** **

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-QSB**

 

**Quarterly Report Under Section 13 or 15(d) of the**

**Securities Exchange Act of 1934**

 

**For the Nine Months EndedSeptember 30, 2007**

 

**Commission File No. 000-51229**

 

**STRATUM HOLDINGS, INC.**

 (Exact Name of Small Business Issuer asspecified in its charter)

 

| **Nevada**                                       | ** ** | **51-0482104**                         |
|--------------------------------------------------|------------|----------------------------------------|
| (State  or other jurisdiction  of incorporation) |       | (IRS  Employer Identification  Number) |
|                                             |       |                                   |
| **Three Riverway, Suite 1500  Houston, Texas**   | ** ** | **77056**                              |
| (Address  of principal  executive offices)       |       | (zip  code)                            |

 

**(713) 479-7000**

 (Issuer’s telephone number, including areacode)

 

Checkwhether the issuer: (1) filed all reports required to be filed by Section 13 or15(d) of the Exchange Act during the past 12 months (or for such shorter periodthat the registrant was required to file such reports); and (2) has beensubject to such filing requirements for the past 90 days. Yes x No o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act) Yes o No x

 

Thenumber of shares outstanding of Common Stock, par value $.001 per share, as ofNovember 9, 2007 was 25,393,572 shares and the aggregate market value of suchshares held by non-affiliates of the registrant (based upon the closing bidprice of such shares as listed on the NASD Bulletin Board on November 9, 2007)was approximately $1,628,900.

 

TransitionalSmall Business Disclosure Format (check one):   Yes o No x

 

 

----

 

**STRATUM HOLDINGS, INC.**

**(formerly, Tradestar Services,Inc.)**

**FORM 10-QSB**

 

**INDEX**

 

 
|                                                                                                                | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|
| PART I. FINANCIAL INFORMATION                                                                                       | ** ** |
|                                                                                                                |       |
| Item 1. Financial Statements                                                                                        |       |
| Condensed Consolidated  Balance Sheets as of September 30, 2007 (Unaudited) and December 31, 2006                   | 3          |
| Condensed Consolidated  Statements of Operations for the three months ended September 30, 2007 and 2006 (Unaudited) | 4          |
| Condensed Consolidated  Statements of Operations for the nine months ended September 30, 2007 and 2006 (Unaudited)  | 5          |
| Condensed Consolidated  Statements of Cash Flows for the nine months ended September 30, 2007 and 2006 (Unaudited)  | 6          |
|                                                                                                                |       |
| Notes to Condensed Consolidated  Financial Statements                                                               | 7          |
| Item 2.  Management’s Discussion and Analysis or Plan of Operation                                             | 13         |
| Item 3. Controls and  Procedures                                                                                    | 20         |
|                                                                                                                |       |
| PART II. OTHER INFORMATION                                                                                          | 21         |
|                                                                                                                |       |
| Item 1. Legal Proceedings                                                                                           | 21         |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                                | 21         |
| Item 3.  Defaults Upon Senior Securities                                                                            | 21         |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                        | 21         |
| Item 5. Other Information                                                                                           | 21         |
| Item  6. Exhibits                                                                                                   | 21         |
| Signatures                                                                                                          | 22         |

 

2

----

 

**STRATUM HOLDINGS, INC.**

**(formerly, Tradestar Services, Inc.)**

**CondensedConsolidated Balance Sheets**

 
| ** **                                                                                                                                     | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                     | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                     | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                      |       | $                            | 74,170     |                        | $          | 261,010 |   |
| Accounts receivable, less allowances of  $163,337 and $352,263, respectively                                                                   |       | 10,834,420                   |       | 8,277,568                   |       |
| Prepaid expenses and other                                                                                                                     |       | 2,070,214                    |       | 880,230                     |       |
| Total current assets                                                                                                                           |       | 12,978,804                   |       | 9,418,808                   |       |
|                                                                                                                                           |       |                         |       |                        |       |
| Property and equipment:                                                                                                                        |       |                         |       |                        |       |
| Oil and gas properties (full cost method)                                                                                                      |       | 13,592,039                   |       | 13,433,333                  |       |
| Other property and equipment                                                                                                                   |       | 1,107,656                    |       | 893,512                     |       |
|                                                                                                                                           |       | 14,699,695                   |       | 14,326,845                  |       |
| Less: Accumulated depreciation, depletion  and amortization                                                                                    |       | (1,392,645                   | )          | (816,871                    | )          |
|   Impairment  allowance                                                                                                                   |       | (7,000,000                   | )          | —                      |       |
| Net property and equipment                                                                                                                     |       | 6,307,050                    |       | 13,509,974                  |       |
|                                                                                                                                           |       |                         |       |                        |       |
| Other assets:                                                                                                                                  |       |                         |       |                        |       |
| Goodwill                                                                                                                                       |       | 14,160,475                   |       | 9,089,162                   |       |
| Deferred income taxes                                                                                                                          |       | 489,100                      |       | 489,100                     |       |
| Other                                                                                                                                          |       | 255,781                      |       | 636,821                     |       |
| Total other assets                                                                                                                             |       | 14,905,356                   |       | 10,215,083                  |       |
|                                                                                                                                           |       |                         |       |                        |       |
| Total assets                                                                                                                                   |       | $                            | 34,191,210 |                        | $          | 33,143,865 |   |
|                                                                                                                                           |       |                         |       |                        |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                 | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                           |       |                         |       |                        |       |
| Current portion of long-term debt                                                                                                              |       | $                            | 14,546,875 |                        | $          | 7,661,885 |   |
| Accounts payable                                                                                                                               |       | 4,067,136                    |       | 2,129,381                   |       |
| Accrued liabilities                                                                                                                            |       | 1,568,032                    |       | 1,514,856                   |       |
| Total current liabilities                                                                                                                      |       | 20,182,043                   |       | 11,306,122                  |       |
|                                                                                                                                           |       |                         |       |                        |       |
| Long-term debt, net of current portion                                                                                                         |       | 7,959,296                    |       | 10,577,969                  |       |
| Deferred income taxes                                                                                                                          |       | 801,100                      |       | 3,378,400                   |       |
| Total liabilities                                                                                                                              |       | 28,942,439                   |       | 25,262,491                  |       |
|                                                                                                                                           |       |                         |       |                        |       |
| 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, 25,393,572 and 23,804,286 shares issued and  outstanding, respectively |       | 25,394                       |       | 23,804                      |       |
| Additional paid in capital                                                                                                                     |       | 11,980,239                   |       | 9,441,664                   |       |
| Accumulated deficit                                                                                                                            |       | (6,587,166                   | )          | (1,584,094                  | )          |
| Foreign currency translation                                                                                                                   |       | (169,696                     | )          | —                      |       |
| Total stockholders’ equity                                                                                                                |       | 5,248,771                    |       | 7,881,374                   |       |
|                                                                                                                                           |       |                         |       |                        |       |
| Total liabilities and stockholders’ equity                                                                                                |       | $                            | 34,191,210 |                        | $          | 33,143,865 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

3

----

 

**(formerly,Tradestar Services, Inc.)**

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

 
| ** **                                      | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                                 | ** ** | **2006** | ** ** |
| Revenues:                                       |       |                                                     |       |   |   |
| Staffing services                               |       |                                                     |       |   |   |
| Construction                                    |       | $                                                        | 4,678,311  |   | $ | 4,953,523 |   |
| Petroleum engineering                           |       | 11,866,317                                               |       | 6,333,879 |   |
| Oil and gas sales                               |       | 825,013                                                  |       | 1,107,385 |   |
| Other                                           |       | 18,449                                                   |       | 3,813 |   |
|                                            |       | 17,388,090                                               |       | 12,398,600 |   |
| Expenses:                                       |       |                                                     |       |   |   |
| Cost of staffing services                       |       |                                                     |       |   |   |
| Construction                                    |       | 3,763,287                                                |       | 4,041,357 |   |
| Petroleum engineering                           |       | 9,510,077                                                |       | 4,720,089 |   |
| Lease operating expense                         |       | 340,596                                                  |       | 467,633 |   |
| Depreciation, depletion and amortization        |       | 243,257                                                  |       | 353,138 |   |
| Impairment expense                              |       | 7,000,000                                                |       | — |   |
| Workover expense                                |       | 73,632                                                   |       | 312,708 |   |
| Selling, general and administrative             |       | 2,428,856                                                |       | 2,086,012 |   |
| Interest expense                                |       | 584,167                                                  |       | 416,077 |   |
|                                            |       | 23,943,872                                               |       | 12,397,014 |   |
|                                            |       |                                                     |       |   |   |
| Income (loss) before income taxes               |       | (6,555,782                                               | )          | 1,586 |   |
|                                            |       |                                                     |       |   |   |
| Benefit (provision) for income taxes            |       | 2,228,966                                                |       | (539 | ) |
|                                            |       |                                                     |       |   |   |
| Net income (loss)                               |       | $                                                        | (4,326,816 | ) | $ | 1,047 |   |
|                                            |       |                                                     |       |   |   |
| Net income (loss) per share, basic and  diluted |       | $                                                        | (0.17      | ) | $ | 0.00 |   |
|                                            |       |                                                     |       |   |   |
| Weighted average shares outstanding, basic      |       | 25,393,572                                               |       | 23,490,000 |   |
|                                            |       |                                                     |       |   |   |
| Weighted average shares outstanding,  diluted   |       | 25,393,572                                               |       | 24,263,257 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

4

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**STRATUMHOLDINGS, INC.**

**(formerly,Tradestar Services, Inc.)**

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

 
| ** **                                      | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                                | ** ** | **2006** | ** ** |
| Revenues:                                       |       |                                                    |       |   |   |
| Staffing services                               |       |                                                    |       |   |   |
| Construction                                    |       | $                                                       | 11,841,377 |   | $ | 12,381,960 |   |
| Petroleum engineering                           |       | 30,599,927                                              |       | 8,280,830 |   |
| Oil and gas sales                               |       | 2,233,880                                               |       | 1,450,346 |   |
| Other                                           |       | 95,948                                                  |       | 65,724 |   |
|                                            |       | 44,771,132                                              |       | 22,178,860 |   |
| Expenses:                                       |       |                                                    |       |   |   |
| Cost of staffing services                       |       |                                                    |       |   |   |
| Construction                                    |       | 9,335,129                                               |       | 10,112,762 |   |
| Petroleum engineering                           |       | 24,074,233                                              |       | 6,011,789 |   |
| Lease operating expense                         |       | 1,052,387                                               |       | 619,466 |   |
| Depreciation, depletion and amortization        |       | 727,735                                                 |       | 494,302 |   |
| Impairment expense                              |       | 7,000,000                                               |       | — |   |
| Workover expense                                |       | 528,638                                                 |       | 402,068 |   |
| Selling, general and administrative             |       | 8,124,065                                               |       | 3,748,775 |   |
| Interest expense                                |       | 1,509,358                                               |       | 596,305 |   |
|                                            |       | 52,351,545                                              |       | 21,985,467 |   |
|                                            |       |                                                    |       |   |   |
| Income (loss) before income taxes               |       | (7,580,413                                              | )          | 193,393 |   |
|                                            |       |                                                    |       |   |   |
| Benefit (provision) for income taxes            |       | 2,577,341                                               |       | (65,775 | ) |
|                                            |       |                                                    |       |   |   |
| Net income (loss)                               |       | $                                                       | (5,003,072 | ) | $ | 127,618 |   |
|                                            |       |                                                    |       |   |   |
| Net income (loss) per share, basic and  diluted |       | $                                                       | (0.20      | ) | $ | 0.01 |   |
|                                            |       |                                                    |       |   |   |
| Weighted average shares outstanding, basic      |       | 25,112,620                                              |       | 16,921,429 |   |
|                                            |       |                                                    |       |   |   |
| Weighted average shares outstanding,  diluted   |       | 25,112,620                                              |       | 17,517,340 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

5

----

 

**STRATUMHOLDINGS, INC.**

**(formerly,Tradestar Services, Inc.)**

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2007**                                                | ** ** | **2006** | ** ** |
| **Cash flows provided (used) in operating  activities:**                  |       |                                                    |       |   |   |
| Net income (loss)                                                         |       | $                                                       | (5,003,072 | ) | $ | 127,618 |   |
| Adjustments to reconcile net income (loss)  to cash (used in) operations: |       |                                                    |       |   |   |
| Depreciation, depletion and amortization                                  |       | 727,735                                                 |       | 494,302 |   |
| Impairment expense                                                        |       | 7,000,000                                               |       | — |   |
| Deferred income taxes                                                     |       | (2,577,341                                              | )          | 65,775 |   |
| Stock based compensation                                                  |       | 317,664                                                 |       | — |   |
| Services contributed by officers                                          |       | —                                                  |       | 25,000 |   |
| Other changes, net                                                        |       | (312,947                                                | )          | (94,332 | ) |
| Changes in current assets and liabilities:                                |       |                                                    |       |   |   |
| Accounts receivable                                                       |       | 617,005                                                 |       | (1,980,373 | ) |
| Other current assets                                                      |       | (1,144,173                                              | )          | (724,716 | ) |
| Accounts payable                                                          |       | (762,854                                                | )          | (1,204,178 | ) |
| Accrued liabilities                                                       |       | 53,176                                                  |       | 37,450 |   |
| Net cash (used) in operating activities                                   |       | (1,084,807                                              | )          | (3,253,454 | ) |
|                                                                      |       |                                                    |       |   |   |
| **Cash flows (used) in investing activities:**                            |       |                                                    |       |   |   |
| Net cash used in acquisition of subsidiary                                |       | (151,841                                                | )          | (2,000,000 | ) |
| Purchase of property and equipment                                        |       | (515,139                                                | )          | (905,411 | ) |
| Net cash (used) in investing activities                                   |       | (666,980                                                | )          | (2,905,411 | ) |
|                                                                      |       |                                                    |       |   |   |
| **Cash flows provided (used) in financing  activities:**                  |       |                                                    |       |   |   |
| Net proceeds of stockholder advances                                      |       | 518,046                                                 |       | 525,000 |   |
| Proceeds from long term debt                                              |       | 4,848,264                                               |       | 5,335,285 |   |
| Payments of long term debt                                                |       | (4,573,863                                              | )          | (402,898 | ) |
| Proceeds from issuance of common stock                                    |       | 675,000                                                 |       | — |   |
| Proceeds from exercise of warrants                                        |       | 75,000                                                  |       | — |   |
| Proceeds from exercise of options                                         |       | 22,500                                                  |       | — |   |
| Net cash provided in financing activities                                 |       | 1,564,947                                               |       | 5,457,387 |   |
|                                                                      |       |                                                    |       |   |   |
| Net (decrease) in cash and cash equivalents                               |       | (186,840                                                | )          | (701,478 | ) |
| Cash and equivalents at beginning of period                               |       | 261,010                                                 |       | 759,750 |   |
|                                                                      |       |                                                    |       |   |   |
| Cash and equivalents at end of period                                     |       | $                                                       | 74,170     |   | $ | 58,272 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

6

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**STRATUM HOLDINGS, INC.**

**(formerly, Tradestar Services,Inc.)**

**Notes to Condensed ConsolidatedFinancial Statements**

**(Unaudited)**

 

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

 

The accompanying condensed consolidatedfinancial statements have been prepared by the Company without audit, pursuantto the rules and regulations of the Securities and Exchange Commission and inaccordance with accounting principles for interim financial information. In theopinion of management, these condensed consolidated financial statementscontain all adjustments (consisting only of normal recurring adjustments)necessary to fairly state the financial position of the Company as of September30, 2007, the results of its operations for the three and nine month periodsended September 30, 2007 and cash flows for the nine month periods endedSeptember 30, 2007 and 2006. Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted. Interim resultsof operations are not necessarily indicative of results for subsequent interimperiods or the remainder of the full year. These financial statements should beread in conjunction with our Annual Report on Form 10-KSB for the year endedDecember 31, 2006.

 

The Company has reported a net loss of$5,003,072 for the nine months ended September 30, 2007 and has a workingcapital deficit of $7,203,239 at September 30, 2007. As indicated in Note 3,the Company currently has no unutilized borrowing capacity available under itscredit agreements. In order to address its liquidity needs, the Company’s Boardof Directors recently authorized Management to pursue a range of alternativeactions including debt restructurings and the possible sales of one or more ofthe Company’s operating assets or businesses as a means of addressing itsfinancial obligations. The accompanying financial statements do not reflect anyadjustments that might be necessary should the Company ultimately be unable tomeet its financial obligations as presently structured. As further discussed inNote 9, the Company sold its construction staffing business in October 2007 andhas applied the sales proceeds to the repayment of debt and other accruedobligations.

 

**(2)****                                ****Corporate Acquisitions**

 

On May 23, 2006, the Company acquired theoutstanding common stock of The CYMRI Corporation (“CYMRI”) for total considerationof $12.7 million paid in a combination of cash, notes payable and 12,540,000shares of Common Stock, along with Warrants to purchase 1,136,043 shares ofCommon Stock at $1.87 per share. CYMRI and its subsidiaries perform petroleumengineering services largely for customers in the United States and are engagedin the exploration and production of oil and natural gas from propertieslocated in Texas and Louisiana. The Company has accounted for the acquisitionof CYMRI as a purchase with Stratum treated as the acquirer. The following is acondensed balance sheet showing the fair values of the assets acquired andliabilities assumed from CYMRI as of the date of the acquisition (includingtransaction costs of $250,000):

 
| Current assets                      |   | $          | 4,850,647  |   |
|-------------------------------------|--------|------------|------------|--------|
| Property and equipment              |   | 13,774,229 |       |
| Goodwill arising in the acquisition |   | 9,224,162  |       |
| Other assets                        |   | 77,453     |       |
| Current liabilities                 |   | (3,208,571 | )          |
| Long-term debt (see Note 3)         |   | (8,666,639 | )          |
| Deferred income taxes               |   | (3,318,081 | )          |
|                                |   | $          | 12,733,200 |   |

 

7

----

 

 

The deemed effective date of the CYMRIacquisition for accounting purposes was June 1, 2006 and the one year periodfor making purchase accounting adjustments expired on May 31, 2007. The effectof including CYMRI’s results of operations in the Company’s consolidatedfinancial statements was to increase revenues for the five months ended May 31,2007 by $13,320,000 and to decrease net loss, after giving effect to thepurchase accounting adjustments, by approximately $300,000 ($0.01 per share).

 

On March 2, 2007, the Company acquiredthe outstanding capital stock of Decca Consulting, Ltd. (“Decca”) for totalconsideration of $5.1 million (plus working capital) paid in a combination ofcash, notes payable and 828,572 shares of Common Stock, along with Warrants topurchase 200,000 shares of Common Stock at $2.10 per share. Decca providesconsulting services for the Canadian energy industry. The Company has accountedfor the acquisition of Decca as a purchase with Stratum treated as theacquirer. The following is a condensed balance sheet showing the fair values ofthe assets acquired and liabilities assumed from Decca as of the date of theacquisition (including transaction costs of $300,000):

 
| Current assets                      |   | $          | 3,280,427 |   |
|-------------------------------------|--------|------------|-----------|--------|
| Property and equipment              |   | 9,675      |      |
| Goodwill arising in the acquisition |   | 4,936,313  |      |
| Current liabilities                 |   | (2,442,015 | )         |
|                                |   | $          | 5,784,400 |   |

 

The deemed effective date of the Deccaacquisition for accounting purposes was March 1, 2007 and the one year periodfor making any subsequent purchase accounting adjustments expires on February28, 2008. The effect of including Decca’s results of operations in theCompany’s consolidated financial statements was to increase revenues for thenine months ended September 30, 2007 by $9,780,000 and to decrease net loss,after giving effect to purchase accounting adjustments, by $225,000 ($0.01 pershare).

 

**(3)****                                ****Long Term Debt**

 

As of September 30, 2007 and December 31,2006, the Company had the following long-term debt obligations, includingamounts assumed or incurred in the CYMRI and Decca acquisitions (see Note 2):

 
| ** **                                                                                                                                                                                                                                                            | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
|                                                                                                                                                                                                                                                                  |       |                             |       |                            |       |
| $ 20,000,000 line of credit with a bank,  principal payable $115,000 per month through maturity in November 2007, interest  at 1.0% above prime payable monthly, secured by first lien on CYMRI’s oil and  gas properties and deposits held by stockholders |       | $                                | 5,300,000  |                            | $          | 6,035,000 |   |
|                                                                                                                                                                                                                                                                  |       |                             |       |                            |       |
| $ 7,000,000 revolving line of credit with a  bank, interest at 3.0% above prime payable monthly through maturity in May  2010, secured by accounts receivable of domestic petroleum and construction  services businesses                                        |       | 3,982,363                        |       | 3,805,861                       |       |
|                                                                                                                                                                                                                                                                  |       |                             |       |                            |       |
| Notes payable to former CYMRI shareholders,  bearing interest at 10%, payable in total monthly installments of $65,335  beginning in June 2006 through maturity at May 2008, and secured by  substantially all assets, subject to liens on oil and gas properties     |       | 2,398,349                        |       | 2,789,986                       |       |
|                                                                                                                                                                                                                                                                  |       |                             |       |                            |       |
| Notes payable to 8 individuals, incurred in  acquisition of CYMRI, bearing interest at 10%, interest only payable monthly  beginning in July 2006 through maturity at May 2008, unsecured                                                                             |       | 2,250,000                        |       | 2,250,000                       |       |
|                                                                                                                                                                                                                                                                       |            |                                  |            |                                 |            |  |  |

 

8

----

 
| ** **                                                                                                                                                                                                                                                                   | ** ** | **Balance at**              | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                   | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|                                                                                                                                                                                                                                                                         |       |                             |       |   |   |
| $ 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                                                   |       | 1,693,229                        |       | — |   |
|                                                                                                                                                                                                                                                                         |       |                             |       |   |   |
| $ 1,500,000 term loan from a bank, interest  at 6.0% above prime payable monthly through maturity in March 2009, secured  by accounts receivable of petroleum and construction staffing services  businesses                                                            |       | 1,074,686                        |       | — |   |
|                                                                                                                                                                                                                                                                         |       |                             |       |   |   |
| Notes payable to 3 individuals, incurred by  CYMRI in acquisition of a subsidiary, bearing interest at 8%, payable in  total monthly installments of $54,219 beginning in March 2005 through  maturity at February 2010, secured by subsidiary’s oil and gas properties |       | 1,380,716                        |       | 1,772,676 |   |
|                                                                                                                                                                                                                                                                         |       |                             |       |   |   |
| Notes payable to 2 individuals, incurred in  acquisition of Decca, bearing interest at 9%, payable in monthly installments  of $30,099 (Cdn) from April 1, 2007 through March 31, 2012, unsecured                                                                            |       | 1,126,838                        |       | — |   |
|                                                                                                                                                                                                                                                                         |       |                             |       |   |   |
| Advances from stockholders, bearing  interest at 10%, interest only payable monthly through maturity, unsecured  (Note 7)                                                                                                                                                    |       | 1,359,725                        |       | 973,294 |   |
|                                                                                                                                                                                                                                                                         |       |                             |       |   |   |
| Other short term notes for liability  insurance and accrued payables, interest rates at 7% to 9%                                                                                                                                                                             |       | 1,940,265                        |       | 613,037 |   |
|                                                                                                                                                                                                                                                                         |       | 22,506,171                       |       | 18,239,854 |   |
| Current portion of long term debt                                                                                                                                                                                                                                            |       | (14,546,875                      | )          | (7,661,885 | ) |
|                                                                                                                                                                                                                                                                         |       | $                                | 7,959,296  |   | $ | 10,577,969 |   |
|                                                                                                                                                                                                                                                                              |            |                                  |            |  |  |  |  |

 

Borrowings under the bank creditagreement secured by CYMRI’s oil and gas properties are subject to a borrowingbase, which is periodically redetermined, and amounted to $6,035,000 as ofDecember 31, 2006, the latest redetermination date. The terms of the bankcredit agreement, as amended, require CYMRI to maintain certain financialcovenants regarding working capital ratio, interest coverage level, the ratioof loan balance to loan balance plus stockholders’ equity, and the non-paymentof dividends. As of September 30, 2007, the Company had no unutilized borrowingcapacity available under the credit agreement. Due to operational circumstances,the Company was not in compliance with the defined interest coverage and debtratio covenants as of September 30, 2007. The bank is aware of these covenantviolations, however, it has not requested, nor does the Company expect it torequest,  accelerated payment of the loanas a result thereof. The Company’s monthly payment obligations under the bankcredit facility are dependent upon periodic evaluations of CYMRI’s producingoil and gas properties. As presently structured, borrowings outstanding under thebank credit facility are due on November 30, 2007 and the bank has notindicated that it is willing to enter into a new credit agreement beyond thatdate. However, the Company expects the bank to grant an extension of thematurity, as needed, to enable the Company to extinguish the debt in a possibletransaction that may result in a disposition of the oil and gas properties to arelated party (see Note 4).

 

The terms of the revolving bank creditagreement secured by domestic accounts receivable of the petroleum andconstruction staffing services businesses provided for a borrowing base of 85%of qualifying accounts receivable up to $7,000,000, with an interest rate of 1%above prime through June 30, 2007. As of that date, the Company was not incompliance with the minimum net worth covenant of its

 

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construction staffing subsidiary andcertain other equity related financial covenants of the revolving creditagreement. Accordingly, the bank modified the revolving credit agreement torequire: (a) 2% increase in the interest rate charged on borrowings made underthe revolving credit agreement, effective July 1, 2007; (b) The appointment ofa bank approved consultant to approve the Company’s weekly cash flow budgetsand borrowing requests made to the bank; and (c) The bank’s approval of anyintercompany cash transfers. As of September 30, 2007, a subsidiary borrowerhad one minor covenant violation, however, the bank is aware of the violationand the Company does not expect the bank to request accelerated payment of theloan as a result thereof. As further discussed in Note 8, the Company sold itsconstruction staffing business to a private construction staffing company inOctober 2007. At the closing of the sale, the Company repaid the outstandingindebtedness of its construction staffing subsidiary under the revolving creditagreement in the amount of $1,810,210 and also repaid $451,920 of the bank termloan.

 

**(4)****                                ****Impairment of Oil and Gas Properties**

 

As of September 30, 2007, the Companyrecognized a non-cash impairment adjustment in the carrying value of its oiland gas properties in the amount of $7,000,000. This decline in value reflecteda continuing downward trend in the Company’s field operations during the thirdquarter of 2007 as well as a lack of financial resources to adequately maintainthe value of the properties. As a result of this adjustment, the Companyreduced the net book value of its oil and gas properties to approximately $5.7million to reflect the estimated fair value of the properties. This net bookvalue approximates the amount at which the Company may possibly dispose of theproperties to a related party in conjunction with the anticipated maturity ofthe November 2007 loan secured by the properties (see Note 3). However, theCompany has no firm commitment to sell the oil and gas properties at thatprice.

 

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

 

Basic income (loss) per common share iscomputed by dividing the net income or loss by the weighted average number ofshares of common stock outstanding during the period, including the issuance of385,714 shares in a private placement at $1.75 per share for gross proceeds of$675,000 in the nine months ended September 30, 2007. Diluted income (loss) percommon share is computed by dividing net income or loss by the weighted averagenumber of shares of common stock outstanding during the period and potentiallydilutive common share equivalents, consisting of stock options and warrants,under the Treasury Stock Method. The effects of potential common stockequivalents are not included in computations when their effect isanti-dilutive. Because of the net loss for the three and nine months endedSeptember 30, 2007, the basic and diluted average outstanding shares areconsidered the same, since including the shares would have an antidilutiveeffect on the net loss per share calculation.

 

**(6)****                                ****Stock-Based Compensation**

 

The Company has a stock-basedcompensation plan which was approved by the stockholders in October 2005 andamended in October 2006. Under the plan, as amended, a maximum of 2,400,000shares may be awarded to directors and employees in the form of stock options,restricted stock or stock appreciation rights. The exercise price, terms andother conditions applicable to each stock option grant are generally determinedby the Board of Directors. The exercise price of stock options is set on thegrant date and may not be less than the fair market value of the Company’sCommon Stock on that date. The stock options generally become exercisable overa three year period and expire after five years.

 

Effective January 1, 2006, the Companyadopted SFAS No. 123 (revised 2004), “*Share-BasedPaymen*t” (“SFAS 123R”) requiring that compensation expense relatedto share-based payment transactions with 

 

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employees be recognized in the financialstatements. The cost is measured at the grant date, based on the calculatedfair value of the award, and is recognized as an expense over the employee’srequisite service period (generally, the vesting period of the award). Prior toJanuary 1, 2006, the Company accounted for share-based compensation toemployees in accordance with APB Opinion No. 25, “*Accountingfor Stock Issued to Employees”* (“APB 25”) and relatedinterpretations. The Company adopted SFAS 123R using the modifiedprospective method, accordingly, financial statements for prior periods werenot restated.

 

Option activity with directors andemployees since January 1, 2006 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, 2006    |       | 550,000    |       | $                          | 0.25       |                       |       |          |       |   |
| Options granted                   |       | 1,144,100  |       | 1.87                       |       |                       |       |          |       |
| Outstanding at December 31, 2006  |       | 1,694,100  |       | 1.34                       |       |                       |       |          |       |
| Options granted                   |       | 400,000    |       | 2.10                       |       |                       |       |          |       |
| Options exercised                 |       | (125,000   | )          | (0.18                      | )          |                       |       |          |       |
| Options forfeited                 |       | (154,500   | )          | (2.10                      | )          |                       |       |          |       |
| Outstanding at September 30, 2007 |       | 1,814,600  |       | $                          | 1.53       |                       | 4.0        |          | $          | 57,500 |   |
|                              |       |       |       |                       |       |                       |       |          |       |
| Exercisable at September 30, 2007 |       | 954,866    |       | $                          | 1.38       |                       | 4.0        |          | $          | 47,500 |   |

 

Stock-based compensation expense for thenine months ended September 30, 2007 in the amount of $317,664 has beenrecognized as a current period expense in the accompanying ConsolidatedFinancial Statements. As of September 30, 2007, total unrecognized compensationcost of $1,138,088 related to stock options is expected to be recognized over aweighted average period of approximately 4.5 years. The estimated fair value ofthe options granted to employees under the plan was calculated using a BlackScholes option pricing model. The following schedule reflects the assumptionsincluded in this model as it relates to the valuation of such options: (a)Expected volatility – 95%; (b) Expected risk free interest rate – 6%; (c)Expected dividend yield – zero; and (d) Expected option term – 3 years.

 

The aggregate intrinsic value in thetable above represents the total pre-tax intrinsic value (the differencebetween the Company’s closing stock price on the last trading day of the thirdquarter of 2007 and the exercise price, multiplied by the number ofin-the-money options) that would have been received by the option holders hadall option holders exercised their options on September 30, 2007. The amount ofaggregate intrinsic value will change based on the fair market value of theCompany’s stock.

 

**(7)****                                ****Stockholder Advances and Related Matters**

 

The Company received net stockholderadvances in the amounts of $518,000 and $525,000 in the nine months endedSeptember 30, 2007 and 2006, respectively. Stockholder advances, excludingamounts advanced to finance the cash portion of the CYMRI purchase price (seeNote 2), are reflected as unsecured long term debt obligations and accrueinterest at a rate of 10% per annum.

 

The Company’s former President was notpaid any salary for full-time services rendered prior to his resignation inJuly 2006. The Company estimated the value of the forgone salary at $12,500 perquarter through the second quarter of 2006, and recorded such amounts as anexpense and as a contribution to capital in the respective periods.

 

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**(8)****                                ****Contingencies**

 

Two of the Company’s subsidiaries are defendants in certain lawsuitsinvolving professional liability arising in the normal course of business. Inthe second quarter of 2007, one of the subsidiaries settled a long-standinglawsuit for an amount in excess of the $100,000 insurance deductible. TheCompany recorded the deductible payment and the associated settlement costs ofapproximately $35,000 as an adjustment to the purchase price paid for CYMRI(see Note 2). With respect to the subsidiaries’ other lawsuits, it is notpractical at the present time to determine the amount or likelihood of anunfavorable outcome to the Company’s consolidated financial position or resultsof operations. However, management believes that the Company’s subsidiarieshave meritorious defenses in each case and are vigorously defending thesematters.

 

**(9)****                                ****Subsequent Events**

 

On October 26, 2007, the Company soldsubstantially all of the assets of its construction staffing business to aprivate construction staffing company. The Company received cash proceeds of$3,200,000 at closing of the sale and expects to receive additional cashproceeds in January 2008 as a working capital adjustment. The Companyanticipates reporting a pre-tax gain from the sale of these assets in thefourth quarter of 2007. The Company has applied the sales proceeds to therepayment of debt and other accrued obligations including the payment of theoutstanding indebtedness of its construction staffing subsidiary under arevolving bank credit agreement in the amount of $1,810,210 and also repaid$451,920 of a bank term loan (see Note 3). Because of the substantialuncertainty that existed regarding completion of this transaction as ofSeptember 30, 2007, the Company will not commence treatment of its constructionstaffing business as discontinued operations until the fourth quarter of 2007.The pre-tax results of operations of the Company’s construction staffingbusiness are summarized below (in 000’s).

 
| ** **                     | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **September 30,**          | ** ** |
| ** **                     | ** ** | **2007**                        | ** ** | **2006** | ** ** |
| Construction staffing revenues |       | $                               | 11,841     |   | $ | 12,382 |   |
| Cost of construction staffing  |       | (9,335                          | )          | (10,113 | ) |
| Gross profit                   |       | 2,506                           |       | 2,269 |   |
| General & administrative   |       | (1,860                          | )          | (1,642 | ) |
| Interest expense, net          |       | (78                             | )          | (94 | ) |
| Net income before taxes        |       | $                               | 568        |   | $ | 533 |   |

 

The Company has also entered intonon-binding negotiations with a third party to sell its two subsidiaries in thepetroleum engineering services business (see Note 2).  At this point, theCompany does not believe that it is determinable whether such a sale will ultimatelybe completed.  If the sale is completed, the Company expects to apply thesales proceeds primarily to the repayment of debt and other accruedobligations.

 

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**ITEM 2.****                            ****MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLANOF OPERATION**

 

The following discussion of our financialcondition and results of operations should be read in conjunction with, and isqualified in its entirety by, the condensed consolidated financial statementsand notes thereto included in Item 1 in this Quarterly Report on Form 10-QSB.This item contains forward-looking statements that involve risks anduncertainties. Actual results may differ materially from those indicated insuch forward-looking statements.

 

**Forward-Looking Statements**

 

This Quarterly Report on Form 10-QSB andthe documents incorporated herein by reference contain forward-lookingstatements that have been made pursuant to the provisions of the PrivateSecurities Litigation Reform Act of 1995. Such forward-looking statements arebased on current expectations, estimates, and projections about our industry,management beliefs, and certain assumptions made by our management. Words suchas “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,”“estimates,” variations of such words, and similar expressions are intended toidentify such forward-looking statements. These statements are not guaranteesof future performance and are subject to certain risks, uncertainties, and assumptionsthat are difficult to predict; therefore, actual results may differ materiallyfrom those expressed or forecasted in any such forward-looking statements.Unless required by law, we undertake no obligation to update publicly anyforward-looking statements, whether as a result of new information, futureevents, or otherwise. However, readers should carefully review the risk factorsset forth in other reports and documents that we file from time to time withthe Securities and Exchange Commission, particularly the Quarterly Reports onForm 10-QSB, and future Annual Reports on Form 10-KSB and any Current Reportson Form 8-K.

 

**Overview and History**

 

Stratum Holdings, Inc. (formerly,Tradestar Services, Inc.) was incorporated in the State of Nevada on September3, 2003 under the name Frontier Staffing, Inc. We were formed to acquireTradestar Construction Services, Inc., a New Mexico corporation, which is awholly-owned subsidiary operating as an employment staffing servicespecializing in the placement of both long-term and short-term skilled andunskilled construction labor to the New Mexico construction market. In January2004, we acquired Tradestar Construction Services, Inc. in a stock-for-stockexchange. We issued a total of 6,400,000 shares of Common Stock in connectionwith this transaction.

 

In the construction services business, wedevelop, own, and operate employment service centers in specific regional areasspecializing in the placement of skilled construction labor. We provide bothskilled commercial craftsmen and general unskilled labor to major, non-unionconstruction contractors in several of the fast-growing markets in theSouthwestern U.S.

 

On July 7, 2004, we filed a registrationstatement under cover of Form SB-2 with the SEC. This registration statementwas declared effective by the SEC on February 10, 2005. On March 30, 2005, weclosed this public offering. We raised a total of $600,000 and sold a total of2,000,000 shares of Common Stock. In October 2005, we changed our name toTradestar Services, Inc.

 

On May 23, 2006, we acquired theoutstanding common stock of The CYMRI Corporation (“CYMRI”) for totalconsideration of $12.7 million paid in a combination of cash, notes payable andCommon Stock. CYMRI and its subsidiaries perform petroleum engineering serviceslargely for customers in the United States and are engaged in the explorationand production of oil and natural gas from properties located in Texas andLouisiana. The deemed effective date of the CYMRI acquisition for accountingpurposes was June 1, 2006. The effect of including CYMRI’s results ofoperations in the Company’s consolidated financial statements was to increaserevenues for the five months ended May 31, 2007 by $13,320,000 and to decreasenet loss, after giving effect to the purchase accounting adjustments, byapproximately $300,000 ($0.01 per share).

 

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On March 2, 2007, we acquired theoutstanding capital stock of Decca Consulting, Ltd. (“Decca”) for totalconsideration of $5.1 million paid in a combination of cash, notes payable andCommon Stock. Decca provides consulting services for the Canadian energyindustry. The deemed effective date of the Decca acquisition for accountingpurposes was March 1, 2007. The effect of including Decca’s results ofoperations in the Company’s consolidated financial statements since March 1,2007 was to increase revenues for the nine months ended September 30, 2007 by$9,780,000 and to decrease net loss, after giving effect to the purchaseaccounting adjustments, by $225,000 ($0.01 per share).

 

As a result of the CYMRI and Deccaacquisitions, the Company had the following three business segments as ofSeptember 30, 2007:

 
| •  Petroleum  Engineering (service based)                | - Houston, Texas          |
|--------------------------------------------------------------------|---------------------------|
|                                                               |                      | - Lafayette, Louisiana |
|                                                               |                      | - Calgary, Alberta |
|                                                               |                      |   |
| •  Construction  Staffing (service based)                | - Albuquerque, New Mexico |
|                                                               |                      | - Phoenix and Tempe,  Arizona |
|                                                               |                      | - Las Vegas, Nevada |
|                                                               |                      |   |
| •  Petroleum  Exploration & Production (asset based) | - Houston, Texas          |
|                                                               |                      | - Lafayette, Louisiana |

 

The Company has reported substantialconsolidated operating losses and working capital deficits since completing theCYMRI and Decca acquisitions. In order to address its liquidity needs, theCompany’s Board of Directors recently authorized Management to pursue a rangeof alternative actions including debt restructurings and the possible sales ofone or more of the Company’s operating assets or businesses as a means ofaddressing its financial obligations. As further described in “Subsequent Events”below, the Company sold its construction staffing business in October 2007 andhas applied the sales proceeds to the repayment of debt and other accruedobligations. The Company has also entered into non-binding negotiations with athird party for the sale of its petroleum engineering services business.

 

**Results of Operations**

 

The following commentary relates to thehistorical results of operations of the Company through September 30, 2007,prior to the sale of its construction staffing business referenced above.

 

The acquisitions of CYMRI in May 2006 andDecca in March 2007 substantially changed the Company’s operating profile andshifted its focus from one of solely a construction services company to one ofa company having a more diversified staffing segment with highly developedpetroleum engineering services businesses in the U.S. and Canada and a stilldeveloping construction services business. The acquired petroleum engineeringservices businesses are established operations with staffs who have performed awide variety of long term and short term projects for customers throughoutNorth and South America over a lengthy history. These projects tend to be of amore specialized, technical nature than the work performed in the traditionalconstruction services business. Additionally, the CYMRI acquisition has giventhe Company a non-core, capital-intensive petroleum exploration and productionsegment which is subject to the operational risks of oil and gas exploration aswell as the financial risks of a commodity pricing environment.

 

In its traditional construction servicesbusiness, the Company’s results of operations have been subject to variationsdue to a number of factors including the overall state of the constructionstaffing segment of the economy, the demand for our services and products,economic conditions in our markets, and product enhancements by us or ourcompetitors as well as other competitive conditions.

 

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*Threemonths ended September 30, 2007 versus three months ended September 30, 2006*— Total revenues for the three months endedSeptember 30, 2007 were $17,388,000 compared to $12,399,000 in the three monthsended September 30, 2006.

 

Revenues from construction staffing servicesfor the three months ended September 30, 2007 were $4,678,000 compared to$4,954,000 for the three months ended September 30, 2006. This decrease is dueprimarily to the decline in revenues in the construction branch in Las Vegas,Nevada, due to the Company’s 2007 decision to reduce its level of operations inthat market.

 

Revenues from petroleum engineering servicesfor the three months ended September 30, 2007 were $11,866,000 compared to$6,334,000 for the three months ended September 30, 2006. Included in the 2007period were three months of revenues from CYMRI’s petroleum engineeringbusiness, acquired effective June 1, 2006, plus three months of revenues fromDecca, acquired effective March 1, 2007, whereas the 2006 period included onlythree months of revenues from CYMRI’s petroleum engineering business. Totalbillings for petroleum engineering services in the three months ended September30, 2007, exclusive of cost reimbursements, were approximately 7,915 man daysat an average billing rate of approximately $1,425 per day.

 

Revenues from oil and gas sales for the threemonths ended September 30, 2007 were $825,000 compared to $1,107,000 for thethree months ended September 30, 2006. Revenues from oil production in thethree months ended September 30, 2007 were $638,000, reflecting volumes of9,763 barrels at an average price of $65.36 per barrel, while gas revenues were$187,000, reflecting volumes of 23,456 Mcf at an average price of $7.97 perMcf.

 

Costs of construction staffing services forthe three months ended September 30, 2007 was $3,763,000 versus $4,041,000 forthe three months ended September 30, 2006. Cost of construction staffingservices includes wages for temporary employees, federal and state payrolltaxes, workers compensation and other direct costs. Costs of constructionservices are generally consistent, except for payroll taxes where the maximumcontribution has been met and for workers compensation, which vary with eachjob site. Costs of construction services decreased as a percentage of revenuesto approximately 80% for the three months ended September 30, 2007, compared toapproximately 82% for the three months ended September 30, 2006, due to anincrease in billing rates.

 

Costs of petroleum engineering services forthe three months ended September 30, 2007 were $9,510,000 versus $4,720,000 forthe three months ended September 30, 2006. Included in the 2007 period werethree months of costs from CYMRI’s petroleum engineering business, acquiredeffective June 1, 2006, plus three months of costs from Decca, acquiredeffective March 1, 2007, whereas the 2006 period included only three months ofcosts from CYMRI’s petroleum engineering business. Costs of petroleumengineering services for the three months ended September 30, 2007 representedapproximately 80% of revenues, consistent with the blended historicalpercentages experienced by CYMRI’s staffing services subsidiary, PEI, andDecca.

 

Lease operating expenses (“LOE”), includingproduction taxes, were $341,000 for the three months ended September 30, 2007versus $468,000 for the three months ended September 30, 2006, reflectingdeclining volumes associated with LOE of CYMRI’s oil and gas productionoperations.

 

Depreciation, depletion and amortization(“DD&A”) expense for the three months ended September 30, 2007 was $243,000versus $353,000 for the three months ended September 30, 2006, primarilyreflecting declining volumes associated with DD&A of CYMRI’s oil and gasproduction operations.

 

Impairment expense to reduce oil and gasproperties to their estimated fair value was $7,000,000 for the three monthsended September 30, 2007 versus zero for the three months ended September 30,2006, reflecting a continuing downward trend in CYMRI’s field operations duringthe third quarter of 2007 as well as a lack of financial resources toadequately maintain the value of the properties.

 

Workover expenses for the three months endedSeptember 30, 2007 were $74,000 versus $313,000 for the three months endedSeptember 30, 2006, reflecting declining level of maintenance performed onCYMRI’s South Texas oil and gas properties, acquired effective June 1, 2006.

 

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Selling, general and administrative(“SG&A”) expenses for the three months ended September 30, 2007 were$2,429,000 compared to $2,086,000 for the three months ended September 30,2006. This increase reflected SG&A expenses applicable to CYMRI’s petroleumengineering and exploration and production operations, acquired effective June1, 2006, for a total of three months in 2007, plus the SG&A expenses ofDecca, acquired effective March 1, 2007, for three months, whereas the 2006period included only three months of SG&A expenses from CYMRI’s petroleumengineering and exploration and production operations. The major components ofSG&A expenses include professional fees, administrative salaries andassociated payroll costs, rent and telephone expenses.

 

Interest expense for the three months endedSeptember 30, 2007 was $584,000 versus $416,000 for the three months endedSeptember 30, 2006. This increase largely results from an increase in interestrates as well as a moderate increase in overall borrowings.

 

Income taxes were a benefit of $2,229,000for the three months ended September 30, 2007 versus a provision of $539 forthe three months ended September 30, 2006, and reflect a benefit rate of 34% ona pre-tax net loss of $6,556,000 in the three months ended September 30, 2007.

 

*Ninemonths ended September 30, 2007 versus nine months ended September 30, 2006*— Total revenues for the nine months endedSeptember 30, 2007 were $44,771,000 compared to $22,179,000 for the nine monthsended September 30, 2006.

 

Revenues from construction staffing servicesfor the nine months ended September 30, 2007 were $11,841,000 compared to$12,382,000 for the nine months ended September 30, 2006. This decrease is dueprimarily to the decline in revenues in the construction branch in Las Vegas,Nevada, due to the Company’s 2007 decision to reduce its level of operations inthat market.

 

Revenues from petroleum engineering servicesfor the nine months ended September 30, 2007 were $30,600,000 compared to$8,281,000 for the nine months ended September 30, 2006. Included in the 2007period were nine months of revenues from CYMRI’s petroleum engineeringbusiness, acquired effective June 1, 2006, plus seven months of revenues fromDecca, acquired effective March 1, 2007, whereas the 2006 period included onlyfour months of revenues from CYMRI’s petroleum engineering business. Total billingsfor petroleum engineering services in the nine months ended September 30, 2007,exclusive of cost reimbursements, were approximately 21,840 man days at anaverage billing rate of approximately $1,330 per day.

 

Revenues from oil and gas sales for the ninemonths ended September 30, 2007 were $2,234,000 compared to $1,450,000 for thenine months ended September 30, 2006. Included in the 2007 period were ninemonths of revenues from CYMRI’s oil and gas production operations, acquiredeffective June 1, 2006, whereas the 2006 period included only four months ofrevenues from CYMRI’s oil and gas production operations. Revenues from oilproduction in the nine months ended September 30, 2007 were $1,700,000reflecting volumes of 28,452 barrels at an average price of $59.75 per barrel,while gas revenues were $534,000, reflecting volumes of 72,021 Mcf at anaverage price of $7.41 per Mcf.

 

Costs of construction staffing services forthe nine months ended September 30, 2007 was $9,335,000 versus $10,113,000 for thenine months ended September 30, 2006. Cost of construction services includeswages for temporary employees, federal and state payroll taxes, workerscompensation and other direct costs. Costs of construction services aregenerally consistent, except for payroll taxes where the maximum contributionhas been met and for workers compensation, which vary with each job site. Costsof construction services decreased as a percentage of revenues to approximately79% for the nine months ended September 30, 2007, compared to approximately 82%for the nine months ended September 30, 2006, due to an increase in billingrates.

 

Costs of petroleum engineering services forthe nine months ended September 30, 2007 were $24,074,000 versus $6,012,000 forthe nine months ended September 30, 2006. Included in the 2007 period were ninemonths of costs from CYMRI’s petroleum engineering business, acquired effectiveJune 1, 2006, plus seven months of costs

 

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from Decca, acquired effective March 1, 2007,whereas the 2006 period included only four months of costs from CYMRI’spetroleum engineering business. Costs of petroleum engineering services for thenine months ended September 30, 2007 represented approximately 79% of revenues,consistent with the blended historical percentages experienced by CYMRI’sstaffing services subsidiary, PEI, and Decca.

 

Lease operating expenses (“LOE”), includingproduction taxes, were $1,052,000 for the nine months ended September 30, 2007versus $619,000 for the nine months ended September 30, 2006, representing LOEof CYMRI’s oil and gas production operations, acquired effective June 1, 2006,for a total of nine months in the 2007 period and four months in the 2006period.

 

Depreciation, depletion and amortization(“DD&A”) expense for the nine months ended September 30, 2007 was $728,000versus $494,000 for the nine months ended September 30, 2006, representingDD&A of CYMRI’s oil and gas production operations, acquired effective June1, 2006, for a total of nine months in the 2007 period and four months in the2006 period.

 

Impairment expense to reduce oil and gasproperties to their estimated fair value was $7,000,000 for the nine monthsended September 30, 2007 versus zero for the nine months ended September 30,2006, reflecting a continuing downward trend in CYMRI’s field operations duringthe third quarter of 2007 as well as a lack of financial resources toadequately maintain the value of the properties.

 

Workover expenses for the nine months endedSeptember 30, 2007 were $529,000 versus $402,000 for the nine months endedSeptember 30, 2006, representing workovers on CYMRI’s South Texas oil and gasproperties, acquired effective June 1, 2006, for a total of nine months in the2007 period and four months in the 2006 period.

 

Selling, general and administrative(“SG&A”) expenses for the nine months ended September 30, 2007 were$8,124,000 compared to $3,749,000 for the nine months ended September 30, 2006.This increase reflected SG&A expenses applicable to CYMRI’s petroleumengineering and exploration and production operations, acquired effective June1, 2006, for a total of nine months in 2007, plus the SG&A expenses ofDecca, acquired effective March 1, 2007, for seven months, whereas the 2006 periodincluded only four months of SG&A expenses from CYMRI’s petroleumengineering and exploration and production operations. The major components ofSG&A expenses include professional fees, administrative salaries andassociated payroll costs, rent and telephone expenses.

 

Interest expense for the nine months endedSeptember 30, 2007 was $1,509,000 versus $596,000 for the nine months endedSeptember 30, 2006. This substantial increase reflects interest expense onCYMRI’s long term debt applicable to CYMRI’s oil and gas production operations,acquired effective June 1, 2006, for a total of nine months in the 2007 periodand four months in the 2006 period.

 

Income taxes were a benefit of $2,577,000for the nine months ended September 30, 2007 versus a provision of $65,000 forthe nine months ended September 30, 2006, and reflect a benefit rate of 34% ona pre-tax net loss of $7,580,000 in the nine months ended September 30, 2007.

 

**Liquidity and Capital Resources**

 

*Operating**activities.*Cashflow from operating activities for the nine months ended September 30, 2007reflected revenues, less operating expenses, resulting from the acquisitions ofCYMRI and Decca for the nine and seven months, respectively, whereas only fourmonths of cash flow from CYMRI’s acquired operations was reflected in cash flowfrom operating activities for the nine months ended September 30, 2006. Cashflow from operating activities was also impacted by changes in working capital.Net cash flow used in operating activities for the nine months ended September30, 2007 was $1,085,000 versus $3,253,000 for the nine months ended September30, 2006. These operating cash flow amounts were net of changes in workingcapital, which resulted in net cash decreases in the amounts of $1,237,000 and$3,872,000 in the nine month periods ended September 30, 2007 and

 

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2006,respectively, due primarily to changes in relative timing between the accrualand payment of accounts receivable and accounts payable.

 

*Investing**activities.*Net cash used in investingactivities for the nine months ended September 30, 2007 was $667,000 comparedto $2,905,000 for the nine months ended September 30, 2006. The 2007 amountreflected cash expended for: (a) The cash portion of the Decca purchase pricein the amount of $152,000; and (b) Capital expenditures in the amount of$515,000, primarily for drilling and equipment costs incurred on CYMRI’s oiland gas properties. CYMRI’s capital expenditures were relatively low in thenine months ended September 30, 2007 due to the decline in drilling activity.

 

*Financing activities.*Netcash provided by financing activities for the nine months ended September 30,2007 was $1,565,000 compared to $5,457,000 for the nine months ended September 30,2006. In the nine months ended September 30, 2007, net proceeds of long termdebt borrowings and stockholder advances provided cash in the amount of$5,366,000, payments of long term debt used cash of $4,574,000, and privatestock issuances plus warrant/option exercises provided total cash of $772,000.In the nine months ended September 30, 2006, net proceeds of stockholderadvances and long term debt borrowings provided cash in the amount of$5,457,000.

 

The Company’s capital expenditure profilehas changed significantly since the CYMRI acquisition. In our constructionservices business, capital expenditure requirements are relatively low, exceptfor the periodic opening of new construction services centers. Likewise,capital expenditure requirements of CYMRI’s staffing services subsidiary,Petroleum Engineers, Inc. (“PEI”) are relatively low. However, CYMRI’sexploration and production business can be highly capital intensive. In thisbusiness, expenditures for the drilling and equipping of oil and gas wells aretypically required to maintain or increase existing production levels andproduction often declines in a relatively short period of time if maintenancecapital is not invested timely. Further, acquisitions of additional leaseacreage are often needed to drill new oil and gas wells. As is the case withmost companies with oil and gas producing operations, the Company would expectto finance its capital expenditure requirements through a combination of cashflow from operations, secured bank borrowings and other sources.

 

The CYMRI and Decca acquisitions havesubstantially increased the Company’s long term debt obligations (see Note 3,“Long Term Debt”). A substantial portion of our long term debt is in the formof a bank credit facility secured by our producing oil and gas properties.Borrowings under the bank credit agreement are subject to a borrowing base,which is periodically redetermined, and amounted to $6,035,000 as of December31, 2006. The terms of the bank credit agreement, as amended, require CYMRI tomaintain certain financial covenants regarding working capital ratio, interestcoverage level, the ratio of loan balance to loan balance plus stockholders’equity, and the non-payment of dividends. As of September 30, 2007, the Companyhad no unutilized borrowing capacity available under the credit agreement. Dueto operational circumstances, the Company was not in compliance with thedefined interest coverage and debt ratio covenants as of September 30, 2007.The bank is aware of these covenant violations, however, it has not requested,nor does the Company expect it to request, accelerated payment of the loan as a result thereof. The Company’smonthly payment obligations under the bank credit facility are dependent upon aperiodic evaluation of CYMRI’s producing oil and gas properties. As presentlystructured, borrowings outstanding under the bank credit facility in the amountof $5,300,000 are due on November 30, 2007 and the bank has not indicated thatit is willing to enter into a new credit agreement beyond that date. However,the Company expects the bank to grant an extension of the maturity, as needed,to enable the Company to extinguish the debt in a possible transaction that mayresult in a disposition of the oil and gas properties to a related party.

 

The terms of a second bank credit agreement,secured by domestic accounts receivable of the petroleum and constructionstaffing services businesses, provide for a revolving borrowing base of 85% ofqualifying accounts receivable up to $7,000,000, with an interest rate of 1%above prime through June 30, 2007. As of that date, the Company was not incompliance with the minimum net worth covenant of its construction staffingsubsidiary and certain other equity related financial covenants of therevolving credit agreement. Accordingly, the bank modified the revolving creditagreement to require: (a) 2% increase in the interest rate charged onborrowings made under the revolving credit agreement, effective July 1, 2007;(b) The appointment of a bank approved 

 

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consultant to approve the Company’s weeklycash flow budgets and borrowing requests made to the bank; and (c) The bank’sapproval of any intercompany cash transfers. As of September 30, 2007, asubsidiary borrower had one minor covenant violation, however, the bank isaware of the violation and the Company does not expect the bank to requestaccelerated payment of the loan as a result thereof. As further discussed in“Subsequent Events” below, the Company sold its construction staffing businessto a private construction staffing company in October 2007. At the closing ofthe sale, the Company repaid the outstanding indebtedness of its constructionstaffing subsidiary under the revolving credit agreement in the amount of$1,810,210 and also repaid $451,920 of a bank term loan.

 

To meet short term liquidity needs followingthe CYMRI acquisition, the Company commenced a private offering of shares ofCommon Stock and Warrants to a group of Accredited Investors in October 2006.In the fourth quarter of 2006, we sold a total of 314,286 shares of CommonStock to Accredited Investors at $1.75 per share for gross proceeds of $550,000and issued one year Warrants to such Investors to purchase an additional314,286 shares of our Common Stock at $2.50 per share. In the first quarter of2007, we sold a total of 385,714 shares of Common Stock to Accredited Investorsat $1.75 per share for gross proceeds of $675,000 and issued one year Warrantsto such Investors to purchase an additional 385,714 shares of our Common Stockat $2.50 per share.

 

**Subsequent Events**

 

On October 26, 2007, the Company soldsubstantially all of the assets of its construction staffing business to aprivate construction staffing company. The Company received cash proceeds of$3,200,000 at closing of the sale and expects to receive additional cashproceeds in January 2008 as a working capital adjustment. The Companyanticipates reporting a pre-tax gain from the sale of these assets in the fourthquarter of 2007. The Company has applied the sales proceeds to the repayment ofdebt and other accrued obligations including the payment of the outstandingindebtedness of its construction staffing subsidiary under a revolving bankcredit agreement in the amount of $1,810,210 and also repaid $451,920 of a bankterm loan.

 

The Company has also entered intonon-binding negotiations with a third party to sell its two subsidiaries in thepetroleum engineering services business.  At this point, the Company doesnot believe that it is determinable whether such a sale will ultimately becompleted.  If the sale is completed, the Company expects to apply thesales proceeds primarily to the repayment of debt and other accruedobligations.

 

**Recently Issued AccountingPronouncements**

 

InFebruary 2007, the Financial Accounting Standards Board (“FASB”) issuedStatement No. 159 “**The Fair Value Option for Financial Assetsand Financial Liabilities—Including an amendment of FASB Statement No. 115**”(“SFAS 159”), which allows measurement at fair value of eligible financialassets and liabilities that are not otherwise measured at fair value. SFAS 159is effective for fiscal years beginning after November 15, 2007. We do notexpect the adoption of SFAS 159 to have a material impact on our consolidatedfinancial statements.

 

In September 2006, the FASB issuedStatement No. 158 “*Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans, anamendment of FASB Statements No. 87, 88, 106, and 132(R)*”(“SFAS 158”), which requires companies to recognize the funded status of adefined benefit postretirement plan as an asset or liability in its balancesheet.  SFAS 158 is effective for fiscal years ending after December 15,2006. We do not expect the adoption of SFAS 158 to have an impact on us sincewe have no defined benefit plans.

 

In September 2006, the FASB issuedSFAS No. 157, “*Fair ValueMeasurements*” (“SFAS 157”), which defines fair value, establishes aframework for measuring fair value and expands disclosures about fair valuemeasurements. This Statement applies under other accounting pronouncements thatrequire or permit fair value measurements, the FASB having previously concludedin those accounting pronouncements that fair value is the relevant measurementattribute. SFAS 157 is effective for fiscal years beginning afterDecember 15, 2007. We do not expect the adoption of SFAS 157 to have amaterial impact on our consolidated financial statements.

 

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In July 2006, the FASB issued FinancialInterpretation No. 48, “*Accounting forUncertainty in Income Taxes — an interpretation of FASB Statement No. 109*”(“FIN 48”), to clarify certain aspects of accounting for uncertain taxpositions, including issues related to the recognition and measurement of thosetax positions. This interpretation is effective for fiscal years beginningafter December 15, 2006. We are in the process of evaluating the impact ofthe adoption of this interpretation on our consolidated financial position,results of operations or cash flows.

 

In March 2006, the FASB issued SFASNo.156, “*Accounting for Servicing ofFinancial Assets*” (“SFAS 156”), which requires all separatelyrecognized servicing assets and servicing liabilities be initially measured atfair value. SFAS 156 permits, but does not require, the subsequent measurementof servicing assets and servicing liabilities at fair value. Adoption isrequired as of the beginning of the first fiscal year that begins afterSeptember 15, 2006. Early adoption is permitted. The adoption of SFAS 156is not expected to have a material effect on our consolidated financialposition, results of operations or cash flows.

 

In February 2006, the FASB issued SFAS No.155, “*Accounting for Certain Hybrid FinancialInstruments, an amendment of FASB Statements No. 133 and 140*” (“SFAS155”). SFAS 155 clarifies certain issues relating to embedded derivatives andbeneficial interests in securitized financial assets. The provisions of SFAS155 are effective for all financial instruments acquired or issued after fiscalyears beginning after September 15, 2006. We do not expect that the adoption ofSFAS 155 will have a material impact on our consolidated financial position,results of operations or cash flows.

 

**Critical Accounting Policies andEstimates**

 

Our discussion and analysis of ourfinancial condition and results of operations are based on consolidatedfinancial statements which have been prepared in accordance with generallyaccepted accounting principles in the United States. The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenues and expenses. We believethat certain accounting policies affect our more significant judgments andestimates used in the preparation of our consolidated financial statements asindicated below. See our Annual Report on Form 10-KSB for the year endedDecember 31, 2006 for a further description of our critical accounting policiesand estimates.

 

**ITEM 3.****                            ****CONTROLS AND PROCEDURES**

 

As of the date of this report, our ChiefExecutive Officer and our Chief Financial Officer evaluated the effectivenessof the design and operation of our disclosure controls and procedures pursuantto Rule 13a-15b under the Securities Exchange Act of 1934. Based on theirreview of our disclosure controls and procedures, they have concluded that ourdisclosure controls and procedures are effective in timely alerting each ofthem to material information relating to us that is required to be included inour periodic SEC filings. Further, there were no significant changes in theinternal controls or in other factors that could significantly affect thesedisclosure controls after the evaluation date and the date of this report. Norwere there any significant deficiencies or material weaknesses in suchdisclosure controls and procedures requiring corrective actions. As a result,no corrective actions were taken. The Company has made no changes in itsinternal controls over financial reporting in the most recent quarterlyreporting period that has materially affected, or is reasonably likely toaffect, the Company’s internal controls over financial reporting.

 

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

 

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

 

See Note 8 toCondensed Consolidated Financial Statements.

 

**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**

 

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 Executive 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 the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
|   | STRATUM HOLDINGS, INC. |
|--------|------------------------|
|   |                   |   |
|   |                   |   |
|   | /s/                    | Richard A. Piske, III |   |
|   |                   | Richard A. Piske, III |
|   |                   | Chief Executive Officer |
|   |                   |   |
|   | /s/                    | D. Hughes Watler, Jr. |   |
|   |                   | D. Hughes Watler, Jr. |
|   |                   | Chief  Financial Officer |

 

 

November12, 2007

 

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