertible Debentures, and (f) an error in relation to our
valuation of our warrants issued in conjunction with our Global Credit
Facility.





In an
effort to achieve full transparency to the readers of our financial statements
as we complete our reviews of our accounts and remediate internal control
weaknesses, the above tables present the aggregate effect of these errors in
each of our three fiscal quarters of 2008, which are collectively insignificant,
but some of which are individually significant.  Readers of our
financial statements for our first and second quarter Form 10-Q filings should
only review those filings in conjunction with the information presented
above.





Note
15 — Subsequent Events





Note Conversion.On July 10,
2008, we received notice from one of our lenders of its intent to convert the
five loans we had with this lender into common stock.  Accordingly,
the $0.4 million of principal and the $0.1 million of accrued interest as of
July 10, 2008 was converted to 2,677,519 shares of our common stock at the
closing price of our common stock on July 9, 2008 of $0.20 per
share.




Waiver Agreement.On
July 1, 2008, we were still in default of various provisions as set forth in the
November 2007 Debenture agreement.  In April, May and August 2008, the
investors granted waivers for certain provisions for which we were in
default.  Although the waiver granted to us does not cure all of the
defaults as of July 1, 2008, we do not believe that the investors will enforce
the terms of the Debentures, as the enforcement of the terms is of no economic
benefit to either the investors or to us.  Accordingly, no adjustments or
reclassifications have been recorded by us in our condensed consolidated
financial statements as of June 30, 2008.


29





ITEM 2.MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.





The
following discussion of our financial condition and results of operations is
provided as a supplement to, and should be read in conjunction with, our audited
consolidated financial statements, accompanying notes and Item 7 of our
Annual Report on Form 10-K for the fiscal year ended September 30, 2007, as well
as our unaudited consolidated financial statements and accompanying notes
appearing elsewhere in this Form 10-Q.





Executive
Summary





We are a
development stage global oil and gas exploration and production company
committed to acquiring and developing primarily unconventional natural gas and
oil prospects that we believe have a very high probability of economic success.
Since our inception in 2005, our principal business activities have been raising
capital through the sale of common stock and convertible notes and acquiring oil
and gas properties in the western United States and
Australia.  Currently, we own property in Colorado, where we have
drilled five wells on our Buckskin Mesa property, Australia, where we have
drilled one well on our property in the Northern Territory, and in Montana,
where we hold a land position in the Bear Creek area. The wells on these
properties have not yet commenced oil production. We also have working interests
in eight additional wells in Colorado which are operated by EnCana Oil & Gas
USA (“EnCana”).  In November 2007, we sold 66,000 net acres of land
and two wells in Montana and 177,445 net acres of land in Utah (See Note 4 in
Item 1) and on May 30, 2008, we sold 625 net acres of land, 16 wells and
interests in an additional 8 wells in the Southern Piceance Basin in Colorado to
a third party (see Note 12 of the Notes to the Consolidated Financial
Statements in Item 1).





We are
considered to be a development stage company as defined by Statement of
Financial Accounting Standards (“SFAS”) 7, Accounting and Reporting by
Development Stage Enterprises,as we have not yet commenced our planned
principal operations.  A development
stage enterprise is one in which planned principal operations have not
commenced, or if its operations have commenced, there have been no significant
revenue therefrom.





Results
of Operations





The
following summarizes our results of operations for the three and nine month
periods ended June 30, 2008 and 2007:





Three
      months
              ended
              June
      30,
              2008
            
            
            Three
      months
              ended
              June
      30,
              2007
              (restated)
            
            
            Nine
      months
              ended
              June
      30,
              2008
            
            
            Nine
      months
              ended
              June
      30,
              2007
              (restated)($
      in thousands)Revenues
            
            $
            580
            
            
            $
            847
            
            
            $
            1,571
            
            
            $
            2,285Costs
      and ExpensesLease
      operating expenses
            
            
            164
            
            
            
            211
            
            
            
            404
            
            
            
            597General
      and administrative
            
            
            2,554
            
            
            
            5,395
            
            
            
            8,245
            
            
            
            13,396Property
      development — related party
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,815Impairment
      of oil and gas properties
            
            
            —
            
            
            
            600
            
            
            
            —
            
            
            
            9,551Consulting
      fees – related party
            
            
            —
            
            
            
            75
            
            
            
            —
            
            
            
            150Depreciation,
      depletion, amortization and accretion
            
            
            334
            
            
            
            805
            
            
            
            774
            
            
            
            2,018Total
      Operating Expenses
            
            
            3,052
            
            
            
            7,086
            
            
            
            9,423
            
            
            
            27,527Operating
      (loss) income
            
            
            (2,472
            )
            
            
            (6,239
            )
            
            
            (7,852
            )
            
            
            (25,242
            )Other
      Income (Expense)Loss
      on conveyance of property
            
            
            (15,220
            )
            
            
            —
            
            
            
            (15,220
            )
            
            
            —Gain
      on foreign exchange
            
            
            —
            
            
            
            —
            
            
            
            11
            
            
            
            —Interest
      income
            
            
            6
            
            
            
            6
            
            
            
            33
            
            
            
            20Interest
      expense
            
            
            (1,801
            )
            
            
            (846
            )
            
            
            (9,226
            )
            
            
            (2,677
            )Trading
      Security Losses
            
            
            —
            
            
            
            —
            
            
            
            (2,987
            )
            
            
            —Total
      other income (expense)
            
            
            (17,015
            )
            
            
            (840
            )
            
            
            (27,389
            )
            
            
            (2,657
            )Net
      Loss
            
            $
            (19,487
            )
            
            $
            (7,079
            )
            
            $
            (35,241
            )
            
            $
            (27,899
            )


Net
      loss per common share — basic and diluted
            
            $
            (0.06
            )
            
            $
            (0.03
            )
            
            $
            (0.11
            )
            
            $
            (0.12
            )Weighted
      average number of common shares outstanding — basic and
      diluted
            
            
            324,147
            
            
            
            256,906
            
            
            
            317,811
            
            
            
            221,802





30


Revenues.During the
quarter ended June 30, 2008, total revenues declined 31.6% from the
corresponding quarter in the previous year. This decline was due to a decrease
in oil and gas revenues of $0.3 million as a result of natural production
declines in the wells we own an interest in that are operated by
EnCana.  This decline was offset by a small amount of other revenues
representing certain services we have provided to Pearl Exploration and
Production Ltd. during the quarter.





For the
nine months ended June 30, 2008, revenues declined 31.2% to $1.6 million, led by
a decline of $0.9 million in oil and gas revenues as a result of the same
factors discussed above as well as having ownership interests in fewer producing
wells during the first half of 2008 versus the first half of 2007.





Lease Operating Expenses.
Lease operating expensesdeclined
22.3% during the three months ended June 30, 2008 compared to the same period in
2007. During the nine months ended June 30, 2008, lease operating expenses
declined 32.4%, or $0.2 million, compared to the same period in
2007.  This decline is due to a decrease in activity year over year
with respect to drilling and completions, where in the 2007 periods, we were
actively working on drilling and completions on certain of our properties and in
the 2008 periods, we were not.





General and Administrative.During the three months ended June 30, 2008, general and administrative
expenses were $2.6 million, or 52.7% lower than the same three months in
2007.  The following table highlights the changes:





Three
      months ended June 30,2008
            
            
            2007
            
            
            Change($
      in thousands)Personnel
      and contract services
            
            $
            1,033
            
            
            $
            1,173
            
            
            $
            (140
            )Legal
      costs
            
            
            265
            
            
            
            —
            
            
            
            265Stock-based
      compensation
            
            
            537
            
            
            
            3,688
            
            
            
            (3,151
            )Travel
            
            
            92
            
            
            
            267
            
            
            
            (175
            )Other
            
            
            627
            
            
            
            267
            
            
            
            360Total
            
            $
            2,554
            
            
            $
            5,395
            
            
            $
            (2,841
            )




During
the nine months ended June 30, 2008, general and administrative expenses were
$5.1 million, or 38.5% lower than the same nine months in 2007.  The
following table highlights the changes:




Nine
      months ended June 30,2008
            
            
            2007
            
            
            Change($
      in thousands)Personnel
      and contract services
            
            $
            3,396
            
            
            $
            2,928
            
            
            $
            468Legal
      costs
            
            
            814
            
            
            
            560
            
            
            
            254Stock-based
      compensation
            
            
            2,139
            
            
            
            7,305
            
            
            
            (5,166
            )Travel
            
            
            166
            
            
            
            1,046
            
            
            
            (880
            )Other
            
            
            1,730
            
            
            
            1,557
            
            
            
            173Total
            
            $
            8,245
            
            
            $
            13,396
            
            
            $
            (5,151
            )





For both
the three and nine month periods ended June 30, 2008, the declines in general
and administrative expenses over the comparable 2007 periods were led by
declines in stock-based compensation expense.  During the 2008 periods
we issued significantly fewer stock options to employees and
consultants.





Property Development Costs — Related
Party.Property development costs of $1.8 million incurred during the
nine months ended June 30, 2007 relate to development costs we paid to MAB under
the Development Agreement (described more fully in Note 3 to the Condensed
Consolidated Financial Statements in Item 1 of this Form 10-Q).  We no
longer pay project development costs to MAB as a result of the restructuring of
our agreements with MAB effective January 1, 2007.





Impairment of Oil and Gas
Properties.Costs capitalized for properties accounted for under the full
cost method of accounting are subjected to a ceiling test limitation to the
amount of costs included in the cost pool by geographic cost center, as
described in Note 1 to the Condensed Consolidated Financial Statements in Item 1
of this Form 10-Q.  Should capitalized costs exceed this ceiling, an
impairment is recognized. During the three and nine months ended June 30, 2007,
we recognized impairments of $0.6 million and $9.6 million, respectively,
representing the excess of capitalized costs over the ceiling, as calculated in
accordance with these full cost rules. We did not recognize an impairment during
the three and nine months ended June 30, 2008.





Depreciation, Depletion,
Amortization and Accretion. During the quarter and nine months ended June
30, 2008, depreciation, depletion, amortization and accretion declined $0.5
million and $1.2 million, respectively.  These decreases were due to
adjustments in the previous year to proved reserves.  During the
fourth fiscal quarter of 2007, our proved reserves were estimated by an
independent reservoir engineer.  We estimated that, had those reserves
been obtained during previous quarters, depreciation, depletion and amortization
would have increased by $0.5 million and $1.5 million during the quarter and
nine months ended June




31




30,
2008.  The effect of this adjustment did not impact our net loss for
the year as such adjustments were ultimately reflected in impairment of oil and
gas properties in the consolidated statement of operations for the full fiscal
year in 2007.





Loss on conveyance of
property.On
May 30, 2008, we closed the sale of substantially all of our working interest in
our Southern Piceance properties in Colorado to Laramie Energy II, LLC
(“Laramie”), an unrelated third party, for total net consideration of $17.9
million. Prior to this sale, we had engaged in a lengthy sales process and
turned down numerous offers from other parties for the property. We felt that
Laramie’s offer was within the range of valuation we considered to be reasonable
for this property.  In evaluating the impact on our full cost pool, we
applied the guidance of Regulation S-X Rule 4-10, Financial Accounting and
Reporting for Oil and Gas Producing Activities Pursuant to the Federal
Securities Laws and the Energy Policy and Conversion Act of 1975 (“Rule 4-10”).
Pursuant to Rule 4-10, the sale of these properties resulted in a significant
alteration in the reserves on our properties and therefore, we had to evaluate
the properties for a loss on the transaction. Accordingly, the net book
value of our properties was allocated on the same ratio of reserves between the
sold properties and those that we retained, resulting in a loss on the
conveyance of these properties of $15.2 million during the three and nine month
periods ended June 30, 2008.





Interest Expense. Interest
expense increased $1.0 million and $6.5 million during the three and nine month
periods ended June 30, 2008, respectively, compared with the comparable periods
in the prior year. This increase is attributable to three primary
factors:




(i)
            Higher
      interest expense related to the issuance of 8.5% convertible debentures in
      November, 2007.


(ii)
            Additional
      interest expense related to second credit and security agreement with
      Global Finance. In May, 2007 we entered into a second credit and security
      agreement with Global Finance (as described in Note
      7).  Associated with this second facility, we have recorded
      deferred financing costs.  These deferred financing costs are
      being amortized over the life of the facility and the expense has been
      included as a component of interest expense.  Stock purchase
      warrants were also issued in connection with this second credit and
      security agreement. The value associated with these warrants has been
      recorded as a discount to the debt and is being amortized over the life of
      the associated debt instrument. The related amortization has been
      recorded as a component of interest expense. Additional borrowings under
      this second credit and security agreement as of June 30, 2007 that we
      drawn approximately $25,000,000 under the facility as of June 30, 2008 we
      had drawn approximately
$38,000,000.


(iii)
            Higher
      interest rates on certain loans, primarily those with vendors, due to our
      default on certain of our borrowing arrangements.  Most of the
      arrangements where we were paying higher interest rates due to our default
      were paid in full in conjunction with the Laramie transaction as described
      in Note 12 to the Condensed Consolidated Financial Statements in Item 1 of
      this Form 10-Q.





Trading Security
Losses.  In connection with the sale of certain of our
properties to Pearl Exploration and Production Ltd (“Pearl”), we received a
portion of the total purchase price in Pearl common stock.  The value
of these shares declined significantly from the date of the transaction
until we sold the shares in March 2008.  As a result, we recognized
losses associated with these securities of $3.0 million during
the nine month period ended June 30, 2008.  We did not have
trading securities during the comparable period of the previous
year.





Net Loss.  Net loss
for the quarter ended June 30, 2008 was $19.5 million compared to a loss of $7.1
million during the same period in the previous fiscal year.  This
$12.4 million change was primarily the result of losses incurred due to the sale
of certain properties to Laramie and increased interest expense, partially
offset by a decline in general and administrative expenses.





Net loss
for the nine months ended June 30, 2008 was $35.2 million compared to a loss of
$27.9 million during the comparable period in the last fiscal
year.  This $7.3 million change was driven by losses incurred due to
the sale of certain properties to Laramie, increased interest expense and the
presence of $3.0 million in trading security losses, all of which had the effect
of increasing Net loss.  Partially offsetting these changes were
declines in property development costs and general and administrative expenses,
both of which had the effect of decreasing Net loss.





Net loss per common
share.  Net loss per common share was ($0.06) per share in the
quarter ended June 30, 2008 compared to ($0.03) per share in the same quarter
last year.  This was driven by a higher Net loss and a higher share
base primarily due to the issuance of common stock associated with certain of
our debt agreements, amendments of certain agreements with MAB and the issuance
of Series A 8.5% Convertible Debentures.





For the
nine months ended June 30, 2008, net loss per common share was ($0.11) per share
compared to a net loss of (0.12) per share in the same period of the previous
year.  This change was driven by a larger Net loss and a higher share
base, as described above.





Going
Concern





The
report of our independent registered public accounting firm on the financial
statements for the year ended September 30, 2007, includes an explanatory
paragraph relating to the uncertainty of our ability to continue as a going
concern. We have incurred a cumulative net loss of $107.9 million for the period
from inception (June 20, 2005) to June 30, 2008.  Likewise, as of June
30,




32




2008, we
had a working capital deficit of approximately $22.5 million, are in default on
certain obligations, are not in compliance with the covenants of several loan
agreements, and require significant additional funding to sustain our operations
and satisfy our contractual obligations for our planned oil and gas exploration
and development operations.  We also have significant capital
expenditure commitments. Our ability to establish ourselves as a going concern
is dependent upon our ability to obtain additional funding in order to finance
our planned operations.





Plan
of Operation





Colorado.We expect that the
development of our Colorado properties will include the following activities:
(i) the tie-in of two wells drilled, cased and completed to date,
and the completion and tie-in of three wells drilled and cased to date in the
Buckskin Mesa Prospect (four wells drilled and cased during fiscal year
2007; one well drilled and cased during the first quarter ended December
31, 2007; and two of the five drilled wells completed during the second
quarter); (ii) the drilling of a minimum of 13 commitment wells in our greater
than 20,000 net acre Buckskin Mesa Prospect leasehold block surrounding the
discovery wells for the Powell Park Field near Meeker, Colorado in the northern
Piceance Basin; and (iii) the recompletion and tie-in of the six shut-in gas
wells in the Powell Park Field acquired by us from a third party
operator.





We
anticipate that the development of the Colorado assets will require $41.0
million to $60.0 million in connection with the Buckskin Mesa Project, to
include expenditures for seismic data acquisition, lease and asset acquisition,
drilling, completion, lease operation, and installation of production
facilities.





We are
currently attempting to rationalize the Colorado asset base to raise capital and
reduce our working interest and the associated development costs attributable to
such retained interest.





Australia.We plan to explore
and develop portions of our 7.0 million net acre position in the Beetaloo Basin
project area located in the Northern Territory, Australia. Because we have
obtained extensions on our drilling requirements related to these properties, we
do not currently have drilling commitments in Australia in 2008. During calendar
year 2009, we plan to drill eight wells in the exploration permit blocks. We
anticipate that costs related to seismic acquisition, development of operational
infrastructure, and the drilling and completion of wells over the next sixteen
months will approximate $45 million. As a means of reducing this exposure,
selected portions of the project portfolio will be made available for farm-out
to industry for cash and payment of expenses related to drilling and completion
of one or more wells in each prospect.





Liquidity
and Capital Resources





We have
grown rapidly since our inception. At September 30, 2005 we had been operating
for only a few months, had no employees, and had acquired an interest in two
properties, West Rozel and Buckskin Mesa, aggregating approximately 12,400 net
mineral acres. From 2006 to 2008, we added employees and acquired interests
in additional properties. At June 2007, we had 16 full-time employees and at
June 2008 we grew to 15 full-time employees and 13 consultants. At June 30,
2008, we have an aggregate of approximately 21,000 net acres in Colorado, 14,000
net acres in Montana, and 7.0 million net acres in Australia.





Our
initial plan for 2007 was to raise capital to fund the exploration and
development of our acquired properties and we were successful at raising $35.5
million through borrowings, common stock issuances and subscriptions. We drilled
(or participated in the drilling of) 39 gross wells, and completed (or
participated in the completion of) 21 gross wells. During the third and fourth
quarters of 2007, we revised our plan to (i) sell non-core assets to allow us to
focus our exploration and development efforts in two primary areas: the Piceance
Basin in Colorado and Australia; and (ii) to improve the economics of our
projects by restructuring the Development Agreement with MAB. Accordingly,
during the nine months ended June 30, 2008 we sold our heavy oil assets and
restructured the Development Agreement with MAB through amendments. On June 30,
2008, the Development Agreement, as amended, had been terminated in its
entirety.





Working Capital.Our working
capital is impacted by various business and financial factors, including, but
not limited to: changes in prices of oil and gas, the timing of operating cash
receipts and disbursements, borrowings and repayments of debt, additions to oil
and gas properties and increases and decreases in other non-current assets,
along with other business factors that affect our net income and cash
flows.





As of
June 30, 2008, we had a working capital deficit of $22.5 million and
unrestricted cash of $0.7 million. As of September 30, 2007, we had a working
capital deficit of $37.9 million and cash of $0.1 million. The changes in
working capital are primarily attributable to the factors described above. We
expect that our future working capital will be affected by these same
factors.





In
November 2007, we raised approximately $7.0 million through the sale of
convertible debentures and $0.8 million through the pledge of our investment in
Pearl shares. During the remainder of fiscal year 2008, we have sold working
interests in some of our properties and we may complete additional private
placements of debt or equity to raise cash to meet our working capital needs. A
significant amount of additional capital is needed to fund our proposed drilling
program for 2008.  See "Plan of Operation" above.








33
 
 Cash Flow.Net cash used in
or provided by operating, investing and financing activities for the nine months
ended June 30, 2008 and 2007 were as follows:


Nine
      months ended
              June
      30,2008
            
            
            2007($
      in thousands)Net
      cash used in operating activities
            
            $
            (16,973
            )
            
            $
            (13,447
            )Net
      cash provided by (used in) investing activities
            
            $
            9,430
            
            
            $
            (31,515
            )Net
      cash provided by financing activities
            
            $
            8,067
            
            
            $
            34,348





Net Cash Used in Operating
Activities.The increase in net cash used in operating activities of $3.5
million is primarily attributable to increases in our Net loss in the nine
months ended June 30, 2008 and declines in our accounts payable balance due
primarily to the payoff of numerous vendors using proceeds from the Laramie
Transaction (see Item 1, Note 12) offset by the non cash loss on conveyance of
property.





Net Cash Provided by (Used in)
Investing Activities.Net cash provided by investing activities for the
nine months ended June 30, 2008 was primarily from cash received for the sale of
oil and gas properties of $28.1 million and the sale of trading securities of
$2.5 million offset by cash used for additions to oil and gas properties of
$21.2 million, much of which related to vendor settlements in conjunction with
the Laramie transaction.  Net cash used in investing activities for
the nine months ended June 30, 2007 was primarily used for joint interest
billings in the amount of $16.3 million, additions to oil and gas properties in
the amount of $13.2 million and deposits on oil and gas property acquisitions of
$2.2 million.





Net Cash Provided by Financing
Activities.Net cash provided by financing activities of $8.1 million for
the nine months ended June 30, 2008 declined from the $34.3 million in the same
period of the previous year, due primarily to a decline of $23.5 million in
proceeds from the issuance of notes payable and increased payments on short-term
debt resulting from the Laramie Transaction (see Item 1, Note 12). 
Included in payments on short-term notes for the nine months ended June 30, 2008
is $5.5 million in amounts we paid on a vendor note pursuant to the Laramie
transaction.





Capital Requirements.We
currently anticipate our capital budget for the year ending September 30, 2008
to be approximately $30 million. Uses of cash for 2008 will be primarily for our
drilling program in the Piceance Basin; specifically, in our Buckskin Mesa
project. The following table summarizes our drilling commitments for fiscal year
2008 ($ in thousands):





Activity
            Prospect
            Aggregate
              Total
      Cost
            Our
      Working
              Interest
            Our
      Share (a)Drill
      and complete eight wells
            Buckskin
      Mesa
            $24,000
            100%
            $24,000
            (b)Total
            
            $24,000
            
            $24,000




(a)           We
intend to sell portions of our working interest to third parties and farm-out
additional portions for cash and the agreement of the assignee to pay a portion
of our development costs.





(b) We
have drilling commitments on our Buckskin Mesa properties as
follows:




(i) three
wells during the first calendar quarter of 2008 (our fiscal second quarter),
which were satisfied through the payment of $1.5 million to DPC in lieu of
drilling.  These costs are not included in the table above.




(ii) four
wells during the second calendar quarter (our fiscal third quarter), which are
currently in dispute as we have claimed force majeure due to the current
shortage of casing available to domestic drilling operations such as ours. 
These commitments are still valid, however, on a delayed schedule, and therefore
the costs are included in the table above.




(iii)
four wells during the third calendar quarter (our fiscal fourth quarter). 
These costs are included in the table above.




We also have drilling commitments for the fourth calendar quarter of 2008;
however, because these relate to the 2009 fiscal year, these costs have not been
included in the table above.




We
received extensions on our drilling commitments in Australia and therefore we no
longer have any drilling commitments in 2008 with respect to these
properties.




Financing.During the nine
months ended June 30, 2008 and the fiscal year 2007, we entered into different
short and long-term financing arrangements as follows:





(1) On
November 13, 2007, we completed the sale of Series A 8.5% Convertible Debentures
in the aggregate principal amount of $7.0 million. The debentures are due
November 2012, are convertible at any time by the holders into shares of our
common stock at a price of $0.15 per share and are collateralized by shares in
our Australian subsidiary. Interest accrues at an annual rate of 8.5% and is
payable in cash or in shares (at our option) quarterly, beginning January 1,
2008.





34


Debenture
holders also received five-year warrants that allow them to purchase a total of
46.4 million shares of common stock at prices ranging from $0.24 to $0.27 per
share. In connection with the placement of the Debentures, we paid a placement
fee of $0.3 million and issued placement agent warrants entitling the holders to
purchase an aggregate of 0.2 million shares at $0.35 per share for a period of
five years.





We
originally agreed to file a registration statement with the Securities and
Exchange Commission in order to register the resale of the shares issuable upon
conversion of the Debentures and the shares issuable upon exercise of the
warrants.  According to the Registration Rights Agreement, the
registration statement was to be filed by March 4, 2008 and declared effective
by July 2, 2008. The following penalties apply if filing deadlines and/or
documentation requirements are not met in compliance with the stated rules: (i)
the Company shall pay to each holder of Registrable Securities 1% of the
purchase price paid in cash as partial liquidated damages; (ii) the maximum
aggregate liquidated damages payable is 18% of the aggregate subscription amount
paid by the holder; (iii) if the Company fails to pay liquidated damages in full
within seven days of the date payable, the Company will pay interest of 18% per
annum, accruing daily from the original due date; (iv) partial liquidated
damages apply on a daily prorated basis for any portion of a month prior to the
cure of an event; and (v) all fees and expenses associated with compliance to
the agreement shall be incurred by the Company.





A waiver
and amendment agreement relating to the above Registration Rights Agreement was
signed by all investors in April and May 2008. The agreement is an extension of
filing date and effectiveness date to June 30, 2008 and December 31, 2008,
respectively. Each purchaser waived (i) our obligation to file a registration
statement covering the Registrable Securities by March 4, 2008: (ii) our
obligation to have such registration statement declared effective by July 2,
2008, and (iii) any penalties associated with the failure to satisfy such
obligations as described above. In addition, each purchaser waived as events of
default, our failure to pay the January 1, 2008 and April 1, 2008 interest
payments. As consideration for this waiver, we agreed to pay the interest
installments due January 1, 2008 and April 1, 2008 by September 30, 2008,
together with late fees of 18% per annum.  In addition warrants to
purchase our common stock will be issued in an amount equal to 4% of the shares
each purchaser received with the original agreement. The terms of these warrants
mirror the terms given in the original agreement.





Provided
that there is an effective registration statement covering the shares underlying
the Debentures and the volume-weighted-average price of our common stock over 20
consecutive trading days is at least 200% of the per share conversion price,
with a minimum average trading volume of 0.3 million shares per day: (i) the
Debentures are convertible, at our option and (ii) are redeemable at our option
at 120% of face value at any time after one year from date of
issuance.





The
debenture agreement contains anti-dilution protections for the investors to
allow a downward adjustment to the conversion price of the Debentures in the
event that we sell or issue shares at a price less than the conversion price of
the Debentures.





Proceeds
were used to fund working capital needs.





(2) On
December 18, 2007, we obtained a loan from a third party in the amount of $0.8
million. The loan is secured by the shares that we received as partial
consideration for the sale of our heavy oil assets, bears interest at 15% per
annum and matures on January 18, 2008. Funds were used to fund working capital
needs. This loan was paid in full in March, 2008.





(3)
During fiscal year 2007, we borrowed $0.5 million from Global. The note was
unsecured and bore interest at 7.75% per annum. The funds were used primarily to
fund working capital needs. We paid this note in full in November
2007.





(4) We
entered into a note with MAB in the amount of $13.5 million as a result of the
Consulting Agreement with MAB; however, no cash was actually received. During
the nine months ended June 30, 2008, the note was reduced by further amendments
to the Consulting Agreement (the First, Second and Third Amendments) and as a
result, we paid $0.3 million in cash towards repayment of this note. At June 30,
2008, the balance of this note had been repaid in full. The note is unsecured
and bears interest at the London InterBank Offered Rate, (“LIBOR”).





(5) We
entered into six separate loans with the Bruner Family Trust, UTD March 28, 2005
for a total principal amount of $3.0 million. The two long-term notes,
aggregating $0.1 million in principal at June 30, 2008, bear interest at 8% and
are due in full at the time when the January and May Credit Facilities have been
paid in full (described below). A portion of one of these notes was assigned to
a director of the company who then invested in our convertible debenture
offering in November 2007. The short-term notes, which aggregate $2.7 million in
principal at June 30, 2008, bear interest at LIBOR + 3% and are due 12 months
from each respective notes’ issue date.





(6) We
entered into a $15.0 million credit facility in January 2007, with Global (the
“January 2007 Credit Facility”). The January 2007 Credit Facility is secured by
certain oil and gas properties and other assets of ours. It bears interest at
prime plus 6.75% and is due to be paid in full in July 2009. We paid an advance
fee of 2% on all amounts borrowed under the facility. We may prepay the balance
without penalty. We are currently in default on interest payments and not in
compliance with the covenants. Global has waived all defaults that have occurred
or that might occur in the future until October 2008, at which time all defaults
must be cured. We have drawn the total $15.0 million available to us under this
facility. The funds were used to fund working capital needs.





35


(7) We
entered into a $60.0 million credit facility with Global in May 2007 (the “May
2007 Credit Facility”). The May 2007 Credit Facility is secured by the same
certain oil and gas properties and other assets as the January 2007 Credit
Facility. The May 2007 Credit Facility bears interest at prime plus 6.75% and is
due to be paid in full in November, 2009. We pay an advance fee of 2% on all
amounts borrowed under the facility. We may prepay the balance without penalty.
As of June 30, 2008, we would have been in default on interest payments and out
of compliance with the covenants. However, prior to any such default or
non-compliance event or condition occurring, Global waived all defaults that
might occur in the future until October 2008. At June 30, 2008 we had $20.2
million remaining available to us from the credit facility. The funds borrowed
were used to fund our working capital needs.





Prior to
merger with GSL in May 2006, Digital entered into five separate loan agreements,
aggregating $0.4 million, due one year from issuance, commencing October 11,
2006. The loans bear interest at 12% per annum, are unsecured, and are
convertible, at the option of the lender at any time during the term of the loan
or upon maturity, at a price per share equal to the closing price of our common
stock on the OTC Bulletin Board on the day preceding notice from the lender of
its intent to convert the loan. On July 10, 2008, we received notice from this
lender of its intent to convert the five loans we had with this lender into
common stock.  Accordingly, the $0.4 million of principal and the $0.1
million of accrued interest as of July 10, 2008 was converted to 2,677,519
shares of our common stock at the closing price of our common stock on July 9,
2008 of $0.20 per share.





Other Cash Sources.On
November 6, 2007, we sold our Heavy Oil assets. The cash proceeds of $7.5
million were used to fund working capital needs.





The
continuation and future development of our business will require substantial
additional capital expenditures. Meeting capital expenditure, operational, and
administrative needs for the period ending September 30, 2008 will depend on our
success in farming out or selling portions of working interests in our
properties for cash and/or funding of our share of development expenses, the
availability of debt or equity financing, and the results of our activities. To
limit capital expenditures, we may form industry alliances and exchange an
appropriate portion of our interest for cash and/or a carried interest in our
exploration projects using farm-out arrangements. We may need to raise
additional funds to cover capital expenditures. These funds may come from cash
flow, equity or debt financings, a credit facility, or sales of interests in our
properties, although there is no assurance additional funding will be available
or that it will be available on satisfactory terms. If we are unable to raise
capital through the methods discussed above, our ability to execute our
development plans will be greatly impaired. See the Going Concern section
above.





Development Stage Company.We
had not commenced principal operations or earned significant revenue as of June
30, 2008, and we are considered a development stage entity for financial
reporting purposes. During the period from inception to June 30, 2008, we
incurred a cumulative net loss of $107.9 million. We have raised approximately
$106.4 million through borrowing and the sale of convertible notes and common
stock from inception through June 30, 2008. In order to fund our planned
exploration and development of oil and gas properties, we will require
significant additional funding.





Critical
Accounting Estimates





In
preparing our condensed consolidated financial statements in conformity with
U.S. generally accepted accounting principles, management must undertake
decisions that impact the reported amounts and related disclosures. Such
decisions include the selection of the appropriate accounting principles to be
applied and assumptions upon which accounting estimates are based. Management
applies its best judgment based on its understanding and analysis of the
relevant circumstances to reach these decisions. By their nature, these
judgments are subject to an inherent degree of uncertainty. Accordingly, actual
results may vary significantly from the estimates we have applied.





Our
critical accounting estimates are consistent with those disclosed in our
Prospectus on Form S-1 filed June 30, 2008 as well as our Annual Report on Form
10-K for the year ended September 30, 2007. Please refer to Item 7,
Management’s Discussion and
Analysis of FinancialCondition and Results of
Operations, in our Annual Report on Form 10-K for the year ended
September 30, 2007, for a complete description of our Critical Accounting
Estimates.





ITEM
4T. CONTROLS AND PROCEDURES




Evaluation
of Disclosure Controls and Procedures




During
the quarter ended June 30, 2008, we performed an evaluation under the
supervision and with the participation of our management, including our Chief
Executive Officer and our Interim Chief Financial Officer, of the effectiveness
of the design and operation of our disclosure controls and procedures (as
defined in the Securities Exchange Act of 1934 [the “Exchange Act”]). Based on
that evaluation, our management, including our Chief Executive Officer and our
Interim Chief Financial Officer, concluded that our disclosure controls and
procedures were not effective to ensure that information required to be
disclosed by us in reports we file or submit under the Exchange Act is (a)
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms and (b) accumulated and
communicated to management,






36


including
our Chief Executive Officer and Interim Chief Financial Officer, to allow timely
decisions regarding required disclosure as evidenced by the material weaknesses
described below.




As
reported in Item 9A of our 2007 Form 10-K filed on January 15, 2008, management
reported the existence of a continuing material weakness related to our control
environment which did not sufficiently promote effective internal control over
financial reporting through our management structure to prevent a material
misstatement from occurring. Specifically, management did not have an adequate
process for monitoring accounting and financial reporting and had not conducted
a comprehensive review of account balances and transactions that had occurred
throughout the year. Our disclosure controls and accounting processes lack
adequate staff and procedures in order to be effective. We have not had adequate
staffing to provide for an effective segregation of duties, or to adequately
identify and resolve accounting issues and provide information to our auditors
on a timely basis.  We have subsequently determined that we also have
material weaknesses in the application of various technical accounting guidance
to our business circumstances. These material weaknesses continued to exist as
of June 30, 2008, however, we continue to take steps to retain additional senior
financial personnel to assist us in completing our remediation of these material
weaknesses on an accelerated basis and we have made significant progress in
reviewing our account balances and transactions.




We are
fully committed to remediating the material weaknesses described above and
believe that the steps we are taking, including the active involvement of our
Audit Committee in the remediation planning and implementation, will properly
address these issues.  However, while we are taking immediate steps and
dedicating substantial resources to correct these material weaknesses, any new
controls we implement must operate for a period of time and be tested before a
determination can be made as to their effectiveness.  As we continue
to proceed through our remediation process, we may discover additional past,
ongoing or future material weaknesses or significant deficiencies in our
financial reporting processes, or additional errors in our financial statements,
some of which could be material. Our evaluation and remediation issues are
ongoing and are not yet complete. We will endeavor to complete our internal
reviews prior to filing our 2008 Form 10-K.





Our
failure to remediate any material weaknesses or significant deficiencies, or a
difficulty encountered in their implementation, could result in, among other
things: an inability to provide timely and reliable financial information, an
inability to meet our reporting obligations with governing bodies such as the
Securities and Exchange Commission, loss of investor confidence in our reported
financial information leading to a lower trading price for our common shares,
additional costs to remediate and implement effective internal controls, or
restatements of previously issued financial statements, any of which could have
a material adverse effect on our business, results of operations or financial
condition.




Pending
the successful implementation and testing of new controls, we are performing
mitigating procedures which we believe are sufficient until such new controls
have been implemented.




Changes
in Internal Controls Over Financial Reporting




There
have been changes in our internal controls over financial reporting that
occurred during the first nine months of the 2008 fiscal year that have
materially affected or are reasonably likely to materially affect our internal
controls over accounting and financial reporting in the future.  For
example, we have conducted extensive reviews of our accounts and reconciled our
vendor obligations. Given our remediation efforts discussed above, we expect
further significant changes to our internal controls will occur during the last
quarter of the 2008 fiscal year as we continue to strengthen our internal
control over financial reporting.








PART
II. OTHER INFORMATION





ITEM
1.   LEGAL PROCEEDINGS





As of
June 30, 2008, we were a party to the following legal proceedings, which are
described more fully in Part I - Item 1 - Note 11 Commitments and Contingenciesin this Form 10-Q:





1.  One
vendor has filed a lien applicable to our properties in Rio Blanco County,
Colorado for $0.2 million.





2. A
lawsuit was filed in August 2007 by a law firm in Australia in the Supreme Court
of Victoria for the balance of legal fees owed (0.2 million Australian
dollars).  As of June 30, 2008, we had made payments such that we have
no liability left pursuant to the claims in this lawsuit and the lawsuit was
pending dismissal.





3. A
lawsuit was filed in December 2007 by a vendor in the Supreme Court of
Queensland for the balance which the vendor claims is owed (3.8 million
Australian dollars). We disputed the claim on the basis that the vendor breached
the contract.  As of June 30, 2008, we were in the final stages of
negotiating a written settlement agreement which provides that we will pay 3.5
million Australian dollars as part of the settlement.





4.  On
June 30, 2008, we filed an action requesting the court to issue a declaratory
judgment regarding the interpretation of certain provisions of a contract
between us and DPC.  The primary issue in this matter relates to our
claim of force majeure relating to certain work commitments under the
contract.  On July 29, 2008 DPC filed a response to our complaint and
the case is proceeding in the normal course of litigation.





37


During
the third fiscal quarter of 2008 we resolved numerous legal matters in
conjunction with the Laramie transaction, as more fully described in Part I –
Item 1 – Note 12.  Pursuant to that
transaction, we agreed to settle and release, and did settle and release, all
liens and legal matters related to the property that was sold in the Piceance
Basin using proceeds from the transaction.  As a result, we resolved
all of the liens on the property that had been filed by multiple vendors, as
reported in previous filings, as well as all lawsuits related to those liens,
and a lawsuit filed by the lessor of certain of these properties for breach of
our lease contract.  As of June 30, 2008, approximately $0.8 million
related to this transaction was being held in escrow pending the resolution of a
dispute between us and the lessor of certain of the properties that were
included in the transaction, wherein said lessor claims that the lease will be
terminated upon transfer to the purchaser.  On August 1, 2008, we
transferred the money in escrow back to the purchaser and retained the 435 acres
of land relating to the escrowed amount.





We may
from time to time be involved in various claims, lawsuits, disputes with third
parties, actions involving allegations of discrimination, or breach of contract
incidental to the operations of our business.





ITEM
1A.   RISK FACTORS





During
the quarter, there were no material changes from the risk factors disclosed in
our prospectus on Form S-1 filed June 30, 2008.








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





Our
annual meeting was held on April 7, 2008.  Stockholders were invited
to vote, by proxy or in person, in the election of five directors to our Board
of Directors.  The results of the vote were as follows:





FOR
            WITHHOLDCHARLES
      B. CROWELL
            190,900,168
            1,210,200CARMEN
      J. LOTITO
            190,901,528
            1,208,840MARTIN
      B. ORING
            190,901,528
            1,208,840MATTHEW
      R. SILVERMAN
            190,900,868
            1,209,500DR.
      ANTHONY K. YEATS
            190,892,728
            1,217,640








ITEM
6. EXHIBITS





10.1
            Purchase
      and Sale Agreement between PetroHunter Energy Corporation and PetroHunter
      Operating Company as Seller and Laramie Energy II, LLC as Buyer Dated
      Effective April 1, 2008 (incorporated by reference to Form 8-K as filed
      with the Securities and Exchange Commission on June 5,
    2008)10.2
            Amendment
      to Purchase and Sale Agreement between PetroHunter Energy Corporation and
      PetroHunter Operating Company as Seller and Laramie Energy II, LLC as
      Buyer Dated May 23, 2008 (incorporated by reference to Form 8-K as filed
      with the Securities and Exchange Commission on June 5,
    2008)31.1
            Rule
      13a-14(a) Certification of Charles B. Crowell31.2
            Rule
      13a-14(a) Certification of Charles Josenhans32.1
            Certification
      of Charles B. Crowell Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
  200232.2
            Certification
      of Charles Josenhans Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002








38




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.





PETROHUNTER
      ENERGY CORPORATIONDate: 
      August 13, 2008
            By:
            /s/
      Charles B. CrowellCharles
      B. CrowellChief
      Executive Officer(Principal
      Executive Officer)Date: 
      August 13, 2008
            By:
            /s/
      Charles JosenhansCharles
      JosenhansInterim
      Chief Financial Officer
              (Principal
      Financial Officer)








39








EXHIBIT
INDEX


10.1
              Purchase
      and Sale Agreement between PetroHunter Energy Corporation and PetroHunter
      Operating Company as Seller and Laramie Energy II, LLC as Buyer Dated
      Effective April 1, 2008 (incorporated by reference to Form 8-K as filed
      with the Securities and Exchange Commission on June 5,
    2008)10.2
              Amendment
      to Purchase and Sale Agreement between PetroHunter Energy Corporation and
      PetroHunter Operating Company as Seller and Laramie Energy II, LLC as
      Buyer Dated May 23, 2008 (incorporated by reference to Form 8-K as filed
      with the Securities and Exchange Commission on June 5,
    2008)31.1
              Rule
      13a-14(a) Certification of Charles B. Crowell31.2
              Rule
      13a-14(a) Certification of Charles Josenhans32.1
              Certification
      of Charles B. Crowell Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
  200232.2
              Certification
      of Charles Josenhans Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002