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** **

 

** **

**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**Quarterly Report Under Section 13or 15(d) of the Securities Exchange Act of 1934**

 

**For the Three Months Ended June 30, 2009**

** **

**Commission File No. 000-51229**

 

**STRATUM HOLDINGS, INC.**

 (Exact Name of Registrant as specified in itscharter)

 

| **Nevada**                          | ** ** | **51-0482104**               |
|-------------------------------------|------------|------------------------------|
| (State or other jurisdiction        |       | (IRS Employer Identification |
| of incorporation)                   |       | Number)                      |
|                                |       |                         |
| **Three Riverway, Suite 1590** | ** ** | ** **                   |
| **Houston, Texas**                  | ** ** | **77056**                    |
| (Address of principal               |       | (zip code)                   |
| executive  offices)                 |       |                         |

 

**(713)479-7050**

 (Registrant’s telephone number, including areacode)

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes: x No: o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes: o No: x

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large  accelerated filer  o |   | Accelerated  filer  o    |
|---------------------------------------|--------|------------------------------------|
|                                  |   |                               |
| Non-accelerated  filer  o   |   | Smaller reporting  company  x |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act) Yes o No x

 

The number of sharesoutstanding of Common Stock, par value $.001 per share, as of August 10,2009 was 26,556,429 shares.

 

 

 

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**STRATUMHOLDINGS, INC.**

**FORM 10-Q**

**JUNE30, 2009**

 

**INDEX**

 
| ** **                                                                                                | ** ** | **Page** |
|-----------------------------------------------------------------------------------------------------------|------------|----------|
| **PART I. FINANCIAL  INFORMATION**                                                                   |       |     |
| ** **                                                                                                |       |     |
| Item 1. Financial  Statements                                                                             |       |     |
| Consolidated Balance Sheets as of  June 30, 2009 (Unaudited) and December 31,  2008 (Unaudited) |       | 3        |
| Consolidated Statements of  Operations for the three months endedJune 30, 2009 and 2008 (Unaudited)  |       | 4        |
| Consolidated Statements of  Operations for the six months ended June 30,  2009 and 2008 (Unaudited)  |       | 5        |
| Consolidated Statements of  Cash Flows for the six months ended June 30,  2009 and 2008 (Unaudited)  |       | 6        |
|                                                                                                      |       |     |
| Notes to Consolidated Financial Statements (Unaudited)                                                    |       | 7        |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations       |       | 13       |
| Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                       |       | 18       |
| Item 4T.  Controls and Procedures                                                                         |       | 18       |
|                                                                                                      |       |     |
| PART II. OTHER  INFORMATION                                                                          |       |     |
|                                                                                                      |       |     |
| Item 1. Legal  Proceedings                                                                                |       | 19       |
| Item  1A. Risk Factors                                                                                    |       | 19       |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                      |       | 19       |
| Item 3. Defaults Upon Senior Securities                                                                   |       | 19       |
| Item 4. Submission of Matters to a Vote of Security  Holders                                              |       | 19       |
| Item  5. Other Information                                                                                |       | 19       |
| Item 6.  Exhibits                                                                                         |       | 19       |
| Signatures                                                                                                |       | 20       |

 

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**STRATUM HOLDINGS, INC.**

**Consolidated Balance Sheets**

**(Unaudited)**

 
| ** **                                                                                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                       | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| **Assets**                                                                                                       |       |              |       |                  |       |
| Current assets:                                                                                                  |       |              |       |                  |       |
| Cash and cash equivalents                                                                                        |       | $                 | 155,556    |                  | $          | 203,200 |   |
| Restricted cash (Note 3)                                                                                         |       | 1,612,828         |       | 1,491,958             |       |
| Accounts receivable                                                                                              |       | 1,398,658         |       | 2,900,750             |       |
| Prepaid expenses and other                                                                                       |       | 64,335            |       | 133,088               |       |
| Fair value of oil and gas derivatives                                                                            |       | 27,612            |       | —                |       |
| Total current assets                                                                                             |       | 3,258,989         |       | 4,728,996             |       |
|                                                                                                             |       |              |       |                  |       |
| Property and equipment:                                                                                          |       |              |       |                  |       |
| Oil and gas properties (full cost method)                                                                        |       | 14,299,652        |       | 14,177,055            |       |
| Other property and equipment                                                                                     |       | 108,060           |       | 108,060               |       |
|                                                                                                             |       | 14,407,712        |       | 14,285,115            |       |
| Less: Accumulated depreciation, depletion & amortization                                                |       | (1,554,891        | )          | (1,332,227            | )          |
|   Impairment allowance                                                                                      |       | (7,000,000        | )          | (7,000,000            | )          |
| Net property and equipment                                                                                       |       | 5,852,821         |       | 5,952,888             |       |
|                                                                                                             |       |              |       |                  |       |
| Other assets:                                                                                                    |       |              |       |                  |       |
| Restricted cash (Note 3)                                                                                         |       | —            |       | 1,611,742             |       |
| Goodwill (less impairment allowance of $3,400,000 and $1,500,000, respectively)                                  |       | 1,536,313         |       | 3,436,313             |       |
| Other assets                                                                                                     |       | 250,489           |       | 175,171               |       |
| Total other assets                                                                                               |       | 1,786,802         |       | 5,223,226             |       |
|                                                                                                             |       |              |       |                  |       |
| Total assets                                                                                                     |       | $                 | 10,898,612 |                  | $          | 15,905,110 |   |
|                                                                                                             |       |              |       |                  |       |
| **Liabilities and Stockholders’ Equity**                                                                    |       |              |       |                  |       |
| Current liabilities:                                                                                             |       |              |       |                  |       |
| Current portion of long-term debt - stockholders                                                                 |       | $                 | 1,729,143  |                  | $          | 246,826 |   |
| Current portion of long-term debt - others                                                                       |       | 4,304,242         |       | 81,729                |       |
| Accounts payable                                                                                                 |       | 1,484,107         |       | 2,818,488             |       |
| Accrued liabilities                                                                                              |       | 1,285,460         |       | 1,153,292             |       |
| Income taxes payable                                                                                             |       | —            |       | 282,975               |       |
| Total current liabilities                                                                                        |       | 8,802,952         |       | 4,583,310             |       |
|                                                                                                             |       |              |       |                  |       |
| Long-term debt, net of current portion                                                                           |       | 485,784           |       | 6,884,155             |       |
| Deferred income taxes                                                                                            |       | 1,281,700         |       | 1,486,900             |       |
| Asset retirement obligations                                                                                     |       | 183,910           |       | 175,990               |       |
| Total liabilities                                                                                                |       | 10,754,346        |       | 13,130,355            |       |
|                                                                                                             |       |              |       |                  |       |
| Stockholders’ equity:                                                                                       |       |              |       |                  |       |
| Preferred stock, $.01 par value per share, 1,000,000 shares  authorized, None issued                             |       | —            |       | —                |       |
| Common stock, $.001 par value per share, 50,000,000 shares authorized,  26,556,429 shares issued and outstanding |       | 26,556            |       | 26,556                |       |
| Additional paid in capital                                                                                       |       | 12,783,718        |       | 12,758,510            |       |
| Accumulated deficit                                                                                              |       | (12,515,766       | )          | (9,852,596            | )          |
| Accumulated foreign currency translation adjustment                                                              |       | (150,242          | )          | (157,715              | )          |
| Total stockholders’ equity                                                                                  |       | 144,266           |       | 2,774,755             |       |
|                                                                                                             |       |              |       |                  |       |
| Total liabilities and stockholders’ equity                                                                  |       | $                 | 10,898,612 |                  | $          | 15,905,110 |   |

 

See accompanying notesto consolidated financial statements.

 

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** **

**STRATUMHOLDINGS, INC.**

**Consolidated Statements of Operations**

**(Unaudited)**

 
| ** **                                             | ** ** | **Three  Months Ended June 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                             | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Revenues:                                              |       |                                  |       |   |   |
| Energy services                                        |       | $                                     | 2,220,823  |   | $ | 4,648,573 |   |
| Oil and gas sales                                      |       | 583,912                               |       | 1,179,147 |   |
| Other                                                  |       | 7,955                                 |       | 11,322 |   |
|                                                   |       | 2,812,690                             |       | 5,839,042 |   |
| Expenses:                                              |       |                                  |       |   |   |
| Energy services                                        |       | 2,050,827                             |       | 4,418,048 |   |
| Lease operating expense                                |       | 390,878                               |       | 527,256 |   |
| Depreciation, depletion & amortization        |       | 100,926                               |       | 91,337 |   |
| Impairment of acquisition goodwill                     |       | —                                |       | — |   |
| Workover expense                                       |       | 152,546                               |       | 84,990 |   |
| Selling, general and administrative                    |       | 418,057                               |       | 810,908 |   |
|                                                   |       | 3,113,234                             |       | 5,932,539 |   |
|                                                   |       |                                  |       |   |   |
| Operating loss                                         |       | (300,544                              | )          | (93,497 | ) |
| Other expenses:                                        |       |                                  |       |   |   |
| Interest expense                                       |       | (209,798                              | )          | (238,239 | ) |
| Unrealized loss on oil and gas derivatives             |       | (97,388                               | )          | — |   |
|                                                   |       |                                  |       |   |   |
| Loss from continuing operations before income taxes    |       | (607,730                              | )          | (331,736 | ) |
| Benefit for income taxes                               |       | 103,100                               |       | 112,900 |   |
| Net loss from continuing operations                    |       | (504,630                              | )          | (218,836 | ) |
| Discontinued operations, net of tax                    |       | —                                |       | — |   |
| Net loss                                               |       | $                                     | (504,630   | ) | $ | (218,836 | ) |
|                                                   |       |                                  |       |   |   |
| Net loss per share, basic and diluted                  |       |                                  |       |   |   |
| Net loss from continuing operations                    |       | $                                     | (0.02      | ) | $ | (0.01 | ) |
| Discontinued operations                                |       | —                                |       | — |   |
| Net loss                                               |       | $                                     | (0.02      | ) | $ | (0.01 | ) |
|                                                   |       |                                  |       |   |   |
| Weighted average shares outstanding, basic and diluted |       | 26,556,429                            |       | 26,556,429 |   |

 

 See accompanying notes to consolidatedfinancial statements.

 

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**STRATUMHOLDINGS, INC.**

**Consolidated Statements of Operations**

**(Unaudited)**

 
| ** **                                             | ** ** | **Six Months  Ended June 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                             | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| Revenues:                                              |       |                                |       |   |   |
| Energy services                                        |       | $                                   | 7,814,737  |   | $ | 12,402,762 |   |
| Oil and gas sales                                      |       | 1,132,843                           |       | 2,228,177 |   |
| Other                                                  |       | 50,565                              |       | 97,433 |   |
|                                                   |       | 8,998,145                           |       | 14,728,372 |   |
| Expenses:                                              |       |                                |       |   |   |
| Energy services                                        |       | 7,138,244                           |       | 11,341,863 |   |
| Lease operating expense                                |       | 940,222                             |       | 926,859 |   |
| Depreciation, depletion & amortization        |       | 222,735                             |       | 250,053 |   |
| Impairment of acquisition goodwill                     |       | 1,900,000                           |       | — |   |
| Workover expense                                       |       | 192,144                             |       | 229,006 |   |
| Selling, general and administrative                    |       | 980,102                             |       | 2,662,995 |   |
|                                                   |       | 11,373,447                          |       | 15,410,776 |   |
|                                                   |       |                                |       |   |   |
| Operating loss                                         |       | (2,375,302                          | )          | (682,404 | ) |
| Other expenses:                                        |       |                                |       |   |   |
| Interest expense                                       |       | (388,261                            | )          | (846,399 | ) |
| Unrealized loss on oil and gas derivatives             |       | (97,388                             | )          | — |   |
|                                                   |       |                                |       |   |   |
| Loss from continuing operations before income taxes    |       | (2,860,951                          | )          | (1,528,803 | ) |
| Benefit for income taxes                               |       | 223,200                             |       | 519,800 |   |
| Net loss from continuing operations                    |       | (2,637,751                          | )          | (1,009,003 | ) |
| Discontinued operations, net of tax                    |       | (25,419                             | )          | (409,533 | ) |
| Net loss                                               |       | $                                   | (2,663,170 | ) | $ | (1,418,536 | ) |
|                                                   |       |                                |       |   |   |
| Net loss per share, basic and diluted                  |       |                                |       |   |   |
| Net loss from continuing operations                    |       | $                                   | (0.10      | ) | $ | (0.04 | ) |
| Discontinued operations                                |       | (0.00                               | )          | (0.01 | ) |
| Net loss                                               |       | $                                   | (0.10      | ) | $ | (0.05 | ) |
|                                                   |       |                                |       |   |   |
| Weighted average shares outstanding, basic and diluted |       | 26,556,429                          |       | 26,067,037 |   |

 

 See accompanying notes to consolidatedfinancial statements.

 

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**STRATUM HOLDINGS, INC.**

**Consolidated Statements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                                             | ** ** | **Six Months  Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                             | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| **Cash flows provided by (used in) operating  activities:**                                            |       |                                |       |   |   |
| Net loss from continuing operations                                                                    |       | $                                   | (2,637,751 | ) | $ | (1,009,003 | ) |
| Adjustments to reconcile net loss from continuingoperations to cash provided by (used in)  operations: |       |                                |       |   |   |
| Depreciation, depletion & amortization                                                        |       | 222,735                             |       | 250,053 |   |
| Impairment expense                                                                                     |       | 1,900,000                           |       | — |   |
| Provision (benefit) from income taxes                                                                  |       | (223,200                            | )          | (519,800 | ) |
| Stock based compensation                                                                               |       | 25,208                              |       | 546,934 |   |
| Unrealized loss on oil and gas derivatives                                                             |       | 97,388                              |       | — |   |
| Working capital changes                                                                                |       | 103,657                             |       | — |   |
| Other changes, net                                                                                     |       | (59,996                             | )          | (69,491 | ) |
| Net cash flows from continuing operations                                                              |       | (571,959                            | )          | (801,307 | ) |
| Net cash flows from discontinued operations                                                            |       | (25,419                             | )          | 1,838,587 |   |
| Total cash flows from operating activities                                                             |       | (597,378                            | )          | 1,037,280 |   |
|                                                                                                   |       |                                |       |   |   |
| **Cash flows provided by (used in) investing  activities:**                                            |       |                                |       |   |   |
| Sale of subsidiary                                                                                     |       | —                              |       | 11,895,592 |   |
| Decrease in restricted cash from sale of subsidiary                                                    |       | 1,490,872                           |       | — |   |
| Purchase of property and equipment                                                                     |       | (122,597                            | )          | (236,844 | ) |
| Purchase of oil and gas derivatives                                                                    |       | (125,000                            | )          | — |   |
| Net cash flows from investing activities                                                               |       | 1,243,275                           |       | 11,658,748 |   |
|                                                                                                   |       |                                |       |   |   |
| **Cash flows provided by (used in) financing  activities:**                                            |       |                                |       |   |   |
| Proceeds from long term debt                                                                           |       | 525,000                             |       | — |   |
| Payments of long term debt                                                                             |       | (958,541                            | )          | (12,704,339 | ) |
| Net (payments) proceeds of stockholder advances                                                        |       | (260,000                            | )          | 66,727 |   |
| Net cash flows from financing activities                                                               |       | (693,541                            | )          | (12,637,612 | ) |
|                                                                                                   |       |                                |       |   |   |
| Net increase in cash and cash equivalents                                                              |       | (47,644                             | )          | 58,416 |   |
| Cash and equivalents at beginning of period                                                            |       | 203,200                             |       | 238,395 |   |
|                                                                                                   |       |                                |       |   |   |
| Cash and equivalents at end of period                                                                  |       | $                                   | 155,556    |   | $ | 296,811 |   |
|                                                                                                   |       |                                |       |   |   |
| Supplemental cash flow data:                                                                           |       |                                |       |   |   |
| Cash paid for interest                                                                                 |       | $                                   | 265,049    |   | $ | 846,399 |   |
| Cash paid for income taxes                                                                             |       | 251,875                             |       | — |   |
|                                                                                                   |       |                                |       |   |   |
| Supplemental investing activity:                                                                       |       |                                |       |   |   |
| Restricted cash withheld on sale of subsidiary - current                                               |       | $                                   | —     |   | $ | 1,500,000 |   |
| Restricted cash withheld on sale of subsidiary - noncurrent                                            |       | —                              |       | 1,600,000 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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**STRATUMHOLDINGS, INC.**

**Notesto Consolidated Financial Statements**

**(Unaudited)**

 

**(1)****                              ****Basis of Presentation**

 

*Interim Financial Information*—The accompanying consolidated financial statements have been prepared by theCompany without audit, in accordance with accounting principles generallyaccepted in the Unites States of America for interim financial information andpursuant to the rules and regulations of the Securities and ExchangeCommission.  In the opinion ofmanagement, these consolidated financial statements contain all adjustments(consisting only of normal recurring adjustments) necessary to fairly state thefinancial position of the Company as of June 30, 2009, the results of itsoperations for the three month and six month periods ended June 30, 2009and 2008, and cash flows for the six month periods ended June 30, 2009 and2008.  These financial statements shouldbe read in conjunction with our Annual Report on Form 10-K for the yearended December 31, 2008.

 

*Liquidity*— The accompanying consolidated financial statements have been prepared on agoing concern basis, which contemplates the realization of assets andsatisfaction of liabilities in the normal course of business. The Company hasreported substantial losses from continuing operations in the last two yearsand has a net working capital deficit in the amount of $5,543,963 at June 30,2009.  These factors, among others,indicate that the Company may be unable to continue as a going concern for areasonable period of time.

 

A substantial portion of this deficit relates to outstanding borrowingsunder two separate bank credit agreements, both of which expire in less thanone year as of August 5, 2009 (see Note 4).  The Company expects to ultimately extendand/or restructure these credit agreements on a satisfactory basis.  Accordingly, the Company believes that itwill be able to repay or refinance its present obligations.

 

The consolidated financial statements do not contain any adjustments toreflect the possible future effects on the classification of assets or theamounts and classification of liability that may result should the Company beunable to continue as a going concern.

 

*RecentlyIssued Accounting Pronouncements* — In June 2008,the Financial Accounting Standards Board (“FASB”) issued EITF No. 07-5, “*Determining Whether an Instrument (or Embedded Feature) is Indexed toan Entity’s Own Stock.*”  ThisIssue is effective for fiscal years beginning after December 15, 2008 andthe adoption has not had a material impact on our consolidated financialstatements.

 

*SEC Amendments to Oil and GasReporting Requirements*— In December 2008,the SEC adopted the final rules regarding amendments to current oil andgas reporting requirements.  Theamendments are designed to modernize and update the oil and gas disclosurerequirements to align them with current practices and changes in technology.  The amendments are effective for annualreports on Form 10-K for fiscal years ending on or after December 31,2009.  The Company is currentlyevaluating the impact of the amendments on its consolidated financial position,results of operations and cash flows.

 

**(2)****                              ****Impairment Adjustment**

 

The Company recognized a non-cash impairmentadjustment in the carrying value of the goodwill assigned to its CanadianEnergy Services subsidiary, Decca Consulting, Ltd. (“Decca”), as of March 31,2009 in the amount of $1,900,000.  Thisamount is in addition to a similar impairment adjustment recognized as of December 31,2008 in the amount of $1,500,000.

 

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Since the worldwide decline in energy pricesbegan in the fourth quarter of 2008, Decca has experienced a substantialdecrease in the demand for its drilling, completion and other on-siteconsulting services provided to the Canadian oil and gas industry.  The impairment adjustment recognized as of March 31,2009 was based on then current projections of Decca’s discounted future netcash flows and, based on the latest such projections, no further impairment hasbeen recorded since that date.  As withthe impairment adjustment recorded as of December 31, 2008, the Companyhas not recognized a tax benefit for the impairment adjustment of $1,900,000 inthe six months ended June 30, 2009 because no temporary difference wasrecognized when the goodwill was initially established upon the acquisition ofDecca in March 2007.

 

**(3)****                             ****Discontinued Operations**

 

On March 11, 2008, the Company sold thecapital stock of its domestic Energy Services subsidiary, Petroleum Engineers, Inc.(“PEI”), to Hamilton Engineering, Inc. for a total sales price of $15.0million.  The Company applied the salesproceeds to the repayment of debt and other accrued obligations including theoutstanding indebtedness of PEI under a revolving bank credit agreement in theamount of $3.2 million and unsecured seller debt and other liabilities in theamount of $4.5 million (see Note 4).

 

The Company recognized a pre-tax gain from thesale of PEI in the first quarter of 2008 in the amount of $1,350,000 (which wassubsequently reduced in the first quarter of 2009 due to payment of anindemnified loss in the amount of $39,000). The results of discontinued operations of PEI for the six months ended June 30,2009 and 2008, including the original and adjusted gain on the sale, aresummarized as follows:

 
| ** **                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|------------------------------------|------------|
| ** **                         | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| Energy  services revenues          |       | $                                  | —     |   | $ | 3,876,949 |   |
| Cost  of energy services           |       | —                             |       | (2,919,987 | ) |
| Gross  profit                      |       | —                             |       | 956,962 |   |
| General &  administrative |       | —                             |       | (914,929 | ) |
| Interest  expense, net             |       | —                             |       | (255,321 | ) |
| Gain  on sale                      |       | (38,519                            | )          | 1,349,855 |   |
| Net  income before taxes           |       | (38,519                            | )          | 1,136,567 |   |
| Provision  for income taxes        |       | 13,100                             |       | (1,546,100 | ) |
| Net  income (loss)                 |       | $                                  | (25,419    | ) | $ | (409,533 | ) |

 

The Company has indemnified Hamilton withrespect to certain other pre-sale contingencies of PEI for a two yearperiod.  In order to secure suchindemnities, Hamilton withheld sales proceeds in a two-year escrow account inthe amount of $1.6 million and a one-year tax reserve account in the amount of$1.5 million (which has now expired). Upon expiration of the two-year indemnity period in March 2010, theunexpended balance of the escrow account will revert to the Company.  The escrow account, along with accruedinterest thereon, is reflected as restricted cash on the Balance Sheet as of June 30,2009.

 

**(4)****                               ****Long Term Debt**

 

As of June 30, 2009 and December 31,2008, the Company had the following long-term debt obligations:

 

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| ** **                                                                                                                                                                                                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                          | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| $25,000,000 line of credit with a bank, maturing on August 5,  2010, interest at 1.0% above prime payable monthly, secured by first lien on  CYMRI, LLC’s oil and gas properties, with a declining borrowing base of  $3,250,000 as of June 30, 2009 |       | $                 | 3,125,000  |                  | $          | 2,600,000 |   |
|                                                                                                                                                                                                                                                                |       |              |       |                  |       |
| Notes payable to individuals and entities, incurred in acquisition of  CYMRI, bearing interest at 10%, with principal and accrued interest due at  extended maturity in March 2010, unsecured                                                                  |       | 1,125,000         |       | 1,125,000             |       |
|                                                                                                                                                                                                                                                                |       |              |       |                  |       |
| $4,000,000 (Cdn) revolving line of credit with a bank, interest at  4.5% above Canadian prime payable monthly through maturity in May 2010,  secured by accounts receivable of Canadian petroleum services business                                            |       | 449,935           |       | 1,272,799             |       |
|                                                                                                                                                                                                                                                                |       |              |       |                  |       |
| Notes payable to 2 individuals, incurred in acquisition of Decca  Consulting, Ltd., bearing interest at 9%, payable in monthly installments of  $30,099 (Cdn) from April 1, 2007 through March 31, 2012, unsecured                                        |       | 695,884           |       | 779,040               |       |
|                                                                                                                                                                                                                                                                |       |              |       |                  |       |
| Advances from stockholders, bearing interest at 10%, with principal  and accrued interest due in March 2010, unsecured                                                                                                                                         |       | 1,047,317         |       | 1,307,317             |       |
|                                                                                                                                                                                                                                                                |       |              |       |                  |       |
| Other short term notes for liability insurance and accrued payables,  interest rates at 7% to 9%                                                                                                                                                                    |       | 76,033            |       | 128,554               |       |
|                                                                                                                                                                                                                                                                |       | 6,519,169         |       | 7,212,710             |       |
| Current portion of long term debt - stockholders                                                                                                                                                                                                                    |       | (1,729,143        | )          | (246,826              | )          |
| Current portion of long term debt - others                                                                                                                                                                                                                          |       | (4,304,242        | )          | (81,729               | )          |
|                                                                                                                                                                                                                                                                |       | $                 | 485,784    |                  | $          | 6,884,155 |   |

 

Borrowings under the bankcredit agreement secured by the oil and gas properties owned by CYMRI, LLC (“CYMRI”),a subsidiary in the Exploration & Production segment, are subject to aborrowing base, which is periodically redetermined, based on oil and gasreserves.  The terms of the bank creditagreement require CYMRI to maintain certain financial covenants regardingworking capital ratio, interest coverage level, tangible net worth, and thenon-payment of dividends.  The bankcredit agreement does not require monthly principal payments so long asoutstanding borrowings are less than a declining borrowing base.  As of June 30, 2009, the borrowing basestood at $3,250,000, and was declining by $58,000 per month.

 

CYMRI was in violation ofcertain financial covenants under the credit agreement for the quarter ended March 31,2009, however, the bank granted a waiver of the covenant violation in May 2009in exchange for the Company agreeing to put in place an acceptable hedgingtransaction on approximately 50% of CYMRI’s projected oil production throughthe August 2010 maturity date of the credit agreement (see Note 5).  CYMRI was in violation of the same financialcovenants for the quarter ended June 30, 2009, and the Company iscurrently in discussions with the bank to obtain a waiver of suchviolation.  Because of the covenantviolation and the near term maturity of the credit agreement, the outstandingborrowings are reflected as a current liability as of June 30, 2009.

 

The Company has a secondbank credit agreement, which is secured by accounts receivable of its CanadianEnergy Services subsidiary, Decca.  Thecredit agreement provides for a revolving borrowing base of 85% of qualifyingaccounts receivable up to $4,000,000 (Cdn), with an interest rate of 4.5% aboveCanadian prime (2.25% as of June 30, 2009).  Since March 31, 2009, Decca has been inviolation of certain covenants under the credit agreement, and the Company iscurrently in discussions with the bank to obtain a waiver of suchviolations.  Because the creditagreement, as presently structured, matures in May 2010, the outstandingborrowings are reflected as a current liability as of June 30, 2009.

 

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**(5)****                              ****Commodity Derivatives**

 

In May 2009, theCompany entered into a commodity derivative contract with a major energycompany covering a portion of CYMRI’s projected oil production.  This contract was purchased with a cashoutlay of $125,000 and consists of a “put” option relating to 2,000 barrels ofoil per month for the period from July 2009 to October 2010.  Pursuant to this contract, the counterpartywill make monthly settlement payments to CYMRI for the difference, if any,between the “put” price of $50 per barrel and a published oil index price forthat month, multiplied by 2,000 barrels per month.

 

The Company has applied “markto market” accounting to this derivative contract from its inception inaccordance with FASB Statement No. 133, “*Accountingfor Derivative Instruments and Hedging Activities*” (“SFAS 133”).  The Company is accounting for this commodityderivative contract as a non-hedging transaction, as defined in SFAS 133.  Accordingly, changes in the fair value of thecommodity derivative contract are reflected in current earnings in the periodof the change.  In its ConsolidatedStatement of Operations for the three month and six month periods ended June 30,2009, the Company has reported an unrealized loss in the amount of $97,388 dueto the decrease in the fair value of this derivative contract between theinception date of the contract (May 26, 2009) and June 30, 2009.

 

**(6)****                              ****Net Income (Loss) Per Share**

 

Basic income (loss) per common share is computedby dividing the net income or loss by the weighted average number of shares ofcommon stock outstanding during the period. Diluted income (loss) per common share is computed by dividing netincome or loss by the weighted average number of shares of common stockoutstanding during the period and potentially dilutive common shareequivalents, consisting of stock options and warrants, under the Treasury StockMethod. The effects of potential common stock equivalents are not included incomputations when their effect is anti-dilutive.  Because of the net loss for the three monthand six month periods ended June 30, 2009 and 2008, the basic and dilutedaverage outstanding shares are considered the same, since including the shareswould have an antidilutive effect on the net loss per share calculation.

 

**(7)****                              ****Stock-Based Compensation**

 

The Company has a stock-based compensation planwhich was approved by the stockholders in October 2005 and amended in October 2006.  Under the plan, a maximum of 2,400,000 sharesmay be awarded to directors and employees in the form of stock options,restricted stock or stock appreciation rights. The exercise price, terms and other conditions applicable to each stockoption grant are generally determined by the Board of Directors.  The exercise price of stock options is set onthe grant date and may not be less than the fair market value of the Company’sCommon Stock on that date.

 

Option activity with directors and employeessince January 1, 2008 were as follows (including options granted todirectors outside of the plan):

 
| ** **                             | ** ** | **Number** | ** ** | **Wtd.********Avg.** | ** ** | **Wtd.********Avg.** | ** ** | **Aggregate** | ** ** |
|----------------------------------------|------------|------------|------------|----------------------|------------|----------------------|------------|---------------|------------|
| ** **                             | ** ** | **of**     | ** ** | **Exercise**         | ** ** | **Remaining**        | ** ** | **Intrinsic** | ** ** |
| ** **                             | ** ** | **Shares** | ** ** | **Price**            | ** ** | **Term (Yrs.)**      | ** ** | **Value**     | ** ** |
| Outstanding at  January 1, 2008   |       | 1,814,600  |       | $                    | 1.53       |                 |       |          |       |   |
| Options forfeited                      |       | (1,339,600 | )          | (2.03                | )          |                 |       |          |       |
| Outstanding at  December 31, 2008 |       | 475,000    |       | 0.76                 |       |                 |       |          |       |
| Option activity                        |       | —     |       | —               |       |                 |       |          |       |
| Outstanding at  June 30, 2009     |       | 475,000    |       | $                    | 0.76       |                 | 1.5        |          | $          | — |   |
|                                   |       |       |       |                 |       |                 |       |          |       |
| Exercisable at  June 30, 2009     |       | 458,333    |       | $                    | 0.71       |                 | 1.5        |          | $          | — |   |

 

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Stock-based compensationexpense related to these options in the amounts of $25,208 and $266,934 havebeen recognized as a current period expense in the accompanying ConsolidatedFinancial Statements for the six month periods ended June 30, 2009 and2008, respectively.  As of June 30,2009, total unrecognized compensation cost of approximately $37,000 related tostock options is expected to be recognized over a weighted average period ofapproximately 1.7 years.  The estimatedfair value of the options granted to employees under the plan was calculatedusing a Black Scholes option pricing model. The following schedule reflects theassumptions included in this model as it relates to the valuation of suchoptions: (a) Expected volatility — 95%; (b) Expected risk freeinterest rate — 6%; (c) Expected dividend yield — zero; (d) Expectedoption term — 3 to 4 years, calculated pursuant to the terms of SAB 107 as theoption grants qualify as “plain vanilla” under that pronouncement; and (e) Forfeitures— 0%, subject to adjustment for actual experience.  Vesting terms of the options are generallythree years.  The aggregate intrinsicvalue of employee options granted as of June 30, 2009 was zero as therewere no in-the-money options at that date.

 

Pursuant to a Board approved severanceagreement, the Company made a cash severance payment to its former ChiefExecutive Officer in March 2008 in the amount of $200,000 and granted himan additional severance benefit via the issuance of 1,142,857 restricted sharesof Common Stock with a then current value of $280,000, which was included instock-based compensation expense in March 2008.

 

**(8)****                               ****Stockholder Advances**

 

The Company repaid net stockholder advances inthe amount of $260,000 in the six months ended June 30, 2009 and receivednet stockholder advances in the amount $67,000 in the six months ended June 30,2008.  Stockholder advances, excludingamounts advanced to finance the cash portion of the CYMRI purchase price (seeNote 4), are reflected as unsecured long term debt obligations and accrueinterest at a rate of 10% per annum.

 

**(9)****                              ****Contingencies**

 

Triumph Energy, Inc., a subsidiary in theExploration & Production segment, is a defendant in several lawsuitsinvolving professional liability and other matters arising in the normal courseof business.  It is not practical at thepresent time to determine the amount or likelihood of an unfavorable outcome tothe Company’s consolidated financial position or results of operations of anyof the actions against Triumph.  TheCompany believes that Triumph has meritorious defenses in each case and isvigorously defending these matters.

 

Alawsuit was filed in February 2008 against Decca, the Company’s CanadianEnergy Services subsidiary, claiming unspecified damages related to workperformed by Decca on a well drilled in the U.S. in late 2006, prior to theCompany’s acquisition of Decca.  Pursuantto the terms of the stock purchase agreement under which the Company acquiredDecca in March 2007, the Company is substantially indemnified by the priorowners of Decca for losses that may be sustained as a result of thislitigation.  In July 2009, theplaintiff agreed to dismiss its claim against Decca, while continuing to pursueits claim against a co-defendant. However, the dismissal of the plaintiff’s claim against Decca has notyet been approved by the court.

 

In October 2008,an insurer for the Company’s inactive Construction Staffing subsidiary filed alawsuit against the subsidiary alleging default on a premium finance obligationin the amount of $200,000, plus interest and attorney’s fees.  Limited discovery in this case has beenundertaken to date.  The Company believesthat its inactive Construction Staffing subsidiary hasa meritorious defense in this case.

 

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**(10)****                       ****Segment Information**

 

With the sale of PEIin March 2008 (see Note 3), the Company’s remaining operations are in theCanadian Energy Services and domestic Exploration & Productionsegments.  The table below reflects theallocation of certain amounts in the consolidated Income Statement, other thaninterest expense and income taxes (which the Company does not believe are feasibleto allocate), and the consolidated Balance Sheet as of and for the six monthsended June 30, 2009 (in 000’s):

 
| ** **                                        | ** ** | **Energy**   | ** ** | **Exploration &** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|--------------|------------|----------------------------|------------|------------|------------|
| ** **                                        | ** ** | **Services** | ** ** | **Production**             | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **(Can.)**   | ** ** | **(U. S.)**                | ** ** | **Total**  | ** ** |
| Income Statement Data**:**                        |       |         |       |                       |       |       |       |
| Operating revenues                                |       | $            | 7,815      |                       | $          | 1,133      |       | $ | 8,948 |   |
| Other revenues                                    |       | 38           |       | 12                         |       | 50         |       |
| Total revenues                                    |       | 7,853        |       | 1,145                      |       | 8,998      |       |
| Depreciation,  depletion & amortization  |       | —       |       | (223                       | )          | (223       | )          |
| Impairment expense                                |       | (1,900       | )          | —                     |       | (1,900     | )          |
| Other allocable operating  expenses               |       | (7,138       | )          | (1,132                     | )          | (8,270     | )          |
| Gross profit (loss)                               |       | (1,185       | )          | (210                       | )          | (1,395     | )          |
| General &  administrative                |       |         |       |                       |       | (980       | )          |
| Operating loss                                    |       |         |       |                       |       | (2,375     | )          |
| Interest expense                                  |       |         |       |                       |       | (388       | )          |
| Unrealized loss on oil and  gas derivatives       |       |         |       |                       |       | (97        | )          |
| Net loss from continuing  operations before taxes |       |         |       |                       |       | $          | (2,860     | ) |
| Balance Sheet Data:                               |       |         |       |                       |       |       |       |
| Subsidiary assets                                 |       | $            | 1,069      |                       | $          | 7,051      |       | $ | 8,120 |   |
| Goodwill                                          |       | 1,536        |       | —                     |       | 1,536      |       |
| Segment assets                                    |       | 2,605        |       | 7,051                      |       | 9,656      |       |
| Corporate assets                                  |       |         |       |                       |       | 1,242      |       |
| Consolidated  assets                              |       |         |       |                       |       | $          | 10,898     |   |

 

The table below reflects theallocation of certain Income Statement data between these two reportablesegments for the six months ended June 30, 2008 (in 000’s):

 
| Income Statement Data**:**                        |   |    |   |   |   |    |   |
|---------------------------------------------------|--------|---------|--------|--------|--------|---------|--------|
| Operating revenues                                |   | $       | 12,403 |   | $      | 2,228   |   | $ | 14,631 |   |
| Other revenues                                    |   | 97      |   | — |   | 97      |   |
| Total revenues                                    |   | 12,500  |   | 2,228  |   | 14,728  |   |
| Depreciation,  depletion & amortization  |   | —  |   | (250   | )      | (250    | )      |
| Other allocable operating  expenses               |   | (11,342 | )      | (1,156 | )      | (12,498 | )      |
| Gross profit                                      |   | 1,158   |   | 822    |   | 1,980   |   |
| General &  administrative                |   |    |   |   |   | (2,663  | )      |
| Operating loss                                    |   |    |   |   |   | (683    | )      |
| Interest expense                                  |   |    |   |   |   | (846    | )      |
| Net loss from continuing  operations before taxes |   |    |   |   |   | $       | (1,529 | ) |
|                                                   |        |         |        |        |        |         |        |  |  |  |

 

There is nopresentation of Balance Sheet data allocated between these two reportablesegments as of June 30, 2008 inasmuch as the consolidated Balance Sheet asof that date is not included in this report.

 

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**ITEM2.****                                               ****MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with, and is qualified in its entirety by, theconsolidated financial statements and notes thereto included in Item 1 in thisQuarterly Report on Form 10-Q. This item contains forward-lookingstatements that involve risks and uncertainties. Actual results may differmaterially from those indicated in such forward-looking statements.

 

**Forward-Looking Statements**

 

This QuarterlyReport on Form 10-Q and the documents incorporated herein by referencecontain forward-looking statements that have been made pursuant to theprovisions of the Private Securities Litigation Reform Act of 1995. Suchforward-looking statements are based on current expectations, estimates, andprojections about our industry, management beliefs, and certain assumptionsmade by our management. Words such as “anticipates,” “expects,” “intends,” “plans,”“believes,” “seeks,” “estimates,” variations of such words, and similarexpressions are intended to identify such forward-looking statements. Thesestatements are not guarantees of future performance and are subject to certainrisks, uncertainties, and assumptions that are difficult to predict; therefore,actual results may differ materially from those expressed or forecasted in anysuch forward-looking statements. Unless required by law, we undertake noobligation to update publicly any forward-looking statements, whether as aresult of new information, future events, or otherwise. However, readers shouldcarefully review the risk factors set forth in other reports and documents thatwe file from time to time with the Securities and Exchange Commission,particularly the Quarterly Reports on Form 10-Q, and future Annual Reportson Form 10-K and any Current Reports on Form 8-K.

 

**Overview and History**

 

StratumHoldings, Inc. was originally incorporated in the State of Nevada on September 3,2003 under the name Frontier Staffing, Inc.  We were initially formed to enter theConstruction Staffing business and commenced operations in that segment througha stock-for-stock exchange with a private company in January 2004.  We completed a public offering of our CommonStock in March 2005 and our shares began trading on the OTC Bulletin Boardin July 2005.  We changed our namein October 2005 to Tradestar Services, Inc.

 

On May 23,2006, we acquired the outstanding common stock of CYMRI Corporation (“CYMRI”)for total consideration of $12.7 million paid in a combination of cash, notespayable and Common Stock.  At the time ofthe acquisition, CYMRI was engaged in the Exploration & Productionbusiness with properties located in Texas and Louisiana while its subsidiary,Petroleum Engineers, Inc. (“PEI”), performed Energy Services largely forcustomers in the United States.

 

On March 2,2007, we acquired the outstanding capital stock of Decca Consulting, Ltd. (“Decca”)for total consideration of $5.1 million paid in a combination of cash, notespayable and Common Stock.  At the time ofthe acquisition, Decca provided consulting services for the Canadian energyindustry.  In March 2007, we alsochanged our name to Stratum Holdings, Inc.

 

On October 26,2007, we sold substantially all of the assets of our Construction Staffingsubsidiary, Tradestar Construction Services, Inc. (“Tradestar Construction”),to a private construction staffing company. We received cash proceeds of $3.2 million plus a working capitaladjustment.  We applied the salesproceeds to the repayment of debt and other accrued obligations including theoutstanding indebtedness of Tradestar Construction under a revolving bankcredit agreement in the amount of $1,810,210 and a bank term loan in the amountof $451,920.  We reported a pre-tax gainfrom the sale of these assets in the fourth quarter of 2007 in the amount of$1,664,000 (which was subsequently reduced in the fourth quarter of 2008 due toan uncollectible insurance refund in the amount of $357,000).  As a result of this sale, we exited from theConstruction Staffing segment.

 

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On March 11,2008, we sold the capital stock of our domestic Energy Services subsidiary,PEI, to Hamilton Engineering, Inc. (“Hamilton”) for a total sales price of$15.0 million.  We applied the salesproceeds to the repayment of debt and other accrued obligations including theoutstanding indebtedness of PEI under a revolving bank credit agreement in theamount of $3.2 million and unsecured seller debt and other liabilities in theamount of $4.5 million.  We recognized apre-tax gain from the sale of PEI in the first quarter of 2008 in the amount of$1,350,000 (which was subsequently reduced in the first quarter of 2009 due topayment of an indemnified loss in the amount of $39,000).  We have reported the revenues and expenses ofPEI for the period that we owned it in 2008 as discontinued operations in theaccompanying Consolidated Statement of Operations.

 

As a result ofthe PEI sale, we exited from the domestic portion of our Energy Servicessegment leaving us with the Canadian portion of our Energy Services segment aswell as our operations in the domestic Exploration & Productionsegment.

 

**Results of Operations**

 

The following discussionreflects the revenues and expenses of our retained Canadian Energy Services andour domestic Exploration & Production segments as continuingoperations while the revenues and expenses of our exited domestic EnergyServices segment is reported as discontinued operations.

 

*Three months ended June 30, 2009 versus three months ended June 30,2008*— Total revenues from continuingoperations for the three months ended June 30, 2009 were $2,813,000compared to $5,839,000 for the three months ended June 30, 2008.

 

Revenues from Decca’scontinuing Energy Services for the three months ended June 30, 2009 were$2,221,000 compared to $4,649,000 for the three months ended June 30,2008.  This decrease was due to a seculardecline of nearly 50% in the Canadian drilling rig count as well as a decreaseof approximately 15% in the relative exchange rate of the Canadian dollar.  Total billings for continuing Energy Servicesin the three months ended June 30, 2009 were approximately 1,712 man daysat an average billing rate of approximately $1,295 per day.

 

Revenues from CYMRI’s oiland gas sales for the three months ended June 30, 2009 were $584,000compared to $1,179,000 for the three months ended June 30, 2008.   In the three months ended June 30,2009, revenues from oil production were $544,000, reflecting volumes of 9,820 barrelsat an average price of $55.45 per barrel, while gas revenues were $40,000,reflecting volumes of 19,455 Mcf at an average price of $2.03 per Mcf.  In the three months ended June 30, 2008,revenues from oil production were $982,000, reflecting volumes of 9,679 barrelsat an average price of $101.43 per barrel, while gas revenues were $197,000,reflecting volumes of 21,805 Mcf at an average price of $9.06 per Mcf.

 

Costs of Decca’scontinuing Energy Services for the three months ended June 30, 2009 were$2,051,000 versus $4,418,000 for the three months ended June 30,2008.  As with the decrease in EnergyServices revenues, this decrease was due to the impact of the declines in theCanadian drilling rig count and in the relative exchange rate of the Canadiandollar.  Despite competitive pressures,Decca was able to slightly increase the gross margin on its consulting servicesto approximately 8% of revenues for the three months ended June 30, 2009compared to approximately 5% for the three months ended June 30, 2008.

 

Lease operating expenses (“LOE”),including production taxes, were $391,000 for the three months ended June 30,2009 versus $527,000 for the three months ended June 30, 2008,representing LOE of CYMRI’s oil and gas production operations.  This decrease was due to a change in therelative timing of certain expenses between the first two quarters of 2009compared to the first two quarters of 2008.

 

Depreciation, depletion andamortization (“DD&A”) expense for the three months ended June 30, 2009was $101,000 versus $91,000 for the three months ended June 30, 2008,largely representing DD&A of CYMRI’s oil and gas properties.  This increase was due to slightly higherproduction rates.

 

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Workover expenses for thethree months ended June 30, 2009 were $152,000 versus $85,000 for thethree months ended June 30, 2008, representing workovers on CYMRI’s SouthTexas oil and gas properties.  Thisincrease was due to non-recurring workover operations in the Burnell Field inthe second quarter of 2009.

 

Selling,general and administrative (“SG&A”) expenses attributable to continuingoperations for the three months ended June 30, 2009 were $418,000 comparedto $811,000 for the three months ended June 30, 2008.  This decrease was due to non-recurringSG&A expenses associated with the sale of PEI to Hamilton in March 2008as well as a dramatic reduction in the Company’s level of corporate overheadexpenses following the PEI sale.

 

Interest expenseattributable to continuing operations for the three months ended June 30,2009 was $210,000 versus $238,000 for the three months ended June 30,2008.  This decrease was primarily due tothe repayment of certain corporate debt obligations in conjunction with thesale of PEI to Hamilton in March 2008.

 

Unrealized loss on oil andgas derivatives for the three months ended June 30, 2009 was $97,000versus zero for the three months ended June 30, 2008.  This increase was due to the change in fairvalue of a “put” option covering 2,000 barrels of oil per month for 16 months,which was acquired in May 2009 (see Note 5).

 

Income taxesattributable to continuing operations were a benefit of $103,000 for the threemonths ended June 30, 2009 compared to a benefit of $113,000 for the threemonths ended June 30, 2008 and reflect a benefit rate of 17% on pre-taxnet loss of $608,000 in the three months ended June 30, 2009.

 

*Six months ended June 30, 2009 versus six months ended June 30,2008*— Total revenues from continuingoperations for the six months ended June 30, 2009 were $8,998,000 comparedto $14,728,000 for the six months ended June 30, 2008.

 

Revenues from Decca’scontinuing Energy Services for the six months ended June 30, 2009 were$7,815,000 compared to $12,403,000 for the six months ended June 30,2008.  This decrease was due to a seculardecline of approximately 40% in the Canadian drilling rig count as well as adecrease of approximately 15% in the relative exchange rate of the Canadiandollar.  Total billings for continuingEnergy Services in the six months ended June 30, 2009 were approximately6,588 man days at an average billing rate of approximately $1,185 per day.

 

Revenues from CYMRI’s oiland gas sales for the six months ended June 30, 2009 were $1,133,000compared to $2,228,000 for the six months ended June 30, 2008.   In the six months ended June 30, 2009,revenues from oil production were $939,000, reflecting volumes of 20,586barrels at an average price of $45.60 per barrel, while gas revenues were$194,000, reflecting volumes of 48,042 Mcf at an average price of $4.04 perMcf.  In the six months ended June 30,2008, revenues from oil production were $1,860,000, reflecting volumes of19,321 barrels at an average price of $96.29 per barrel, while gas revenueswere $368,000, reflecting volumes of 44,321 Mcf at an average price of $8.30per Mcf.

 

Costs of Decca’scontinuing Energy Services for the six months ended June 30, 2009 were$7,138,000 versus $11,341,000 for the six months ended June 30, 2008.  As with the decrease in Energy Servicesrevenues, this decrease was due to the impact of the declines in the Canadiandrilling rig count and in the relative exchange rate of the Canadiandollar.  Despite competitive pressures,Decca was able to hold the gross margin on its consulting services toapproximately 9% of revenues for the six months ended June 30, 2009, thesame as for the six months ended June 30, 2008.

 

Lease operating expenses (“LOE”),including production taxes, were $940,000 for the six months ended June 30,2009 versus $927,000 for the six months ended June 30, 2008, representingLOE of CYMRI’s oil and gas production operations.  This increase was primarily due to higherwater handling expenses in CYMRI’s Burnell Field in the first quarter of 2009.

 

Depreciation, depletion andamortization (“DD&A”) expense for the six months ended June 30, 2009was $223,000 versus $250,000 for the six months ended June 30, 2008, largelyrepresenting DD&A of CYMRI’s oil and gas properties.  This decrease was due to slightly lowerdepletion rates.

 

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Impairment expenseapplicable to the goodwill assigned in the Decca acquisition was $1,900,000 forthe six months ended June 30, 2009 versus zero for the six months ended June 30,2008.  This increase reflects animpairment adjustment recognized as of March 31, 2009 in the amount of$1,900,000 (see Note 2).

 

Workover expenses for thesix months ended June 30, 2009 were $192,000 versus $229,000 for the sixmonths ended June 30, 2008, representing workovers on CYMRI’s South Texasoil and gas properties.  This decreasewas due to a reduction in workover operations in the first quarter of 2009.

 

Selling,general and administrative (“SG&A”) expenses attributable to continuingoperations for the six months ended June 30, 2009 were $980,000 comparedto $2,663,000 for the six months ended June 30, 2008.  This decrease was due to non-recurringSG&A expenses associated with the sale of PEI to Hamilton in March 2008as well as a dramatic reduction in the Company’s level of corporate overheadexpenses following the PEI sale.

 

Interest expenseattributable to continuing operations for the six months ended June 30,2009 was $388,000 versus $846,000 for the six months ended June 30,2008.  This decrease was primarily due tothe repayment of certain corporate debt obligations in conjunction with thesale of PEI to Hamilton in March 2008.

 

Unrealized loss on oil andgas derivatives for the six months ended June 30, 2009 was $97,000 versuszero for the six months ended June 30, 2008.  This increase was due to the change in fairvalue of a “put” option covering 2,000 barrels of oil per month for 16 months,which was acquired in May 2009 (see Note 5).

 

Income taxesattributable to continuing operations were a benefit of $223,000 for the sixmonths ended June 30, 2009 compared to a benefit of $520,000 for the sixmonths ended June 30, 2008 and reflect a benefit rate of only 8% onpre-tax net loss of $2,861,000 in the six months ended June 30, 2009 (dueto no tax benefit being booked for the Decca goodwill impairment of $1,900,000).

 

Income fromdiscontinued Energy Services operations, net of income taxes, was a net loss of$25,400 for the six months ended June 30, 2009 versus $410,000 for the sixmonths ended June 30, 2008.  Asfurther described in Note 3, we sold the capital stock of our domestic EnergyServices subsidiary, PEI, to Hamilton in March 2008.  The results of operations of our domesticEnergy Services business, including the pre-tax sales gain in the amount of$1,350,000, have been classified as discontinued operations in the ConsolidatedStatement of Operations, net of applicable income tax expense reflecting theestimated taxable gain on the sale in the 2008 period.

 

**Liquidity and Capital Resources**

 

*Operating**activities.*  Net cash used in operating activities fromcontinuing operations for the six months ended June 30, 2009 was $572,000compared to $801,000 for the six months ended June 30, 2008.  This decreased use of financial resourcesreflected a small net improvement in certain operating cash flowcomponents.  Net cash used in operatingactivities from discontinued operations was only $25,000 for the six monthsended June 30, 2009 whereas net cash provided by operating activities fromdiscontinued operations was $1,839,000 for the six months ended June 30,2008 reflecting positive cash flow from PEI’s operations.

 

*Investing**activities. *Netcash provided by investing activities for the six months ended June 30,2009 was $1,243,000 compared to $11,659,000 for the six months ended June 30,2008.  This fluctuation was largely dueto the sale of PEI to Hamilton in March 2008 for $15.0 million, less theinitial purchases of restricted cash in the amount of $3.1 million for anescrow account and a tax reserve account, pursuant to the securities purchaseagreement with Hamilton.  With theexpiration of the tax reserve account, the Company converted $1,491,000 of thetax reserve account from restricted to unrestricted cash in the six monthsended June 30, 2009.

 

*Financingactivities.*Net cash usedin financing activities for the six months ended June 30, 2009 was$694,000 compared to $12,638,000 for the six months ended June 30,2008.  This relative increase infinancing cash flows was primarily due to the absence of non-recurringrepayments of long term debt and stockholder advances which were made with theproceeds of the sale of PEI to Hamilton in March 2008 in the gross amountof $15.0 million.

 

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Followingthe sale of PEI in March 2008, we have remaining long term debtobligations to banks and other lenders (see Note 4).  A substantial portion of our long term debtis in the form of a bank credit facility secured by CYMRI’s producing oil andgas properties.  Borrowings under thebank credit agreement amounted to $3,125,000 as of June 30, 2009 and aresubject to a borrowing base, which is periodically redetermined, based on oiland gas reserves.  CYMRI’s borrowingsunder its original bank credit agreement were refinanced with another bank,pursuant to a new credit agreement having substantially similar terms, on August 5,2008.  The new bank credit agreement doesnot require monthly principal payments so long as outstanding borrowings areless than a declining borrowing base.  Asof June 30, 2009, the borrowing base stood at $3,250,000, and wasdeclining by $58,000 per month.

 

CYMRIwas in violation of certain financial covenants under the new credit agreementfor the quarter ended March 31, 2009, however, the bank granted a waiverof the covenant violation in May 2009 in exchange for the Company agreeingto put in place an acceptable hedging transaction on approximately 50% of CYMRI’sprojected oil production through the maturity date of the credit agreement (seeNote 5).  CYMRI was in violation of thesame financial covenants for the quarter ended June 30, 2009, and theCompany is currently in discussions with the bank to obtain a waiver of suchviolation.

 

Wealso have a second bank credit agreement, which is secured by accountsreceivable of our Canadian Energy Services subsidiary, with outstandingborrowings of $450,000 as of June 30, 2009 (see Note 4).  Borrowings under a similar credit agreementwith the same bank were fully paid in the sale of our domestic Energy Servicesbusiness in March 2008.  This creditagreement currently provides for a revolving borrowing base of 85% ofqualifying accounts receivable up to $4,000,000 (Cdn), with an interest rate of4.5% above Canadian prime.  Since March 31,2009, Decca has been in violation of certain covenants under the creditagreement, and the Company is currently in discussions with the bank to obtaina waiver of such violations.

 

Withthe completion of our sales of PEI in March 2008 and TradestarConstruction in October 2007, our primary ongoing capital expenditures arein the Exploration & Production segment, which canbe highly capital intensive.  In thisbusiness, expenditures for CYMRI’s drilling and equipping of oil and gas wellsare typically required to maintain or increase existing production levels andproduction often declines in a relatively short period of time if maintenancecapital is not invested timely.  Wenormally attempt to finance CYMRI’s capital expenditure requirements through acombination of cash flow from operations and secured bank borrowings and weexpect that these sources will be sufficient to meet our capital expendituresin 2009.  We presently have relativelylow capital expenditure requirements relating to CYMRI’s oil and gas propertiesas evidenced by a total of only $123,000 being spent in the first two quartersof 2009.  While we expect additionalamounts of capital expenditures in the latter quarters of 2009, we do not expectsuch amounts to be significant (approximately $100,000) and we believe thatsuch amounts, as well as any short term operating losses, can be financed underour existing bank credit agreement through a combination of a borrowing baseincrease and/or reduced monthly principal payments.

 

**Strategic Plans**

 

The Company hasreported substantial consolidated operating losses and working capital deficitssince completing the acquisitions of CYMRI/PEI in May 2006 and Decca in March 2007.  In order to address longer term liquidityneeds, our Board of Directors authorized Management in July 2007 to pursuea range of alternative actions including the sale of one or more of the Company’soperating assets or businesses.  Thisdecision by our Board of Directors ultimately led the Company to seek the salesof: (a) Tradestar Construction to a private construction staffing companyin October 2007; and (b) PEI to an affiliate of Hamilton in March 2008.  There are no further corporate leveltransactions contemplated at the present time although we may decide to expandour domestic Exploration & Production business by making selectiveacquisitions of low risk oil and gas properties with exploitation potential.

 

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**CriticalAccounting Policies and Estimates**

 

Our discussionand analysis of our financial condition and results of operations are based onconsolidated financial statements which have been prepared in accordance withgenerally accepted accounting principles in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses. Webelieve that certain accounting policies affect our more significant judgmentsand estimates used in the preparation of our consolidated financial statementsas indicated below.  See our AnnualReport on Form 10-K for the year ended December 31, 2008 for afurther description of our critical accounting policies and estimates.

 

**ITEM 3.****                                              ****QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Information forthis Item is not required as the Registrant is a “smaller reporting company” asdefined in Rule 12b-2 of the Exchange Act.

 

**ITEM 4T.****                                      ****CONTROLS AND PROCEDURES**

 

(a) Disclosurecontrols and procedures

 

As of the dateof this report, our Chief Executive Officer and Chief Financial Officerevaluated the effectiveness of the design and operation of our internalcontrols over financial reporting which encompasses our disclosure controls andprocedures.  Based on this evaluation,our Chief Executive Office and Chief Financial Officer have concluded that ourdisclosure controls and procedures as of the end of the period covered by thisQuarterly Report were not effective because of a material weakness in ourinternal controls over financial reporting, as described below, which we viewas an integral part of our disclosure controls and procedures.

 

The materialweakness relates to deficient completeness and cut-off controls with regard torevenues and cost of sales at our Canadian Energy Services subsidiary, DeccaConsulting, Ltd.  The situation givingrise to this lack of independent review arose since approximately the end ofthe second quarter of 2008 as Decca previously employed a highly experiencedaccountant to review the subsidiary’s monthly financial statements.  In order to address this material weakness,management has implemented an interim compensating control in the form of anentity level analytical review by its Chief Financial Officer.  To the extent practical in light of Decca’scurrent financial performance (see Note 2), the Company anticipates theimplementation of improved completeness and cut-off controls with regard torevenues and cost of sales at the operating unit level at an appropriatetime.  It should be noted, however, thatthe impact of this material weakness on Stratum’s consolidated results ofoperations is substantially mitigated by the fact that Decca has a relativelylow gross margin between revenues and cost of sales of approximately 9%.

 

Notwithstandingthis material weakness, management believes that the consolidated financialstatements included in this report fairly present, in all material respects,our consolidated financial position and results of operations as of and for thequarter ended June 30, 2009.

 

(b) Changesin internal controls over financial reporting

 

There was nochange in our internal controls over financial reporting that occurred duringthe quarter ended June 30, 2009, that has materially affected, or isreasonably likely to materially affect, our internal controls over financialreporting.

 

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**PART II.****                                         ****OTHER INFORMATION**

 

**ITEM 1.****                                              ****LEGAL PROCEEDINGS**

 

See Note 9 to Consolidated Financial Statements.

 

**ITEM 1A.****                                     ****RISK FACTORS**

 

Informationfor this Item is not required as the Registrant is a “smaller reporting company”as defined in Rule 12b-2 of the Exchange Act.

 

**ITEM 2.****                                              ****UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS**

 

None.

 

**ITEM 3.****                                              ****DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4.****                                              ****SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

None.

 

**ITEM 5.****                                              ****OTHER INFORMATION**

 

None.

 

**ITEM 6.****                                              ****EXHIBITS**

 

10.36                                                     FirstAmendment to Second Amended and Restated Credit Agreement, dated May 28, 2009,among CYMRI, L.L.C. and Triumph Energy, Inc. (as Borrowers) and TexasCapital Bank, N.A. (as Lender) for a Reducing Revolving Line of Credit of up to$25,000,000.

 

31.1                                                           Certificationof Chief Executive Officer pursuant to Rule 13a-14(a)/15(d)-14(a)

 

31.2                                                           Certificationof Chief Financial Officer pursuant to Rule 13a-14(a)/15(d)-14(a)

 

32.1                                                           Certificationof Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuantto Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2                                                           Certificationof Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuantto Section 906 of the Sarbanes-Oxley Act of 2002

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|   | STRATUM HOLDINGS, INC. |
|--------|------------------------|
|   |                   |   |
|   |                   |   |
|   | /s/                    | Larry M. Wright |
|   |                   | Larry M. Wright |
|   |                   | Chief Executive Officer |
|   |                   |   |
|   | /s/                    | D. Hughes Watler, Jr. |
|   |                   | D. Hughes Watler, Jr. |
|   |                   | Chief Financial Officer |

 

 

August 10,2009

 

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