UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





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


Securities Exchange Act of 1934





For the Quarterly Period Ended March 31, 2011




Commission File No. 000-51229





STRATUM HOLDINGS, INC.


(Exact Name of Registrant as specified in its charter)





Nevada

51-0482104(State or other jurisdiction

of incorporation)

(IRS Employer Identification Number)





Three Riverway, Suite 1590

Houston, Texas

77056(Address of principal

executive offices)

(zip code)





(713) 479-7050


(Registrant’s telephone number, including area code)





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





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





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





Large accelerated filer    r      Accelerated filer     r      Non-accelerated filer    r         Smaller reporting company þ





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





The number of shares outstanding of Common Stock, par value $.01 per share, as of May 13, 2011 was 2,655,738shares.











STRATUM HOLDINGS, INC.


FORM 10-Q


MARCH 31, 2011





INDEX





PART I. FINANCIAL INFORMATION
PageItem 1. Financial StatementsConsolidated Balance Sheets as of March 31, 2011 (Unaudited) and

December 31, 2010 (Unaudited)
3Consolidated Statements of Operations for the three months ended

March 31, 2011 and 2010 (Unaudited)
4Consolidated Statements of Cash Flows for the three months ended

March 31, 2011 and 2010 (Unaudited)
5Notes to Consolidated Financial Statements (Unaudited)
6Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
13Item 3. Quantitative and Qualitative Disclosures About Market Risk
16Item 4. Controls and Procedures
16PART II. OTHER INFORMATIONItem 1. Legal Proceedings
17Item 1A. Risk Factors
17Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
17Item 3. Defaults Upon Senior Securities
17Item 5. Other Information
17Item 6. Exhibits
17Signatures
18





- 2 -





STRATUM HOLDINGS, INC.


Consolidated Balance Sheets


(Unaudited)




March 31,


December 31,2011


2010AssetsCurrent assets:Cash and cash equivalents

$
28,864


$
142,236Accounts receivable


4,698,598



4,532,676Prepaid expenses and other


126,938



148,010Total current assets


4,854,400



4,822,922Property and equipment:Oil and gas properties, evaluated (full cost method)


14,683,846



14,560,532Other property and equipment


149,676



149,67614,833,522



14,710,208Less:  Accumulated depreciation, depletion & amortization


(8,739,975
)


(8,615,840
)Net property and equipment


6,093,547



6,094,368Other assets:Goodwill


1,536,313



1,536,313Other assets


119,472



111,139Total other assets


1,655,785



1,647,452Total assets

$
12,603,732


$
12,564,742Liabilities and Stockholders’ DeficitCurrent liabilities:Current portion of long-term debt - stockholders

$
770,000


$
730,709Current portion of long-term debt - others


3,757,012



4,885,961Accounts payable


4,730,002



3,723,754Accrued liabilities


1,382,817



1,246,232Fair value of oil and gas derivatives


78,755



37,835Total current liabilities


10,718,586



10,624,491Long-term debt, net of current portion


262,524



337,378Deferred income taxes


1,578,000



1,559,500Asset retirement obligations


341,180



333,670Total liabilities


12,900,290



12,855,039Stockholders’ deficit:Preferred stock, $.01 par value per share, 1,000,000 shares authorized,None issued


-



-Common stock, $.01 par value per share, 5,000,000 shares authorized,2,655,738 shares issued and outstanding


26,557



26,557Additional paid in capital


12,894,490



12,894,490Accumulated deficit


(12,968,310
)


(13,001,655
)Accumulated foreign currency translation adjustment


(249,295
)


(209,689
)Total stockholders’ deficit


(296,558
)


(290,297
)Total liabilities and stockholders’ deficit

$
12,603,732


$
12,564,742




See accompanying notes to unaudited consolidated financial statements.





- 3 -







STRATUM HOLDINGS, INC.


Consolidated Statements of Operations


(Unaudited)






Three Months Ended

March 31,2011


2010Revenues:Energy services

$
7,775,868


$
5,747,471Oil and gas sales


756,500



594,430Other


15,323



11,1878,547,691



6,353,088Expenses:Energy services


7,152,211



5,234,996Lease operating expense


398,123



477,358Depreciation, depletion & amortization


124,135



168,337Workover expense


103,649



200,495Selling, general and administrative


544,387



417,6608,322,505



6,498,846Operating income (loss)


225,186



(145,758
)Other income (expense):Interest expense


(132,421
)


(190,418
)Gain on debt extinguishment


-



438,967Unrealized gain (loss) on oil and gas derivatives


(40,920
)


21,590Income before income taxes


51,845



124,381Provision for income taxes


(18,500
)


(42,300
)Net income

$
33,345


$
82,081Net income per share, basic and diluted

$
0.01


$
0.03Weighted average shares outstanding, basic and diluted


2,655,738



2,655,738




See accompanying notes to unaudited consolidated financial statements.





- 4 -





STRATUM HOLDINGS, INC.


Consolidated Statements of Cash Flows


(Unaudited)






Three Months Ended

March 31,2011


2010Cash flows from operating activities:Net income

$
33,345


$
82,081Adjustments to reconcile net income to netcash provided by (used in) operationsDepreciation, depletion & amortization


124,135



168,337Provision for income taxes


18,500



42,300Stock based compensation


-



11,525Gain on debt extinguishment


-



(438,967
)Unrealized (gain) loss on oil and gas derivatives


40,920



(21,590
)Changes in current assets and liabilities


958,377



(754,172
)Other changes, net


(823
)


22,667Net cash flows from operating activities


1,174,454



(887,819
)Cash flows from investing activities:Decrease in restricted cash


-



1,613,637Purchase of property and equipment


(123,314
)


(109,893
)Net cash flows from investing activities


(123,314
)


1,503,744Cash flows from financing activities:Payments of long term debt


(1,194,512
)


(953,844
)Proceeds from long term debt


30,000



877,711Net payments of stockholder advances


-



(490,854
)Net cash flows from financing activities


(1,164,512
)


(566,987
)Net increase (decrease) in cash and cash equivalents


(113,372
)


48,938Cash and equivalents at beginning of period


142,236



142,703Cash and equivalents at end of period

$
28,864


$
191,641Supplemental cash flow data:Cash paid for interest

$
111,953


$
97,830Cash paid for income taxes


-



-Supplemental financing activity:Gain on debt extinguishment - related party

$
-


$
74,097





See accompanying notes to unaudited consolidated financial statements.





- 5 -





STRATUM HOLDINGS, INC.


Notes to Consolidated Financial Statements


(Unaudited)





(1)
Basis of Presentation





Interim Financial Information– The accompanying consolidated financial statements have been prepared by Stratum Holdings, Inc. (the “Company”) without audit, in accordance with accounting principles generally accepted in the Unites States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission.  In the opinion of management, these consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to fairly state the financial position of the Company as of March 31, 2011, the results of its operations for the three month periods ended March 31, 2011 and 2010, and cash flows for the three month periods ended March 31, 2011 and 2010.  Certain prior year amounts have been reclassified to conform with the current year presentation.  These financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2010.





Recently Issued Accounting Pronouncements – In April 2010, the Financial Accounting Standards Board (“FASB”) issued ASU 2010-14, “Accounting for Extractive Activities – Oil and Gas.”  This update amends Accounting Standards Codification (“ASC”) 932-10-S99-1 to conform to the SEC’s recently issued final rules regarding amendments to current oil and gas reporting requirements.  The Company’s adoption of ASU 2010-14 has had no impact on its financial position, results of operations or cash flows.








(2)
Going Concern





The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has reported substantial losses from operations in the last two years and has a net working capital deficit in the amount of $5,864,186 as of March 31, 2011.  These factors, among others, indicate that the Company may be unable to continue as a going concern for a reasonable period of time.  The consolidated financial statements do not contain any adjustments to reflect the possible future effects on the classification of assets or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern.








(3)
Commodity Derivatives





Beginning in early 2009, the Company entered into three contiguous commodity derivative contracts with a major energy company covering a portion of a subsidiary’s domestic oil production.  The first two contracts have expired and the third contract remained open as of March 31, 2011.  This contract consists of a “costless collar,” with a floor price of $65.00 per barrel and a ceiling price of $105.50 per barrel, covering 1,000 barrels of oil per month for the calendar year 2011.





The Company applies “mark to market” accounting to open derivative contract in accordance with ASC 815-20, “Accounting for Derivative Instruments and Hedging Activities”.  The Company accounts for commodity derivative contracts as non-hedging transactions, as defined in ASC 815-20.  Accordingly, changes in the fair value of such derivative contracts are reflected in current earnings in the period of the change.  In the three months ended March 31, 2011 and 2010, the Company reported an unrealized derivative loss of $40,920 and an unrealized derivative gain of $21,590, based on “Level 2” inputs.





- 6 -








(4)
Long Term Debt





As of March 31, 2011 and December 31, 2010, the Company had the following long-term debt obligations:




March 31.


December 31.2011


2010$25,000,000 line of credit with a bank, maturity currently extended to June 2011, interest at 1.0% above prime (but not less than 6.0%) payable monthly, secured by first lien on CYMRI, LLC’s oil and gas properties, with a declining borrowing base of $2,911,000 as of March 31, 2011

$
2,911,000


$
2,951,000$4,000,000 (Cdn) receivables factoring facility with a factoring company, interest on factored invoices at annual rate of 18.25%, compounded daily, for a minimum of 15 days, secured by accounts receivable of Canadian energy services business


737,754



1,806,581Notes payable to 2 individuals, incurred in acquisition of Decca Consulting, Ltd., bearing interest at 9%, payable in monthly installments of $30,099 (Cdn) through extended maturity in June 2013, unsecured


502,524



538,087Advances from stockholders, bearing interest at 10%, with principal and accrued interest due in March 2010, unsecured ($530,000 extended since March 2010 - see discussion below)


530,000



530,000Other short term notes for liability insurance and accrued payables, interest rates at 7% to 9%


108,258



128,3804,789,536



5,954,048Current portion of long term debt - stockholders


(770,000
)


(730,709
)Current portion of long term debt - others


(3,757,012
)


(4,885,961
)Long term debt, net of current portions

$
262,524


$
337,378




Borrowings under the bank credit agreement secured by the oil and gas properties owned by CYMRI, LLC (“CYMRI”), a subsidiary in the Exploration & Production segment, are subject to a borrowing base, which is periodically redetermined based on oil and gas reserves.  The bank credit agreement does not require monthly principal payments so long as outstanding borrowings are less than a declining borrowing base.  As of March 31, 2011, there was no available borrowing base and the maturity was scheduled in April 2011, however, the bank informally agreed to extend the maturity on a month-to-month basis provided CYMRI makes monthly principal and interest payments during the extension period.  The bank credit agreement requires maintenance of certain financial covenants which CYMRI did not fully meet as of March 31, 2011 and December 31, 2010.  Due to the covenant violations as well as the near term maturity, we have reported this debt in our current liabilities at March 31, 2011.





- 7 -







We also have outstanding institutional borrowings under a factoring facility, which is secured by accounts receivable of Decca, our Canadian Energy Services subsidiary.  This factoring agreement with a Canadian factoring company provides for a revolving borrowing base of 75% of qualifying accounts receivable up to $4,000,000 (Cdn) at a daily discount rate of 0.05%, for a minimum of 15 days (an annualized interest rate of approximately 18.25%).  The factoring company has recourse against Decca for factored accounts receivable until paid, therefore, Decca accounts for advances from the factoring company as revolving borrowings secured by the factored accounts receivable.  The factoring agreement includes customary restrictive covenants on Decca’s operations but does not include any financial covenants.  Either party may terminate the factoring agreement with sixty days advance notice to the other party.  The factoring agreement replaced a revolving bank credit agreement which expired in September 2010.




In March 2010, the Company’s unsecured notes payable to certain related and unrelated parties became due and payable in the principal amount of $2,172,000.  At that time, the Company reached an agreement with noteholders in the principal amount of $1,407,000 to accept a payment of 80% of the principal balance in full satisfaction of their unsecured notes payable.  Accordingly, the Company fully extinguished the debt to these noteholders in March 2010 with principal payments totaling $1,125,000 resulting in a total gain of $551,000 on the forgiven principal and accrued interest.  Of this amount, $112,000 was attributable to debt of a current shareholder, therefore, the Company credited the after-tax equivalent of $74,000 to Additional paid in capital and recognized a pre-tax gain in the three months ended March 31, 2010 on the remaining portion attributable to unrelated parties in the amount of approximately $439,000.





The remaining unsecured noteholder is a company owned by our Chairman and Chief Executive Officer and the Company also reached an agreement with that company in March 2010 to make a net principal payment of $265,000, in exchange for deferring the maturity of the remaining balance of $500,000 to a date to be mutually determined (an additional $30,000 was borrowed on the same terms in May 2010).  The Company evaluated the application of ASC 470-50 and ASC 470-60 and concluded that the revised terms constituted a debt modification, rather than a debt extinguishment or a troubled debt restructuring.





(5)
Net Income (Loss) Per Share





Basic income (loss) per common share is computed by dividing the net income or loss by the weighted average number of shares of common stock outstanding during the period.  Diluted income (loss) per common share is computed by dividing net income or loss by the weighted average number of shares of common stock outstanding during the period and potentially dilutive common share equivalents, consisting of stock options and warrants, under the Treasury Stock Method. The effects of potential common stock equivalents are not included in computations when their effect is anti-dilutive.





In the three month periods ended March 31, 2011 and 2010, there were no dilutive common stock equivalents reflected in the determination of net income per share as there were no outstanding in-the-money employee stock options in either period (see Note 6).








- 8 -





(6)
Stock-Based Compensation





The Company has a stock-based compensation plan which was approved by the stockholders in October 2005 and amended in October 2006.  Under the plan, a maximum of 240,000 shares may be awarded to directors and employees in the form of stock options, restricted stock or stock appreciation rights.  The exercise price, terms and other conditions applicable to each stock option grant are generally determined by the Board of Directors.  The exercise price of stock options is set on the grant date and may not be less than the fair market value of the Company’s Common Stock on that date.





Option activity with directors and employees since January 1, 2010 were as follows (including options granted to directors outside of the plan):




Number


Wtd. Avg.


Wtd. Avg.


Aggregateof


Exercise


Remaining


IntrinsicShares


Price


Term (Yrs.)


ValueOutstanding at January  1, 2010


47,500


$
7.60Options forfeited


(25,000
)


(2.40
)Outstanding at December 31, 2010


22,500



13.30Option activity


-



-Outstanding at March 31, 2011


22,500


$
13.30



0.17


$
-Exercisable at March 31, 2011


22,500


$
13.30



0.17


$
-





Stock-based compensation expense related to these options in the amounts of zero and $11,525 have been recognized as a current period expense in the accompanying Consolidated Financial Statements for the three month periods ended March 31, 2011 and 2010, respectively.  As of March 31, 2011, there is no unrecognized compensation cost remaining to be recognized in future periods.  The estimated fair value of the options granted to employees under the plan was calculated using a Black Scholes option pricing model. The following schedule reflects the assumptions included 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; (d) Expected option term – 3 to 4 years, calculated pursuant to the terms of ASC 718-10 as the option grants qualify as “plain vanilla” under that pronouncement; and (e) Forfeitures – 0%, subject to adjustment for actual experience.  Vesting terms of the options are generally three years.  The aggregate intrinsic value of employee options granted as of March 31, 2011 and 2010 were zero as there were no in-the-money options at those dates.





- 9 -





(7)
Stockholder Advances





The Company repaid net stockholder notes and advances in the amounts of zero and $491,000 in the three months ended March 31, 2011 and 2010, respectively.  Such advances, excluding amounts advanced to finance the cash portion of the CYMRI purchase price (see Note 4), are reflected as unsecured long term debt obligations and accrue interest at a rate of 10% per annum.








(8)
Contingencies





From time to time the Company may become involved in litigation in the ordinary course of business. At the present time, other than the Company’s disclosures below, the Company’s management is not aware of any such litigation that could have a material adverse effect on its results of operations, cash flows or financial condition.





Triumph Energy, Inc., a subsidiary in the Exploration & Production segment, and a former subsidiary are joint defendants in several lawsuits involving professional liability and other matters arising in the normal course of business in the State of Louisiana.  It is not practical at the present time to determine the amount or likelihood of an unfavorable outcome to the Company’s consolidated financial position or results of operations of any of the these actions against Triumph.  The Company believes that Triumph has meritorious defenses in each case and is vigorously defending these matters.





In October 2008, an insurer for the Company’s inactive Construction Staffing subsidiary filed a lawsuit against the subsidiary alleging default on a premium finance obligation in the amount of approximately $200,000, plus interest and attorney’s fees. The Company believes that its inactive Construction Staffing subsidiary has a meritorious position in this matter and has not engaged legal counsel to defend this case.  A non-appealable judgment was rendered in favor of the plaintiff in January 2011, however, the Company does not believe that it could be held liable for damages owing by its defunct Construction Staffing subsidiary.  Nonetheless, the Company has recorded an accrual for the estimated loss exposure in this matter as of March 31, 2011.





The Company, as a lessee and operator of oil and gas properties, is subject to various federal, state and local laws and regulations relating to discharge of materials into, and protection of, the environment. These laws and regulations may, among other things, impose liability on the lessee under an oil and gas lease for the cost of pollution clean-up resulting from operations and subject the lessee to liability for pollution damages. The Company maintains insurance coverage, which it believes is customary in the industry, although the Company is not fully insured against all environmental risks. The Company is not aware of any environmental claims existing as of March 31, 2011, which have not been provided for, covered by insurance or otherwise have a material impact on its financial position or results of operations. There can be no assurance, however, that current regulatory requirements will not change, or past noncompliance with environmental laws will not be discovered on the Company’s properties.





- 10 -





(9)
Segment Information
 
 The table below reflects the allocation between the Company’s two reportable segments of certain amounts in the consolidated Income Statement, other than interest expense and income taxes (which the Company does not believe are feasible to allocate), and the consolidated Balance Sheet as of and for the three months ended March 31, 2011 (in 000’s):


Energy


Exploration &Services


Production(Canada)


(U. S.)


TotalIncome Statement Data:Operating revenues

$
7,776


$
756


$
8,532Other revenues


15



-



15Total revenues


7,791



756



8,547Depreciation, depletion & amortization


-



(124
)


(124
)Other allocable operating expenses


(7,152
)


(502
)


(7,654
)Gross profit

$
639


$
130



769General and administrative expenses










(544
)Operating income










225Interest expense










(132
)Unrealized loss on oil and gas derivatives










(41
)Net income before income taxes









$
52Balance Sheet Data:Subsidiary assets

$
4,224


$
6,793


$
11,017Goodwill


1,537



-



1,537Segment assets

$
5,761


$
6,793



12,554Corporate assets










50Consolidated assets









$
12,604






- 11 -





The table below reflects the allocation of certain Income Statement data between these two reportable segments for the three months ended March 31, 2010 (in 000’s):
  Income Statement Data:Operating revenues

$
5,748


$
594


$
6,342Other revenues


10



1



11Total revenues


5,758



595



6,353Depreciation, depletion & amortization


-



(168
)


(168
)Other allocable operating expenses


(5,235
)


(678
)


(5,913
)Gross profit (loss)

$
523


$
(251
)


272General and administrative expenses










(418
)Operating loss










(146
)Interest expense










(190
)Gain on debt extinguishment










439Unrealized gain on oil and gas derivatives










21Net income before income taxes









$
124
  There is no presentation of Balance Sheet data allocated between these two reportable segments as of March 31, 2010 inasmuch as the consolidated Balance Sheet as of that date is not included in this report.


(10)
Subsequent Event





In May 2011, the Company reached substantive agreement with a third party to sell the capital stock of its Canadian Energy Services subsidiaries, Decca Consulting, Ltd. and Decca Consulting, Inc. (collectively referred to as “Decca”), for a total sales price in excess of the Company’s net investment in Decca.  Subject to final negotiations, the sales price is payable in a combination of cash, collected accounts receivable and the issuance of a promissory note payable.  Negotiations with the purchaser on a definitive stock purchase agreement are continuing, however, the Company presently expects to close the sale of Decca and to report a pre-tax gain from the sale in the second quarter of 2011.








- 12 -





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





The following discussion of our financial condition and results of operations should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and notes thereto included in Item 1 in this Quarterly Report on Form 10-Q. This item contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those indicated in such forward-looking statements.





Overview





Stratum Holdings, Inc. (“we” or the “Company”) is a holding company whose operations are primarily focused on the domestic Exploration & Production business with a secondary focus on the Canadian Energy Services business.  In the domestic Exploration & Production business, our wholly-owned subsidiaries, CYMRI, L.L.C. and Triumph Energy, Inc., own working interests in approximately 60 producing oil and gas wells in Texas and Louisiana, with net production of approximately 700 MCF equivalent per day.  Our operations in the Canadian Energy Services business are conducted through our wholly-owned subsidiaries, Decca Consulting, Ltd. and Decca Consulting, Inc. (collectively referred to as “Decca”), which provide on-site drilling and completion consulting services to oil and gas operators, primarily in Canada.





We operate our domestic Exploration & Production business and our Canadian Energy Services business on an essentially autonomous basis.





Due to volatility in worldwide energy prices and tightening in credit markets, we have faced significant financial and operational challenges in the past two years.  As a result of those concerns, we recently reached substantive agreement with a third party to sell the capital stock of Decca in a transaction that we expect to close in the second quarter of 2011 and which we project will result in a pre-tax gain on the sale (see Note 10).




Results of Operations





The following discussion reflects the revenues and expenses for the three month periods ended March 31, 2011 and 2010, as reported in our consolidated financial statements and notes thereto included in Item 1.





Three months ended March 31, 2011 versus three months ended March 31, 2010— Total revenues for the three months ended March 31, 2011 were $8,548,000 compared to $6,353,000 for the three months ended March 31, 2010.





Revenues from Decca’s Energy Services operations for the three months ended March 31, 2011 were $7,776,000 compared to $5,747,000 for the three months ended March 31, 2010.  This increase reflected a moderate upturn in the level of work for customers in Decca’s traditional Canadian market, which typically peaks in the first quarter, as well as a larger increase in new work for Decca’s non-Canadian customers.  Decca’s total billings for Energy Services in the first quarter of 2011 were approximately 6,100 man days at an average billing rate of approximately $1,275 per day.  Based on the usual seasonal cycle, the Company expects Decca’s Canadian revenues to decline during the spring thaw in the second quarter before increasing in the third and fourth quarters.





Revenues from CYMRI’s oil and gas sales for the three months ended March 31, 2011 were $756,000 compared to $594,000 for the three months ended March 31, 2010.  In the three months ended March 31, 2011, revenues from oil production were $682,000, reflecting volumes of 7,585 barrels at an average price of $89.97 per barrel, while gas revenues were $74,000, reflecting volumes of 15,643 Mcf at an average price of $4.73 per Mcf.  On an overall basis, these amounts reflect an 11% increase in average oil and gas prices as well as a 15% increase in production volumes.  The Company believes that CYMRI’s production volumes will remain at the same approximate level in the foreseeable future.





- 13 -








Costs of Decca’s Energy Services for the three months ended March 31, 2011 were $7,152,000 versus $5,235,000 for the three months ended March 31, 2010.  This increase in costs of Energy Services was in line with the previously noted increase in Decca’s Energy Services revenues.  As a result of competitive pressures, Decca experienced a slight reduction in the gross margin on its consulting services to approximately 8% of gross revenues in the three months ended March 31, 2011 from 9% in the three months ended March 31, 2010.





Lease operating expenses (“LOE”), including production taxes, were $398,000 for the three months ended March 31, 2011 versus $477,000 for the three months ended March 31, 2010, representing LOE of CYMRI’s oil and gas production operations.  This decrease was due to a change in the relative timing of certain lease operating expenses between the two quarterly periods.





Depreciation, depletion and amortization (“DD&A”) expense for the three months ended March 31, 2011 was $124,000 versus $168,000 for the three months ended March 31, 2010, representing DD&A of CYMRI’s oil and gas properties.  This decrease was due to a significant decline in depletion rates, partially offset by an increase in production volumes.





Workover expenses for the three months ended March 31, 2011 were $104,000 versus $200,000 for the three months ended March 31, 2010, representing workovers on CYMRI’s South Texas oil and gas properties.  This decrease was largely experienced in CYMRI’s Burnell Field.





Selling, general and administrative (“SG&A”) expenses for the three months ended March 31, 2011 were $544,000 compared to $418,000 for the three months ended March 31, 2010.  This increase reflected a reduction in administrative expenses recovered from third parties under contract operating agreements.





Interest expense for the three months ended March 31, 2011 was $132,000 versus $190,000 for the three months ended March 31, 2010.  This decrease was due in large part to interest no longer being incurred on the Company’s unsecured notes payable that were repaid in March 2010 (see Note 4).





Gain on debt extinguishment for the three months ended March 31, 2011 was zero compared to $439,000 for the three months ended March 31, 2010.  This decrease was due to the forgiveness of a portion of the principal and all of the accrued interest on unsecured notes payable to certain unrelated parties in March 2010 (see Note 4).





Unrealized loss on oil and gas derivatives for the three months ended March 31, 2011 was $41,000 versus an unrealized gain of $22,000 for the three months ended March 31, 2010.  This fluctuation was due to the change in fair value of CYMRI’s outstanding oil and gas derivative contracts (see Note 3).





Income taxes were a provision of $19,000 for the three months ended March 31, 2011 compared to $42,000 for the three months ended March 31, 2010.  These provision amounts reflected consolidated income tax rates of 36% and 34%, respectively, in the three month periods ended March 31, 2011 and 2010.





Liquidity and Capital Resources




Operating activities.  Net cash provided by operating activities for the three months ended March 31, 2011 was $1,174,000 compared to net cash used in operating activities of $888,000 for the three months ended March 31, 2010.  This comparative increase in net operating cash flows reflected relative improvements in the levels of cash generated by both of the Company’s operating segments, especially as it relates to the working capital components of Decca’s Energy Services operations.







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Investing activities.Net cash used in investing activities for the three months ended March 31, 2011 was $123,000 compared to net cash provided by investing activities for the three months ended March 31, 2010 of $1,504,000.  This fluctuation was primarily due to the expiration of a two year escrow account in the first quarter of 2010 enabling the Company to convert approximately $1.6 million of restricted cash arising from the March 2008 sale of a former subsidiary to unrestricted cash in the three months ended March 31, 2010.





Financing activities.Net cash used in financing activities for the three months ended March 31, 2011 was $1,165,000 compared to $567,000 for the three months ended March 31, 2010.  This relative decrease in financing cash flows was primarily related to the short term financing requirements of Decca’s Energy Services operations (see Note 4).





As disclosed in Note 4, a substantial portion of our existing long term debt is in the form of a bank credit facility secured by CYMRI’s producing oil and gas properties.  Borrowings under the bank credit agreement amounted to $2,911,000 as of March 31, 2011 and are subject to a borrowing base, which is periodically redetermined, based on oil and gas reserves.  The bank credit agreement does not require monthly principal payments so long as outstanding borrowings are less than a declining borrowing base. As of March 31, 2011, there was no available borrowing base and the maturity was scheduled in April 2011, however, the bank informally agreed to extend the maturity on a month-to-month basis provided CYMRI makes monthly principal and interest payments during the extension period.  The Company is currently seeking commitments from other financial institutions for a new credit facility to replace the maturing credit agreement.





CYMRI did not fully meet certain financial covenants under the credit agreement as of March 31, 2011 and December 31, 2010.  The bank is aware of these covenant violations, however, it has not requested, nor does the Company expect it to request, accelerated payment of this debt, which is classified in our current liabilities, as a result of both the covenant violations and the near term maturity.





As of March 31, 2011, we also had outstanding institutional borrowings of $738,000 under a factoring facility, which is secured by accounts receivable of Decca, our Canadian Energy Services subsidiary (see Note 4).  This factoring agreement with a Canadian factoring company became effective in October 2010 and provides for a revolving borrowing base of 75% of qualifying accounts receivable up to $4,000,000 (Cdn) at an annual interest rate of 18.25%, compounded daily, for a minimum of 15 days.  The factoring agreement includes customary restrictive covenants on Decca’s operations but does not include any financial covenants.  The factoring agreement replaced a revolving bank credit agreement which expired in September 2010.





Our primary ongoing capital expenditures are in the Exploration & Production segment, which can be highly capital intensive.  In this business, expenditures for CYMRI’s drilling and equipping of oil and gas wells are typically required to maintain or increase existing production levels.  We normally attempt to finance CYMRI’s capital expenditure requirements through a combination of cash flow from operations and secured bank borrowings and we expect that these sources will be sufficient to meet our capital expenditures in 2011.  We presently have relatively low capital expenditure requirements relating to CYMRI’s oil and gas properties as evidenced by a total of only $123,000 being spent as of March 31, 2011.  While we expect additional amounts of capital expenditures in the remainder of 2011, we do not expect such amounts to be significant and we believe that such amounts can be financed largely through our traditional sources.





Going Concern





The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has reported substantial losses from operations in the last two years and presently has a net working capital deficit in the amount of $5,864,186 as of March 31, 2011.  These factors, among others, indicate that the Company may be unable to continue as a going concern for a reasonable period of time.  The consolidated financial statements do not contain any adjustments to reflect the possible future effects on the classification of assets or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern.





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We believe that closing of the Decca sale on the terms indicated in Note 10 would substantially improve our financial condition.  Upon closing of the sale, we would expect to apply a portion of the sales proceeds to the repayment of Decca related debt and other accrued obligations.  Subsequent to the sale, we believe that the purchaser’s scheduled note payments will provide an enhanced source of liquidity for our continuing operations.





Critical Accounting Policies and Estimates





Our discussion and analysis of our financial condition and results of operations are based on consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We believe that certain accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.  See our Annual Report on Form 10-K for the year ended December 31, 2010 for a further description of our critical accounting policies and estimates.








ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





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








ITEM 4.
CONTROLS AND PROCEDURES





(a) Disclosure controls and procedures





As of the date of this report, our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of our internal controls over financial reporting which encompasses our disclosure controls and procedures.  Based on this evaluation, our Chief Executive Office and Chief Financial Officer have concluded that our disclosure controls and procedures as of the end of the period covered by this Quarterly Report were not effective because of a material weakness in our internal controls over financial reporting, as described below, which we view as an integral part of our disclosure controls and procedures.





The material weakness relates to deficient completeness and cut-off controls with regard to revenues and cost of sales at our Canadian Energy Services subsidiaries, Decca Consulting, Ltd. and Decca Consulting, Inc. (collectively referred to as “Decca”).  In order to address this material weakness, management has implemented an interim compensating control in the form of an entity level analytical review by its Chief Financial Officer.  To the extent practical in light of Decca’s current financial performance, the Company anticipates the implementation of improved completeness and cut-off controls with regard to revenues and cost of sales at the operating unit level at an appropriate time.  It should be noted, however, that the impact of this material weakness on Stratum’s consolidated results of operations is substantially mitigated in view of the fact that Decca’s receivables and payables invoices are recorded in simultaneous batches and Decca has a relatively low gross margin between revenues and cost of sales of approximately 8-9%.





Notwithstanding this material weakness, management believes that the consolidated financial statements included in this report fairly present, in all material respects, our consolidated financial position and results of operations as of and for the quarter ended March 31, 2011.




(b) Changes in internal controls over financial reporting.




There was no change in our internal controls over financial reporting that occurred during the quarter ended March 31, 2011, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.





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PART  II.
OTHER INFORMATION




ITEM 1.
LEGAL PROCEEDINGS



See Note 8 to Consolidated Financial Statements.








ITEM 1A.
RISK FACTORS



Information for this Item is not required as the Registrant is a “smaller reportingcompany” as defined in Rule 12b-2 of the Exchange Act.





ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS



None.





ITEM 3.
DEFAULTS UPON SENIOR SECURITIES



None.







ITEM 5.
OTHER INFORMATION



None.







ITEM 6.
EXHIBITS





31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15(d)-14(a)31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15(d)-14(a)32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002








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SIGNATURES





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





STRATUM HOLDINGS, INC./s/ Larry M. WrightLarry M. WrightChief Executive Officer/s/ D. Hughes Watler, Jr.D. Hughes Watler, Jr.Chief Financial Officer






May 16, 2011








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