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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-KSB/A**

** **

**AmendmentNo. 1**

 

**ANNUALREPORT**

**UNDER SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE FISCAL YEAR ENDED JUNE 30, 2007**

** **

**COMMISSION FILE NUMBER 0-9355**

 

**CUBICENERGY, INC.**

(Name of Small Business Issuer in itsCharter)

 

| **TEXAS**                 | ** ** | **87-0352095**                        |
|---------------------------|------------|---------------------------------------|
| (State of  Incorporation) |       | (I.R.S. Employer  Identification No.) |

 

**9870 PLANO ROAD, DALLAS,TEXAS 75238**

(Address of Principal Executive Offices)

 

**972-686-0369**

(Issuer’s Telephone Number)

 

Securities Registered Pursuant To Section 12(g) ofthe Exchange Act:

 

**COMMONSTOCK, PAR VALUE $.05 PER SHARE**

 

Check whether the issuer (1) filed allreports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past 12 months, and (2) has been subject to such filingrequirements for the past 90 days.  Yes x         Noo

 

Check if there is no disclosure of delinquentfilers in response to Item 405 of Regulation S-B contained in this form, and nodisclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-KSB or any amendment to this Form 10-KSB.  o

 

Indicate by check mark whether the registrant isa shell company (as defined in Rule 12b-2 of the Exchange Act.  Yes o       Nox

 

The issuer’s revenues for the fiscal year ended June 30,2007 were $583,416.

 

Asof August 31, 2007, the registrant had outstanding 56,130,896 shares ofcommon stock, $.05 par value, which is registrant’s only class of common stock.The aggregate market value of the common stock held by non-affiliates of theregistrant, computed by reference to the last sale price of the common stock asquoted on the Over-the-Counter Bulletin Board, was approximately $25,167,390 asof August 31**,** 2007.  Shares of common stock held by each officerand director of the registrant and by each person who may be deemed to be anaffiliate have been excluded.  Thisdetermination of affiliate status is not necessarily a conclusive determinationfor other purposes.

 

Transitional Small Business DisclosureFormat:  Yes o       Nox

 

 

 

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**CUBICENERGY, INC.**

 

**TABLE OF CONTENTS**

 
| ** **    | ** **                                                                                                                                   | ** ** | **Page**   |
|---------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **    | ** **                                                                                                                                   | ** ** | ** ** |
| **PART I**    | ** **                                                                                                                                   | ** ** | ** ** |
| Item 1.  | Description of Business and  Properties                                                                                                      |       | 4          |
| Item 2.  | Description of  Properties                                                                                                                   |       | 25         |
| Item 3.  | Legal Proceedings                                                                                                                            |       | 25         |
| Item 4.  | Submission  of Matters to a Vote of Security Holders                                                                                         |       | 25         |
|          |                                                                                                                                         |       |       |
| **PART II**   | ** **                                                                                                                                   | ** ** | ** ** |
| Item 5.       | Market for  Common Equity and Related Stockholder Matters, and Small Business Issuer  Purchases of Equity Securities                         |       | 26         |
| Item 6.  | Management’s  Discussion and Analysis or Plan of Operation                                                                              |       | 27         |
| Item 7.  | Financial  Statements                                                                                                                        |       | 31         |
| Item 8.  | Changes In  and Disagreements with Accountants on Accounting and Financial Disclosure                                                        |       | 31         |
| Item 8A.      | Controls and  Procedures                                                                                                                     |       | 31         |
| Item 8B.      | Other Information                                                                                                                            |       | 31         |
|          |                                                                                                                                         |       |       |
| **PART III**  | ** **                                                                                                                                   | ** ** | ** ** |
| Item 9.       | Directors,  Executive Officers, Promoters, Control Persons and Corporate Governance;  Compliance with Section 16(a) of the Exchange Act |       | 32         |
| Item 10. | Executive  Compensation                                                                                                                      |       | 34         |
| Item 11. | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                                             |       | 40         |
| Item 12. | Certain  Relationships and Related Transactions, and Director Independence                                                                   |       | 42         |
| Item 13. | Exhibits                                                                                                                                     |       | 43         |
| Item 14. | Principal  Accountant Fees and Services                                                                                                      |       | 45         |

 

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**SAFE HARBOR STATEMENT UNDER THEPRIVATE SECURITIES LITIGATION REFORM ACT OF 1995**

 

This reportcontains “forward-looking statements” within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. Such forward-looking statements are based oncurrent expectations that involve a number of risks and uncertainties thatcould cause actual results to differ materially from the results discussed inthe forward-looking statements. Generally, forward-looking statements includewords or phrases such as “management anticipates,” “the Company believes,” “theCompany anticipates,” and words and phrases of similar impact. Theforward-looking statements are made pursuant to safe harbor provisions of thePrivate Securities Litigation Reform Act of 1995. The factors that could causeactual results to differ materially from the forward-looking statementsinclude, but are not limited to: (i) industry conditions and competition, (ii) thecyclical nature of the industry, (iii) domestic and worldwide supplies anddemand for oil and gas, (iv) operational risks and insurance, (v) environmentalliabilities which may arise in the future which are not covered by insurance orindemnity, (vi) the impact of current and future laws and governmentregulations, as well as repeal or modification of same, affecting the oil andgas industry and our operations in particular, (vii) production levels andother activities of OPEC and other oil and gas producers, and the impact thatthe above factors and other events have on the current and expected futurepricing of oil and natural gas, and (viii) the risks described from timeto time in our reports filed with the Securities and Exchange Commission.

 

**EXPLANATORYNOTE**

 

CubicEnergy, Inc. is filing this Amendment No. 1 on Form 10-KSB/A (“AmendmentNo.1”) to amend our Form 10-KSB for the year ended June 30, 2007,which was originally filed on September 28, 2007 (the “Original Filing”).We are filing this Amendment No.1 to amend:

 

·                  Part I. Item 1. Description ofBusiness and Properties – Recent Developments;

 

·                  Part II. Item 6. Management’sDiscussion and Analysis or Plan of Operation – Liquidity and Capital Resources –Subsequent events;

 

·                  Part II. Item 7. Notes to FinancialStatements – Note J - Oil and gas reserves information (unaudited); and

 

·                  Part III. Item 10. ExecutiveCompensation.

 

Thesechanges had no impact on the Company’s assets, liabilities, stockholders’equity, statements of operations or statements of cash flows as of and for thefiscal year ended June 30, 2007 as reported in the Original Filing.

 

Pursuantto Rule 12b-15 under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), this Amendment No. 1 amends the aforementioned items in theirentirety and contains new certifications pursuant to Rules 13a-14 and15d-14 under the Exchange Act and Section 302 of the Sarbanes-Oxley Act of2002. Other than as set forth above and the inclusion of new certificationspursuant to Rules 13a-14 and 15d-14 under the Exchange Act and Section 302of the Sarbanes-Oxley Act of 2002, no other changes or amendments to theOriginal Filing are being made. All other exhibits as filed in our Form 10-KSBfiled on September 28, 2007 are hereby incorporated by reference as tosuch. Accordingly, this Amendment No. 1 should be read in conjunction withour other filings made with the Securities and Exchange Commission.

 

Forthe convenience of the reader, this Form 10-KSB/A sets forth the original Form 10-KSBin its entirety, as filed on September 28, 2007, as amended by thisAmendment No. 1.

 

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**PART I**

 

**Item 1.  Descriptionof Business and Properties.**

 

**GENERAL**

 

Cubic Energy, Inc. (referred to as “Cubic”,“we”, “our, “us” or the “Company”) is an independent energy company engaged inthe development and production of, and exploration for, crude oil and naturalgas.  Our oil and gas assets areconcentrated principally in Texas and Louisiana.  At June 30, 2007, our total provedreserves were 4,319,031 MCFE.

 

Our predecessor was incorporated in October 1978.  Cubic was incorporated in 1999 in the Stateof Texas.  Our principal executive officeis located at 9870 Plano Road, Dallas, Texas 75238, and our telephone number is(972) 686-0369.

 

In December 1997, we entered into a StockPurchase Agreement (the “Agreement”) pursuant to which the Company issued12,500,000 shares of our common stock in exchange for the conveyance to theCompany of certain oil and gas properties by Calvin A. Wallen, III and hisaffiliates.  In connection with the StockPurchase Agreement, three of the five members of the Board of Directorsresigned and new directors were appointed, including Mr. Wallen, who alsobecame President and CEO of the Company.

 

**DESCRIPTION OF BUSINESS**

 

Prior to the Agreement, we focused primarily onthe acquisition of non-operated working interests and overriding royaltyinterests in oil and gas properties. Subsequent to the Agreement in December 1997, we moved ourheadquarters from Tulsa, Oklahoma to Garland, Texas in order to utilize anaffiliate’s assembled team of experienced management whose substantialexpertise lay in acquisition, exploitation and development and the ability tomanage both operated and non-operated oil and gas properties.  Current management believes that the abilityto operate our own properties, through this affiliate, will result insignificant cost savings to the Company. In addition, after reviewing our existing property portfolio andrefining our new business strategy, the management team initiated a divestmentstrategy to dispose of our non-strategic assets in non-core areas in order toconcentrate on building core reserves. Pursuant to this strategy, we have acquired additional properties in ourcore areas, primarily in Louisiana, as well as establishing a drilling programfor the drilling of exploratory, development and infill wells, a strategypreviously unavailable to us due to the technical expertise and experiencerequired and the lack of available resources. We have made substantial progress in redirecting our strategic businessefforts and believe that attractive opportunities remain for acquisition anddevelopment of our remaining and future assets.

 

On or about October 1, 2004, we closed a Securities PurchaseAgreement and issued $2,635,000 in principal amount of 7% Senior SecuredConvertible Debentures due September 30, 2009 (the “Debentures”), to agroup of institutional and high net worth investors.  The Debentures were secured by the collateralset forth in the Deed of Trust, Security Agreement, Assignment of Productionand Fixture Filing attached to our Form 8-K filed October 12,2004.  The Debentures paid an annualinterest rate of 7% on a quarterly basis and were convertible into shares ofour common stock at a price of $0.50 per share. We had the option to pay the interest on the Debentures in commonstock.  The investors also receivedwarrants to purchase an additional 2,635,000 shares of common stock with anexercise price of $1.00 per share. Pursuant to the anti-dilution adjustmentprovisions applicable to such warrants, the exercise price applicable to the1,000,000 of such warrants that have not been exercised is currently $0.50 pershare. The proceeds of the Debentures were used primarily for the acquisitionof interests in oil and gas properties. The Debentures were retired on February 6, 2006, as set forthbelow.

 

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On or about January 11, 2005, we issued1,531,661 shares of common stock to Caravel Resources Energy Fund 2003-II, L.P.(the “Partnership”) in exchange for a 0.1914575033 working interest in theKraemer 24-1 Well, Desoto Parish, Township 14 N, Range 15 W, Section 24 (the“Well”).  The Company also issued 468,339shares of common stock to Mr. Wallen in exchange for a 0.0585424967working interest in the Well.  The commonstock closed at a price of $0.90 on January 10, 2005.

 

On December 16, 2005, the Company enteredinto a Securities Purchase Agreement and issued 2,500,000 common shares at aprice of $0.80 per share and issued warrants, with five year expirations, forthe purchase of up to 1,000,000 shares of Company common stock at an exerciseprice of $1.00 per share.  The proceedsof the offering were used for exploratory drilling and working capital.

 

OnFebruary 6, 2006, Cubic entered into a Credit Agreement with Petro CapitalV, L.P. (“Petro Capital”) pursuant to which Petro Capital advanced to theCompany $5,500,000.  The indebtednessbore interest at a rate of 12.5% per annum, was to mature on February 6,2009 and was secured by substantially all of the assets of the Company.  Approximately $1,800,000 of the funded amountwas used to retire the Debentures described above.  In connection with the funding under theCredit Agreement, the Company issued to Petro Capital and Petro CapitalSecurities, LLC, warrants, with five-year expirations, for the purchase of upto 1,833,334 and 250,000 shares, respectively, of Company common stock at anexercise price of $1.00 per share. Pursuant to the anti-dilution adjustment provisionsapplicable to such warrants, the exercise price applicable to all suchwarrants is currently $0.9842 per share. The senior debt held by Petro Capitalwas retired on March 5, 2007, with proceeds from a new senior debt issue,as set forth below.

 

Concurrently,on February 6, 2006, the Company entered into a Purchase Agreement withTauren Exploration, Inc. (“Tauren”), an entity wholly owned by Calvin WallenIII, the Company’s Chairman of the Board and Chief Executive Officer, withrespect to the purchase by the Company of certain Cotton Valley leaseholdinterests (approximately 11,000 gross acres; 5,000 net acres) held byTauren.  Pursuant to the PurchaseAgreement, the Company acquired from Tauren a 35% working interest inapproximately 2,400 acres and a 49% working interest in approximately 8,500acres located in DeSoto and Caddo Parishes, Louisiana, along with an associatedArea of Mutual Interest (“AMI”) and the right to acquire at “cost” (as definedin the Purchase Agreement) a working interest in all additional mineral leasesobtained by Tauren in the AMI, in exchange for (a) $3,500,000 in cash, (b) 2,500,000unregistered shares of Company common stock, (c) a short-term promissorynote in the amount of $1,300,000, which note was convertible into Companycommon stock at a conversion price of $0.80 per share, and (d) a drillingcredit of $2,100,000.

 

On July 28, 2006, Cubic entered into andconsummated transactions pursuant to Subscription and Registration RightsAgreements (the “Subscription Agreements”) with certain investors that areunaffiliated with the Company (the “Investors”).  Pursuant to the Subscription Agreements, theInvestors paid aggregate consideration of $2,100,000 to the Company for3,000,000 shares of the Company’s common stock and warrants, exercisablethrough July 31, 2011, into 1,500,000 shares of common stock at $0.70 pershare.  Pursuant to the anti-dilution adjustmentprovisions applicable to such warrants, the exercise price applicable toall such warrants is currently $0.6885 per share.  In addition to reimbursement of certainexpenses incurred in connection with this offering, the Company agreed to pay2% of the aggregate consideration, in cash, plus 150,000 shares of common stockvalued at $0.70 per share, to a placement agent.

 

OnDecember 15, 2006, the Company entered into Subscription and RegistrationsRights Agreements (the “Subscription Agreements”) with certain investors (the “Investors”).One of the Investors, William Bruggeman (and entities affiliated with him), wasthe beneficial owner, prior to this 

 

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transaction,of approximately 23.0% of the common stock of the Company. Another Investor,Bob Clements, is a director of the Company. The remaining Investors had nomaterial relationship with the Company. Pursuant to the SubscriptionAgreements, the Investors paid aggregate consideration of $3,940,000 to theCompany for 7,880,000 shares of the Company’s common stock and warrantsexercisable into 3,940,000 shares of common stock. The warrants are exercisablethrough November 30, 2011, at $0.70 per share.

 

OnMarch 5, 2007, Cubic entered into a Credit Agreement with Wells FargoEnergy Capital, Inc. (“Wells Fargo”) providing for a revolving creditfacility of $20,000,000 and a convertible term loan of $5,000,000 (the “CreditFacility”). The indebtedness bears interest at a fluctuating rate equal to thesum of the Wells Fargo Bank prime rate plus two percent (2%) per annum, matureson March 1, 2010, and is secured by substantially all of the assets of theCompany. The $5,000,000 convertible term loan was used, together with cash onhand, to retire the Company’s previously outstanding senior debt that was heldby Petro Capital, as described above. The revolving credit facility is subjectto a borrowing base, initially set at $4,000,000, and is subject to periodicreview. The convertible term loan of $5,000,000 is convertible into 5,000,000shares of Cubic common stock at a conversion price of $1.00 per share. Inconnection with entering into the Credit Facility, the Company issued to WellsFargo warrants, with five-year expirations, for the purchase of up to 2,500,000shares of Company common stock at an exercise price of $1.00 per share.

 

The terms of the CreditFacility, among other things, prohibit the Company from merging with anothercompany or paying dividends, and limit additional indebtedness, sales ofcertain assets and investments. Upon the repayment in full of the CreditFacility, and with respect to certain properties, upon the occurrence of theconditions set forth in Section 2.14 of the Credit Agreement, the Companyagreed to convey a net profits interest to Wells Fargo equal up to 5% of Cubic’snet interest in certain of its Louisiana properties.

 

The shares of common stock and warrantsdescribed in the aforementioned transactions were issued by the Company inreliance upon an exemption from registration set forth in Regulation D and/or Section 4(2) ofthe Securities Act of 1933, as amended, which exempts transactions by an issuernot involving a public offering

 

**PRINCIPALOIL AND GAS PROPERTIES**

 

The following table summarizes certaininformation with respect to our principal areas of operation at June 30,2007:

 
| ** ** | ** ** | **Proved Reserves** | ** ** | **Percent** | ** ** | **Present Value** | ** ** |
|------------|------------|--------------------------|------------|-------------|------------|------------------------|------------|
| ** ** | ** ** | **Oil**                  | ** ** | **Gas**     | ** ** | **of Proved**     | ** ** | **(Discounted** | ** ** |
| **Area**   | ** ** | **(Bbl)**                | ** ** | **(Mcf)**   | ** ** | **Reserves**           | ** ** | **@ 10%)** | ** ** |
| Louisiana  |       | 12,673                   |       | 4,159,605   |       | 98.1                   | %          | $ | 6,676,760 |   |
| Texas      |       | 157                      |       | 82,446      |       | 1.9                    | %          | 152,950 |   |
| Total      |       | 12,830                   |       | 4,242,051   |       | 100.0                  | %          | $ | 6,829,710 |   |

 

Our Texas properties are situated in Palo Pinto,Eastland and Callahan Counties. Our Louisiana properties are situated in CaddoParish and in Desoto Parish.  At June 30,2007, the Louisiana properties contained the vast majority of our provedreserves, a situation that is expected to continue. The Texas propertiesconsist primarily of wells acquired by the Company in several transactionsbetween 1991 and 2002 and through overriding royalty interests reserved infarm-out agreements in 1998 and 1999. The Louisiana properties were acquired on or about October 1, 2004,January 11, 2005 and February 6, 2006.

 

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Our net production for the fiscal year ended June 30,2007 for all of the Company wells averaged approximately 193 Mcf of natural gasper day and 3 barrels of oil per day as compared to 147 Mcf of natural gas perday and 3 barrels of oil per day in the fiscal year ended June 30, 2006.

 

**EXPLORATIONACTIVITIES**

** **

Our strategy with respect to our domesticexploration program seeks to maintain a balanced portfolio of drillingopportunities that range from lower risk, field extension wells to higher risk,high reserve potential prospects.  Ourfocus is primarily on exploration opportunities that can benefit from advancedtechnologies, including 3-D seismic, designed to reduce risks and increasesuccess rates.  We develop prospectsin-house with an affiliate and through strategic alliances with explorationcompanies that have expertise in specific target areas.  In addition, we evaluate some externallygenerated prospects and plan to participate in some of these opportunities toenhance our portfolio.

 

We are currently focusing our domesticexploration activities to develop our undeveloped leasehold opportunities inLouisiana and Texas.  Currently we haveexploration opportunities and seek to acquire additional leasehold interests inCaddo and Desoto Parishes, Louisiana, and in Palo Pinto, Callahan and EastlandCounties in Texas.  These areas are a partof geologic studies utilizing regional trend surface analysis, 2-D and 3-Dseismic data, AVO analysis and/or vast sub-surface control. Prospects have beendeveloped from 4,000-10,600 feet in depth in the Cotton Valley, Hosston, Gloyd,Pettet, Paluxy, Strawn sandstone, Bend conglomerate and Caddo limestone.

 

**RECENT DEVELOPMENTS**

 

Near the end of fiscal 2007, utilizing fundsprovided under the Credit Facility with Wells Fargo, we began accelerating ourdrilling pace. To illustrate, while we drilled three wells in fiscal 2007 (ascompared to two wells in fiscal 2006), we have drilled or begun the drilling ofseven wells since the end of fiscal 2007 (as of September 22, 2007).

 

On September 25, 2007, the Companyannounced the results of three new wells delineating large impact reserves inthe Cotton Valley interval.  Preliminarylog analysis, performed by an independent reservoir engineer, for the threewells drilled in Cubic’s Johnson Branch acreage (T15N, R15W) of Caddo Parish,Louisiana, determined the following results: a) the Tabor 4-1 well drilled to atotal depth of 10,550’ and logged 163 feet of net pay in the Cotton Valleybetween depths of 8,901’-9,798’; b) the McDonnell 8-1 well drilled to a totaldepth of 10,500’ and logged 142 feet of net pay in the Cotton Valley betweendepths of 8,907’-9,803’; and c) the Luttrell 7-1 well drilled to a total depthof 10,522’ and logged 113 feet of net pay in the Cotton Valley between depthsof 8,880’-9,648’.  The aggregate net paythickness in the three wells is 418 feet.

 

Cubic’s aforementioned wells are located fivemiles southeast of the Nelson Oil and Gas Alfred #3 well, which completed in1989 and since that time has produced 4.2 Bcf of gas and 75,000 barrels ofcondensate from 112 feet of perforations in the Cotton Valley (8,552’-8,664’).In addition, Cubic is carefully analyzing prolific Hosston intervals found inthese new wells. As of the date of this filing, September 28, 2007, Cubic:had two additional wells at total depth, which are undergoing evaluation; and,was conducting drilling operations on three additional wells in its JohnsonBranch acreage.  We anticipate that bythe end of October 2007 a total of eight wells will have been drilled andevaluated in our Johnson Branch acreage. Our engineering and constructionpersonnel are working on the pipeline and compression infrastructure needed tocommence the completion of the first of these wells in the next six to eightweeks. Cubic has a 49% working interest in its Johnson Branch acreage.

 

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Seven miles to the South, in its BethanyLongstreet acreage, Cubic has drilled a total of eight wells. Work is ongoingat the Bethany Longstreet acreage to complete and fracture stimulate additionalzones and to install gas lift and compression to significantly increase theaverage daily production from this area. Cubic has a 25% working interest in these producing wells.

 

**MARKETINGOF PRODUCTION**

 

### **Crude Oil and Natural Gas**

###  

Our production consists mainly of natural gas.We market our operated production of natural gas to two purchasers (i) inTexas, Enbridge G & P, LP, and (ii) in Louisiana, EROC GatheringCompany, LP.  In fiscal year 2007, wealso marketed our production of natural gas, in Louisiana, to Crosstex GulfCoast Marketing, Ltd., but no longer do so. We sell our crude oil andcondensate production at or near the well-site, although in some cases it isgathered by us or others and delivered to a central point of sale.  Our crude oil and condensate production istransported by truck or by pipeline and is typically committed to arrangementshaving a term of one year or less.  Wehave not engaged in crude oil hedging or trading activities.  We utilize short-term gas contracts withprices that are related to market conditions in varying degrees and have notengaged in natural gas hedging or futures trading.

 

We believe we would be able to locate alternatepurchasers in the event of the loss of any one of these purchasers, and thatany such loss would not have a material adverse effect on our financialcondition or results of operations. Revenue from the sale of natural gas totaled $523,774 for the fiscalyear ended June 30, 2007 and represented 90% of our total oil and gasrevenues for that fiscal year.

 

**Price Considerations**

 

Crude oil prices are established in a highlyliquid, international market, with average crude oil prices that we receivegenerally fluctuating with changes in the futures price established on theNYMEX for West Texas Intermediate Crude Oil (“NYMEX-WTI”). The average crudeoil price per Bbl received by us in fiscal year 2007 was $61.68 as compared to$59.90 in fiscal year 2006.

 

Natural gas prices in the geographical areas inwhich we operate are closely tied to established price indices which areheavily influenced by national and regional supply and demand factors and thefutures price per MMBTU for natural gas delivered at Henry Hub, Louisianaestablished on the NYMEX (“NYMEX-Henry Hub”). At times, these indices correlateclosely with the NYMEX-Henry Hub price, but often there are significantvariances between the NYMEX-Henry Hub price and the indices used to price ournatural gas. Average natural gas prices received by us in each of our operatingareas generally fluctuate with changes in these established indices. Theaverage natural gas price per Mcf received by us in fiscal 2007 was $7.44 ascompared to $8.34 in fiscal 2006.

 

**OILAND GAS RESERVES**

** **

The following tables set forth the proved developed,proved non-producing and proved undeveloped reserves at June 30, 2007, theestimated future net revenues from such proved reserves and the StandardizedMeasure of Discounted Future Net Cash Flows attributable to our reserves at June 30,2007, 2006 and 2005:

 

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| ** **                 | ** ** | **Oil**    | ** ** | **Gas**   | ** ** | **Total**  | ** ** | ** ** | ** ** | **10%**      | ** ** |
|----------------------------|------------|------------|------------|-----------|------------|------------|------------|------------|------------|--------------|------------|
| **Category**               | ** ** | **(Bbls)** | ** ** | **(Mcf)** | ** ** | **(Mcfe)** | ** ** | **Income** | ** ** | **Discount** | ** ** |
| Proved  Producing          |       | 2,244      |       | 686,362   |       | 699,826    |       | $          | 3,345,208  |         | $          | 2,698,067 |   |
| Proved  Non-Producing      |       | 818        |       | 350,876   |       | 355,784    |       | 1,349,363  |       | 1,005,944    |       |
| Proved  Developed Reserves |       | 3,062      |       | 1,037,238 |       | 1,055,610  |       | $          | 4,694,571  |         | $          | 3,704,011 |   |
| Proved  Undeveloped        |       | 9,768      |       | 3,204,813 |       | 3,263,421  |       | 6,926,991  |       | 3,125,699    |       |
| Total  Proved Reserves     |       | 12,830     |       | 4,242,051 |       | 4,319,031  |       | $          | 11,621,562 |         | $          | 6,829,710 |   |

 
| ** **                                         | ** ** | **AT JUNE 30,** | ** ** |
|----------------------------------------------------|------------|---------------------------|------------|
| ** **                                         | ** ** | **2007**                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| PROVED  DEVELOPED RESERVES:                        |       |                      |       |   |   |   |   |
| Oil  (Bbl)                                         |       | 3,062                     |       | 2,893 |   | 1,048 |   |
| Gas  (Mcf)                                         |       | 1,037,238                 |       | 807,057 |   | 509,625 |   |
| MCFE                                               |       | 1,055,610                 |       | 824,415 |   | 515,913 |   |
| Estimated  future net revenues (before income tax) |       | $                         | 4,694,571  |   | $ | 2,841,088 |   | $ | 1,902,300 |   |
| Standardized  Measure (1)                          |       | $                         | 3,704,011  |   | $ | 2,343,348 |   | $ | 1,071,100 |   |
|                                               |       |                      |       |   |   |   |   |
| PROVED  UNDEVELOPED RESERVES:                      |       |                      |       |   |   |   |   |
| Oil  (Bbl)                                         |       | 9,768                     |       | 5,970 |   | — |   |
| Gas  (Mcf)                                         |       | 3,204,813                 |       | 1,989,843 |   | — |   |
| MCFE                                               |       | 3,263,421                 |       | 2,025,663 |   | — |   |
| Estimated  future net revenues (before income tax) |       | $                         | 6,926,991  |   | $ | 6,050,495 |   | $ | — |   |
| Standardized  Measure (1)                          |       | $                         | 3,125,699  |   | $ | 4,104,037 |   | $ | — |   |
|                                               |       |                      |       |   |   |   |   |
| TOTAL  PROVED RESERVES:                            |       |                      |       |   |   |   |   |
| Oil  (Bbl)                                         |       | 12,830                    |       | 8,863 |   | 1,048 |   |
| Gas  (Mcf)                                         |       | 4,242,051                 |       | 2,796,900 |   | 509,625 |   |
| MCFE                                               |       | 4,319,031                 |       | 2,850,078 |   | 515,913 |   |
| Estimated  future net revenues (before income tax) |       | $                         | 11,621,562 |   | $ | 8,891,583 |   | $ | 1,902,300 |   |
| Standardized  Measure (1)                          |       | $                         | 6,829,710  |   | $ | 6,447,385 |   | $ | 1,071,100 |   |
|                                               |       |                      |       |   |   |   |   |
| Average  price used to calculate reserves:         |       |                      |       |   |   |   |   |
| Oil  (Bbl)                                         |       | $                         | 64.46      |   | $ | 70.09 |   | $ | 50.57 |   |
| Gas  (Mcf)                                         |       | $                         | 7.06       |   | $ | 5.55 |   | $ | 6.65 |   |

 

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| (1) |   | The  Standardized Measure of Discounted Future Net Cash Flows prepared by the  Company represents the present value (using an annual discount rate of 10%)  of estimated future net revenues from the production of proved reserves,  after giving effect to income taxes. See “Note J - Oil and gas reserves  information (unaudited)” in the Notes to the Financial Statements of the  Company included elsewhere in this Report for additional information  regarding the disclosure of the Standardized Measure information in  accordance with the provisions of Statement of Financial Accounting Standards  (“FAS”) No. 69 (“FAS No. 69”), “Disclosures about Oil and Gas  Producing Activities.” |
|-----|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The information set forth in this Reportrelating to our proved reserves, estimated future net revenues and PresentValues is taken from reports prepared by the Dallas office of The Scotia Group, Inc.,an independent, petroleum engineering firm, for fiscal years 2007 and 2006 andby the Houston office of Netherland Sewell & Associates, Inc. forfiscal 2005. The estimates of these independent petroleum engineering firmswere based upon review of production histories and other geological, economic,ownership and engineering data provided by the Company. Information withrespect to approximately 1% of the total proved reserves as of June 30,2007, was prepared in-house and was not 

 

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reviewed by an independent engineering firm. Noreports on our reserves have been filed with any federal agency.  In accordance with guidelines of the SEC, ourestimates of proved reserves and the future net revenues from which presentvalues are derived are made using year end oil and gas sales prices heldconstant throughout the life of the properties (except to the extent a contractspecifically provides otherwise). Operating costs, development costs andcertain production-related taxes were deducted in arriving at estimated futurenet revenues, but such costs do not include debt service or general andadministrative expenses.

 

There are numerous uncertainties inherent inestimating oil and gas reserves and their values, including many factors beyondour control. The reserve data set forth in this Report represents estimatesonly. Reservoir engineering is a subjective process of estimating the sizes ofunderground accumulations of oil and gas that cannot be measured in an exactmanner. The accuracy of any reserve estimate is a function of the quality ofavailable data, engineering and geological interpretation, and judgment. As aresult, estimates of different engineers, including those used by us, may vary.In addition, estimates of reserves are subject to revision based upon actualproduction, results of future development, exploitation and explorationactivities, prevailing oil and gas prices, operating costs and other factors,which revisions may be material. Accordingly, reserve estimates are oftendifferent from the quantities of oil and gas that are ultimately recovered andare highly dependent upon the accuracy of the assumptions upon which they arebased. There can be no assurance that these estimates are accurate predictionsof our oil and gas reserves or their values. Estimates with respect to provedreserves that may be developed and produced in the future are often based uponvolumetric calculations and upon analogy to similar types of reserves ratherthan actual production history. Estimates based on these methods are generallyless reliable than those based on actual production history. Subsequentevaluation of the same reserves based upon production history will result invariations, which may be substantial, in the estimated reserves.

 

**NETPRODUCTION, SALES PRICES AND COSTS**

 

The following table presents certain informationwith respect to oil and gas production, prices and costs attributable to alloil and gas property interests owned by us for the fiscal years ended June 30,2007, 2006 and 2005:

** **
| ** **                                    | ** ** | **Year Ended June 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------|------------|
| ** **                                    | ** ** | **2007**                               | ** ** | **2006** | ** ** | **2005** | ** ** |
| PRODUCTION  VOLUMES:                          |       |                                   |       |   |   |   |   |
| Oil  (Bbl)                                    |       | 967                                    |       | 1,047 |   | 506 |   |
| Gas  (Mcf)                                    |       | 70,412                                 |       | 53,516 |   | 67,744 |   |
| Total  Oil and Gas (MCFE)                     |       | 76,214                                 |       | 59,798 |   | 70,780 |   |
|                                          |       |                                   |       |   |   |   |   |
| WEIGHTED  AVERAGE SALES PRICES:               |       |                                   |       |   |   |   |   |
| Oil  (per Bbl)                                |       | $                                      | 61.68      |   | $ | 59.90 |   | $ | 43.42 |   |
| Gas  (per Mcf)                                |       | $                                      | 7.44       |   | $ | 8.34 |   | $ | 6.61 |   |
|                                          |       |                                   |       |   |   |   |   |
| SELECTED  EXPENSES PER MCFE:                  |       |                                   |       |   |   |   |   |
| Production  costs                             |       | $                                      | 4.18       |   | $ | 5.05 |   | $ | 3.33 |   |
| Workover  expenses (non-recurring)            |       | $                                      | 1.40       |   | $ | — |   | $ | 0.08 |   |
| Severance  taxes                              |       | $                                      | 0.39       |   | $ | 0.39 |   | $ | 0.34 |   |
| Other  revenue deductions                     |       | $                                      | 0.34       |   | $ | 0.22 |   | $ | 0.11 |   |
| Total  lease operating expenses               |       | $                                      | 6.31       |   | $ | 5.66 |   | $ | 3.86 |   |
| Selling,  general and administrative expenses |       | $                                      | 17.39      |   | $ | 23.42 |   | $ | 5.58 |   |
| Depreciation,  depletion and amortization     |       | $                                      | 4.76       |   | $ | 3.00 |   | $ | 5.15 |   |

 

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** **

**PRODUCTIVEWELLS AND ACREAGE**

** **

### **Productive Wells**

###  

The following table sets forth our domesticproductive wells at June 30, 2007:

 
| **Oil**   | ** ** | **Gas** | ** ** | **TOTAL** | ** ** |
|-----------|------------|---------|------------|-----------|------------|
| **Gross** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Net** | ** ** |
| —    |       | —  |       | 22        |       | 14.42 |   | 22 |   | 14.42 |   |

 

**Acreage**

 

The following table sets forth our undevelopedand developed gross and net leasehold acreage at June 30, 2007.Undeveloped acreage includes leased acres on which wells have not been drilledor completed to a point that would permit the production of commercialquantities of oil and gas, regardless of whether or not such acreage containsproved reserves.

 
| **Undeveloped** | ** ** | **Developed** | ** ** | **TOTAL** | ** ** |
|-----------------|------------|---------------|------------|-----------|------------|
| **Gross**       | ** ** | **Net**       | ** ** | **Gross** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Net** | ** ** |
| 15,462          |       | 6,281         |       | 2,080     |       | 1,083 |   | 17,542 |   | 7,364 |   |

 

All the leases for the undeveloped acreagesummarized in the preceding table will expire at the end of their respectiveprimary terms unless prior to that date the existing leases are renewed orproduction has been obtained from the acreage subject to the lease, in whichevent the lease will remain in effect until the cessation of production. As iscustomary in the industry, we generally acquire oil and gas acreage without anywarranty of title except as to claims made by, through or under the transferor.Although we have title to developed acreage examined prior to acquisition inthose cases in which the economic significance of the acreage justifies thecost, there can be no assurance that losses will not result from title defectsor from defects in the assignment of leasehold rights.

 

**OPERATIONS**

** **

We are not the operator of our wells, but, inall cases, as of August 31, 2007, Fossil Operating, Inc. (“Fossil”),an entity wholly owned by Mr. Wallen, is the operator.

 

We have contract relationships with petroleumengineers, geologists and other operations and production specialists who webelieve will be able to improve production rates, increase reserves and/orlower the cost of operating our oil and gas properties.

 

Oil and gas properties are customarily operatedunder the terms of a joint operating agreement, which provides forreimbursement of the operator’s direct expenses and monthly per wellsupervision fees. Per well supervision fees vary widely depending on thegeographic location and producing formation of the well, whether the wellproduces oil or gas and other factors.

 

### **EMPLOYEES**

###  

At August 31, 2007, the Company had four (4) full-and seven (7) part-time employees. We regularly use independent consultants and contractors to performvarious professional services, including well-site supervision, design,construction, permitting and environmental assessment.  We use independent contractors to performfield and on-site production operation services.

 

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### **FACILITIES**

###  

The Company’s principal executive andadministrative offices are located at 9870 Plano Road, Dallas, Texas. Theoffices are subleased from an affiliate controlled by Mr. Wallen and theoffices are owned by this affiliate.  Theaverage monthly amount charged to the Company during the year ended June 30,2007, was $2,229.  The Company believesthat there is other appropriate space available in the event the Company shouldterminate its current leasing arrangement.

 

**RISKFACTORS**

** **

Youshould carefully consider the following risk factors, in addition to the otherinformation set forth in this Report, before investing in shares of our commonstock.  Each of these risk factors couldadversely affect our business, operating results and financial condition, aswell as adversely affect the value of an investment in our common stock.  Some information in this Report may contain “forward-looking”statements that discuss future expectations of our financial condition andresults of operation.  The risk factorsnoted in this section and other factors could cause our actual results todiffer materially from those contained in any forward-looking statements.

 

**We face significant competition, and many of our competitors have resources in excess of our available resources.**

 

The oil and gas industry is highlycompetitive.  We encounter competitionfrom other oil and gas companies in all areas of our operations, including theacquisition of producing properties and sale of crude oil and natural gas.  Our competitors include major integrated oiland gas companies and numerous independent oil and gas companies, individualsand drilling and income programs.  Manyof our competitors are large, well established companies with substantiallylarger operating staffs and greater capital resources than us.  Such companies may be able to pay more forproductive oil and gas properties and exploratory prospects and to define,evaluate, bid for and purchase a greater number of properties and prospectsthan our financial or human resources permit. Our ability to acquire additional properties and to discover reserves inthe future will depend upon our ability to evaluate and select suitableproperties and to consummate transactions in this highly competitiveenvironment.

 

**Exploratory drilling is a speculative activity that may not result in commercially productive reserves and may require expenditures in excess of budgeted amounts.**

 

Drilling activities are subject to many risks,including the risk that no commercially productive oil or gas reservoirs willbe encountered.  There can be noassurance that new wells drilled by us will be productive or that we will recoverall or any portion of our investment. Drilling for oil and gas may involve unprofitable efforts, not only fromdry wells, but also from wells that are productive but do not producesufficient net revenues to return a profit after drilling, operating and othercosts.  The cost of drilling, completingand operating wells is often uncertain. Our drilling operations may be curtailed, delayed or canceled as aresult of a variety of factors, many of which are beyond our control, includingeconomic conditions, mechanical problems, pressure or irregularities informations, title problems, weather conditions, compliance with governmentalrequirements and shortages in or delays in the delivery of equipment andservices.  Such equipment shortages anddelays sometimes involve drilling rigs where inclement weather prohibits themovement of land rigs causing a high demand for rigs by a large number ofcompanies during a relatively short period of time.  Our future drilling activities may not besuccessful.  Lack of drilling successcould have a material adverse effect on our financial condition and results ofoperations.

 

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Our operations are also subject to all thehazards and risks normally incident to the development, exploitation,production and transportation of, and the exploration for, oil and gas,including unusual or unexpected geologic formations, pressures, down hole fires,mechanical failures, blowouts, explosions, uncontrollable flows of oil, gas orwell fluids and pollution and other environmental risks.  These hazards could result in substantiallosses to us due to injury and loss of life, severe damage to and destructionof property and equipment, pollution and other environmental damage andsuspension of operations.  We participatein insurance coverage maintained by the operator of our wells, although therecan be no assurances that such coverage will be sufficient to prevent amaterial adverse effect to us in such events.

 

**We are in a capital-intensivebusiness and we will need additional funds.**

 

Ourbusiness is highly capital-intensive requiring continuous development andacquisition of oil and gas reserves.  In addition,capital is required to operate and expand our oil and gas field operations,purchase equipment and to fund our drilling program.

 

AtJune 30, 2007, we had working capital of $2,606,796. On March 5,2007, Cubic entered into a Credit Agreement with Wells Fargo providing for arevolving credit facility of $20,000,000 and a convertible term loan of$5,000,000 (the “Credit Facility”) in order to fund the drilling of new wells.There can be no assurance that funds under the Credit Facility and funds fromoperations will be adequate to satisfy our capital requirements.

 

Wehave experienced and will continue to experience significant capitalexpenditures and working capital requirements, principally as a result of ourdrilling program.  We expect that we willrequire additional financing, in addition to cash generated from operations, tofund our expected growth.  There can beno assurance, however, that additional financing will be available onacceptable terms or at all.  In the eventthat additional capital resources are unavailable, we may curtail drilling,development and other activities or be forced to sell some of our assets on anuntimely or unfavorable basis. Additionally, failure to drill on certain of our leasehold interestscould result in the forfeiture of our interest.

 

Anyfuture issuances of equity securities would likely result in dilution to ourthen existing shareholders while incurring additional indebtedness would resultin increased interest expense and debt service changes.  See “Management’s Discussion and Analysis orPlan of Operation.”

 

**We have a history of operating losses and may not be profitable in the future.**

 

Weincurred losses before income tax provisions of $(5,800,774) and $(2,769,050)for the fiscal years ended June 30, 2007 and 2006.  Our accumulated deficit as of June 30,2007 was $(19,322,692). Historically, we have funded our operating losses,acquisitions and drilling costs primarily through a combination of privateofferings of convertible debt, senior secured debt, exempt transactions, andequity securities; however, on March 5, 2007 we established a bank line ofcredit with Wells Fargo under the terms of the Credit Facility describedelsewhere herein, the primary purpose of which is to fund drilling costs. Oursuccess in obtaining the necessary capital resources to fund future costsassociated with our operations and drilling plans is dependent upon our abilityto: (i) increase revenues through acquisitions and recovery of our provedproducing and proved developed non-producing oil and gas reserves; (ii) maintaineffective cost controls at the corporate administrative office and in fieldoperations; and (iii) obtain additional financing, including the exerciseof outstanding warrants.  However, evenif we achieve some success with our plans, there can be no assurance that wewill be able to generate sufficient revenues to achieve significant profitableoperations or to fund our drilling plans. See “Management’s Discussion and Analysis or Plan of Operation.”

 

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**We have substantial capital requirements necessary for undeveloped properties for which we may not be able to obtain adequate financing.**

 

Themajority of our oil and gas reserves are undeveloped.  At June 30, 2007, we had provedundeveloped reserves of 3,263,421 MCFE, which represent approximately 76% ofour total proved reserves of 4,319,031 MCFE. Recovery of the Company’s futureundeveloped reserves will require significant capital expenditures. As such,our management intends to make capital expenditures of approximately$22,500,000 to further develop these reserves during fiscal year 2008.  No assurance can be given that our estimatesof capital expenditures will prove accurate, that our financing sources will besufficient to fully fund our planned development activities or that developmentactivities will be either successful or in accordance with our schedule.  Additionally, any significant decrease in oiland gas prices or any significant increase in the cost of development couldresult in a significant reduction in the number of wells drilled and/orreworked.  No assurance can be given thatany wells will produce oil or gas in commercially profitable quantities.

 

Developmentof our properties will require additional capital resources. Except for our$20,000,000 revolving credit facility with Wells Fargo Energy Capital, we haveno commitments to obtain any additional debt or equity financing and there canbe no assurance that additional financing will be available, when required, onfavorable terms to us. The inability to borrow under the revolving creditfacility or obtain additional financing could have a material adverse effect onus, including requiring us to curtail significantly our oil and gas developmentplans or farm-out development of our properties. Any additional financing mayinvolve substantial dilution to the interests of our shareholders at that time.See “Management’s Discussion and Analysis or Plan of Operation.”

 

**Oil and natural gas prices fluctuate widely and low prices could have a material adverse impact on our business and financial results.**

 

Ourrevenues, profitability and the carrying value of our oil and gas propertiesare substantially dependent upon prevailing prices of, and demand for, oil andgas and the costs of acquiring, finding, developing and producingreserves.  Our ability to obtainborrowing capacity, to repay future indebtedness, and to obtain additionalcapital on favorable terms is also substantially dependent upon oil and gasprices.  Historically, the markets foroil and gas have been volatile and are likely to continue to be volatile in thefuture.  Prices for oil and gas aresubject to wide fluctuations in response to: (i) relatively minor changesin the supply of, and demand for, oil and gas; (ii) market uncertainty;and (iii) a variety of additional factors, all of which are beyond ourcontrol.  These factors include domesticand foreign political conditions, the price and availability of domestic andimported oil and gas, the level of consumer and industrial demand, weather,domestic and foreign government relations, the price and availability ofalternative fuels and overall economic conditions.  Furthermore, the marketability of ourproduction depends in part upon the availability, proximity and capacity ofgathering systems, pipelines and processing facilities.  Volatility in oil and gas prices could affectour ability to market our production through such systems, pipelines orfacilities.  Substantially all of our gasproduction is currently sold to two gas marketing firms on a month-to-monthbasis at prevailing spot market prices. Oil prices remained subject to unpredictable political and economicforces during fiscal years 2005, 2006 and 2007, and experienced fluctuationssimilar to those seen in natural gas prices for the year.  We believe that oil prices will continue tofluctuate in response to changes in the policies of the Organization ofPetroleum Exporting Countries (“OPEC”), changes in demand from many Asiancountries, current events in the Middle East, security threats to the UnitedStates, and other factors associated with the world political and economicenvironment.  As a result of the manyuncertainties associated with levels of production maintained by OPEC and otheroil producing countries, the availabilities of worldwide energy supplies andcompetitive relationships and consumer perceptions of various energy sources,we are unable to predict what changes will occur in crude oil and natural gasprices.

 

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**We are subject to uncertainties in reserve estimates and future net cash flows.**

 

Thisreport contains estimates of our oil and gas reserves and the future net cashflows from those reserves, which have been prepared by certain independentpetroleum consultants.  There are numerousuncertainties inherent in estimating quantities of reserves of oil and gas andin projecting future rates of production and the timing of developmentexpenditures, including many factors beyond our control.  The reserve estimates in this report are basedon various assumptions, including, for example, constant oil and gas prices,operating expenses, capital expenditures and the availability of funds, and,therefore, are inherently imprecise indications of future net cash flows.  Actual future production, cash flows, taxes,operating expenses, development expenditures and quantities of recoverable oiland gas reserves may vary substantially from those assumed in theestimates.  Any significant variance inthese assumptions could materially affect the estimated quantity and value ofreserves set forth in this report. Additionally, our reserves may be subject to downward or upward revisionbased upon actual production performance, results of future development and exploration,prevailing oil and gas prices and other factors, many of which are beyond ourcontrol.

 

Thepresent value of future net reserves discounted at 10% (the “PV-10”) of provedreserves referred to in this report should not be construed as the currentmarket value of the estimated proved reserves of oil and gas attributable toour properties.  In accordance withapplicable requirements of the SEC, the estimated discounted future net cashflows from proved reserves are generally based on prices and costs as of thedate of the estimate, whereas actual future prices and costs may be materiallyhigher or lower.  Actual future net cashflows also will be affected by: (i) the timing of both production andrelated expenses; (ii) changes in consumption levels; and (iii) governmentalregulations or taxation.  In addition,the calculation of the present value of the future net cash flows using a 10%discount as required by the SEC is not necessarily the most appropriatediscount factor based on interest rates in effect from time to time and risksassociated with our reserves or the oil and gas industry in general.  Furthermore, our reserves may be subject todownward or upward revision based upon actual production, results of futuredevelopment, supply and demand for oil and gas, prevailing oil and gas pricesand other factors.  See “Description ofBusiness and Properties – Oil and Gas Reserves.”

 

**We are subject to various operating and other casualty risks that could result in liability exposure or the loss of production and revenues.**

 

Ouroil and gas business involves a variety of operating risks, including, but notlimited to, unexpected formations or pressures, uncontrollable flows of oil,gas, brine or well fluids into the environment (including groundwatercontamination), blowouts, fires, explosions, pollution and other risks, any ofwhich could result in personal injuries, loss of life, damage to properties andsubstantial losses.  Although we carryinsurance at levels that we believe are reasonable, we are not fully insuredagainst all risks.  We do not carrybusiness interruption insurance.  Lossesand liabilities arising from uninsured or under-insured events could have amaterial adverse effect on our financial condition and operations.

 

Fromtime to time, due primarily to contract terms, pipeline interruptions orweather conditions, the producing wells in which we own an interest have beensubject to production curtailments.  Thecurtailments range from production being partially restricted to wells being completelyshut-in.  The duration of curtailmentsvaries from a few days to several months. In most cases, we are provided only limited notice as to when productionwill be curtailed and the duration of such curtailments.  We are not currently experiencing anymaterial curtailment of our production.

 

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Weintend to increase our development and, to a lesser extent, explorationactivities.  Exploration drilling and, toa lesser extent, development drilling of oil and gas reserves involve a highdegree of risk that no commercial production will be obtained and/or thatproduction will be insufficient to recover drilling and completion costs.  The cost of drilling, completing andoperating wells is often uncertain.  Ourdrilling operations may be curtailed, delayed or canceled as a result ofnumerous factors, including title problems, weather conditions, compliance withgovernmental requirements and shortages or delays in the delivery ofequipment.  Furthermore, completion of awell does not assure a profit on the investment or a recovery of drilling,completion and operating costs.

 

**Our business may suffer if we lose key personnel.**

 

Wedepend to a large extent on the services of Calvin A. Wallen, III, ourPresident, Chairman of the Board, and Chief Executive Officer.  The loss of the services of Mr. Wallenwould have a material adverse effect on our operations.  We have not entered into any employmentcontracts with our executive officers and have not obtained key personnel lifeinsurance on Mr. Wallen.

 

**Certain of our affiliates control a majority of our outstanding common stock, which may affect your vote as a shareholder.**

 

Asof August 31, 2007, our executive officers, directors and their affiliatesand certain 5% shareholders hold approximately 61% of our outstanding shares ofcommon stock. As a result, officers, directors and their affiliates and suchshareholders have the ability to exert significant influence over our businessaffairs, including the ability to control the election of directors and resultsof voting on all matters requiring shareholder approval.  This concentration of voting power may delayor prevent a potential change in control.

 

**Certainof our affiliates have engaged in business transactions with the Company, whichmay result in conflicts of interest.**

 

Certainofficers, directors and related parties, including entities controlled by Mr. Wallen,the President and Chief Executive Officer, have engaged in businesstransactions with the Company which were not the result of arm’s lengthnegotiations between independent parties. Our management believes that the terms of these transactions were asfavorable to us as those that could have been obtained from unaffiliatedparties under similar circumstances.  Allfuture transactions between us and our affiliates will be on terms no lessfavorable than could be obtained from unaffiliated third parties and will beapproved by a majority of the disinterested members of our Board of Directors.

 

**Theliquidity, market price and volume of our stock are volatile, and our stock issubject to certain penny stock rules.**

 

Ourcommon stock is traded on the Over-the-Counter Bulletin Board (“OTCBB”).  The liquidity of our common stock may beadversely affected, and purchasers of our common stock may have difficultyselling our common stock, if our common stock does not continue to trade inthat or another suitable trading market.

 

Thereis presently only a limited public market for our common stock, and there is noassurance that a ready public market for our securities will develop.  It is likely that any market that developsfor our common stock will be highly volatile and that the trading volume insuch market will be limited.  The tradingprice of our common stock could be subject to wide fluctuations in response toquarter-to-quarter variations in our operating results, announcements of ourdrilling results and other events or factors. In addition, the U.S. stock market has from time to time experiencedextreme price and volume fluctuations

 

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that have affected themarket price for many companies and which often have been unrelated to theoperating performance of these companies. These broad market fluctuations may adversely affect the market price ofour securities.

 

Thetrading price of our common stock is below $5.00 per share.  As long as the trading price of our commonstock remains below $5.00 per share, trading in our common stock is subject tothe requirements of certain rules under the Exchange Act which requireadditional disclosure by broker-dealers in connection with any trades generallyinvolving any non-NASDAQ equity security that has a market price of less than$5.00 per share, subject to certain exceptions. Such rules require the delivery, prior to any penny stocktransaction, of a disclosure schedule explaining the penny stock market and theassociated risks, and impose various sales practice requirements onbroker-dealers who sell penny stocks to persons other than establishedcustomers and accredited investors.  Forthese types of transactions, the broker-dealer must make a special suitabilitydetermination for the purchaser and have received the purchaser’s writtenconsent to the transaction prior to sale. The additional burdens imposed upon broker-dealers by such requirementsmay discourage broker-dealers from effecting transactions in our common stock,which could severely limit the market liquidity of our common stock.

 

**We may experience adverse consequences because of requiredindemnification of officers and directors.**

 

Provisions of our Articles of Incorporation andBylaws provide that we will indemnify any director and officer as toliabilities incurred in their capacity as a director or officer and on thoseterms and conditions set forth therein to the fullest extent of Texas law.  Further, we may purchase and maintaininsurance on behalf of any such persons whether or not we would have the powerto indemnify such person against the liability insured against.  The foregoing could result in substantialexpenditures by us and prevent any recovery from our officers, directors,agents and employees for losses incurred by us as a result of theiractions.  Further, the SEC takes theposition that indemnification against liability under the Securities Act isagainst the public policy as expressed in the Securities Act, and is,therefore, unenforceable.

 

**Certainanti-takeover provisions may discourage a change in control.**

 

Provisions of Texas law and our Articles ofIncorporation and Bylaws may have the effect of delaying or preventing a changein control or acquisition of our Company. Our Articles of Incorporation and Bylaws include provisions for aclassified Board of Directors (although we do not currently have a classifiedboard), “blank check” preferred stock (the terms of which may be fixed by ourBoard of Directors without shareholder approval), purported limits onshareholder action by written consent in lieu of a meeting, and certainprocedural requirements governing shareholder meetings.  These provisions could have the effect ofdelaying or preventing a change in control of our Company.

 

**We do not intend to declare dividends in the foreseeablefuture.**

 

Our Board of Directors presently intends toretain all of our earnings for the expansion of our business.  We therefore do not anticipate thedistribution of cash dividends in the foreseeable future.  Any future decision of our Board of Directorsto pay cash dividends will depend, among other factors, upon our earnings,financial position and cash requirements.

 

**We may not have satisfactory title to our properties.**

 

Ourcontract land professionals have reviewed title records or other title reviewmaterials relating to substantially all of our producing properties.  The title investigation performed by us priorto acquiring

 

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undevelopedproperties is thorough, but less rigorous than that conducted prior todrilling, consistent with industry standards. A title opinion obtained on the drill site prior to drilling does notnecessarily ensure satisfactory title. We believe we have satisfactory title to all our producing properties inaccordance with standards generally accepted in the oil and gas industry.  Our properties are subject to customaryroyalty interests, liens incident to operating agreements, liens for currenttaxes and other burdens, which we believe do not materially interfere with theuse of or affect the value of such properties. At June 30, 2007, our leaseholds for some of our net acreage werebeing kept in force by virtue of production on that acreage in payingquantities.  The remaining net acreagewas held by lease rentals and similar provisions and requires production inpaying quantities prior to expiration of various time periods to avoid leasetermination. In the normal course of our business, title defects of varyingdegrees will arise, and, if practicable, reasonable efforts will be made tocure any such defects.

 

We expect to make acquisitions of oil and gasproperties from time to time subject to available resources.  In making an acquisition, we generally focusmost of our title and valuation efforts on the more significant properties.  It is generally not feasible for us to reviewin-depth every property we purchase and all records with respect to suchproperties.  However, even an in-depthreview of properties and records may not necessarily reveal existing orpotential problems, nor will it permit us to become familiar enough with theproperties to assess fully their deficiencies and capabilities.  Evaluation of future recoverable reserves ofoil and gas, which is an integral part of the property selection process, is aprocess that depends upon evaluation of existing geological, engineering andproduction data, some or all of which may prove to be unreliable or notindicative of future performance.  To theextent the seller does not operate the properties, obtaining access toproperties and records may be more difficult. Even when problems are identified, the seller may not be willing orfinancially able to give contractual protection against such problems, and wemay decide to assume environmental and other liabilities in connection withacquired properties.

 

**We are subject to various governmental regulations which may cause us to incur substantial costs.**

 

Ouroperations are affected from time to time in varying degrees by politicaldevelopments and federal, state and local laws and regulations.  In particular, oil and gas production andrelated operations are or have been subject to price controls, taxes and otherlaws and regulations relating to the oil and gas industry.  Failure to comply with such laws andregulations can result in substantial penalties.  The regulatory burden on the oil and gasindustry increases our cost of doing business and affects ourprofitability.  Although we believe weare in substantial compliance with all applicable laws and regulations, becausesuch laws and regulations are frequently amended or reinterpreted, we areunable to predict the future cost or impact of complying with such laws andregulations.

 

Sales of natural gas by us are not regulatedand are generally made at market prices. However, the Federal Energy Regulatory Commission (“FERC”) regulatesinterstate natural gas transportation rates and service conditions, whichaffect the marketing of natural gas produced by us, as well as the revenuesreceived by us for sales of such production. Sales of our natural gas currently are made at uncontrolled marketprices, subject to applicable contract provisions and price fluctuations thatnormally attend sales of commodity products.

 

Since the mid-1980’s, the FERC has issued aseries of orders, culminating in Order Nos. 636, 636-A and 636-B (“Order 636”),that have significantly altered the marketing and transportation of naturalgas. Order 636 mandated a fundamental restructuring of interstate pipelinesales and transportation service, including the unbundling by interstatepipelines of the sale, transportation, storage and other components of thecity-gate sales services such pipelines previously performed.  One of the FERC’s purposes in issuing theorders was to increase competition within all phases of the natural gasindustry. 

 

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Order 636 and subsequent FERC orders issued in individual pipelinerestructuring proceedings have been the subject of appeals, and the courts havelargely upheld Order 636.  Becausefurther review of certain of these orders is still possible, and other appealsmay be pending, it is difficult to exactly predict the ultimate impact of theorders on us and our natural gas marketing efforts.  Generally, Order 636 has eliminated orsubstantially reduced the interstate pipelines’ traditional role as wholesalersof natural gas, and has substantially increased competition and volatility innatural gas markets.

 

While significant regulatory uncertainty remains,Order 636 may ultimately enhance our ability to market and transport ournatural gas, although it may also subject us to greater competition, morerestrictive pipeline imbalance tolerances and greater associated penalties forviolation of such tolerances.

 

The FERC has announced several importanttransportation-related policy statements and proposed rule changes,including the appropriate manner in which interstate pipelines release capacityunder Order 636 and, more recently, the price which shippers can charge fortheir released capacity.  In addition, in1995, the FERC issued a policy statement on how interstate natural gaspipelines can recover the costs of new pipeline facilities.  In January 1997, the FERC issued apolicy statement and a request for comments concerning alternatives to itstraditional cost-of-service rate making methodology.  A number of pipelines have obtained FERCauthorization to charge negotiated rates as one such alternative.  While any additional FERC action on thesematters would affect us only indirectly, these policy statements and proposed rule changesare intended to further enhance competition in natural gas markets.  We cannot predict what action the FERC willtake on these matters, nor can we predict whether the FERC’s actions willachieve its stated goal of increasing competition in natural gas markets.  However, we do not believe that we will betreated materially differently than other natural gas producers and marketerswith which we compete.

 

The price we receive from the sale of oil isaffected by the cost of transporting such products to market.  Effective January 1, 1995, the FERCimplemented regulations establishing an indexing system for transportationrates for oil pipelines, which, generally, would index such rates to inflation,subject to certain conditions and limitations. These regulations could increase the cost of transporting oil byinterstate pipelines, although the most recent adjustment generally decreasedrates.  These regulations have generallybeen approved on judicial review.  We arenot able to predict with certainty the effect, if any, of these regulations onour operations.  However, the regulationsmay increase transportation costs or reduce wellhead prices for oil.

 

The State of Texas and many other states requirepermits for drilling operations, drilling bonds and reports concerningoperations and impose other requirements relating to the exploration for andproduction of oil and gas.  Such statesalso have statutes or regulations addressing conservation matters, includingprovisions for the unitization or pooling of oil and gas properties, theestablishment of maximum rates of production from wells and the regulation ofspacing, plugging and abandonment of such wells.  The statutes and regulations of certainstates limit the rate at which oil and gas can be produced from ourproperties.  However, we do not believewe will be affected materially differently by these statutes and regulationsthan any other similarly situated oil and gas company.

 

**Weare subject to various environmental risks which may cause us to incursubstantial costs.**

** **

Our operations and properties are subject toextensive and changing federal, state and local laws and regulations relatingto environmental protection, including the generation, storage, handling andtransportation of oil and gas and the discharge of materials into theenvironment, and relating to safety and health. The recent trend in environmental legislation and regulation generallyis toward stricter standards, and this trend will likely continue.  These laws and regulations may require theacquisition of a

 

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permitor other authorization before construction or drilling commences and forcertain other activities; limit or prohibit construction, drilling and otheractivities on certain lands lying within wilderness and other protected areas;and impose substantial liabilities for pollution resulting from ouroperations.  The permits required for ourvarious operations are subject to revocation, modification and renewal byissuing authorities.  Governmentalauthorities have the power to enforce compliance with their regulations, andviolations are subject to fines, penalties or injunctions. In the opinion ofmanagement, we are in substantial compliance with current applicableenvironmental laws and regulations, and we have no material commitments forcapital expenditures to comply with existing environmental requirements.  Nevertheless, changes in existingenvironmental laws and regulations or in interpretations thereof could have asignificant impact on us. The impact of such changes, however, would not likelybe any more burdensome to us than to any other similarly situated oil and gascompany.

 

The Comprehensive Environmental Response,Compensation, and Liability Act (“CERCLA”), also known as the “Superfund” law,and similar state laws impose liability, without regard to fault or thelegality of the original conduct, on certain classes of persons that areconsidered to have contributed to the release of a “hazardous substance” intothe environment.  These persons includethe owner or operator of the disposal site or sites where the release occurredand companies that disposed or arranged for the disposal of the hazardoussubstances found at the site.  Personswho are or were responsible for releases of hazardous substances under CERCLAmay be subject to joint and several liability for the costs of cleaning up thehazardous substances that have been released into the environment and fordamages to natural resources. Furthermore, neighboring landowners and other third parties may fileclaims for personal injury and property damage allegedly caused by thehazardous substances released into the environment.

 

We generate typical oil and gas field wastes,including hazardous wastes that are subject to the federal ResourcesConservation and Recovery Act and comparable state statutes.  The United States Environmental ProtectionAgency and various state agencies have limited the approved methods of disposalfor certain hazardous and non-hazardous wastes. Furthermore, certain wastes generated by our oil and gas operations thatare currently exempt from regulation as “hazardous wastes” may in the future bedesignated as “hazardous wastes,” and therefore be subject to more rigorous andcostly operating and disposal requirements.

 

The Oil Pollution Act (“OPA”) imposes a varietyof requirements on responsible parties for onshore and offshore oil and gasfacilities and vessels related to the prevention of oil spills and liabilityfor damages resulting from such spills in waters of the United States.  The “responsible party” includes the owner oroperator of an onshore facility or vessel or the lessee or permittee of, or theholder of a right of use and easement for, the area where an onshore facilityis located. OPA assigns liability to each responsible party for oil spillremoval costs and a variety of public and private damages from oil spills.  Few defenses exist to the liability for oilspills imposed by OPA.  OPA also imposesfinancial responsibility requirements. Failure to comply with ongoingrequirements or inadequate cooperation in a spill event may subject aresponsible party to civil or criminal enforcement actions.

 

We own or lease properties that for many yearshave produced oil and gas.  We also ownnatural gas gathering systems.  It is notuncommon for such properties to be contaminated with hydrocarbons.  Although we or previous owners of theseinterests may have used operating and disposal practices that were standard inthe industry at the time, hydrocarbons or other wastes may have been disposedof or released on or under the properties or on or under other locations wheresuch wastes have been taken for disposal. These properties may be subject to federal or state requirements thatcould require us to remove any such wastes or to remediate the resultingcontamination.  All of our properties areoperated by third parties over whom we have limited control.  Notwithstanding our lack of control overproperties operated

 

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by others, the failure of the previous owners oroperators to comply with applicable environmental regulations may, in certaincircumstances, adversely impact us.

 

**We maybe responsible for additional costs in connection with abandonment ofproperties.**

 

We are responsible for payment of plugging andabandonment costs on our oil and gas properties pro rata to our workinginterest.  Based on our experience, weanticipate that the ultimate aggregate salvage value of lease and wellequipment located on our properties will exceed the costs of abandoning suchproperties.  There can be no assurance,however, that we will be successful in avoiding additional expenses inconnection with the abandonment of any of our properties.  In addition, abandonment costs and theirtiming may change due to many factors, including actual production results,inflation rates and changes in environmental laws and regulations.

 

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** **

**GLOSSARY OF OIL AND GAS TERMS**

** **

The following areabbreviations and definitions of terms commonly used in the oil and gasindustry that are used in this Report.

 

“**BBL**” means a barrel of 42 U.S. gallons.

 

“**BOE**” means barrels of oil equivalent;converting volumes of natural gas to oil equivalent volumes using a ratio ofsix Mcf of natural gas to one Bbl of oil.

 

“**BTU**” means British Thermal Units. BritishThermal Unit means the quantity of heat required to raise the temperature ofone pound of water by one degree Fahrenheit.

 

“**Completion**” means the installation ofpermanent equipment for the production of oil or gas.

 

“**Development Well**” means a well drilledwithin the proved area of an oil or gas reservoir to the depth of astratigraphic horizon known to be productive.

 

“**Dry****Hole**”or “**Dry****Well**” means a well found to be incapable of producinghydrocarbons in sufficient quantities such that proceeds from the sale of suchproduction exceed production expenses and taxes.

 

“**Exploratory Well**” means a well drilled tofind and produce oil or gas reserves not classified as proved, to find a newproduction reservoir in a field previously found to be productive of oil or gasin another reservoir or to extend a known reservoir.

 

“**Farm-Out**” means an agreement pursuant towhich the owner of a working interest in an oil and gas lease assigns theworking interest or a portion thereof to another party who desires to drill onthe leased acreage.  Generally, theassignee is required to drill one or more wells in order to earn its interestin the acreage.  The assignor usuallyretains a royalty or reversionary interest in the lease.  The interest received by an assignee is a “farm-in”and the assignor issues a “farm-out.”

 

“**Farm-In**” see “Farm-Out” above.

 

“**Gas**” means natural gas.

 

“**Gross**” when used with respect to acres orwells, refers to the total acres or wells in which we have a working interest.

 

“**Infill Drilling**” means drilling of an additionalwell or wells provided for by an existing spacing order to more adequatelydrain a reservoir.

 

“**MCF**” means thousand cubic feet.

 

**“MCFE”**means MCF of natural gas equivalent;converting volumes of oil to natural gas equivalent volumes using a ratio ofone BBL of oil to six MCF of natural gas.

 

“**MMBTU**” means one million BTUs.

 

“**Net**” when used with respect to acres or wells, refers togross acres or wells multiplied, in each case, by the percentage workinginterest owned by the Company.

 

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“**Net Production**” means production that isowned by the Company less royalties and production due others.

 

“**Operator**” means the individual or companyresponsible for the exploration, development and production of an oil or gaswell or lease.

 

“**Present Value**” (“**PV**”) when used with respect to oil and gas reserves, means theestimated future gross revenues to be generated from the production of provedreserves calculated in accordance with the guidelines of the SEC, net ofestimated production and future development costs, using prices and costs as ofthe date of estimation without future escalation (except to the extent a contractspecifically provides otherwise), without giving effect to non-property relatedexpenses such as general and administrative expenses, debt service, futureincome tax expense and depreciation, depletion and amortization, and discountedusing an annual discount rate of 10%.

 

“**Productive Wells**” or “**Producing Wells**” consist of producing wellsand wells capable of production, including wells waiting on pipelineconnections.

 

“**Proved Developed Reserves**” means reservesthat can be expected to be recovered through existing wells with existingequipment and operating methods. Additional oil and gas expected to be obtainedthrough the application of fluid injection or other improved recoverytechniques for supplementing the natural forces and mechanisms of primary recoverywill be included as “proved developed reserves” only after testing by a pilotproject or after the operation of an installed program has confirmed throughproduction response that increased recovery will be achieved.

 

“**Proved Reserves**” means the estimatedquantities of crude oil and natural gas which upon analysis of geological andengineering data appear with reasonable certainty to be recoverable in futureyears from known reservoirs under existing economic and operating conditions,i.e., prices and costs as of the date the estimate is made. Prices includeconsideration of changes in existing prices provided only by contractualarrangements, but not on escalations based upon future conditions.

 

(i)                                    Reservoirsare considered proved if either actual production or conclusive formation testssupport economic producibility.  The areaof a reservoir considered proved includes (A) that portion delineated bydrilling and defined by gas-oil and/or oil-water contacts, if any; and (B) theimmediately adjoining portions not yet drilled, but which can be reasonablyjudged as economically productive on the basis of available geological andengineering data. In the absence of information on fluid contacts, the lowestknown structural occurrence of hydrocarbons controls the lower proved limit ofthe reservoir.

 

(ii)                                 Reserveswhich can be produced economically through application of improved recoverytechniques (such as fluid injection) are included in the “proved”classification when successful testing by a pilot project, or the operation ofan installed program in the reservoir, provides support for the engineeringanalysis on which the project or program was based.

 

(iii)                              Estimatesof proved reserves do not include the following: (A) oil that may becomeavailable from known reservoirs but is classified separately as “indicatedadditional reserves”; (B) crude oil and natural gas, the recovery of whichis subject to reasonable doubt because of uncertainty as to geology, reservoircharacteristics or economic factors; (C) crude oil and natural gas thatmay occur in undrilled prospects; and (D) crude oil and natural gas thatmay be recovered from oil shales, coal, gilsonite and other such resources.

 

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“**Proved Undeveloped Reserves**” means reservesthat are recovered from new wells on undrilled acreage, or from existing wellswhere a relatively major expenditure is required for completion. Reserves onundrilled acreage shall be limited to those drilling units offsettingproductive units that are reasonably certain of production when drilled. Provedreserves for other undrilled units can be claimed only where it can bedemonstrated with certainty that there is continuity of production from theexisting productive formation. Under no circumstances should estimates forproved undeveloped reserves be attributable to any acreage for which anapplication of fluid injection or other improved recovery technique iscontemplated, unless such techniques have been proved effective by actual testsin the area and in the same reservoir.

 

“**Recompletion**” means the completion forproduction of an existing well bore in another formation from that in which thewell has been previously completed.

 

“**Reserves**” means proved reserves.

 

“**Reservoir**” means a porous and permeableunderground formation containing a natural accumulation of producible oiland/or gas that is confined by impermeable rock or water barriers and isindividual and separate from other reservoirs.

 

“**Royalty**” means an interest in an oil andgas lease that gives the owner of the interest the right to receive a portionof the production from the leased acreage (or of the proceeds of the salethereof), but generally does not require the owner to pay any portion of thecosts of drilling or operating the wells on the leased acreage. Royalties maybe either landowner’s royalties, which are reserved by the owner of the leasedacreage at the time the lease is granted, or overriding royalties, which areusually reserved by an owner of the leasehold in connection with a transfer toa subsequent owner.

 

“**2-D Seismic**” means an advanced technologymethod by which a cross-section of the earth’s subsurface is created throughthe interpretation of reflecting seismic data collected along a single sourceprofile.

 

“**3-D Seismic**” means an advanced technologymethod by which a three dimensional image of the earth’s subsurface is createdthrough the interpretation of reflection seismic data collected over a surfacegrid. 3-D seismic surveys allow for a more detailed understanding of thesubsurface than do conventional surveys and contribute significantly to fieldappraisal, development and production.

 

“**Working Interest**” means an interest in anoil and gas lease that gives the owner of the interest the right to drill forand produce oil and gas on the leased acreage and requires the owner to pay ashare of the costs of drilling and production operations. The share of productionto which a working interest owner is entitled will always be smaller than theshare of costs that the working interest owner is required to bear, with thebalance of the production accruing to the owners of royalties.

 

“**Workover**” means operations on a producingwell to restore or increase production.

 

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** **

**Item 2. Description of Properties.**

** **

See“Description of Business and Properties.”

 

**Item 3. Legal Proceedings.**

** **

Thereare no legal proceedings to which the Company is a party or to which itsproperties are subject which are, in the opinion of management, likely to havea material adverse effect on the Company’s results of operations or financialcondition.

 

**Item 4. Submission of Matters to a Vote of Security Holders.**

** **

NotApplicable.

 

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**PART II**

 

**Item 5.  Marketfor Common Equity and Related Stockholder Matters, and Small Business IssuerPurchases of Equity Securities**

** **

**Common Stock and Market**

 

The common stock ofthe Company is traded on the OTCBB, with the trading symbol “QBIK”.

 

At August 31, 2007, there were 56,130,896 shares of common stockoutstanding held by approximately 882 shareholders of record.

 

Under its Articles ofIncorporation, as amended, the Company is authorized to issue one class of upto 100,000,000 common shares, par value $0.05 per share, and one class of up to10,000,000 preferred shares, par value $0.01 per share.  As of August 31, 2007, there were nopreferred shares of the Company outstanding.

 

**Common Stock Price Range**

 

The following table shows, for the periods indicated, the range of highand low closing bid information for our common stock as reported by theOTCBB.  Any market for our common stockshould be considered sporadic, illiquid and highly volatile.  Prices reflect inter-dealer quotations, withoutadjustment for retail markup, markdowns or commissions, and may not representactual transactions.  Our common stock’strading range during the periods indicated is as follows:

 
| **Fiscal Year 2006** | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------------|------------|----------|------------|---------|------------|
| 1st Quarter                    |       | $        | 1.10       |    | $          | 0.65 |   |
| 2nd Quarter                    |       | $        | 1.35       |    | $          | 0.68 |   |
| 3rd Quarter                    |       | $        | 0.87       |    | $          | 0.47 |   |
| 4th Quarter                    |       | $        | 0.90       |    | $          | 0.70 |   |

 
| **Fiscal Year 2007** | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------------|------------|----------|------------|---------|------------|
| 1st Quarter                    |       | $        | 0.90       |    | $          | 0.51 |   |
| 2nd Quarter                    |       | $        | 0.90       |    | $          | 0.46 |   |
| 3rd Quarter                    |       | $        | 0.90       |    | $          | 0.65 |   |
| 4th Quarter                    |       | $        | 1.46       |    | $          | 0.51 |   |

 

**DividendPolicy**

 

Wehave neither declared nor paid any dividends on our common stock since ourinception.  Presently, we intend toretain our earnings, if any, to provide funds for expansion of our business.  Therefore, we do not anticipate declaring orpaying cash dividends on our common stock in the foreseeable future.  Any future dividends will be subject to thediscretion of our Board of Directors and will depend upon, among other things,future earnings, our operating and financial condition, our capital requirements,debt obligation agreements, general business conditions and other pertinentfacts.

 

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**SecuritiesAuthorized for Issuance under Equity Compensation Plans**

 

The following table provides information as of August 31, 2007with respect to compensation plans (including individual compensationarrangements) under which equity securities of the registrant are authorizedfor issuance:

 
| ** **                                              | ** ** | **Number of securities  to be issued upon  exercise of  outstanding  options, warrants  and rights** | ** ** | **Weighted average  exercise price of  outstanding  options, warrants  and rights** | ** ** | **Number of shares  of common stock  remaining available  for future issuance  under equity  compensation plans** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                    |       |                                                                                                                                         |       |                                                                                                         |       |                                                                                                                                                           |       |
| 2005 Stock  Option Plan approved by shareholders        |       | —                                                                                                                                       |       | $                                                                                                            | —     |                                                                                                                                                           | 1,949,000  |   |
|                                                    |       |                                                                                                                                         |       |                                                                                                         |       |                                                                                                                                                           |       |
| Equity  compensation plans not approved by shareholders |       | —                                                                                                                                       |       | $                                                                                                            | —     |                                                                                                                                                           | —     |   |
| Total                                                   |       | —                                                                                                                                       |       |                                                                                                         |       | 1,949,000                                                                                                                                                      |       |

 

**Item 6. Management’s Discussion and Analysis orPlan of Operation.**

** **

The followingdiscussion is intended to assist in an understanding of the Company’shistorical financial position and results of operations for each year in thetwo-year period ended June 30, 2007. The Company’s Financial Statements and notes thereto included elsewherein this Report contain detailed information that should be referred to inconjunction with the following discussion.

 

**General**

 

The Company’s futureresults of operations and growth are substantially dependent upon (i) itsability to acquire or find and successfully develop additional oil and gasreserves and (ii) the prevailing prices for oil and gas. We have aninventory of exploration drilling locations to pursue after the fiscal yearending June 30, 2007. If we are unable to economically acquire or findsignificant new reserves for development and exploitation, the Company’s oiland gas production, and thus its revenues, would likely decline gradually asits reserves are produced. In addition, oil and gas prices are dependent uponnumerous factors beyond the Company’s control, such as economic, political andregulatory developments and competition from other sources of energy. The oiland gas markets have historically been very volatile, and any significant andextended decline in the price of oil or gas would have a material adverseeffect on the Company’s financial condition and results of operations, andcould result in a reduction in the carrying value of the Company’s provedreserves and adversely affect its access to capital.

 

THISMANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION CONTAINSFORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THESECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIESEXCHANGE ACT OF 1934, AS AMENDED. ACTUAL RESULTS COULD DIFFER MATERIALLY FROMTHOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAINFACTORS DESCRIBED HEREIN AND IN OTHER DOCUMENTS THE COMPANY FILES FROM TIME TOTIME WITH THE SECURITIES AND EXCHANGE COMMISSION. READERS SHOULD CAREFULLYREVIEW THE RISK FACTORS DESCRIBED IN THIS ANNUAL REPORT AND THE DOCUMENTS THECOMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION.

 

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**RESULTS OFOPERATIONS**

** **

## **Comparisonof Fiscal 2007 to Fiscal 2006**

##  

## **Revenues**

##  

OIL AND GAS SALESincreased 15% to $583,416 in the fiscal year ended June 30, 2007 (“fiscal2007”) from $508,925 in the fiscal year ended June 30, 2006 (“fiscal 2006”),due primarily to a 27% increase in oil and gas production, which was partiallyoffset by an 11% decrease in the weighted average sales prices for gas (perMcf).

 

### **Costs andExpenses**

###  

OIL AND GASPRODUCTION, OPERATING AND DEVELOPMENT COSTS (also referred to as “LEASEOPERATING EXPENSES” elsewhere herein) increased 42% to $481,145 in fiscal 2007from $338,239 in fiscal 2006 due primarily to greater activity resulting frommore wells being brought on-line in Louisiana.

 

SELLING, GENERAL ANDADMINISTRATIVE EXPENSES (“G&A”) decreased 5% to $1,325,192 in fiscal 2007from $1,400,482 in fiscal 2006 primarily as a result of a $266,700 decrease innon-cash compensation expense related to stock grants to officers anddirectors.  Such decrease was partiallyoffset by a $128,736 increase in compensation expenses resulting from anincrease in the number of employees.

 

DEPRECIATION,DEPLETION AND AMORTIZATION (“DD&A”) increased 102% to $362,434 in fiscal2007 from $179,237 in fiscal 2006. The increase was primarily due to a$2,595,469, or 143%, increase in capital expenditures in fiscal 2006 related tothe acquisition and development of oil and gas properties.

 

IMPAIRMENT OF OIL ANDGAS PROPERTIES increased to $1,790,882 in fiscal 2007 from $0 in fiscal 2006.The impairment resulted from a downward revision of our reserve estimates,which was effected by the following events: (i) we experienced delaysrelated to third party providers in our Bethany Longstreet acreage in DeSotoParish, Louisiana, including not receiving contracted-for compression services,which temporarily delayed our ability to produce from these wells; (ii) wedid not effectuate final completion of certain wells due to a short-term shiftin our focus to the development of our Johnson Branch acreage in Caddo Parish,Louisiana; and, (iii) the lack of production history in wells recentlybrought online lead to a sharper decline curve being utilized by The ScotiaGroup, Inc. in formulating the reserve estimates.

 

INTEREST EXPENSEincreased 100% to $1,278,721 in fiscal 2007 from $638,800 in fiscal 2006 due tothe increase in debt as a result of the $5,500,000 of Petro Capital debt beingin place for eight months in fiscal 2007 as compared to four months in fiscal2006; and, the borrowing of $5,000,000 pursuant to a new senior convertibleterm loan on March 5, 2007, and subsequent draws of approximately$4,000,000 on a related revolving line of credit, with Wells Fargo. The CreditFacility with Wells Fargo also resulted in a loan discount being recorded.  The discount is being amortized over theoriginal three-year term of the debt as additional interest expense with$164,961 being recorded in fiscal 2007.

 

LOSS ON EXTINGUISHMENTOF DEBT increased 64% to $1,082,887 from $660,330 in fiscal 2007. On March 5,2007, the senior debt held by Petro Capital was retired with proceedsfrom the Credit Facility with Wells Fargo. In connection with this retirement, the Company recorded a loss onextinguishment of debt in the amount of $(1,082,887) in fiscal 2007.  Such amount includes the write-off

 

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of deferred loan costs ($235,898), and thewrite-off of the remaining loan discount ($846,989).  In fiscal 2006, the remaining Debentures were retired withproceeds from the then-new senior debt issue held by Petro Capital.  In connection with this retirement, theCompany recorded a loss on extinguishment of debt in the amount of $(660,330)in fiscal 2006.  Such amount included thewrite-off of deferred loan costs ($99,204), the write-off of the remaining loandiscount ($237,931), and a prepayment penalty and associated legal fees($323,195).

 

## **Liquidityand Capital Resources**

##  

### **Overview**

###  

The Company’s primary resource is its oil and gas reserves. The Companyhas entered into a senior credit facility, but such facility is not expected tosupplement the Company’s internally generated cash flow as a source offinancing for its general working capital purposes. Product prices, over whichwe have no control, have a significant impact on revenues from production andthe value of such reserves and thereby on the Company’s borrowing capacity inthe event the Company determines to borrow additional funds. Within theconfines of product pricing, the Company must be able to find and develop oracquire oil and gas reserves in a cost effective manner in order to generatesufficient financial resources through internal means to complete the financingof its capital expenditure program.

 

AtJune 30, 2007, the Company had working capital of $2,606,796.  On July 28 and December 15, 2006,we raised $2,100,000 and $3,940,000, respectively, through the privateplacement of common stock. On March 5, 2007, Cubic entered into a CreditAgreement with Wells Fargo providing for the Credit Facility, which consists ofa convertible term loan of $5,000,000 and a revolving credit facility of$20,000,000 in order to fund the drilling of new wells (see “Notes to FinancialStatements – Note E – Long-term debt” elsewhere herein).

 

The following discussion sets forth the Company’s current plans forcapital expenditures in fiscal 2008, and the expected capital resources neededto finance such plans.

 

### **CapitalExpenditures**

###  

The majority of our oil and gas reserves are undeveloped.  Recovery of the Company’s future undevelopedproved reserves will require significant capital expenditures.  Our management estimates that aggregatecapital expenditures of approximately $22,500,000 will be made to furtherdevelop these reserves during fiscal 2008. Moreover, additional capital expenditures may be required forexploratory drilling on our undeveloped acreage.

 

The Company will increase its planned activities for fiscal 2008 ifproduct prices remain strong and if we are able to obtain the additionalcapital resources necessary to finance such activities.

 

### **WorkingCapital and Cash Flow**

###  

During fiscal 2007,the Company incurred a cash flow deficit from operating activities of$(1,802,068). Cash flow from operations is dependent on our ability to increaseproduction through our development and exploratory activities and the pricereceived for oil and natural gas.

 

The Company’s working capital increased to $2,606,796 at June 30,2007 from a deficit of $(1,357,230) at June 30, 2006, primarily due to anincrease in cash and cash equivalents resulting from the borrowing ofapproximately $4,000,000 on the aforementioned revolving line of credit withWells Fargo.

 

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### **CapitalResources**

###  

The Company plans to fund its development and exploratory activitiesthrough cash provided from operations and the utilization of the CreditFacility (see “Notes to Financial Statements – Note E – Long-term debt”elsewhere herein).

 

The Company cannot be certain that adequate funds will be availablefrom operating cash flow and the Credit Facility to fully fund the projectedcapital expenditures for fiscal 2008. Additionally, because future cash flowsand the availability of borrowings are subject to a number of variables, suchas prevailing prices of oil and gas, actual production from existing andnewly-completed wells, the Company’s success in developing and producing newreserves, and the uncertainty with respect to the amount of funds which mayultimately be required to finance the Company’s development and explorationprogram, there can be no assurance that the Company’s capital resources will besufficient to sustain the Company’s development and exploratory activities.

 

Although the Company believes it will be able to obtain funds pursuantto the above-mentioned alternatives, management cannot be assured that suchcapital resources will be available to the Company.  If we are unable to obtain such capitalresources on a timely basis, the Company may curtail its planned developmentand exploratory activities.

 

### **Inflation**

###  

Although the level of inflation affects certain of the Company’s costsand expenses, inflation did not have a significant effect on the Company’sresults of operations during fiscal 2007.

 

**Subsequent Events**

 

Subsequent to the end of the fiscal year ended June 30, 2007, on September 7,2007, Wells Fargo increased the Company’s Borrowing Base to $8,600,000 in orderto fund: the remaining drilling and casing costs of five wells drilled sincethe beginning of fiscal 2008; the drilling and casing costs of two new wells;and the costs of installing a gathering/sales line and associated equipment inthe Company’s Johnson Branch acreage in Caddo Parish, Louisiana.

 

Subsequent to the end of the fiscal year ended June 30, 2007, andas of the date of this filing, September 28, 2007, the Company hassuccessfully drilled 13 wells in its northwest Louisiana properties (eight inits Bethany Longstreet acreage in Caddo and DeSoto Parishes, and five in itsJohnson Branch acreage in Caddo Parish) and has completed and brought onlinefor production seven of such wells (all in its Bethany Longstreet acreage).While it is in the Company’s future development plans to re-complete this firstround of producing wells at a later date, the Company’s focus has changed frommaximizing production and reserves in the first round of drilling to holdingacreage and preserving capital for potentially much greater production andreserves from an emerging resource play (what is now known in the industry asthe “Haynesville shale play”).

 

Given the forgoing subsequent events, the Company does not believe thatthe downward revisions in estimates taken in the fiscal 2007 reserve report(please also see “Description of Business and Properties – Recent Developments”and Notes to Financial Statements, “Note J - Oil and gas reserves information(unaudited)”) will have a material impact on the Company’s future prospects.

 

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**Item 7.    FinancialStatements.**

** **

The Report ofIndependent Accountants, Financial Statements and any supplementary financialdata required by this Item are set forth on pages F-1 through F-30 of thisReport and are incorporated herein by reference.

 

**Item 8.    ChangesIn and Disagreements with Accountants on Accounting and Financial Disclosure.**

** **

None.

 

**Item 8A. Controls and Procedures.**

** **

Ourprincipal executive and financial officer have concluded, based on theirevaluation as of the end of the period covered by this report, that ourdisclosure controls and procedures under ExchangeAct Rules 13a -15(e) and 15d-15(e), are effective to ensure that information we are required todisclose in the reports we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms, and include controls and procedures designed to ensurethat information we are required to disclose in such reports is accumulated andcommunicated to management, including our principle executive and financialofficer, as appropriate to allow timely decisions regarding requireddisclosure.  Subsequent to ourevaluation, there were no changes in internal controls or other factors thatcould materially affect, or are reasonably likely to materially affect, theseinternal controls.

 

Wemaintain a system of internal control over financial reporting.  There has been no change in our internalcontrol over financial reporting that occurred during our fourth fiscal quarterthat has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**Item 8B.  OtherInformation.**

** **

None.

 

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**PART III**

 

**Item 9.    Directors,Executive Officers, Promoters, Control Persons and Corporate Governance;Compliance with Section 16(a) of the Exchange Act.**

** **

**Directors and Executive Officers**

 

The following table provides information concerning each of ourexecutive officers and directors as of August 31, 2007:

 
| **Name**                   | ** ** | **Age** | ** ** | **Position(s) Held with Cubic**                          | ** ** | **Director  Since** |
|----------------------------|------------|---------|------------|---------------------------------------------------------------|------------|---------------------|
|                       |       |    |       |                                                          |       |                |
| Calvin A. Wallen, III |       | 52      |       | Chairman of the Board,  President and Chief Executive Officer |       | 1997                |
|                       |       |    |       |                                                          |       |                |
| Scott D. Guffey            |       | 43      |       | Chief Financial Officer                                       |       | n/a                 |
|                       |       |    |       |                                                          |       |                |
| Jon S. Ross                |       | 43      |       | Corporate Secretary and  Director                             |       | 1998                |
|                       |       |    |       |                                                          |       |                |
| Gene C. Howard             |       | 78      |       | Director                                                      |       | 1991                |
|                       |       |    |       |                                                          |       |                |
| Herbert A. Bayer           |       | 56      |       | Director                                                      |       | 2003                |
|                       |       |    |       |                                                          |       |                |
| Bob L. Clements            |       | 64      |       | Director                                                      |       | 2004                |

 

CALVIN A. WALLEN, IIIhas served as the President and Chief Executive Officer of the Company since December 1997,and as Chairman of the Board of Directors since June 1999.  Mr. Wallen has over 20 years ofexperience in the oil and gas industry working as a drilling and petroleumengineer.   Prior to joining Cubic, Mr. Wallenwas employed by Superior Oil and various other drilling contractors includingResource, Tom Brown and Rowan International. Mr. Wallen assisted in thedesign and construction of several land rigs with advanced drilling systems andhas domestic and international experience in drilling engineering.  While employed by Rowan International, Mr. Wallengained experience in drilling high angle directional wells at Prudhoe Bay oncontract to Arco.  In 1982, Mr. Wallenbegan acquiring and developing oil and gas properties, forming a productioncompany that has evolved into Tauren Exploration, Inc. Mr. Wallenattended Texas A&M University at College Station, Texas.

 

SCOTT D. GUFFEY joinedthe Company in August 2007 as Chief Financial Officer and brings more than19 years of corporate finance-related experience to the Company.  Prior to joining Cubic, Mr. Guffeyserved as Vice President of Corporate Finance for BenefitMall Inc. from 2000through 2006.  Prior to joiningBenefitMall, Mr. Guffey served as Vice President of Finance, Mergers &Acquisitions (“M&A”) and Investor Relations for publicly-traded AegisCommunications Group, Inc. from 1997 through 2000.  Before joining Aegis, he was Vice Presidentof Technology Investment Banking with Principal Financial Securities, Inc.for three years, and has seven years of Financial Planning & Analysisand M&A experience with Electronic Data Systems Corporation.  Mr. Guffey holds an M.B.A from SouthernMethodist University and a B.A. in Economics from the University of Virginia.

 

JON S. ROSS has servedas a director of the Company since April 1998 and as Secretary since November 1998.  Since 1989, Mr. Ross has been apracticing attorney in Dallas, Texas specializing in the representation of overeighty corporate entities within the past fifteen years.  He has served on several

 

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community and not-for-profit committees andBoards and has been asked to speak to corporate and civic leaders on a varietyof corporate law topics.  Mr. Rossgraduated from St. Mark’s School of Texas with honors in 1982 and graduatedfrom the University of Texas at Austin in 1986 with a B.B.A. inAccounting.  He then graduated from theUniversity of Texas School of Law in 1989 attaining a Juris Doctorate degree.

 

GENE C. HOWARD is theSenior Partner of the law firm of Howard, Widdows, and Bufogle, P.C. of Tulsa,Oklahoma and has been engaged primarily in the private practice of law over thepast thirty-five years.  Mr. Howardserved in the Oklahoma State Senate from 1964 through 1982 and was PresidentPro Tem from 1975 through 1981.  Inaddition, he served as the Chairman of the Board of Farmers and Exchange Bankfrom 1972 through 1991 and on the Board of Directors of Local Federal Bank ofOklahoma.  Mr. Howard is a Directorof the Oklahoma State Education and Employment Group Insurance Board andpresently acts as Chairman.  Mr. Howardserved as Director of EntreCap and Hinderliter corporations from 1991 to August of1992.  He is also Chairman of the Boardof Philadelphia Mortgage Trust.

 

HERBERT A. BAYER has served as a director of Cubic Energy, Inc.since May, 2003. His major course of study at Indiana State University wasBusiness Management. In 1999, he was the top salesman for ITRON, a technologyprovider for collecting, analyzing, and applying electric, gas, and water usagedata. From 2002 to 2003 he served as the Regional Director of Sales for UtilityAutomation Integrators. Mr. Bayer was the National Director of Sales forthe gas division of Hexagram, Inc. from 2003 to 2005. Before his mostrecent appointment in 2006, he served as the Director of Client Services forCommunications and Information Solutions for CH2M HILL, a $3.5 billionworld-wide engineering and construction company. He currently serves in thecapacity of Director of WiFi Markets for SmartSynch, Inc.

 

BOB L. CLEMENTS joined the Company’s board of directors in February 2004.Mr. Clements has a degree in the OPM Program from the Harvard BusinessSchool.  Mr. Clements has been inthe wholesale food and restaurant business for over thirty years, currentlycontrolling the largest independent producer of stuffed jalapenos and corn dogsas well as two successful restaurants in the Rockwall, Texas area.  Mr. Clements has served and currentlyserves on a variety of profit and charitable committees and boards.

 

There are no familyrelationships among any of the directors or executive officers of theCompany.  See “Certain Relationships andRelated Transactions” for a description of transactions between the Company andits directors, executive officers or their affiliates.

 

**Audit Committee; Financial Expert**

 

The Audit Committee iscomprised of Messrs. Howard (Chairman), Clements and Bayer.  All of the members of the Audit Committee are“independent” under the rules of the SEC. The Board of Directors, after reviewing all of the relevant facts,circumstances and attributes, has determined that Mr. Howard is the sole “auditcommittee financial expert” on the Audit Committee.

 

## **Compliance with Section 16(a) of the Exchange Act**

##  

Section 16(a) of the Exchange Act requires the Company’sdirectors, executive officers, and holders of more than 10% of the common stockto file with the SEC reports of ownership and changes in ownership of commonstock.  SEC regulations require thosedirectors, executive officers, and greater than 10% shareholders to furnish theCompany with copies of all Section 16(a) forms they file.

 

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Basedon the Company’s review of reports, the Company believes that the directors,executive officers, and greater than 10% shareholders complied with allapplicable Section 16(a) filing requirements, except as set forthbelow:

 

BobClements filed one report on Form 4 one day after the time period for thefiling of such reports on a timely basis had expired.  Such report covered one stock purchasetransaction.

 

**Code of Ethics**

 

The Company has adopted a Code of Ethics that applies to its directors,officers and employees.  The Company willprovide a copy of its Code of Ethics, without charge, to any stockholder whomakes such request in writing to the Company, attention:  Secretary.

 

**Item 10. Executive Compensation.**

** **

**CompensationDiscussion and Analysis**

 

***General*****. **Our Board of Directors has established aCompensation Committee, comprised entirely of independent non-employeedirectors, with authority to set all forms of compensation of our executiveofficers.  Messrs. Bayer, Clementsand Howard comprised the Compensation Committee in fiscal 2007, with Mr. Howardserving as its Chairman. The Compensation Committee has overall responsibilityfor our executive compensation policies as provided in a written charteradopted by the Board of Directors. The Compensation Committee is empowered toreview and approve the annual compensation and compensation procedures for ourexecutives: the President and Chief Executive Officer, the Chief FinancialOfficer, and the Secretary. The Compensation Committee does not delegate any ofits functions to others in setting compensation.

 

When establishing basesalaries, cash bonuses and equity grants for each of the executives, theCompensation Committee considers the recommendations of the President and ChiefExecutive Officer and the Secretary, the executive’s role and contribution tothe management team, responsibilities and performance during the past year andfuture anticipated contributions, corporate performance, and the amount oftotal compensation paid to executives in similar positions, and performingsimilar functions, at other companies for which data was available, as providedby third party compensation studies. One such study, published in April 2007was a blind survey of over 1,000 companies located in the Dallas metropolitanarea in the “Energy & Utilities” industry with less than 100 full-timeequivalent employees. Another study, published in December 2004, includeddata from a survey of the following comparable companies: Arena Resources, Inc.,ATP Oil & Gas, Berry Petroleum Company, Canadian Superior Energy, EdgePetroleum, Goodrich Petroleum, Infinity Inc., Petroleum Development Corp., TheMeridian Resources Corp., and The Exploration Company.

 

TheCompensation Committee relies upon its judgment in making compensationdecisions, after reviewing the Company’s performance and evaluating eachexecutive’s performance during the year. The Committee generally does notadhere to rigid formulas or necessarily react to short-term changes in businessperformance in determining the amount and mix of compensation elements. Weincorporate flexibility into our compensation programs and in the assessmentprocess to respond to and adjust for the evolving business environment.

 

***Compensation Philosophy*****.**The Compensation Committee’s compensationphilosophy is to reward executive officers for the achievement of short andlong-term corporate objectives and for individual performance.  The objective of this philosophy is toprovide a balance between short-term goals and long-term priorities to achieveimmediate objectives while also focusing on increasing

 

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shareholder value over thelong term. Also, to ensure that we are strategically and competitivelypositioned for the future, the Compensation Committee has the discretion toattribute significant weight to other factors in determining executivecompensation, such as maintaining competitiveness, pursuing growthopportunities and achieving other long-range business and operating objectives.The level of compensation should also allow us to attract, motivate, and retaintalented executive officers that contribute to our long-term success. The compensationof our President and Chief Executive Officer and other executive officers iscomprised of cash compensation and long-term incentive compensation in the formof base salary, discretionary bonuses and unregistered stock awards.

 

***Elements of Our Compensation Program andWhy We Pay Each Element.*** For fiscal 2007, our totalcompensation for executive officers consisted of base salary, bonuses andlong-term incentives in the form of common stock awards. In setting fiscal 2007compensation, the Compensation Committee considered the specific factorsdiscussed below:

 

*Base Salary.*In setting the executive officers’ base salaries, the CompensationCommittee considers the achievement of corporate objectives as well asindividual performance. Because the Compensation Committee believes thatexecutive compensation should be viewed in terms of a balanced combination ofcash compensation (i.e., base salaries and bonuses) and long-term incentive(i.e., stock grants), base salaries are targeted to approximate the low end ofthe range of base salaries paid to executives of similar companies for eachposition. To ensure that each executive is paid appropriately, the CompensationCommittee considers the executive’s level of responsibility, prior experience,overall knowledge, contribution to business results, executive pay for similarpositions in other companies, and executive pay within our company.

 

*Discretionary Bonuses. ** ***Executive bonuses are intended to linkexecutive compensation with the attainment of Company goals. The actual paymentof bonuses is primarily dependent upon the extent to which these Company-wideobjectives are achieved. Determination of executive bonus amounts is not madein accordance with a strict formula, but rather is based on objective data combinedwith competitive ranges and internal policies and practices, including anoverall review of both individual and corporate performance.  For fiscal year 2007, bonuses to executiveswere primarily based upon the achievement of certain business objectivesincluding progress in meeting our expected drilling schedule and the obtainmentof a new senior credit facility. The President and Chief Executive Officer hasthe discretion to recommend to the Compensation Committee to increase ordecrease bonuses for all other executive officers, but any bonus amounts mustbe approved by the Compensation Committee.

 

*Long-Term Incentives**. *On December 29,2005, the shareholders of the Company approved the 2005 Stock Option Plan (the “Plan”)under which our executive officersmay be, among other forms of compensation, compensated through grants ofunregistered shares of our common stock and/or grants of options to purchaseshares of common stock. The Compensation Committee approves Plan grants thatprovide additional incentives and align the executives’ long-term interestswith those of the shareholders of the Company by tying executive compensationto the long-term performance of the Company’s stock price.  Annual equity grants for our executives aretypically approved in January.

 

The Compensation Committee recommends equity to be granted to anexecutive with respect to shares of common stock based on the followingprincipal elements including, but not limited to:

 

·                  President and Chief Executive Officer’s andSecretary’s recommendations;

 

·                  Management role and contribution to themanagement team;

 

·                  Job responsibilities and past performance;

 

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·                  Future anticipated contributions;

 

·                  Corporate performance; and

 

·                  Existing equity holdings.

 

Determinationof equity grant amounts is not made in accordance with a strict formula, butrather is based on objective data combined with competitive ranges, pastinternal policies and practices and an overall review of both individual andcorporate performance. Equity grants may also be made to new executives uponcommencement of employment and, on occasion, to executives in connection with asignificant change in job responsibility. The Compensation Committee believesannual equity grants more closely align the long-term interests of executiveswith those of shareholders and assist in the retention of key executives.  As such, these grants comprise the Company’sprincipal long-term incentive to executives.

 

**OtherCompensation Policies Affecting the Executive Officers**

 

*Compliance with Section 162(m) of the InternalRevenue Code*. Section 162(m) disallowsa federal income tax deduction to publicly held companies for certaincompensation paid to our Named Executive Officers to the extent thatcompensation exceeds $1 million per executive officer covered by Section 162(m) inany fiscal year. The limitation applies only to compensation that is not considered“performance based” as defined in the Section 162(m) rules. Indesigning our compensation programs, the Compensation Committee considers theeffect of Section 162(m) together with other factors relevant to ourbusiness needs. We have historically taken, and intend to continue taking,appropriate actions, to the extent we believe desirable, to preserve thedeductibility of annual incentive and long-term performance awards. However,the Compensation Committee has not adopted a policy that all compensation paidmust be tax-deductible and qualified under Section 162(m). We believe thatthe fiscal 2007 base salary, annual bonus and stock grants paid to theindividual executive officers covered by Section 162(m) will notexceed the Section 162(m) limit and will be fully deductible under Section 162(m).

 

*Stock Ownership Requirements.* The Compensation Committee does not maintaina policy relating to stock ownership guidelines or requirements for ourexecutive officers because the Compensation Committee does not feel that it isnecessary to impose such a policy on our executive officers. If circumstanceschange, the Compensation Committee will review whether such a policy isappropriate for executive officers.

 

*Employment Agreements.*During fiscal 2007, our executive officersdid not have employment, severance or change-of-control agreements. Ourexecutive officers served at the will of the Board, which enabled us toterminate their employment with discretion as to the terms of any severancearrangement. This is consistent with our compensation philosophy.

 

**ChiefExecutive Officer Compensation**

 

Mr. Wallen’sannual base salary for fiscal 2007 was $150,000. He received a common stockaward of 150,000 unregistered shares granted on January 10, 2007, whichvested immediately.  Rule 144promulgated under the Securities Act, which permits certain re-sales ofunregistered securities, currently requires that such securities be paid forand held for a minimum of one year before they may be resold.

 

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**ChiefFinancial Officer Compensation**

 

TheCompany’s former Chief Financial Officer, James L. Busby’s annual base salaryfor fiscal 2007 was $87,500, of which he received $80,601 prior to hisresignation effective May 18, 2007. He received a common stock award of 75,000 unregistered shares grantedon January 10, 2007, which vested immediately.

 

**Summary Compensation Table**

 

The following table shows information regarding thecompensation earned during the fiscal year ended June 30, 2007 by ourChief Executive Officer, our current Chief Financial Officer, our former ChiefFinancial Officer and our other most highly compensated executive officers whowere employed by us as of June 30, 2007 and whose total compensationexceeded $100,000 during that fiscal year (the “Named Executive Officers”).

 
| **Name and  Principal Position**                                                | ** ** | **Fiscal  Year** | ** ** | **Salary** | ** ** | **Bonus** | ** ** | **Stock  Awards (1)** | ** ** | **All  Other  Compen-  sation (2)** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------|------------|------------|------------|-----------|------------|----------------------------|------------|------------------------------------------|------------|-----------|------------|
|                                                                                      |       |             |       |       |       |      |       |                       |       |                                     |       |      |       |
| Calvin A. Wallen, III  Chairman of the Board,  President and Chief Executive Officer |       | 2007             |       | $          | 150,000    |      | $          | —                     |       | $                                        | 120,000    |      | $          | 3,600 |   | $ | 273,600 |   |
|                                                                                      |       |             |       |       |       |      |       |                       |       |                                     |       |      |       |
| James L. Busby (3) Former Chief Financial Officer                                         |       | 2007             |       | $          | 80,601     |      | $          | 2,100                      |       | $                                        | 60,000     |      | $          | 3,300 |   | $ | 146,001 |   |
|                                                                                      |       |             |       |       |       |      |       |                       |       |                                     |       |      |       |
| Scott D. Guffey (4) Chief Financial Officer                                               |       | 2007             |       | $          | —     |      | $          | —                     |       | $                                        | —     |      | $          | — |   | $ | — |   |
|                                                                                      |       |             |       |       |       |      |       |                       |       |                                     |       |      |       |
| Jon S. Ross  Secretary                                                                    |       | 2007             |       | $          | 60,000     |      | $          | 23,000                     |       | $                                        | 38,000     |      | $          | 3,600 |   | $ | 124,600 |   |

 

----

| (1) |   | On January 10, 2007 we granted our named  executive officers a total of 272,500 unregistered shares of common stock as  follows: Mr. Wallen, 150,000 shares; Mr. Busby, 75,000 shares; and  Mr. Ross, 47,500 shares. These shares vested immediately on the grant  date. |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | All Other Compensation consists solely of a $300  per month reimbursement towards each officer’s medical insurance premiums.  The Company does not provide group health insurance coverage to its  employees.                                                                           |
| (3) |   | Mr. Busby resigned as Cubic’s Chief Financial  Officer effective May 18, 2007.                                                                                                                                                                                                |
| (4) |   | Mr. Guffey was appointed Cubic’s Chief  Financial Officer subsequent to the end of fiscal 2007, on August 20,  2007.                                                                                                                                                          |

 

**Fiscal2007 Grants of Plan-Based Awards**

 

The following table provides details regardingequity grants in fiscal 2007 to the Named Executive Officers. No stock optionswere granted to executive officers last year and thus any reference to optionsin the table below has been omitted.

 

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| **Name**                    | ** ** | **Grant Date**   | ** ** | **All Other Stock  Awards:  Number of  Shares** | ** ** | **Grant Date  Fair Value of  Stock Award** | ** ** |
|-----------------------------|------------|-----------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
|                        |       |                  |       |                                                           |       |                                                           |       |
| Calvin A.  Wallen, III |       | January 10, 2007 |       | 150,000                                                        |       | $                                                              | 120,000    |   |
|                        |       |                  |       |                                                           |       |                                                           |       |
| James L. Busby              |       | January 10, 2007 |       | 75,000                                                         |       | $                                                              | 60,000     |   |
|                        |       |                  |       |                                                           |       |                                                           |       |
| Scott D. Guffey             |       | —                |       | —                                                         |       | —                                                         |       |
|                        |       |                  |       |                                                           |       |                                                           |       |
| Jon S. Ross                 |       | January 10, 2007 |       | 47,500                                                         |       | $                                                              | 38,000     |   |

 

**Stock Grants**

 

On October 25, 2004, Cubic issued 155,000shares of common stock to its officers and directors pursuant to a then currentDirector and Officer compensation plan. Based on a then market price of $0.51per share, Cubic recorded a compensation expense of $79,050, which was includedin general and administrative expenses for the fiscal year ended June 30,2005.

 

On December 29, 2005, the shareholders ofthe Company approved the 2005 Stock Option Plan (the “Plan”) and 3,750,000shares of common stock were reserved, of which 1,711,000 shares had been issuedthrough June 30, 2007, and 1,801,000 shares have been issued through August 31,2007, as set forth below.

 

On December 29, 2005, stock grantsaggregating 597,000 unregistered shares were approved for issuance to theofficers and directors of the Company. As of such date, the aggregate market value of the common stock grantedwas $483,570 based on the last sale price on the OTC Bulletin Board of theCompany’s common stock.  Such amount wasrecorded as compensation expense and is included in general and administrativeexpenses for the fiscal year ended June 30, 2006.

 

On January 5,2006, the Company issued 572,000 unregistered shares to the officers anddirectors of the Company pursuant to the Plan. As of such date, the aggregatemarket value of the common stock granted was $486,200 based on the last saleprice on the OTC Bulletin Board of the Company’s common stock.  Such amount was amortized to compensationexpense on a quarterly basis during calendar year 2006.  Accordingly, $243,100 was recorded ascompensation expense and included in general and administrative expenses foreach of the fiscal years ended June 30, 2007 and 2006.

 

On January 10 andJanuary 18, 2007, the Company issued 489,500 and 52,500 unregisteredshares, respectively, to the officers, directors, and key employees of theCompany pursuant to the Plan.  As of suchdates, the aggregate market value of the common stock granted was $391,600 and$42,000, respectively, based on the last sale price on the OTC Bulletin Boardof the Company’s common stock.  Suchamounts were amortized to compensation expense on a quarterly basis duringcalendar year 2007.  An additional$30,000 was recorded when our former Chief Financial Officer resigned duringfiscal 2007. Accordingly, $246,800 was recorded as compensation expense andincluded in general and administrative expense for the fiscal year ended June 30,2007. The Named Executive Officers received the following grants: (i) 150,000unregistered shares to Calvin A. Wallen, III, (ii) 75,000unregistered shares to James L. Busby, and (iii) 47,500 unregisteredshares to Jon S. Ross.

 

Subsequent to the endof fiscal 2007, on August 20, 2007, the Company issued 90,000 unregisteredshares to an officer of the Company pursuant to the Plan, with such grantsubject to vesting in quarterly installments over the following 12 months.  As of such date, the aggregate market valueof

 

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the common stock granted was $103,500 based onthe then market price on the OTC Bulletin Board of the Company’s commonstock.  Such amount is being amortized tocompensation expense on a quarterly basis during fiscal year 2008.  Accordingly, $12,937 and $25,875 was recordedas compensation expense and included in general and administrative expenses forthe quarters ended September 30, 2007 and December 31, 2007,respectively. On January 31 and February 4, 2008, the Company issued555,000 and 52,500 unregistered shares, respectively, to the officers,directors, and key employees of the Company pursuant to the Plan.  As of such dates, the aggregate market valueof the common stock granted was $880,000 and $84,525, respectively, based onthe then-market price on the OTC Bulletin Board of the Company’s commonstock.  Such amounts will be amortized tocompensation expense on a quarterly basis during calendar year 2008.

 

**Outstanding Equity Awards atFiscal Year-End**

 

The Company had no outstanding stock optionsand no unvested stock awards at June 30, 2007; therefore, the tablesetting forth outstanding equity-based awards has been omitted.

 

**Options Exercises and StockVesting**

 

The following table sets forth dollar amountsrealized pursuant to the vesting or exercise of equity-based award during thelatest fiscal year. No stock options were granted to executive officers lastyear and thus any reference to options in the table below has been omitted.

 
| ** **                  | ** ** | **Number of Shares**    | ** ** | **Value Realized** | ** ** |
|-----------------------------|------------|-----------------------------------|------------|-------------------------|------------|
| **Name**                    | ** ** | **Acquired on Vesting** | ** ** | **on Vesting**     | ** ** |
|                        |       |                              |       |                    |       |   |
| Calvin A.  Wallen, III |       | 150,000                           |       | $                       | 120,000    |   |
|                        |       |                              |       |                    |       |   |
| James L. Busby              |       | 75,000                            |       | $                       | 60,000     |   |
|                        |       |                              |       |                    |       |   |
| Jon S. Ross                 |       | 47,500                            |       | $                       | 38,000     |   |

 

**Pension Benefits and Non-Qualified Defined Contribution Plans**

 

None of our named executive officers participate in or have accountbalances in qualified or non-qualified defined benefit plans or non-qualifieddefined contribution plans sponsored by us. The Compensation Committee, whichis comprised solely of “outside directors” as defined for purposes of Section 162(m) ofthe Code, may elect to adopt qualified or non-qualified defined benefit ornon-qualified contribution plans if the Compensation Committee determines thatdoing so is in our best interests.

 

**Information Related to Stock-Based Compensation**

 

The Company accounts for its stock-basedemployee compensation plans pursuant to SFAS 123(R), *“Share-BasedPayment”*, which is a revision of SFAS 123, *“Accountingfor Stock-Based Compensation”*; and supersedes APB No. 25, *“Accounting for Stock Issued to Employees”*. This Statementrequires the Company to recognize compensation costs related to stock-basedpayment transactions (i.e. granting of stock options and warrants) in thefinancial statements. With limited exceptions, the amount of compensation costwill be measured based on the grant-date fair value of the equity or liabilityinstruments issued. In addition, liability awards will be re-measured eachreporting period. Compensation cost will be recognized over the period that anemployee provides services in exchange for the award. This new standard iseffective for awards that are granted, modified or settled in cash in interimand annual financial periods beginning after June 30, 2006. See “StockGrants”.

 

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**Non-Employee DirectorCompensation for Fiscal 2007**

 
| ** **       | ** ** | **Fees Earned or**        | ** ** | **Stock**           | ** ** | **All Other** | ** ** | ** ** | ** ** |
|------------------|------------|-------------------------------------|------------|---------------------|------------|--------------------|------------|------------|------------|
| **Name**         | ** ** | **Paid in Cash (1)** | ** ** | **Awards (2)** | ** ** | **Compensation**   | ** ** | **Total**  | ** ** |
|             |       |                                |       |                |       |               |       |       |       |   |   |   |   |
| Gene C. Howard   |       | $                                   | 2,000      |                | $          | 42,400             |       | $          | —     |   | $ | 44,400 |   |
|             |       |                                |       |                |       |               |       |       |       |   |   |   |   |
| Herbert A. Bayer |       | $                                   | 2,000      |                | $          | 37,600             |       |       |       | $ | 39,600 |   |
|             |       |                                |       |                |       |               |       |       |       |   |   |   |
| Bob L. Clements  |       | $                                   | 2,000      |                | $          | 37,600             |       | $          | —     |   | $ | 39,600 |   |

** **

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| (1) |   | Represents the amount  of cash compensation earned in fiscal 2007 for Board and Committee service.  Each non-employee director was paid $1,000 for each Board of Directors  meeting attended. During fiscal 2007, Board of Directors meetings were held  on October 31, 2006 and May 11, 2007.                                                                                                   |
|-----|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Each non-employee  director received: 25,000 shares of common stock for service on the Board of  Directors; 14,000 shares of common stock for service on the Audit Committee;  and, 6,000 shares of common stock for service on the Compensation Committee.  Mr. Howard received an additional 6,000 shares of common stock for  serving as the financial expert and Chairman of the Audit Committee. |

 

**Item 11. Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters.**

** **

The following table sets forth the number of shares of the Company’scommon stock beneficially owned, as of August 31, 2007 by (i) eachperson known to the Company to beneficially own more than 5% of the commonstock of the Company (the only class of voting securities now outstanding), (ii) eachdirector and executive officer, and (iii) all directors and executiveofficers as a group. Unless otherwise indicated, we consider all shares ofcommon stock that can be issued under convertible securities or warrantscurrently or within 60 days of August 31, 2007 to be outstanding for thepurpose of computing the percentage ownership of the person holding thosesecurities, but do not consider those securities to be outstanding forcomputing the percentage ownership of any other person. Each owner’s percentageis calculated by dividing the number of shares beneficially held by that ownerby the sum of 56,130,896 and the number of shares that owner has the right toacquire within 60 days.

 

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| ** **                                         | ** ** | ** **         | ** ** | **Approximate**     | ** ** |
|----------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                         | ** ** | **Number**         | ** ** | **Percent of** | ** ** |
| **Name and Address**                     | ** ** | **of Shares** | ** ** | **Class (1)**  | ** ** |
| ** **                                         |       |               |       |                |       |
| **5% Stockholders**                                |       |               |       |                |       |
| William Bruggeman                                  |       | 16,739,303         | (2)        | 28.7                | %          |
| 20 Anemone Circle, North Oaks, MN 55127            |       |               |       |                |       |
|                                               |       |               |       |                |       |
| Wells Fargo Energy Capital, Inc.              |       | 7,500,000          | (3)        | 11.8                | %          |
| 1000 Louisiana 9th Floor, Houston, TX 77002        |       |               |       |                |       |
|                                               |       |               |       |                |       |
| Steven S. Bruggeman                                |       | 4,189,955          | (4)        | 7.3                 | %          |
| 5609 St. Albans Circle, Shoreview, MN 55126        |       |               |       |                |       |
|                                               |       |               |       |                |       |
| George Karfunkel                                   |       | 3,375,000          | (5)        | 5.9                 | %          |
| 9870 Plano Road, Dallas, TX 75238                  |       |               |       |                |       |
|                                               |       |               |       |                |       |
| **Named  Executive Officers and Directors**        |       |               |       |                |       |
| Calvin A. Wallen, III                         |       | 12,027,212         | (6)        | 21.4                | %          |
| 9870 Plano Road, Dallas, TX 75238                  |       |               |       |                |       |
|                                               |       |               |       |                |       |
| Bob Clements                                       |       | 727,527            | (7)        | 1.3                 | %          |
| 9870 Plano Road, Dallas, TX 75238                  |       |               |       |                |       |
|                                               |       |               |       |                |       |
| Gene Howard                                        |       | 577,425            | (8)        | 1.0                 | %          |
| 2402 East 29th St., Tulsa, OK 74114                |       |               |       |                |       |
|                                               |       |               |       |                |       |
| Jon S. Ross                                        |       | 398,000            | (9)        | *                   |       |
| 9870 Plano Road, Dallas, TX 75238                  |       |               |       |                |       |
|                                               |       |               |       |                |       |
| Herbert Bayer                                      |       | 335,287            | (10)       | *                   |       |
| 9870 Plano Road, Dallas, TX 75238                  |       |               |       |                |       |
|                                               |       |               |       |                |       |
| James L. Busby                                     |       | 251,500            | (11)       | *                   |       |
| 2018 Portsmouth Dr., Richardson, TX 75082          |       |               |       |                |       |
|                                               |       |               |       |                |       |
| Scott D. Guffey                                    |       | 90,000             | (12)       | *                   |       |
| 9870 Plano Road, Dallas, TX 75238                  |       |               |       |                |       |
|                                               |       |               |       |                |       |
| All officers and  directors as a group (6 persons) |       | 14,406,951         |       | 25.6                | %          |

 

----

* Denotes less than onepercent

 
| (1) |   | Based on a total of  56,130,896 shares of Common Stock issued and outstanding on August 31,  2007.                                                                                                                                                                                                                                                                                                                                        |
|-----|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Includes 2,034,000  shares and warrants to purchase 600,000 shares held by Diversified Dynamics  Corp., a company controlled by William Bruggeman; 120,000 shares owned by  Consumer Products Corp., in which Mr. Bruggeman’s spouse, Ruth, is a  joint owner; and, 12,401,303 shares and warrants to purchase 1,544,000 held  jointly by William Bruggeman & Ruth Bruggeman as joint tenants with  rights of survivorship. |
| (3) |   | Includes warrants to  purchase 2,500,000 shares and a promissory note convertible into 5,000,000  shares.                                                                                                                                                                                                                                                                                                                                      |
| (4) |   | Includes 901,955 shares  held jointly by Steven S. Bruggeman and Jacqueline Bruggeman as joint tenants  with rights of survivorship; 48,000 shares and warrants to purchase 24,000  shares held by Jacqueline Bruggeman, of which Steven S. Bruggeman disclaims  beneficial ownership; 96,000 shares and warrants to purchase 48,000 shares  held by minor children; and, warrants to purchase 1,024,000 shares held by  Steven S. Bruggeman.  |
| (5) |   | Includes warrants to  purchase 1,125,000 shares.                                                                                                                                                                                                                                                                                                                                                                                               |

 

41

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Tableof Contents

 
| (6)  |   | Includes 1,714,000  shares and warrants to purchase 50,000 shares held by Tauren  Exploration, Inc., an entity controlled by Mr. Wallen; 500,000  shares held by spouse; and, 340,000 shares held by minor children. |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (7)  |   | Includes 109,527 shares  held with spouse as joint tenants with rights of survivorship; and, warrants  to purchase 50,000 shares.                                                                                              |
| (8)  |   | Includes 322,245 shares  are held by Mr. Howard’s spouse, Belva, of which Mr. Howard  disclaims beneficial ownership.                                                                                           |
| (9)  |   | Includes 6,000 shares held by minor children.                                                                                                                                                                                  |
| (10) |   | Includes 335, 287  shares held with spouse as joint tenants with rights of survivorship.                                                                                                                                       |
| (11) |   | Mr. Busby is the  Company’s former Chief Financial Officer. Mr. Busby resigned from the  Company effective May 18, 2007.                                                                                   |
| (12) |   | Mr. Guffey was appointed  Chief Financial Officer of the Company on August 20, 2007.                                                                                                                                 |

 

**Item 12. Certain Relationships and Related Transactions, and DirectorIndependence.**

** **

**CertainRelationships and Related Transactions**

 

OnFebruary 6, 2006 the Company entered into a Purchase Agreement with TaurenExploration, Inc., an entity wholly owned by Calvin Wallen III, theCompany’s Chairman of the Board and Chief Executive Officer, with respect tothe purchase by the Company of certain Cotton Valley leasehold interests(approximately 11,000 gross acres; 5,000 net acres) held by Tauren.  Pursuant to the Purchase Agreement, theCompany acquired from Tauren a 35% working interest in approximately 2,400acres and a 49% working interest in approximately 8,500 acres located in DeSotoand Caddo Parishes, Louisiana, along with an associated Area of Mutual Interest(“AMI”) and the right to acquire at “cost” (as defined in the PurchaseAgreement) a working interest in all additional mineral leases obtained byTauren in the AMI, in exchange for (a) $3,500,000 in cash, (b) 2,500,000unregistered shares of Company common stock, (c) a short-term promissorynote in the amount of $1,300,000, which note is convertible into Company commonstock at a conversion price of $0.80 per share, and (d) a drilling creditof $2,100,000.  The considerationdescribed above was determined based upon negotiations between Tauren and aSpecial Committee of the Company’s directors, excluding Mr. Wallen.  The Special Committee obtained an opinionfrom its independent financial advisor with respect to the fairness, from afinancial point of view, to the public stockholders of the Company, of suchtransactions.

 

OnDecember 15, 2006, the Company entered into Subscription and RegistrationRights Agreements with certain investors. One of the investors, WilliamBruggeman (and entities affiliated with him) was the beneficial owner, prior tothis transaction, of approximately 23.0% of the common stock of the Company. Inthis transaction, Mr. Bruggeman (and entities affiliated with him)purchased an aggregate of 4,288,000 shares of common stock at a purchase priceof $0.50 per share, or an aggregate of $2,144,000. Mr. Bruggeman (andentities affiliated with him) received warrants to purchase 2,144,000 shares ofcommon stock with an exercise price of $0.70 per share. Another investor, BobClements, a director of the Company, purchased 100,000 shares of common stockat a purchase price of $0.50 per share, or an aggregate of $50,000. Mr. Clementsreceived warrants to purchase 50,000 shares of common stock with an exerciseprice of $0.70 per share. The consideration described above was determinedbased upon negotiations between the Company and various potential investors.

 

**Director Independence**

** **

Messrs. Howard,Clements and Bayer meet the independence standards for independent directorsunder the rules of the SEC and the rules of the Nasdaq Stock Marketpublished in the Nasdaq Marketplace Rules.

 

42

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Table of Contents

 

**Item** 13.  Exhibits.

 
| **No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                              |
|---------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 3.1     |       | Articles of Incorporation (incorporated by reference to  Exhibit 3.1 to the Registrant’s Form 10-QSB for the period ended  September 30, 1999).                                                                                                                                                          |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 3.2     |       | Articles of Amendment to the Articles of Incorporation of the Company  dated December 30, 2005 (incorporated by reference to Exhibit 3.1  of the Company’s Form 10-QSB for the period ended December 31,  2005).                                                                                    |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 3.3     |       | Bylaws (incorporated by reference to Exhibit 3.2 of the  Company’s Form 10-KSB for the period ended June 30, 2000).                                                                                                                                                                                      |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 10.1    |       | Form of Common Stock Purchase Warrant (incorporated by reference  to Exhibit 10.3 of the Company’s Current Report on Form 8-K, filed with  the SEC on October 12, 2004).                                                                                                                            |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 10.2    |       | Registration Rights Agreement, effective as of September 30,  2004, among Cubic Energy, Inc. and the purchasers signatory thereto  (incorporated by reference to Exhibit 10.1 of the Company’s Current  Report on Form 8-K, filed with the SEC on October 12, 2004).                           |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 10.3    |       | Securities Purchase Agreement, dated as of December 12, 2005,  among Cubic Energy, Inc. and each purchaser identified on the signature  pages thereto (incorporated by reference to Exhibit 10.1 of the  Company’s Current Report on Form 8-K, filed with the SEC on  December 16, 2005). |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 10.4    |       | Registration Rights Agreement, dated as of December 12, 2005,  among Cubic Energy, Inc. and the purchasers signatory thereto  (incorporated by reference to Exhibit 10.2 of the Company’s Current  Report on Form 8-K, filed with the SEC on December 16, 2005).                               |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 10.5    |       | Form of Common Stock Purchase Warrant (incorporated by reference  to Exhibit 10.3 of the Company’s Current Report on Form 8-K, filed  with the SEC on December 16, 2005).                                                                                                                           |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 10.6    |       | Credit Agreement, dated February 6, 2006, by and among Cubic  Energy, Inc. and Petro Capital V, L.P. (filed as exhibit 10.1 to the  Company’s Form 8-K dated February 8, 2006, and incorporated herein  by reference).                                                                              |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 10.7    |       | Promissory Note, dated as of February 6, 2006, by Cubic  Energy, Inc., payable to Petro Capital V, L.P. in the maximum principal  amount of $7,000,000 (filed as exhibit 10.2 to the Company’s Form 8-K  dated February 8, 2006, and incorporated herein by reference).                             |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 10.8    |       | Common Stock Purchase Warrant, dated February 6, 2006, issued to  Petro Capital Securities, LLC (filed as exhibit 10.3 to the Company’s  Form 8-K dated February 8, 2006, and incorporated herein by  reference).                                                                                        |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 10.9    |       | Common Stock Purchase Warrant, dated February 6, 2006, issued to  Petro Capital V, L.P. (filed as exhibit 10.4 to the Company’s Form 8-K  dated February 8, 2006, and incorporated herein by reference).                                                                                                 |
|    |       |                                                                                                                                                                                                                                                                                                                         |
| 10.10   |       | Registration Rights Agreement, dated as of February 6, 2006, by  and between Cubic Energy, Inc., Petro Capital V, L.P. and Petro Capital  Securities, LLC (filed as exhibit 10.5 to the Company’s Form 8-K dated  February 8, 2006, and incorporated herein by reference).                          |

 

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| 10.11  |   | Purchase Agreement, dated as of February 6, 2006, by and among  Cubic Energy, Inc., Calvin Wallen III, and Tauren Exploration, Inc.  (filed as exhibit 10.6 to the Company’s Form 8-K dated February 8,  2006, and incorporated herein by reference).              |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.12  |   | Promissory Note, dated as of February 6, 2006, by Cubic  Energy, Inc., payable to Tauren Exploration, Inc. in the principal  amount of $1,300,000 (filed as exhibit 10.7 to the Company’s Form 8-K  dated February 8, 2006, and incorporated herein by reference). |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.13  |   | Amendment to Promissory Note, dated March 30, 2006, by and  between, Cubic Energy, Inc. and Tauren Exploration, Inc.  (incorporated by reference to Exhibit 10.8 of the Company’s  Form 10-QSB for the quarter ended March 31, 2006).                         |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.14  |   | Amendment to Purchase Agreement, dated April 3, 2006, by and  among Cubic Energy, Inc., Calvin Wallen III and Tauren  Exploration, Inc. (incorporated by reference to Exhibit 10.9 of the  Company’s Form 10-QSB for the quarter ended March 31, 2006).       |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.15  |   | Amendment to Purchase Agreement, dated May 5, 2006, by and among  Cubic Energy, Inc., Calvin Wallen III and Tauren Exploration, Inc.  (incorporated by reference to Exhibit 10.10 of the Company’s  Form 10-QSB for the quarter ended March 31, 2006).        |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.16  |   | Subscription and Registration Rights Agreement with George Karfunkel,  dated July 26, 2006 (filed as Exhibit 10.1 to the Company’s  Form 8-K dated July 28, 2006).                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.17  |   | Subscription and Registration Rights Agreement with Yehuda Neuberger  and Anne Neuberger JTWROS dated July 26, 2006 (filed as  Exhibit 10.2 to the Company’s Form 8-K dated July 28, 2006).                                                                             |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.18  |   | Warrant issued to George Karfunkel (filed as Exhibit 10.3 to the  Company’s Form 8-K dated July 28, 2006).                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.19  |   | Warrant issued to Yehuda Neuberger and Anne Neuberger JTWROS (filed  as Exhibit 10.4 to the Company’s Form 8-K dated July 28,  2006).                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.20  |   | Third Amendment to Promissory Note, dated November 10, 2006, by  and between, Cubic Energy, Inc. and Tauren Exploration, Inc. (filed  as Exhibit 10.1 to the Company’s Form 10-QSB for the quarter ended  September 30, 2006).                                |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.21  |   | Warrant issued to Tauren Exploration, Inc. dated  November 10, 2006 (filed as Exhibit 10.2 to the Company’s  Form 10-QSB for the quarter ended September 30, 2006).                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.22  |   | Form of Subscription and Registration Rights Agreement (filed as  Exhibit 10.1 to the Company’s Form 8-K filed December 21,  2006).                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.23  |   | Form of Warrant (filed as Exhibit 10.2 to the Company’s  Form 8-K filed December 21, 2006).                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                             |
| 10.24  |   | Credit Agreement dated March 5, 2007 by and between Cubic  Energy, Inc. and Wells Fargo Capital, Inc. (filed as  Exhibit 10.1 to the Company’s Form 8-K filed March 9, 2007).                                                                                 |

 

44

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| 10.25  |   | Convertible Promissory Note dated as of March 5, 2007 by Cubic  Energy, Inc. payable to Wells Fargo Energy Capital, Inc. in the  principal amount of $5,000,000 (filed as Exhibit 10.2 to the Company’s  Form 8-K filed March 9, 2007). |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                       |
| 10.26  |   | Promissory Note dated as of March 5, 2007 by Cubic Energy  payable to Wells Fargo Energy Capital, Inc. in the maximum principal  amount of $20,000,000 (filed as Exhibit 10.3 to the Company’s  Form 8-K on March 9, 2007).                  |
|   |   |                                                                                                                                                                                                                                                                       |
| 10.27  |   | Warrant to Purchase Shares of Common Stock of Cubic Energy, Inc.  dated March 5, 2007, issued to Wells Fargo Energy Capital, Inc.  (filed as Exhibit 10.4 to the Company’s Form 8-K on March 9,  2007).                                 |
|   |   |                                                                                                                                                                                                                                                                       |
| 10.28  |   | Registration Rights Agreement dated as of March 5, 2007 by and  between Cubic Energy, Inc. and Wells Fargo Energy Capital, Inc.  (filed as Exhibit 10.5 to the Company’s Form 8-K on March 9,  2007).                                   |
|   |   |                                                                                                                                                                                                                                                                       |
| 10.29  |   | Form of Assignment of Net Profits Interest (filed as  Exhibit 10.6 to the Company’s Form 8-K on March 9, 2007).                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                       |
| 23.1*  |   | Consent of Philip Vogel & Co., PC                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                       |
| 31.1*  |   | Rule 13a-14(a)/15d-14(a) Certification of Calvin A.  Wallen, III                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                       |
| 31.2*  |   | Rule 13a-14(a)/15d-14(a) Certification of Scott D. Guffey                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                       |
| 32.1*  |   | Section 1350 Certification of Calvin A. Wallen, III                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                       |
| 32.2*  |   | Section 1350 Certification of Scott D. Guffey                                                                                                                                                                                                                         |

 

----

* Filed herewith.

 

**Item 14.       PrincipalAccountant Fees and Services**.

 
| ** **          | ** ** | **July 1, 2006 -** | ** ** | **July 1, 2005 -** | ** ** |
|---------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **          | ** ** | **June 30, 2007**       | ** ** | **June 30, 2006**       | ** ** |
| Audit  fees         |       | $                                 | 21,000     |                              | $          | 18,750 |   |
| Audit-related  fees |       | 8,500                             |       | 8,675                             |       |
| Tax  fees           |       | 4,585                             |       | 3,500                             |       |
| All  other fees     |       | 8,500                             |       | 3,140                             |       |
| Total               |       | $                                 | 42,585     |                              | $          | 34,065 |   |

** **

**Audit Fees**

 

Aggregateaudit fees billed for professional services rendered by Philip Vogel &Co., PC were $21,000 for the year ended June 30, 2007 and $18,750 for theyear ended June 30, 2006. Such fees were primarily for professionalservices rendered for the audits of our consolidated financial statements as ofand for the years ended June 30, 2007 and 2006.

 

45

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**Audit-Related Fees**

 

Aggregateaudit-related fees billed for professional services rendered by Philip Vogel &Co., PC were $8,500 for the year ended June 30, 2007 and $8,675 for theyear ended June 30, 2006. Such fees were for limited reviews of ourunaudited condensed consolidated interim financial statements.

 

**Tax Fees**

 

Aggregateincome tax compliance and related services fees billed for professionalservices rendered by Philip Vogel & Co., PC were $4,585 for the yearended June 30, 2007 and $3,500 for the year ended June 30, 2006.

 

**All Other Fees**

 

Inaddition to the fees described above, aggregate fees of $8,500 and $3,140 werebilled by Philip Vogel & Co., PC during the years ended June 30,2007 and 2006, respectively, primarily for review of our Form SB-2registration statements and related amendments, and for research regarding ouruse of shares of common stock as compensation.

 

**Audit Committee Pre-Approval Policies and Procedures**

 

Inaccordance with Company policy, any additional audit or non-audit services mustbe approved in advance. All of the foregoing professional services provided byPhilip Vogel & Co., PC during the years ended June 30, 2007 and June 30,2006 were pre-approved in accordance with policies of our Audit Committee.  The Audit Committee has approved the engagement ofPhilip Vogel & Co., PC to perform auditing services for the currentfiscal year ending June 30, 2008.

 

46

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**SIGNATURES**

** **

In accordance with the Section 13 or 15(d) ofthe exchange act, the registrant caused this report to be signed on its behalfby the undersigned, thereunto duly authorized, on the 5th day of August, 2008.

 

 
|   | CUBIC  ENERGY, INC. |
|--------|---------------------|
|   |                |
|   |                |
|   | By:                 | /s/ Calvin A. Wallen, III |
|   |                | Calvin  A. Wallen, III |
|   |                | President  and Chief |
|   |                | Executive Officer |
|   |                |   |
|   |                |   |
|   | By:                 | /s/ Scott D. Guffey |
|   |                | Scott D. Guffey |
|   |                | Chief Financial Officer |

 

In accordance with the Exchange Act, this reporthas been signed below by the following persons on behalf of the registrant andin the capacities and on the dates indicated.

 
| **Signature**                  | ** ** | **Title**               | ** ** | **Date**            |
|--------------------------------|------------|-------------------------|------------|---------------------|
|                           |       |                    |       |                |
|                           |       | President, Chief        |       | August 5, 2008 |
| /s/ Calvin A. Wallen, III |       | Executive               |       |                |
| Calvin A. Wallen, III     |       | Officer and Director    |       |                |
|                           |       |                    |       |                |
|                           |       | Chief Financial Officer |       | August 5, 2008 |
| /s/ Scott D. Guffey            |       | (principal accounting   |       |                |
| Scott D. Guffey                |       | officer)                |       |                |
|                           |       |                    |       |                |
|                           |       | Secretary and Director  |       | August 5, 2008 |
| /s/ Jon Stuart Ross            |       |                    |       |                |
| Jon Stuart Ross                |       |                    |       |                |
|                           |       |                    |       |                |
|                           |       | Director                |       | August 5, 2008 |
| /s/ Gene Howard                |       |                    |       |                |
| Gene Howard                    |       |                    |       |                |
|                           |       |                    |       |                |
|                           |       | Director                |       | August 5, 2008 |
| /s/ Herbert A. Bayer           |       |                    |       |                |
| Herbert A. Bayer               |       |                    |       |                |
|                           |       |                    |       |                |
|                           |       | Director                |       | August 5, 2008 |
| /s/ Bob Clements               |       |                    |       |                |
| Bob Clements                   |       |                    |       |                |

 

----

Tableof Contents

 

**CUBIC ENERGY, INC.**

 

FINANCIAL STATEMENTS

*and*

INDEPENDENT AUDITORS’ REPORT

 

JUNE 30, 2007

 

**CONTENTS**

 
| ** **                                                 | **Page**   |
|------------------------------------------------------------|------------|
|                                                       | ** ** |
| Independent Auditors’ Report                          | F-1        |
|                                                       |       |
| Financial Statements:                                      |       |
|                                                       |       |
| Balance Sheets                                             | F-2        |
|                                                       |       |
| Statements of Operations                                   | F-3        |
|                                                       |       |
| Statements of Changes in  Stockholders’ Equity        | F-4        |
|                                                       |
| Statements of  Cash Flows                                  | F-5        |
|                                                       |       |
| Notes to Financial Statements                              | F-6-30     |
| Note A– Background and general                        | F-6        |
| Note B – Significant accounting policies              | F-6-16     |
| Note  C – Stockholders’ equity                   | F-17-19    |
| Note  D – Loss per common share                       | F-20       |
| Note  E – Long-term debt                              | F-20-22    |
| Note F – Related party transactions                   | F-22-23    |
| Note G – Income taxes                                 | F-24-25    |
| Note H – Commitments and contingencies                | F-25-26    |
| Note I – Cost of oil and gas properties               | F-26-27    |
| Note J – Oil and gas reserves information (unaudited) | F-28-29    |
| Note  K – Subsequent events                           | F-30       |

 

----

Tableof Contents

 

**INDEPENDENT AUDITORS’ REPORT**

 

**To theBoard of Directors and Stockholders of Cubic Energy, Inc.,**

 

Wehave audited the balance sheets of Cubic Energy, Inc., a Texascorporation, as of June 30, 2007 and 2006, and the related statements ofoperations, of changes in stockholders’ equity and of cash flows for each ofthe three years in the period ended June 30, 2007.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free of materialmisstatement.  An audit includes examining,on a test basis, evidence supporting the amounts and disclosures in thefinancial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of Cubic Energy, Inc. as of June 30,2007 and 2006, and the results of its operations and its cash flows for each ofthe three years in the period ended June 30, 2007, in conformity withaccounting principles generally accepted in the United States of America.

 

 
| ** **                   | ** ** | **PHILIP  VOGEL & CO. PC** |
|------------------------------|------------|-------------------------------------|
|                         |       |                                |
|                         |       |                                |
| ** **                   | ** ** | **Certified  Public Accountants**   |
|                         |       |                                |
| **Dallas,  Texas**           |       |                                |
|                         |       |                                |
| **September 26,  2007** |       |                                |

 

F-1

----

Table of Contents

 

**CUBIC ENERGY, INC.**

 

**BALANCE SHEETS**

**JUNE 30, 2007 AND 2006**

** **
| ** **                                                                                                              | ** ** | **2007**    | ** ** | **2006**    | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| **Assets**                                                                                                              |       |        |       |        |       |
| Current assets:                                                                                                         |       |        |       |        |       |
| Cash and cash  equivalents                                                                                              |       | $           | 3,122,273  |        | $          | 259,157 |   |
| Accounts  receivable - trade                                                                                            |       | 218,874     |       | 41,680      |       |
| Prepaid drilling  costs                                                                                                 |       | 721,136     |       | 264,223     |       |
| Prepaid expenses                                                                                                        |       | 231,232     |       | 243,100     |       |
| Total current  assets                                                                                                   |       | 4,293,515   |       | 808,160     |       |
| Property and  equipment (at cost):                                                                                      |       |        |       |        |       |
| Oil and gas  properties, full cost method:                                                                              |       |        |       |        |       |
| Proved  properties (including wells and related equipment and facilities)                                               |       | 8,836,790   |       | 6,679,730   |       |
| Unproven  properties                                                                                                    |       | 6,827,341   |       | 6,780,530   |       |
| Office and other  equipment                                                                                             |       | 12,886      |       | 7,876       |       |
|                                                                                                                    |       | 15,677,017  |       | 13,468,136  |       |
| Less accumulated  depreciation, depletion and amortization                                                              |       | 2,011,015   |       | 1,648,581   |       |
| Property and  equipment, net                                                                                            |       | 13,666,002  |       | 11,819,555  |       |
| Other assets:                                                                                                           |       |        |       |        |       |
| Deferred loan  costs - net                                                                                              |       | 148,724     |       | 318,999     |       |
| Restricted cash                                                                                                         |       | —      |       | 401,723     |       |
| Other                                                                                                                   |       | —      |       | 25,000      |       |
| Total other  assets                                                                                                     |       | 148,724     |       | 745,722     |       |
|                                                                                                                    |       | $           | 18,108,241 |        | $          | 13,373,437 |   |
| **Liabilities  and stockholders’ equity**                                                                          |       |        |       |        |       |
| Current  liabilities:                                                                                                   |       |        |       |        |       |
| Current portion  of long term debt                                                                                      |       | $           | —     |        | $          | 500,000 |   |
| Accounts payable  and accrued expenses                                                                                  |       | 51,664      |       | 165,628     |       |
| Due to  affiliates                                                                                                      |       | 1,635,055   |       | 1,499,762   |       |
| Total current  liabilities                                                                                              |       | 1,686,719   |       | 2,165,390   |       |
| Long-term  liabilities:                                                                                                 |       |        |       |        |       |
| Long-term debt,  net of discounts                                                                                       |       | 7,626,739   |       | 3,854,641   |       |
| Note payable to  affiliate                                                                                              |       | —      |       | 1,300,000   |       |
| Total long-term  liabilities                                                                                            |       | 7,626,739   |       | 5,154,641   |       |
| Commitments and  contingencies (Note H)                                                                                 |       | —      |       | —      |       |
| Stockholders’  equity:                                                                                             |       |        |       |        |       |
| Preferred stock  - $.01 par value, authorized 10,000,000 shares, issued none                                            |       | —      |       | —      |       |
| Common stock -  $.05 par value, authorized 100,000,000 shares, issued 55,840,896 in 2007 and  42,450,768 shares in 2006 |       | 2,792,046   |       | 2,122,540   |       |
| Additional  paid-in capital                                                                                             |       | 25,325,429  |       | 17,452,784  |       |
| Accumulated  deficit                                                                                                    |       | (19,322,692 | )          | (13,521,918 | )          |
| Stockholders’  equity                                                                                              |       | 8,794,783   |       | 6,053,406   |       |
|                                                                                                                    |       | $           | 18,108,241 |        | $          | 13,373,437 |   |

 

*Theaccompanying notes are and integral part of these statements.*

 

F-2

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Tableof Contents

 

**CUBIC ENERGY, INC.**

 

**STATEMENTS OF OPERATIONS**

**FOR THE YEARS ENDED JUNE 30, 2007, 2006, AND 2005**

** **
| ** **                                               | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|----------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Revenues:                                                |       |       |       |       |       |       |       |
| Oil and gas  sales                                       |       | $          | 583,416    |       | $          | 508,925    |       | $ | 469,441 |   |
| Total revenues                                           |       | $          | 583,416    |       | $          | 508,925    |       | $ | 469,441 |   |
|                                                     |       |       |       |       |       |       |       |
| Costs and  expenses:                                     |       |       |       |       |       |       |       |
| Oil and gas  production, operating and development costs |       | 481,145    |       | 338,329    |       | 273,074    |       |
| Selling, general  and administrative expenses            |       | 1,325,192  |       | 1,400,482  |       | 394,827    |       |
| Depreciation,  depletion and amortization                |       | 362,434    |       | 179,237    |       | 364,496    |       |
| Impairment loss  on oil and gas properties               |       | 1,790,882  |       | —     |       | —     |       |
| Total costs and  expenses                                |       | 3,959,653  |       | 1,918,048  |       | 1,032,397  |       |
| Operating income  (loss)                                 |       | (3,376,237 | )          | (1,409,123 | )          | (562,956   | )          |
|                                                     |       |       |       |       |       |       |       |
| Non-operating  income (expense):                         |       |       |       |       |       |       |       |
| Other income                                             |       | 38,037     |       | 6,402      |       | —     |       |
| Interest expense                                         |       | (1,278,721 | )          | (638,800   | )          | (193,313   | )          |
| Amortization of  loan costs                              |       | (100,966   | )          | (67,199    | )          | (28,257    | )          |
| Total  non-operating income (expense)                    |       | (1,341,650 | )          | (699,597   | )          | (221,570   | )          |
| Loss on debt  extinguishment                             |       | (1,082,887 | )          | (660,330   | )          | —     |       |
| Loss from  operations before income taxes                |       | (5,800,774 | )          | (2,769,050 | )          | (784,526   | )          |
| Provision for  income taxes                              |       | —     |       | —     |       | —     |       |
| Net loss                                                 |       | $          | (5,800,774 | )          | $          | (2,769,050 | )          | $ | (784,526 | ) |
| Net loss per  common share - basic and diluted           |       | $          | (0.12      | )          | $          | (0.07      | )          | $ | (0.02 | ) |
| Weighted average  common shares outstanding              |       | 50,338,450 |       | 38,477,353 |       | 33,112,644 |       |

 

*Theaccompanying notes are and integral part of these statements.*

 

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Tableof Contents

 

**CUBIC ENERGY, INC.**

 

**STATEMENTS OF CHANGES INSTOCKHOLDERS’ EQUITY**

**FOR THE YEARS ENDED JUNE 30, 2007, 2006, AND 2005**

** **
| ** **                                           | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | **Accum-**  | ** ** | **Total**   | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-------------|------------|-------------|------------|
| ** **                                           | ** ** | **Shares**            | ** ** | **Par**        | ** ** | **paid-in** | ** ** | **ulated**  | ** ** | **stockholders’** | ** ** |
| ** **                                           | ** ** | **outstanding**       | ** ** | **value**      | ** ** | **capital** | ** ** | **deficit** | ** ** | **equity** | ** ** |
| Balance,  June 30, 2004                         |       | 31,451,826            |       | $              | 1,572,592  |        | $          | 8,972,467   |       | $ | (9,968,342 | ) | $ | 576,717 |   |
| Debt proceeds  allocated to warrants                 |       | —                |       | —         |       | 510,961     |       | —      |       | 510,961 |   |
| Stock issued  under compensation plan                |       | 155,000               |       | 7,750          |       | 71,300      |       | —      |       | 79,050 |   |
| Stock issued  under convertible debenture agreements |       | 1,410,000             |       | 70,500         |       | 406,006     |       | —      |       | 476,506 |   |
| Stock issued in  payment of interest obligations     |       | 145,137               |       | 7,258          |       | 118,181     |       | —      |       | 125,439 |   |
| Stock issued for  acquisition of property interests  |       | 2,000,000             |       | 100,000        |       | 1,700,000   |       | —      |       | 1,800,000 |   |
| Net loss, year  ended June 30, 2005             |       | —                |       | —         |       | —      |       | (784,526    | )          | (784,526 | ) |
| Balance,  June 30, 2005                         |       | 35,161,963            |       | $              | 1,758,100  |        | $          | 11,778,915  |       | $ | (10,752,868 | ) | $ | 2,784,147 |   |
| Stock issued for  acquisition of property interests  |       | 2,500,000             |       | 125,000        |       | 1,175,000   |       | —      |       | 1,300,000 |   |
| Stock issued  under compensation plan                |       | 1,169,000             |       | 58,450         |       | 911,320     |       | —      |       | 969,770 |   |
| Stock issued for  working capital                    |       | 2,679,000             |       | 133,950        |       | 1,786,836   |       | —      |       | 1,920,786 |   |
| Stock issued  under convertible debenture agreements |       | 900,000               |       | 45,000         |       | 354,626     |       | —      |       | 399,626 |   |
| Warrants issued  for debt costs                      |       | —                |       | —         |       | 208,333     |       | —      |       | 208,333 |   |
| Debt proceeds  allocated to warrants                 |       | —                |       | —         |       | 1,203,752   |       | —      |       | 1,203,752 |   |
| Stock issued in  payment of interest obligations     |       | 40,805                |       | 2,040          |       | 34,002      |       | —      |       | 36,042 |   |
| Net loss, year  ended June 30, 2006             |       | —                |       | —         |       | —      |       | (2,769,050  | )          | (2,769,050 | ) |
| Balance,  June 30, 2006                         |       | 42,450,768            |       | $              | 2,122,540  |        | $          | 17,452,784  |       | $ | (13,521,918 | ) | $ | 6,053,406 |   |
| Stock issued  under compensation plan                |       | 542,000               |       | 27,100         |       | 406,500     |       | —      |       | 433,600 |   |
| Stock issued for  working capital                    |       | 10,880,000            |       | 544,000        |       | 5,496,000   |       | —      |       | 6,040,000 |   |
| Stock issued for  placement fee                      |       | 150,000               |       | 7,500          |       | (7,500      | )          | —      |       | — |   |
| Stock issued for  warrant exercise                   |       | 1,818,128             |       | 90,906         |       | 726,594     |       | —      |       | 817,500 |   |
| Debt proceeds  allocated to warrants                 |       | —                |       | —         |       | 1,251,051   |       | —      |       | 1,251,051 |   |
| Net loss, year  ended June 30, 2007             |       | —                |       | —         |       | —      |       | (5,800,774  | )          | (5,800,774 | ) |
| Balance,  June 30, 2007                         |       | 55,840,896            |       | $              | 2,792,046  |        | $          | 25,325,429  |       | $ | (19,322,692 | ) | $ | 8,794,783 |   |

 

*The accompanyingnotes are and integral part of these statements.*

 

F-4

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**CUBIC ENERGY, INC.**

 

**STATEMENTS OF CASH FLOWS**

**FOR THE YEARS ENDED JUNE 30, 2007, 2006, AND 2005**

** **
| ** **                                                                            | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|---------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Cash  flows from operating activities:**                                            |       |       |       |       |       |       |       |
| Net (loss)                                                                            |       | $          | (5,800,774 | )          | $          | (2,769,050 | )          | $ | (784,526 | ) |
| Adjustments to  reconcile net (loss) to cash provided (used) by operating activities: |       |       |       |       |       |       |       |
| Depreciation,  depletion and amortization                                             |       | 545,261    |       | 465,519    |       | 460,509    |       |
| Impairment loss                                                                       |       | 1,790,882  |       | —     |       | —     |       |
| Stock issued for  interest                                                            |       | —     |       | 36,042     |       | 125,440    |       |
| Stock issued for  compensation                                                        |       | 489,900    |       | 726,670    |       | 79,050     |       |
| Write off deferred  loan costs                                                        |       | 318,999    |       | 99,203     |       | —     |       |
| Write off note  payable discount                                                      |       | 1,145,359  |       | 237,931    |       | —     |       |
| Change in assets  and liabilities:                                                    |       |       |       |       |       |       |       |
| (Increase)  decrease in accounts receivable                                           |       | (177,194   | )          | (7,326     | )          | 45,826     |       |
| (Increase)  decrease in prepaid expenses                                              |       | (44,432    | )          | —     |       | —     |       |
| Increase  (decrease) in loan from affiliates                                          |       | 43,895     |       | 92,771     |       | 4,119      |       |
| Increase  (decrease) in accounts payable and accrued liabilities                      |       | (113,964   | )          | 154,367    |       | (115,503   | )          |
| Net cash  provided (used) by operating activities                                     |       | (1,802,068 | )          | (963,873   | )          | (185,085   | )          |
|                                                                                  |       |       |       |       |       |       |       |
| **Cash  flows from investing activities:**                                            |       |       |       |       |       |       |       |
| Acquisition and  development of oil and gas properties                                |       | (4,016,503 | )          | (4,409,415 | )          | (1,813,946 | )          |
| Purchase of  office equipment                                                         |       | (5,010     | )          | (3,003     | )          | (3,963     | )          |
| Advances on development  costs                                                        |       | (456,913   | )          | 39,443     |       | (303,666   | )          |
| Cash restricted  by debt                                                              |       | 401,723    |       | (401,723   | )          | —     |       |
| Increase in  other assets                                                             |       | 25,000     |       | (25,000    | )          | —     |       |
| Net cash  provided (used) by investing activities                                     |       | (4,051,703 | )          | (4,799,698 | )          | (2,121,575 | )          |
|                                                                                  |       |       |       |       |       |       |       |
| **Cash  flows from financing activities:**                                            |       |       |       |       |       |       |       |
| Issuance of  debentures and warrants                                                  |       | 9,000,000  |       | 5,500,000  |       | 2,635,000  |       |
| Issuance of  common stock, net                                                        |       | 6,857,500  |       | 2,020,786  |       | —     |       |
| Repayment of  debentures                                                              |       | (5,500,000 | )          | (1,480,000 | )          | —     |       |
| Payment of note  payable to affiliate                                                 |       | (1,300,000 | )          | —     |       | —     |       |
| Loan costs  incurred and other                                                        |       | (240,613   | )          | (275,311   | )          | (264,300   | )          |
| Repayment of  advances                                                                |       | (100,000   | )          | —     |       | —     |       |
| Net cash  provided (used) by financing activities                                     |       | 8,716,887  |       | 5,765,475  |       | 2,370,700  |       |
|                                                                                  |       |       |       |       |       |       |       |
| **Net  increase (decrease) in cash and cash equivalents**                             |       | $          | 2,863,116  |       | $          | 1,904      |       | $ | 64,040 |   |
| Cash and cash  equivalents:                                                           |       |       |       |       |       |       |       |
| Beginning of  year                                                                    |       | 259,157    |       | 257,253    |       | 193,213    |       |
| End of year                                                                           |       | $          | 3,122,273  |       | $          | 259,157    |       | $ | 257,253 |   |
| Other  information:                                                                   |       |       |       |       |       |       |       |
| Interest paid                                                                         |       | $          | 1,342,831  |       | $          | 355,607    |       | $ | 125,557 |   |
| Non-cash  investing and financing activities:                                         |       |       |       |       |       |       |       |
| Acquisition of  property with stock issue                                             |       | $          | —     |       | $          | 1,300,000  |       | $ | — |   |
| Acquisition of  property with debt issue                                              |       | $          | —     |       | $          | 2,599,274  |       | $ | — |   |

 

*The accompanying notes are andintegral part of these statements.*

 

F-5

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**Note A - Background and general:**

 

CubicEnergy, Inc. (“Company”) is engaged in domestic crude oil and natural gasexploration, development and production, with primary emphasis on theproduction of oil and gas reserves through the acquisition and development ofproved, producing oil and gas properties in the states of Texas and Louisiana.

 

**Note B - Significant accounting policies:**

 

**Cashequivalents**

 

Forpurposes of the statements of cash flows, the Company considers allcertificates of deposit and other financial instruments with original maturitydates of three months or less to be cash equivalents.

 

**Officeand other equipment**

 

Officeand other equipment are stated at cost and depreciated by the straight-linemethod over estimated useful lives ranging from five to seven years.Depreciation and amortization of office and other equipment amounted to $1,524,$1,173 and $330 for the yearsended June 30, 2007, 2006 and 2005, respectively.

 

**Impairmentof long-lived assets and long-lived assets to be disposed of**

 

TheCompany has adopted the provisions of the Financial Accounting Standards Board’s(the “FASB”) Statement of Financial Accounting Standards (“FAS”) No. 144 (“FASNo. 144”),*Accounting for the Impairment or Disposalof Long-Lived Assets*effective for periods beginning July 1,2002, and thereafter.  FAS No. 144replaces FAS No. 121, and, among other matters, addresses financialaccounting and reporting for the impairment or disposal of long-livedassets.  FAS No. 144 retains thebasic provisions of FAS No. 121, but broadens its scope and establishes asingle model for long-lived assets to be disposed of by sale. In addition, theCompany is subject to the rules of the Securities and Exchange Commissionwith respect to impairment of oil and gas properties accounted for under thefull cost method of accounting, as described below.

 

**Fullcost method of accounting for oil and gas properties**

 

TheCompany has adopted the full cost method of accounting for oil and gasproperties.  Management believes adoptionof the full cost method more accurately reflects management’s explorationobjectives and results by including all costs incurred as integral for theacquisition, discovery and development of whatever reserves ultimately resultfrom its efforts as a whole. Under the full cost method of accounting, allcosts associated with acquisition, exploration and development of oil and gasreserves, including directly related overhead costs, are capitalized.

 

Allcapitalized costs of oil and gas properties, including the estimated futurecosts to develop proved reserves, are amortized on the unit-of-productionmethod using estimates of proved reserves. Investments in unproved properties and major development projects arenot amortized until proved reserves associated with the projects can bedetermined or until impairment occurs. If the results of an assessment indicate that the properties areimpaired, the amount of the impairment is added to the capitalized costs to beamortized.

 

F-6

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

Inaddition, the capitalized costs are subject to a “full cost ceiling test,”which generally limits such costs to the aggregate of the “estimated presentvalue,” discounted at a 10 percent (10%) interest rate of future net revenuesfrom proved reserves, based on current economic and operating conditions, plusthe lower of cost or fair market value of unproved properties. Accordingly, animpairment of oil and gas properties charge of $1,790,882 was recorded for theyear ended June 30, 2007; however, an excess of the capitalized costs overthe full cost ceiling test limitation at June 30, 2006, was not chargedagainst earnings for the year ended June 30, 2006 because of an increasein oil and gas prices subsequent to year end.

 

Salesof proved and unproved properties are accounted for as adjustments ofcapitalized costs with no gain or loss recognized, unless such adjustmentswould significantly alter the relationship between capitalized costs and provedreserves of oil and gas, in which case the gain or loss is recognized inincome.

 

Depletionof producing oil and gas properties amounted to $360,910, $178,064 and $364,166 for the years ended June 30,2007, 2006 and 2005, respectively.

 

**Incometaxes**

 

Incometaxes are accounted for under the asset and liability method.  Deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax basis.  Deferred taxassets and liabilities are measured using enacted tax rates that will apply inthe years in which those temporary differences are expected to be recovered orsettled.  The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date.

 

In September 2005, theEmerging Issues Task Force (“EITF”) reached a consensus on Issue No. 05-08,*Income Tax Consequences of Issuing Convertible Debtwith a Beneficial Conversion Feature* (“EITF 05-08”). Under EITF05-08, the issuance of convertible debt with a beneficial conversion featureresults in a temporary difference for purposes of applying FAS No. 109, *Accounting for Income Taxes*. The deferred taxes recognizedfor the temporary difference should be recorded as an adjustment to paid-incapital. EITF 98-05, *Accounting for ConvertibleSecurities with Beneficial Conversion Features or Contingently AdjustableConversion Ratios*, and EITF 00-27, *Applicationof Issue No. 98-05 to Certain Convertible Instruments*, requirethat the non-detachable conversion feature of a convertible debt security beaccounted for separately if it is a beneficial conversion feature. A beneficialconversion feature is recognized and measured by allocating to additionalpaid-in capital a portion of the proceeds equal to the conversion feature’sintrinsic value. A discount on the convertible debt is recognized for theamount that is allocated to additional paid-in capital. The debt discount isaccreted from the date of issuance to the stated redemption date of theconvertible instrument or through the earliest conversion date if theinstrument does not have a stated redemption date. The U.S. Federal Income TaxCode includes the entire amount of proceeds received at issuance as the taxbasis of the convertible debt security. The adoption of EITF 05-08 has had noimpact on the Company’s financial statements because none of the conversionfeatures embedded in the Company’s notes payable is considered beneficial.

 

F-7

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**CUBICENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

In July 2006, the FASBissued Interpretation No. 48 (“FIN No. 48”), *Accountingfor Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109*,which clarifies the accounting for uncertainty in tax positions. FIN No. 48requires that the Company recognize in the financial statements the impact of atax position if that position is more likely than not of being sustained uponaudit, based on the technical merits of the position. FIN No. 48 iseffective for fiscal years beginning after December 15, 2006. Managementis evaluating the impact of adopting FIN No. 48 on the Company’s financialposition, results of operations and cash flows.

 

**Oil andgas revenues**

 

TheCompany recognizes oil and gas revenues by the sales method as oil and gasproduction is sold.  Differences betweensales and production volumes during the years ended June 30, 2007, 2006and 2005 were not significant.

 

**Earnings(loss) per common share**

 

TheCompany has adopted the provisions of FAS No. 128, *Earnings perShare*.  FAS No. 128requires the presentation of basic earnings (loss) per share (EPS) and dilutedEPS.  Basic EPS is calculated by dividingnet income or loss (available to common stockholders) by the weighted averagenumber of common shares outstanding for the period.  Diluted EPS reflects the potential dilutionthat could occur if securities or other contracts to issue common stock, suchas stock options, warrants, convertible preferred stock and convertibledebentures, were exercised or converted into common stock.

 

Asdiscussed in Note E, there were no dilutive securities outstanding during theyears ended June 30, 2007, 2006 and 2005. The weighted average number of common and common equivalent sharesoutstanding was 50,338,450, 38,477,353, and 33,112,644 for the years ended June 30,2007, 2006 and 2005, respectively.

 

**Concentrationof credit risk**

 

Financialinstruments which potentially subject the Company to a concentration of creditrisk consists primarily of trade accounts receivable with a variety of local,national, and international oil and natural gas companies. Such credit risksare considered by management to be limited due to the financial resources ofthe oil and natural gas companies.

 

TheCompany had cash balances of approximately $3,259,000 at June 30, 2007, inone banking institution in excess of the federally insured amount of $100,000for each institution.  This balance isbefore considering outstanding items.

 

F-8

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**Reportingcomprehensive income (loss) and operating segments**

 

TheCompany has adopted the provisions of FAS No. 130, *ReportingComprehensive Income*, and FAS No. 131, *Disclosureabout Segments of an Enterprise and Related Information*.  FAS No. 130 requires that an enterprisereport, by major components and as a single total, the change in its net assetsduring the period from non-owner sources. FAS No. 131 establishes annual and interim reporting standards foran enterprise’s operating segments and related disclosures about its products,services, geographic areas and major customers. Adoption of FAS No. 131 has had no impact on the Company’sfinancial position, results of operations, cash flows, or related disclosuressince the Company’s operations are considered to be a single segment.

 

**Use of estimates**

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the amounts reported in the financial statements and accompanyingnotes.  Actual results could differ fromthose estimates.

 

**Certain significant estimates**

 

Managementestimates included in these financial statements for which it is reasonablypossible that a future event in the near term could cause the estimate tochange and the change could have a severe impact are as follows: Management’sestimates of oil and gas reserves are based on various assumptions, includingconstant oil and gas prices.  Actualfuture production, cash flows, taxes, operating expenses, developmentexpenditures and quantities of recoverable oil and gas reserves may varysubstantially from those assumed in the estimate.  The accuracy of any reserve estimate is afunction of the quality of available data, engineering and geologicalinterpretation, and judgment. Subsequent evaluation of the same reserves basedupon production history will result in variations, which may be substantial, inthe estimated reserves.  While it is atleast reasonably possible that the estimates above will change materially inthe near term, no estimate can be made of the range of possible losses thatmight occur.

 

**Fair value of financial instruments**

 

TheCompany defines the fair value of a financial instrument as the amount at whichthe instrument could be exchanged in a current transaction between willingparties.  Financial instruments includedin the Company’s financial statements include cash and cash equivalents,short-term investments, accounts receivable, other receivables, other assets,accounts payable, notes payable and due to affiliates.  Unless otherwise disclosed in the notes tothe financial statements, the carrying value of financial instruments isconsidered to approximate fair value due to the short maturity andcharacteristics of those instruments. The carrying value of debt approximates fair value as terms approximatethose currently available for similar debt instruments.

 

F-9

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**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**Obligations associated with the retirement of assets**

 

TheCompany has adopted the provisions of FAS No. 143, *Accountingfor Asset Retirement Obligations*, effective July 1, 2002.  FAS No. 143 amended FAS No. 19, *Financial Accounting and Reporting by Oil and Gas Producing Companies*,and, among other matters, addresses financial accounting and reporting forlegal obligations associated with the retirement of tangible long-lived assetsand the associated asset retirement costs. FAS No. 143 requires that the fair value of a liability for anasset retirement obligation be recognized in the period in which it is incurred,with the associated asset retirement cost capitalized as part of the relatedasset and allocated to expense over the asset’s useful life.

 

Thisis a change from the approach taken under FAS No. 19, whereby an amountfor an asset retirement obligation was recognized using a cost-accumulationmeasurement approach.  Under thatapproach, the obligation was reported as a contra-asset recognized as part ofdepletion and depreciation over the life of the asset without discounting.  Management has determined that adopting FAS No. 143has had no significant effect on the Company’s financial statements sinceabandonment costs for which it is responsible are not material.

 

In March 2005, the FASBissued FASB Interpretation No. 47 (“FIN No. 47”), *Accounting for Conditional Asset Retirement Obligations*. FINNo. 47 clarifies that a conditional asset retirement obligation, as usedin FAS No. 143, refers to a legal obligation to perform an assetretirement activity in which the timing or method of the settlement are conditionalon a future event that may or may not be within the control of the entity.Accordingly, an entity is required to recognize a liability for the fair valueof a conditional asset retirement obligation if the fair value can bereasonably estimated. FIN No. 47 is effective no later than fiscal yearsending after December 15, 2005. The adoption of FIN No. 47 has had noimpact on the financial statements of the Company.

 

**Stock-based compensation**

 

AccountingPrinciples Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related interpretations requirethat compensation expense be recorded on the date of the grant of stock optionsand warrants only if the current market price of the underlying stock exceededthe exercise price.  Alternatively, FAS No. 123,*Accounting for Stock-Based Compensation*,permits entities to recognize, as expense over the vesting period, the fairvalue of all stock-based awards on the date of grant.  FAS No. 123 allows entities to continueto apply the provisions of APB Opinion No. 25 and provide proforma netincome and proforma earnings per share disclosures for employee stock optiongrants made in 1996 and future years as if the fair-valued-based method definedin FAS No. 123 had been applied. The Company has elected to apply the provisions of APB Opinion No. 25and provide the proforma disclosure provisions of FAS No. 123.

 

Inaddition, the Company has adopted the provisions of Financial AccountingStandards Board Interpretation (FIN) 44, *Accounting for CertainTransactions Involving Stock Compensation*, which became effective July 1,2000.  FIN No. 44 clarifies theapplication of APB 25 for certain issues. Among other issues, this interpretation clarifies the definition of anemployee for purposes of applying APB 25, the criteria for qualification of aplan as compensatory, the consequences of modifications to the terms of a plan,and the treatment of stock compensation issued to service providers who are notemployees.

 

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

InDecember 2002, the FASB issued FAS No. 148, *Accountingfor Stock-Based Compensation - Transition and Disclosure*, whichamends FAS No. 123.  FAS No. 148provides alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based compensation.  In addition, FAS No. 148 amends thedisclosure requirements of FAS No. 123 to require more prominent and morefrequent disclosures in financial statements about the effects of stock-basedcompensation.  The transition guidanceand annual disclosure provisions are effective for years ending after December 15,2002.  The interim disclosure provisionsbecame effective for financial reports containing financial statements forinterim periods beginning after December 15, 2002. The other requirementsof this standard have been adopted by the Company for periods beginning January 1,2003.

 

InDecember 2004, the FASB issued FAS No. 123R, *Share-BasedPayment*, which is a revision of FAS No. 123 and supersedes APB No. 25.  This Statement requires the Company torecognize compensation costs related to stock-based payment transactions (i.e.,the granting of shares of common stock, stock options and warrants) in itsfinancial statements.  With limitedexceptions, the amount of compensation cost is measured based on the grant-datefair value of the equity or liability instruments issued.  In addition, liability awards are re-measuredeach reporting period.  Compensation costis recognized over the period that an employee provides services in exchange forthe award.  This new standard becameeffective for awards that were granted, modified or settled in cash in interimand annual financial periods beginning after June 30, 2006.

 

Additionally,in August 2005, the FASB issued FASB Staff Position (“FSP”) No. 123R-1(“FSP1”), *Classification and Measurement of FreestandingFinancial Instruments Originally Issued in Exchange for Employee Services underFASB Statement No. 123(R)*. In FSP1, the FASB decided to deferthe requirements in FAS No. 123 that make a freestanding financialinstrument subject to the recognition and measurement requirements of otherGAAP when the rights conveyed by the instrument are no longer dependent on theholder being an employee. In October 2005, the FASB issued FSP No. 123R-2(“FSP2”), *Practical Accommodation to the Application of GrantDate as Defined in FASB Statement No. 123(R)*. In FSP2, the FASBis providing companies with a “practical accommodation” when determining thegrant date of an award that is subject to the accounting provisions in FAS No. 123R.In November 2005, the FASB issued FSP No. 123R-3 (“FSP3”), *Transition Election Related to Accounting for the Tax Effects ofShare-Based Payment Awards*. FSP3 provides an elective alternativemethod that establishes a computational component to arrive at the beginningbalance of the accumulated paid-in capital pool related to employeecompensation and a simplified method to determine the subsequent impact on theaccumulated paid-in capital pool of employee awards that are fully vested andoutstanding upon the adoption of FAS No. 123R.

 

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

InFebruary 2006, the FASB issued FSP No. 123R-4  (“FSP4”), *Classification of Optionsand Similar Instruments Issued as Employee Compensation That Allow for CashSettlement upon the Occurrence of a Contingent Event*, whichconcludes that a cash settlement feature that can be exercised only upon theoccurrence of a contingent event that is outside the employee’s control doesnot become a liability until it becomes probable that the event will occur. Anoption or similar instrument that is classified as equity, but subsequentlybecomes a liability because the contingent cash settlement event is probable ofoccurring, shall be accounted for similar to modification from an equity toliability award. To the extent that the liability exceeds the amount previouslyrecognized in equity, the excess is recognized as compensation cost. The totalrecognized compensation cost for an award with a contingent cash settlementfeature shall at least equal the fair value of the award at the grant date.FSP4 is applicable only for options or similar instruments issued as part ofemployee compensation arrangements. The guidance in FSP1, FSP2, FSP3 and FSP4has been applied concurrent with our adoption of FAS No. 123R.

 

InMarch 2005, the SEC published Staff Accounting Bulletin No. 107 (“SABNo. 107”). The interpretations in this staff accounting bulletin express theviews of the staff regarding the interaction between FAS No. 123R andcertain SEC rules and regulations and provide the staff’s views regardingthe valuation of share-based payment arrangements for public companies. Inparticular, SAB No. 107 provides guidance related to share-based paymenttransactions with non-employees, the transition from non-public to publicentity status, valuation methods (including assumptions such as expectedvolatility and expected term), the accounting for certain redeemable financialinstruments issued under share-based payment arrangements, the classificationof compensation expense, non-GAAP financial measures, first-time adoption ofFAS No. 123R in an interim period, capitalization of compensation costrelated to share-based payment arrangements, the accounting for income taxeffects of share-based payment arrangements upon adoption of FAS No. 123R,the modification of employee share options prior to adoption of FAS No. 123Rand disclosures in Management’s Discussion and Analysis subsequent to adoptionof FAS No. 123R. We will comply with SAB No. 107 upon our adoption ofFAS No. 123R. The provisions of SAB No. 107 became effective with ouradoption of FAS No. 123R.

 

Theper share weighted-average fair value of stock warrants granted to employeesduring the year ended June 30, 2002, was $0.29, on the date of grant,using the Black-Scholes pricing model. There were no stock warrants granted toemployees during the fiscal years ended June 30, 2007, 2006 and 2005.

 
| ** **               | ** ** | **2002**  | ** ** |
|--------------------------|------------|-----------|------------|
| Expected  dividend yield |       | 0.00%     |       |
| Risk-free  interest rate |       | 1.80%     |       |
| Expected life            |       | 1.7 years |       |
| Expected  volatility     |       | 133.00%   |       |

 

TheCompany applies APB Opinion No. 25 in accounting for its stock warrantsissued to employees and directors, and, accordingly, has recognized nocompensation expense for stock warrants and options granted at exercise pricesat least equal to the market value of the Company’s common stock. Had theCompany determined compensation cost based on the fair value at the grant datefor its stock options under FAS No. 123, the Company’s net loss and lossper share would have been reduced to the proforma amounts indicated below:

 

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 
| ** **                          | ** ** | **Year ended June 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|
| ** **                          | ** ** | **2007**                               | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net loss:                           |       |                                   |       |   |   |   |   |
| As reported                         |       | $                                      | (5,800,774 | ) | $ | (2,769,050 | ) | $ | (784,526 | ) |
| Proforma                            |       | $                                      | (5,800,774 | ) | $ | (2,769,050 | ) | $ | (802,026 | ) |
|                                |       |                                   |       |   |   |   |   |
| Stock-based  employee compensation: |       |                                   |       |   |   |   |   |
| As reported                         |       | $                                      | 489,900    |   | $ | 726,670 |   | $ | — |   |
| Proforma                            |       | $                                      | 489,900    |   | $ | 726,670 |   | $ | 17,500 |   |
|                                |       |                                   |       |   |   |   |   |
| Basic loss per  common share:       |       |                                   |       |   |   |   |   |
| As reported                         |       | $                                      | (0.12      | ) | $ | (0.07 | ) | $ | (0.02 | ) |
| Proforma                            |       | $                                      | (0.12      | ) | $ | (0.07 | ) | $ | (0.02 | ) |

 

**Exit or disposal activities**

 

InJuly 2002, the FASB issued FAS No. 146, *Accountingfor Cost Associated with Exit or Disposal Activities*.  FAS No. 146 requires companies torecognize costs associated with exit or disposal activities when they areincurred rather than at the date of a commitment to an exit or disposalplan.  Examples of costs covered by thestandard include lease termination costs and certain employee severance coststhat are associated with a restructuring, discontinued operations, or otherexit or disposal activities.  FAS No. 146is effective prospectively for exit or disposal activities initiated after December 31,2002, with earlier adoption encouraged. No exit or disposal activities have been entered into by management.

 

**Financial instruments with characteristics of both liabilities andequity**

 

InMay 2003, the FASB issued FAS No. 150 (“FAS No. 150”), *Accounting for Certain Financial Instruments with Characteristics ofBoth Liabilities and Equity*. FAS No. 150 established standards for how a company classifies andmeasures certain financial instruments with characteristics of both liabilitiesand equity.  The statement requires thata company classify a financial instrument that is within its scope as a liability(or an asset in some circumstances) if certain criteria are met.  Freestanding financial instruments thatobligate the issuer to redeem the holder’s shares, or are indexed to such anobligation, and are settled in cash or settled with shares meeting certainconditions would be treated as liabilities. Many of those instruments were previously classified as equity.

 

InJune 2005, the FASB issued FSP FAS No. 150-5 (“FAS No. 150-5”), *Issuers Accounting under FASB Statement No. 150 for FreestandingWarrants and Other Similar Instruments on Shares that are Redeemable*.FAS No. 150-5 clarifies that freestanding warrants and similar instrumentson shares that are redeemable should be accounted for as liabilities under FAS No. 150regardless of the timing of the redemption feature or price, even though theunderlying shares may be classified as equity. FAS No. 150-5 is effectivefor the first reporting period beginning after June 30, 2005. Although theCompany had outstanding warrants as of June 30, 2007, the shares issuedupon exercise of the warrants are not redeemable; consequently, adoption of FASNo. 150-5 has not had an impact on the Company’s financial position,results of operations or cash flows.

 

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**Guarantee of debt**

 

InNovember 2002, the FASB issued Interpretation No. 45 (“FIN No. 45”),*Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others, anInterpretation of FASB Statements No. 5, 57, and 107 and Rescission ofFASB Interpretation No. 34*. FIN No. 45 clarifies the requirements of FAS No. 5, relatingto the guarantor’s accounting for, and disclosure of, the issuance of certaintypes of guarantees.  This Interpretationclarifies that a guarantor is required to recognize, at the inception ofcertain types of guarantees, a liability for the fair value of the obligationundertaken in issuing the guarantee, and requires additional disclosures onexisting guarantees even if the likelihood of future liability under theguarantees is deemed remote.  The Companyhas not issued any guarantees and, therefore, the adoption of FIN No. 45does not have a significant impact on the Company’s financial statements.

 

**Variable interest entities**

 

InJanuary 2003, the FASB issued Interpretation No. 46 (“FIN No. 46”),*Consolidation of Variable Interest Entities, anInterpretation of ARB No. 51*. FIN No. 46 states that if a business enterprise has a controllingfinancial interest in a variable interest entity as the primary beneficiary,the assets, liabilities and results of the activities of the variable interestentity should be included in the consolidated financial statements of thebusiness enterprise.  This Interpretationexplains how to identify variable interest entities and how an enterpriseassesses its interests in a variable interest entity to decide whether to consolidatethat entity.  The primary beneficiary ofa variable interest entity would be required to consolidate if the other equityinvestors in the entity do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties.  FIN No. 46 appliesimmediately to variable interest entities created after January 31, 2003,and to variable interest entities in which an enterprise obtains an interestafter that date.  It applies in the firstfiscal year or interim period beginning after June 15, 2003, to variableinterest entities in which an enterprise holds a variable interest that itacquired before February 1, 2003.  The Company has no current contractual relationships or other businessrelationships with variable interest entities.

 

**Accounting changes and errorcorrections**

 

InMay 2005, the FASB issued FAS No. 154 (“FAS No. 154”), *Accounting Changes and Error Corrections — A Replacement of APB OpinionNo. 20 and FASB Statement No. 3*. FAS No. 154 replacesAPB Opinion No. 20 (“APB No. 20”), *AccountingChanges*, and FAS No. 3 (“FAS No. 3”), *ReportingAccounting Changes in Interim Financial Statements*, and changes the requirementsfor the accounting for, and reporting of, a change in accounting principles.FAS No. 154 applies to all voluntary changes in accounting principles andchanges required by an accounting pronouncement in the unusual instance thatthe pronouncement does not include specific transition provisions. Underprevious guidance, changes in accounting principle were recognized as acumulative effect in the net income of the period of the change. FAS No. 154requires retrospective application of changes in accounting principle, limitedto the direct effects of the change, to prior periods’ financial statements,unless it is impracticable to determine either the period-specific effects orthe cumulative effect of the change in accounting principle.

 

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

Additionally, FAS No. 154requires that a change in depreciation, amortization or depletion method forlong-lived, non-financial assets be accounted for as a change in accountingestimate affected by a change in accounting principle and that correction oferrors in previously issued financial statements should be termed a “restatement.”The provisions in FAS No. 154 became effective for accounting changes andcorrection of errors made in fiscal years beginning after December 15,2005. The adoption of FAS No. 154 did not have a material impact on theCompany’s financial position, results of operations or cash flows.

 

**Debt modifications**

 

In September 2005, theEITF reached a consensus on Issue No. No. 05-07 (“EITF No. No. 05-07”),*Accounting for Modifications to Conversion OptionsEmbedded in Debt Instruments and Related Issues*. EITF No. 05-07requires that a change in the fair value of a conversion option brought aboutby modifying the debt agreement be included in analyzing in accordance withEITF consensus on Issue No. No. 96-19 (“EITF No. 96-19”), *Debtor’s Accounting for a Modification or Exchange of Debt Instruments*,whether a debt instrument is considered extinguished. Under EITF No. 96-19’srequirements, an issuer who modifies a debt instrument must compare the presentvalue of the original debt instrument’s cash flows to the present value of thecash flows of the modified debt. If the present value of those cash flowsvaries by more than 10 percent (10%), the modification is consideredsignificant and extinguishments accounting is applied to the original debt. Ifthe change in the present value of the cash flows is less than 10 percent(10%), the debt is considered to be modified and is subject to EITF No. 96-19’smodification accounting. EITF No. 05-07 requires that in applying the 10percent (10%) test the change in the fair value of the conversion option betreated in the same manner as a current period cash flow. EITF No. 05-07also requires that, if a modification does not result in an extinguishment, thechange in fair value of the conversion option be accounted for as an adjustmentto interest expense over the remaining term of the debt. The issuer should notrecognize a beneficial conversion feature or reassess an existing beneficialconversion feature upon modification of the conversion option of a debtinstrument that does not result in an extinguishment. EITF No. 05-07became effective for modifications of debt instruments beginning in the firstinterim or annual reporting period beginning after December 15, 2005. Theadoption of EITF No. 05-07 did not have a material impact on the Company’sfinancial position, results of operations or cash flows.

 

**Certain hybrid financialinstruments**

 

In February 2006, theFASB issued FAS No. 155 (“FAS No. 155”), *Accountingfor Certain Hybrid Financial Instruments*, which amends FAS No. 133(“FAS No. 133”), *Accounting for DerivativeInstruments and Hedging Activities*and FAS No. 140 (“FAS No. 140”),*Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities*, and improves thefinancial reporting of certain hybrid financial instruments by requiring moreconsistent accounting that eliminates exemptions and provides a means tosimplify the accounting for these instruments. Specifically, FAS No. 155allows financial instruments that have embedded derivatives to be accounted foras a whole (eliminating the need to bifurcate the derivative from its host) ifthe holder elects to account for the whole instrument on a fair value basis.FAS No. 155 is effective for all financial instruments acquired or issuedafter the beginning of an entity’s first fiscal year that begins after September 15,2006. Management does not expect the adoption of FAS No. 155 will have amaterial impact on the Company’s financial position, results of operations orcash flows.

 

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**Reporting taxes collected**

 

In March 2006, the EITFreached a tentative consensus on Issue No. No. 06-03 (“EITFNo. 06-03”), *How Sales Taxes Collected from Customers andRemitted to Governmental Authorities Should Be Presented in the IncomeStatement (That Is, Gross versus Net Presentation)*. EITFNo. 06-03 addresses income statement classification and disclosurerequirements of externally-imposed taxes on revenue-producing transactions.EITF No. 06-03 is effective for periods beginning after December 15,2006. Management is currently evaluating the effect implementation of EITFNo. 06-03 will have on the Company’s financial position, results ofoperations and cash flows.

 

**Other recent pronouncements**

 

InSeptember 2006, the Securities and Exchange Commission issued StaffAccounting Bulletin No. 108 (“SAB No. 108”), *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*. SAB No. 108 was issuedto address diversity in practice in quantifying financial statementmisstatements. Current practice allows for the evaluation of materiality on thebasis of either (1) the error quantified as the amount by which thecurrent year income statement was misstated (“rollover method”) or (2) thecumulative error quantified as the cumulative amount by which the current yearbalance sheet was misstated (“iron curtain method”). The guidance provided inSAB No. 108 requires both methods to be used in evaluatingmateriality (“dual approach”). SAB No. 108 permits companies toinitially apply its provisions either by (1) restating prior financialstatements as if the dual approach had always been used or (2) recordingthe cumulative effect of initially applying the “dual approach” as adjustmentsto the carrying values of assets and liabilities as of January 1, 2006with an offsetting adjustment recorded to the opening balance of retainedearnings. The adoption of SAB No. 108 did not have a material impact onthe Company’s financial position, results of operations or cash flows.

 

InSeptember 2006, the FASB issued FAS No. 157 (“FAS No. 157”),*Fair Value Measurements*. FASNo. 157 defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles, and expands disclosuresabout fair value measurements. FAS No. 157 does not require any new fairvalue measurements in financial statements, but standardizes its definition andguidance in GAAP. Thus, for some entities, the application of this statementmay change current practice. FAS No. 157 will be effective for usbeginning on January 1, 2008. Management is currently evaluating theimpact that the adoption of this statement may have on its financial position,results of operations, earnings per share, and cash flows.

 

InFebruary 2007, the FASB issued Statement of FAS No. 159 (“FASNo. 159”), *The Fair Value Option for Financial Assetsand Financial Liabilities*. FAS No. 159 allows entities tochoose, at specified election dates, to measure eligible financial assets andliabilities at fair value that are not otherwise required to be measured atfair value. If a company elects the fair value option for an eligible item,changes in that item’s fair value in subsequent reporting periods must berecognized in current earnings. FAS No. 159 also establishes presentationand disclosure requirements designed to draw comparison between entities thatelect different measurement attributes for similar assets and liabilities.  FAS No. 159 is effective for fiscalyears beginning after November 15, 2007. Early adoption is permittedsubject to specific requirements outlined in the Statement. Management iscurrently evaluating the effect of this pronouncement on its financialstatements.

 

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**NoteC – Stockholders’ equity:**

 

TheCompany’s authorized capital is 100,000,000 shares of $0.05 par value commonstock and 10,000,000 shares of $0.01 par value preferred stock.  No shares of preferred stock were issued oroutstanding at June 30, 2007 and 2006.

 

**Stock and warrants**

 

OnJanuary 1, 2002, the Company issued three series of warrants to TaurenExploration, Inc. (“Tauren”), an entity wholly owned by the CEO and majorstockholder of the Company (see Note E). These warrants allowed Tauren to purchase unregistered common shares inthe Company as follows: 1) exercisable after May 1, 2002, to purchase125,000 unregistered common shares at an exercise price of $1.00, which expiredon April 30, 2003; 2) exercisable after May 1, 2003, to purchase150,000 unregistered common shares at the exercise price of $1.50, whichexpired on April 30, 2004; and 3) exercisable after May 1, 2004, topurchase 200,000 unregistered common shares at an exercise price of $2.00,which expired on April 30, 2005. All of the above-referenced warrants expired unexercised.

 

On or about October 1,2004, the Company closed a Securities Purchase Agreement and issued $2,635,000in principal amount of 7% Senior Secured Convertible Debentures due September 30,2009 (the “Debentures”), to a group of institutional and high net worthinvestors. The Company had the option to pay the interest on the Debentures incommon stock. The investors also received warrants to purchase an additional2,635,000 shares of common stock with an exercise price of $1.00 per share.Pursuant to the anti-dilution adjustment provisions applicable to suchwarrants, the exercise price applicable to the 1,000,000 of such warrants thathave not been exercised is currently $0.50 per share. 1,635,000 of theabove-referenced warrants had been exercised and 1,000,000 remained outstandingat June 30, 2007.

 

The Company allocated theproceeds from the issuance of the Debentures to the warrants and the Debenturesbased on their relative fair market values at the date of issuance. The valueassigned to the warrants of $510,961 was recorded as an increase in additionalpaid in capital for the year ended June 30, 2006.

 

On or about January 11,2005, the Company issued 1,531,661 shares of common stock to Caravel ResourcesEnergy Fund 2003-II, L.P. (the “Partnership”) in exchange for a 0.1914575033working interest in the Kraemer 24-1 Well, Desoto Parish, Township 14 N, Range15 W, Section 24 (the “Well”). The Company also issued 468,339 shares ofcommon stock to Mr. Wallen in exchange for a 0.0585424967 working interestin the Well. The common stock closed at a price of $0.90 on January 10, 2005.

 

On December 16,2005, the Company entered into a Securities Purchase Agreement and issued2,500,000 common shares at a price of $0.80 per share and issued warrants, withfive year expirations, for the purchase of up to 1,000,000 shares of Companycommon stock at an exercise price of $1.00 per share. The proceeds of theoffering were used for exploratory drilling and working capital. None of theabove-referenced warrants had been exercised and all remained outstanding at June 30,2007.

 

On February 6, 2006,Cubic entered into a Credit Agreement with Petro Capital V, L.P. (“PetroCapital”) pursuant to which Petro Capital advanced to the Company $5,500,000.In connection with the funding under the Credit Agreement, the Company issuedto Petro Capital and Petro Capital Securities, LLC, warrants, with five-yearexpirations, for the purchase of up to 1,833,334 and 250,000 shares,respectively,

 

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

of Company common stockat an exercise price of $1.00 per share. Pursuant to the anti-dilution adjustment provisions applicable to suchwarrants, the exercise price applicable to all such warrants is currently $0.9842 pershare. On May 8,2007, 300,000 warrants were exercised utilizing a cashless exercise price of$1.35 per share and 81,289 shares were issued; and, on May 15, 2007,300,000 warrants were exercised utilizing a cashless exercise price of $1.49per share and 101,839 shares were issued. 1,233,334 of the above-referencedwarrants issued to Petro Capital remained outstanding at June 30,2007.  None of the 250,000 warrantsissued to Petro Capital Securities, LLC have been exercised and all remainedoutstanding at June 30, 2007. The Company allocated the proceeds from theissuance of the senior debt to the warrants and the senior debt based on theirrelative fair market values at the date of issuance. The value assigned to thewarrants of $1,203,752 was recorded as an increase in additional paid incapital.

 

OnJuly 28, 2006, Cubic entered into and consummated transactions pursuant toSubscription and Registration Rights Agreements (the “Subscription Agreements”)with certain investors that are unaffiliated with the Company (the “Investors”).  Pursuant to the Subscription Agreements, theInvestors paid aggregate consideration of $2,100,000 to the Company for3,000,000 shares of the Company’s common stock and warrants exercisable,through July 31, 2011, into 1,500,000 shares of common stock at $0.70 pershare.  Pursuant to the anti-dilution adjustmentprovisions applicable to such warrants, the exercise price applicable toall such warrants is currently $0.6885 per share. None of the above-referenced warrants had beenexercised and all remained outstanding at June 30, 2007.

 

OnDecember 15, 2006, the Company entered into Subscription and RegistrationRights Agreements with certain investors. One of the investors, William Bruggeman(and entities affiliated with him) was the beneficial owner, prior to thistransaction, of approximately 23.0% of the common stock of the Company. In thistransaction, Mr. Bruggeman (and entities affiliated with him) purchased anaggregate of 4,288,000 shares of common stock at a purchase price of $0.50 pershare, or an aggregate of $2,144,000. Mr. Bruggeman (and entitiesaffiliated with him) received warrants to purchase 2,144,000 shares of commonstock with an exercise price of $0.70 per share. Another investor, BobClements, a director of the Company, purchased 100,000 shares of common stockat a purchase price of $0.50 per share, or an aggregate of $50,000. Mr. Clementsreceived warrants to purchase 50,000 shares of common stock with an exerciseprice of $0.70 per share. None of the above-referenced warrants had been exercised and allremained outstanding at June 30, 2007.

 

On March 5, 2007,Cubic entered into a Credit Agreement with Wells Fargo Energy Capital (“WellsFargo”) providing for a revolving credit facility of $20,000,000 and aconvertible term loan of $5,000,000 (the “Credit Facility”). In connection withentering into the Credit Facility, the Company issued to Wells Fargo warrants,with five-year expirations, for the purchase of up to 2,500,000 shares ofCompany common stock at an exercise price of $1.00 per share. The term loan isalso convertible into 5,000,000 shares of Company common stock at a conversionprice of $1.00 per share.  None of theabove-referenced warrants had been exercised and all remained outstanding at June 30,2007. The Company allocated the proceeds from the issuance of the debt to thewarrants, the debt and net profits interest (see “Note E – Long-term debt”)based on their relative fair market values at the date of issuance. The valueassigned to the warrants of $1,314,289 was recorded as an increase inadditional paid in capital and the value assigned to the net profits interestof $213,148 was recorded as a credit to the full cost pool for oil and gasproperties.

 

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

Duringthe fiscal year ended June 30, 2007, the Company received $817,500relating to the exercise of 2,235,000 warrants representing 1,818,128 shares ofcommon stock.

 

**Stock-based compensation**

 

On October 25, 2004, Cubic issued 155,000 shares of common stockto its officers and directors pursuant to a then current Director and Officercompensation plan. Based on a then market price of $0.51 per share, Cubicrecorded a compensation expense of $79,050, which was included in general andadministrative expenses for the fiscal year ended June 30, 2005.

 

On December 29, 2005, the shareholders ofthe Company approved the 2005 Stock Option Plan (the “Plan”) and 3,750,000 shares of commonstock were reserved, of which 1,711,000 shares have been issued through June 30,2007, as set forth below.

 

On December 29, 2005, stock grants aggregating 597,000unregistered shares were approved for issuance to the officers and directors ofthe Company.  As of such date, theaggregate market value of the common stock granted was $483,570 based on thelast sale price on the OTC Bulletin Board of the Company’s common stock.  Such amount was recorded as compensationexpense and is included in general and administrative expenses for the fiscalyear ended June 30, 2006.

 

On January 5, 2006, the Company issued572,000 unregistered shares to the officers and directors of the Companypursuant to the Plan. As of such date, the aggregate market value of the commonstock granted was $486,200 based on the last sale price on the OTC BulletinBoard of the Company’s common stock. Such amount was amortized to compensation expense on a quarterly basisduring calendar year 2006.  Accordingly,$243,100 was recorded as compensation expense and included in general andadministrative expenses for each of the fiscal years ended June 30, 2007and 2006.

 

On January 10 and January 18, 2007,the Company issued 489,500 and 52,500 unregistered shares, respectively, to theofficers, directors, and key employees of the Company pursuant to thePlan.  As of such dates, the aggregatemarket value of the common stock granted was $391,600 and $42,000,respectively, based on the last sale price on the OTC Bulletin Board of theCompany’s common stock.  Such amountswere amortized to compensation expense on a quarterly basis during calendaryear 2007. An additional $30,000 was recorded when our former Chief FinancialOfficer resigned during fiscal 2007. Accordingly, $246,800 was recorded ascompensation expense and included in general and administrative expense for thefiscal year ended June 30, 2007. The Named Executive Officers received thefollowing grants: (i) 150,000 unregistered shares to Calvin A. Wallen, III,(ii) 75,000 unregistered shares to James L. Busby, and (iii) 47,500unregistered shares to Jon S. Ross.

 

F-19

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Tableof Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**Note D – Loss per common share:**

 
| ** **                                         | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                               |       |       |       |       |       |       |       |   |   |   |
| Net loss  attributable to stockholders             |       | $          | (5,800,774 | )          | $          | (2,769,050 | )          | $ | (784,526 | ) |
|                                               |       |       |       |       |       |       |       |
| Weighted average  number of shares of common stock |       | 50,338,450 |       | 38,477,353 |       | 33,112,644 |       |
|                                               |       |       |       |       |       |       |       |
| Income (loss)  per common share                    |       | $          | (0.12      | )          | $          | (0.07      | )          | $ | (0.02 | ) |

 

Potentialdilutive securities (stock warrants, convertible debt) have not been consideredsince the Company reported a net loss and, accordingly, their effects would beanti-dilutive.

 

**Note E – Long-term debt:**

 

**October 2004 debt issue**

 

Onor about October 1, 2004, the Company closed a Securities Purchase Agreementand issued $2,635,000 in principal amount of 7% Senior Secured ConvertibleDebentures due September 30, 2009 (the “Debentures”), to a group ofinstitutional and high net worth investors. The Debentures were secured by thecollateral set forth in the Deed of Trust, Security Agreement, Assignment ofProduction and Fixture Filing attached to a Form 8-K filed October 12,2004. The Debentures paid an annual interest rate of 7% on a quarterly basisand were convertible into shares of our common stock at a price of $0.50 pershare. The Company had the option to pay the interest on the Debentures incommon stock. The proceeds of the Debentures were used for the acquisition ofinterests in oil and gas properties. The investors also received warrants topurchase an additional 2,635,000 shares of common stock with an exercise priceof $1.00 per share. During the fiscal year ended June 30, 2005, $705,000of debt was converted into 1,410,000 shares of common stock, and 145,137 sharesof common stock were issued in lieu of cash to pay interest. During the fiscalyear ended June 30, 2006, $450,000 of debt was converted into 900,000shares of common stock, and 40,805 shares of common stock were issued in lieuof cash to pay interest.

 

TheCompany allocated the proceeds from the issuance of the Debentures to thewarrants and the Debentures based on their relative fair market values at thedate of issuance. The value assigned to the warrants of $510,961 was recordedas an increase in additional paid in capital. The assignment of a value to thewarrants resulted in a loan discount being recorded for the same amount. Thediscount was being amortized over the original five year term of the Debenturesas additional interest expense. Amortization of the discount was $44,632 and$67,756, for the years ended June 30, 2006 and 2005, respectively. TheCompany also incurred loan costs of $264,300 on the issuance of the Debenturesand warrants. The amount allocable to the Debentures of $213,049 wascapitalized and was being amortized over the term of the Debentures.Amortization of loan costs was $18,612 and $28,258, for the years ended June 30,2006 and 2005, respectively.

 

Thedebentures were retired on February 6, 2006, with proceeds from a newsenior debt issue, as set forth below. In connection with this retirement, theCompany recorded a loss on extinguishment of debt in the amount of $660,330.Such amount includes the write-off of deferred loan costs ($99,204), thewrite-off of the remaining loan discount ($237,931), and a prepayment penaltyand associated legal fees ($323,195).

 

F-20

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**February 2006 debt issue**

 

OnFebruary 6, 2006, Cubic entered into a Credit Agreement with Petro CapitalV, L.P. (Petro Capital) pursuant to which Petro Capital advanced to the Company$5,500,000. The indebtedness bore interest at a rate of 12.5% per annum, was scheduledto mature on February 6, 2009, and was secured by substantially all of theassets of the Company. $1,800,000 of the funded amount was used to retire the7% Senior Secured Convertible Debentures that were due September 30, 2009,described above. In connection with the funding under the Credit Agreement, theCompany issued to Petro Capital and Petro Capital Securities, LLC, warrants,with five-year expirations, for the purchase of up to 1,833,334 and 250,000shares, respectively, of Company common stock at an exercise price of $1.00 pershare.

 

TheCompany allocated the proceeds from the issuance of the senior debt to thewarrants and the senior debt based on their relative fair market values at thedate of issuance. The value assigned to the warrants of $1,203,752 was recordedas an increase in additional paid in capital. The assignment of a value to thewarrants resulted in a loan discount being recorded. The discount was beingamortized over the original three-year term of the senior debt as additionalinterest expense. Amortization for the year ended June 30, 2007 was$298,371 and for the year ended June 30, 2006 was $174,451.

 

Cubicincurred loan costs of $483,643 on the issuance of the senior debt andwarrants. The amount allocable to the senior debt of $367,586 was capitalizedand was being amortized over the term of the senior debt. Amortization of loancosts for the senior debt was $83,101 for the year ended June 30, 2007 andwas $48,587 for the year ended June 30, 2006.

 

Thesenior debt was retired on March 5, 2007, with proceeds from a new seniordebt issue, as set forth below.  Inconnection with this retirement, the Company recorded a loss on extinguishmentof debt in the amount of $(1,082,887). Such amount includes the write-off of deferred loan costs ($235,898),and the write-off of the remaining loan discount ($846,989).

 

**March 2007 debt issue**

 

OnMarch 5, 2007, Cubic entered into a Credit Agreement with Wells FargoEnergy Capital, Inc. (“Wells Fargo”) providing for a revolving credit facilityof $20,000,000 and a convertible term loan of $5,000,000 (the “Credit Facility”).  The indebtedness bears interest at afluctuating rate equal to the sum of the Wells Fargo Bank prime rate plus twopercent (2%) per annum, matures on March 1, 2010, and is secured bysubstantially all of the assets of the Company. Approximately $5,000,000 of the funded amount was used, together withcash on hand, to retire the Company’s previously outstanding senior debt thatwas due February 6, 2009, described above.

 

Therevolving credit facility is subject to a borrowing base, initially set at$4,000,000, and is subject to periodic review. The convertible term loan of $5,000,000 is convertible into 5,000,000shares of Cubic common stock at a conversion price of $1.00 per share.

 

Inconnection with entering into the Credit Facility, the Company issued to WellsFargo warrants, with five-year expirations, for the purchase of up to 2,500,000shares of Company common stock at an exercise price of $1.00 per share.

 

F-21

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

TheCompany allocated the proceeds from the issuance of the debt to the warrants,the debt and net profits interest (see below) based on their relative fairmarket values at the date of issuance. The value assigned to the warrants of $1,314,289 was recorded as anincrease in additional paid in capital and the value assigned to the netprofits interest of $213,148 was recorded as a credit to the full cost pool foroil and gas properties.  The assignmentof a value to the warrants and net profit interest resulted in a loan discountbeing recorded.  The discount is being amortizedover the original three-year term of the debt as additional interestexpense.  Amortization for the year endedJune 30, 2007 was $164,961. Amortization for the years ending June 30,2008 and 2009 is expected to be $516,030, and $514,620, respectively.

 

Cubic incurred loan costsof $240,613 on the issuance of the debt and warrants.  The amount allocable to the debt of $166,590has been capitalized and is being amortized over the term of the debt.  Amortization for the year ended June 30,2007 was $17,865.  Amortization for theyears ending June 30, 2008 and 2009 is expected to be $55,886, and $55,733, respectively.

 

**Note F – Related party transactions:**

 

EffectiveJanuary 1, 2002, the Company entered into an agreement with Tauren thatprovides for the following:

 

1)As of January 1, 2002, the Company owed Tauren $856,712, primarilycomprised of non-interest bearing advances the Company had received over thecourse of several years. In exchange for the amounts owed to it, Taurenaccepted the transfer of 856,712 newly issued and unregistered shares of commonstock in the Company that had a market price of $.70 per share.

 

2)The Company received the rights to participate in prospective oil and gasprojects in which Tauren owns a working interest.

 

3)The Company shall, as requested, have the future privilege of using the generaland administrative services of Tauren based on an agreed pro rata cost.

 

4)The Company issued three series of warrants to Tauren as described in Note C.

 

OnDecember 1, 1997, as renewed and revised on January 1, 2002, theCompany entered into a contract with Tauren to provide the necessary technical,administrative and management expertise needed to conduct its business. Taurenalso paid various organization costs and consulting fees on behalf of theCompany.  The monthly amount charged tothe Company was based on actual costs of materials and labor hours of Taurenthat were used pursuant to the terms of the agreement. The agreement wasterminated effective January 1, 2006, except as to the office sharingprovisions, which were extended to June 30, 2006 and since continue on amonth to month basis.  The Company nowhas 11 employees and its offices are subleased from Tauren. During fiscal 2007,the Company’s only expense under the office sharing arrangement was the rentsublease.  Charges to the Company underthe contracts and subsequent arrangements were $26,748, $29,285 and $35,322 forthe years ended June 30, 2007, 2006, and 2005, respectively.

 

Anaffiliated company, Tauren, owns a working interest in the wells in which theCompany owns a working interest.  As of June 30,2007, the Company owed Tauren $3,715 for miscellaneous general andadministrative expenses paid by Tauren on the Company’s behalf; and, as of June 30,2006, the Company owed Tauren $100,000, for advances for payments of jointinterest leasehold and development costs. As of June 30, 2007 and 2006,The Company was owed by Tauren $0 and $12,685, respectively, for miscellaneousgeneral and administrative expenses paid by the Company on Tauren’s behalf.

 

F-22

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

Inaddition, the wells in which the Company owns a working interest are operatedby an affiliated company, Fossil Operating, Inc. (“Fossil”), which isowned 100% by the Company’s President and Chief Executive Officer, CalvinWallen III.  As of June 30, 2007 and2006, the Company owed Fossil $1,659,786 and $1,196,203, respectively, fordrilling costs and lease and operating expenses, and was owed by Fossil $28,446and $88,477, respectively, for oil and gas sales.

 

Onor about October 6, 2004, the Company acquired from Tauren and itsaffiliates, a 25% working interest in eight sections in Desoto Parish,Louisiana, in exchange for $1,080,000. The eight sections include Sections 24(excluding the Kraemer 24-1 well), 25 and 26 of Township 14 N, Range 16 W andSections 18, 19, 20, 29 and 30 of Township 14 N, Range 15 W.

 

Onor about January 11, 2005, the Company issued 1,531,661 shares of commonstock to Caravel Resources Energy Fund 2003-II, L.P. (the “Partnership”) inexchange for a 0.1914575033 working interest in the Kraemer 24-1 Well, DesotoParish, Township 14 N, Range 15 W, Section 24 (the “Well”).  The Company also issued 468,339 shares ofcommon stock to Mr. Wallen in exchange for a 0.0585424967 working interestin the Well.  The common stock closed ata price of $0.90 on January 10, 2005.

 

OnFebruary 6, 2006, the Company entered into a Purchase Agreement withTauren Exploration, Inc., an entity wholly owned by Calvin Wallen III, theCompany’s Chairman of the Board and Chief Executive Officer, with respect tothe purchase by the Company of certain Cotton Valley leasehold interests(approximately 11,000 gross acres; 5,000 net acres) held by Tauren. Pursuant tothe Purchase Agreement, the Company acquired from Tauren a 35% working interestin approximately 2,400 acres and a 49% working interest in approximately 8,500acres located in DeSoto and Caddo Parishes, Louisiana, along with an associatedArea of Mutual Interest (“AMI”) and the right to acquire at “cost” (as definedin the Purchase Agreement) a seventy percent (70%) working interest in alladditional mineral leases obtained by Tauren in the AMI, in exchange for (a) $3,500,000in cash, (b) 2,500,000 unregistered shares of Company common stock, (c) anunsecured 12.5% promissory note in the amount of $1,300,000, which note wasconvertible into Company common stock at a conversion price of $0.80 per share(the “Tauren Note”), and (d) a drilling credit of $2,100,000. Totalinterest paid to Tauren under terms of the Tauren Note was $96,610 in fiscal2007 and $64,110 in fiscal 2006.  Theconsideration described above was determined based upon negotiations betweenTauren and a Special Committee of the Company’s directors, excluding Mr. Wallen.The Special Committee obtained an opinion from its independent financialadvisor with respect to the fairness, from a financial point of view, to thepublic stockholders of the Company, of such transactions.

 

OnNovember 10, 2006, the maturity of the Tauren Note was extended to October 5,2007.  In connection with the extensionof the Tauren Note, the Company issued to Tauren warrants, with three-yearexpirations, for the purchase of up to 50,000 shares of Company common stock atan exercise price of $0.70 per share.

 

OnFebruary 2, 2007, the Tauren Note was retired pursuant to a provision inthe note that required payment from the proceeds of an equity offering. Theequity offering that occurred in December 2006 (see “Note C – Stockholders’Equity”) was sufficient to facilitate such repayment.

 

F-23

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**NoteG – Income taxes:**

 

Deferredtax assets and liabilities are computed by applying the effective U.S. federalincome tax rate to the gross amounts of temporary differences and other taxattributes.  Deferred tax assets andliabilities relating to state income taxes are not material.  In assessing the realizability of deferredtax assets, management considers whether it is more likely than not that someportion or all of the deferred tax assets will not be realized.  The ultimate realization of deferred taxassets is dependent upon the generation of future taxable income during theperiods in which those temporary differences become deductible.  Management considers the scheduled reversalof deferred tax liabilities, projected future taxable income, and tax planningstrategies in making this assessment.  Asof June 30, 2007 and 2006, the Company believed it was more likely thannot that future tax benefits from net operating loss carryforwards and otherdeferred tax assets would not be realizable through generation of futuretaxable income; therefore, they were fully reserved.

 

Thecomponents of the net deferred federal income tax assets (liabilities) at June 30were as follows:

 
| ** **                                                        | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                              |       |       |       |       |       |
| Deferred tax  assets:                                             |       |       |       |       |       |
| Net operating  loss carryforwards                                 |       | $          | 4,013,000  |       | $          | 2,441,800 |   |
| Depletion basis  of assets and related accounts                   |       | 93,300     |       | —     |       |
|                                                              |       | $          | 4,106,300  |       | $          | 2,441,800 |   |
|                                                              |       |       |       |       |       |
| Deferred tax  liabilities:                                        |       |       |       |       |       |
| Depletion basis  of assets and related accounts                   |       | $          | (1,500     | )          | $          | (493,800 | ) |
|                                                              |       | $          | (1,500     | )          | $          | (493,800 | ) |
|                                                              |       |       |       |       |       |
| Net deferred tax  (liabilities) assets before valuation allowance |       | $          | 4,104,800  |       | $          | 1,948,000 |   |
| Valuation  allowance                                              |       | (4,104,800 | )          | (1,948,000 | )          |
| Net deferred tax  (liabilities) assets                            |       | $          | —     |       | $          | — |   |

 

Thefollowing table summarizes the difference between the actual tax provision andthe amounts obtained by applying the statutory tax rates to the income or lossbefore income taxes for the years ended June 30, 2007, 2006 and 2005:

 
| ** **                                      | ** ** | **2007**  | ** ** | **2006** | ** ** | **2005**  | ** ** |
|-------------------------------------------------|------------|-----------|------------|----------|------------|-----------|------------|
| Tax (benefit)  calculated at statutory rate     |       | $         | (1,450,000 | )        | $          | (692,000  | )          | $ | (197,000 | ) |
| Losses not  providing tax benefits              |       | 1,450,000 |       | 692,000  |       | 197,000   |       |
| Current federal  income tax provision (benefit) |       | $         | —     |     | $          | —    |       | $ | — |   |
| Change in  valuation allowance                  |       | $         | (2,156,800 | )        | $          | 1,346,200 |       | $ | 137,800 |   |

 

F-24

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

Asof June 30, 2007, the Company had net operating loss carryforwards ofapproximately $16,034,600, which are available to reduce future taxableincome.  These carryforwards expire asfollows:

 
| ** ** | ** ** | **Net operating** | ** ** |
|------------|------------|------------------------|------------|
| **Year**   | ** ** | **losses**             | ** ** |
| 2009       |       | $                      | 5,700      |   |
| 2011       |       | 431,100                |       |
| 2012       |       | 205,100                |       |
| 2013       |       | 639,800                |       |
| 2019       |       | 845,600                |       |
| 2020       |       | 297,100                |       |
| 2021       |       | 172,100                |       |
| 2022       |       | 15,400                 |       |
| 2023       |       | 571,900                |       |
| 2024       |       | 37,000                 |       |
| 2025       |       | 1,321,800              |       |
| 2026       |       | 5,095,600              |       |
| 2027       |       | 6,413,700              |       |
|       |       | $                      | 16,051,900 |   |

 

**Note H – Commitments and contingencies:**

 

**Key personnel**

 

TheCompany depends to a large extent on the services of Calvin A. Wallen III, theCompany’s President, Chairman of the Board, and Chief Executive Officer.  The loss of the services of Mr. Wallenwould have a material adverse effect on the Company’s operations. The Companyhas not entered into any employment contracts with any of its executiveofficers.

 

**Environmental matters**

 

TheCompany’s operations and properties are subject to extensive and changingfederal, state, provincial and local laws and regulations relating toenvironmental protection, including the generation, storage, handling andtransportation of oil and gas and the discharge of materials into the environment.  The Company generates typical oil and gasfield wastes, including hazardous wastes that are subject to the federalResources Conservation and Recovery Act and comparable state statutes.  Furthermore, certain wastes generated by theCompany’s oil and gas operations that are currently exempt from regulation as “hazardouswastes” may in the future be designated as “hazardous wastes” and therefore besubject to more rigorous and costly operating and disposal requirements.  All of the Company’s properties are operatedby third parties over whom the Company has limited control.  In addition to the Company’s lack of controlover properties operated by others, the failure of previous owners or operatorsto comply with applicable environmental regulations may, in certaincircumstances, adversely impact the Company.

 

F-25

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**Litigation matters**

 

TheCompany had filed suit in the 29th Judicial District Court in Palo PintoCounty, Texas, styled “Roseland Oil and Gas, Inc. v. William Vandever, etal,” bringing suit against Clifford Kees, William Vandever and various persons,seeking a judicial determination that all grants of preferential rights in theReagan Section 11 and 12 are void. This lawsuit was filed on April 26, 1999.  All section 11 preferential rights werereturned to the Company on or about January 2002.  However, Clifford Kees was to retain his 1%override interest in these Reagan Lease Sections.  Clifford Kees then moved to trial on theclaim of attorney fees owed to him for the prosecution of this lawsuit.  The trial was heard on September 25,2002, with Kees requesting in excess of $200,000 in attorney fees andcosts.  In June 2003, the Courtre-opened the trial as to attorney fees and costs, to allow Kees to put onadditional evidence, and such trial was re-convened on June 19, 2003.  On July 15, 2003, the Court entered ajudgment in favor of Kees and against the Company for approximately$112,000.  The Company appealed thejudgment.  On or about, September 17,2004, the Eastland Court of Appeals issued its ruling, modifying the amountsowed by the Company under the judgment to $59,000.  The Company was been denied a re-hearing asto clarification and a further reduction of the judgment.  The Company filed a petition for review withthe Texas Supreme Court that was denied on or about January 21, 2005.

 

TheCompany had put into the registry of the court a cash bond in the amount of$92,500.  On or about March 14,2005, the trial court issued a final ruling which ordered Cubic to pay out toKees $83,726 of the monies in the registry of the court, with $8,774 of the moniesin the registry of the court refunded to Cubic.

 

**NoteI - Cost of oil and gas properties:**

 

**Costs incurred**

 

Costs(capitalized and expensed) incurred in oil and gas property acquisition,exploration, and development activities for the years ended June 30, 2007,2006 and 2005 were as follows:

 
| ** **             | ** ** | **2007**  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Property  acquisitions |       | $         | 481,229    |      | $          | 6,176,766 |       | $ | 2,880,000 |   |
| Exploration            |       | 2,759,794 |       | 808,678   |       | 733,946   |       |
| Development            |       | 966,879   |       | 1,323,243 |       | —    |       |
|                   |       | $         | 4,207,902  |      | $          | 8,308,687 |       | $ | 3,613,946 |   |

 

F-26

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**Capitalized costs**

 

Theaggregate amounts of capitalized costs relating to oil and gas producingactivities and the aggregate amounts of the related accumulated depreciation,depletion, and amortization at June 30, 2007, 2006 and 2005 were asfollows:

** **
| ** **                                                                | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|---------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Proved  properties                                                        |       | $          | 10,627,672 |       | $          | 6,679,730  |       | $ | 4,098,571 |   |
| Unproved  properties                                                      |       | 6,827,341  |       | 6,780,529  |       | 1,053,000  |       |
|                                                                      |       | 17,455,013 |       | 13,460,259 |       | 5,151,571  |       |
|                                                                      |       |       |       |       |       |       |       |
| Less:  Accumulated depreciation, depletion and amortization               |       | 2,007,080  |       | 1,646,170  |       | 1,468,106  |       |
| Total properties                                                          |       | 15,447,933 |       | 11,814,089 |       | 3,683,465  |       |
|                                                                      |       |       |       |       |       |       |       |
| Less: impairment  of oil and gas properties due to full cost ceiling test |       | 1,790,882  |       | —     |       | —     |       |
| Net properties                                                            |       | $          | 13,657,051 |       | $          | 11,814,089 |       | $ | 3,683,465 |   |

 

**Results of operations**

 

Theresults of operations from oil and gas producing activities for the years endedJune 30, 2007, 2006 and 2005 were as follows:

 
| ** **                                                                 | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenues:                                                                  |       |     |       |     |       |     |       |
| Revenues                                                                   |       | $        | 583,416    |     | $          | 508,925  |       | $ | 469,441 |   |
| Preferred return                                                           |       | —   |       | —   |       | —   |       |
|                                                                       |       | 583,416  |       | 508,925  |       | 469,441  |       |
|                                                                       |       |     |       |     |       |     |       |
| Expenses  (excluding G&A and interest expense):                        |       |     |       |     |       |     |       |
| Production and  development costs                                          |       | 481,145  |       | 338,329  |       | 273,074  |       |
| Depreciation,  depletion and amortization                                  |       | 360,910  |       | 178,064  |       | 364,496  |       |
|                                                                       |       | 842,055  |       | 516,393  |       | 637,570  |       |
| Results before  income taxes                                               |       | (258,639 | )          | (7,468   | )          | (168,129 | )          |
| Provision for  income taxes                                                |       | —   |       | —   |       | —   |       |
| Results of  operations (excluding corporate overhead and interest expense) |       | $        | (258,639   | )        | $          | (7,468   | )          | $ | (168,129 | ) |

 

F-27

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**Note J - Oil and gas reserves information (unaudited):**

 

Theestimates of proved oil and gas reserves utilized in the preparation of thefinancial statements are estimated in accordance with guidelines established bythe Securities and Exchange Commission and the FASB, which require that reserveestimates be prepared under existing economic and operating conditions with noprovision for price and cost escalations over prices and costs existing atyear-end except by contractual arrangements.

 

TheCompany emphasizes that reserve estimates are inherently imprecise.  Accordingly, the estimates are expected tochange as more current information becomes available.  The Company’s policy is to amortizecapitalized oil and gas costs on the unit of production method, based uponthese reserve estimates.  It isreasonably possible that, because of changes in market conditions or theinherent imprecision of these reserve estimates, that the estimates of futurecash inflows, future gross revenues, the amount of oil and gas reserves, theremaining estimated lives of the oil and gas properties, or any combination ofthe above may be increased or reduced in the near term.

 

Ifreduced, the carrying amount of capitalized oil and gas properties may bereduced materially in the near term.

 

Thefollowing unaudited table sets forth proved oil and gas reserves, all withinthe United States, at June 30, 2007, 2006 and 2005 together with thechanges therein:

 
| ** **                                  | ** ** | **Natural Gas (Mcf)** |
|---------------------------------------------|------------|---------------------------------|
| ** **                                  | ** ** | **2007**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Proved developed  and undeveloped reserves: |       |                            |   |   |   |   |   |
| Beginning of  year                          |       | 2,796,900                       |   | 509,625 |   | 311,098 |   |
| Revisions of  previous estimates            |       | (1,188,985                      | ) | 226,730 |   | — |   |
| Purchases of  reserves in place             |       | —                          |   | — |   | 269,308 |   |
| Extensions and  discoveries                 |       | 2,704,548                       |   | 2,114,061 |   | — |   |
| Less: Production                            |       | (70,412                         | ) | (53,516 | ) | (70,781 | ) |
| Disposals of  reserves in place             |       | —                          |   | — |   | — |   |
| End of year                                 |       | 4,242,051                       |   | 2,796,900 |   | 509,625 |   |

 
| ** **                                  | ** ** | **Oil and condensate (Bbls)** | ** ** |
|---------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| Proved developed  and undeveloped reserves: |       |                                         |       |   |   |   |   |
| Beginning of  year                          |       | 8,863                                        |       | 1,048 |   | — |   |
| Revisions of  previous estimates            |       | (2,437                                       | )          | 1,029 |   | 1,194 |   |
| Purchases of  reserves in place             |       | —                                       |       | — |   | 14 |   |
| Extensions and  discoveries                 |       | 7,371                                        |       | 7,833 |   | 346 |   |
| Less: Production                            |       | (967                                         | )          | (1,047 | ) | (506 | ) |
| Disposals of  reserves in place             |       | —                                       |       | — |   | — |   |
| End of year                                 |       | 12,830                                       |       | 8,863 |   | 1,048 |   |

 

F-28

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

The“Revisions of previous estimates” amount of (1,188,985) Mcf was due to moreperformance information being available for the fiscal 2007 reserve report anda change in our estimation procedure. In fiscal 2006, reserves were based onanalogy to the Taylor Alt-2 well, a comparable well located in Section 22in T14N-R16W, which is adjacent to the Company’s Bethany Longstreet acreage.The initial rate was based on the ratio of hydrocarbon pore volume (“HPCV”)calculated from the well logs of Cubic wells awaiting completion and the TaylorAlt-2 well. This ratio was then multiplied by the initial rate of the TaylorAlt-2 well. The Calculated Initial Rate for each Cubic well was capped at theinitial rate of the Taylor Alt-2 well.

 

Forthe fiscal 2007 report, more information was available. Several of the wells orzones that were previously categorized as “behind pipe” were now producing andhad initial potential tests giving a better indication of initial productionrates. These better defined, and lower, initial production rates were combinedwith typical declines for each formation (the Cotton Valley and the Hosston) inthe field and overall reserves were cut off using volumetric analysis. Theseinitial production rates were lower than initially expected (i.e., at the timeof the fiscal 2006 reserve report).

 

Basedon these updated performance rates, downward revisions of an aggregate of369,087 Mcf were made to the Proved Developed reserves of the Moseley 25-1 andMoseley 26-1 wells and downward revisions of an aggregate of 1,079,274 Mcf weremade to these wells’ Proved Undeveloped (“PUD”) offset locations. Thesedownward revisions were partially offset by upward revisions of an aggregate of196,010 Mcf to the Kraemer 24-1, S.E. Johnson 20-1 and S.E. Johnson 29-1 wellsresulting from completions in the Hosston zone.

 

The“Extensions and discoveries” amount of 2,704,548 Mcf is a result ofdevelopmental, or “step out”, drilling in fiscal 2007. This drilling, coupledwith the proving up of the Hosston formation as a result of the drilling andcompletion of the Company’s S.E. Johnson 20-1 and S.E. Johnson 29-1 wells(which were non-proved as of June 30, 2006) and recompletion of theKraemer 24-1 well, lead to additional PUD offset locations. The reserveestimates attributable to these new PUD locations are listed under “Extensionsand discoveries.”

 

**Standardized measure of discounted future net cash flows relating toproved reserves:**

 

Thestandardized measure of discounted future net cash flows was calculated byapplying current year-end prices, considering fixed and determinable pricechanges only to the extent provided by contractual arrangements or law, toestimated future production, less future expenditures (based on fiscal year-endcosts) to be incurred in developing proved undeveloped and proved producing oiland gas reserves, and future income taxes. The resulting future net cash flows were discounted using a rate of 10%per annum (Table 1).  The standardizedmeasure of discounted net cash flow amounts contained in the followingtabulation does not purport to represent the fair market value of the Company’soil and gas proved by drilling or production history.  There are significant uncertainties inherentin estimating timing and amount of future costs.  In addition, the method of valuationutilized, is based on current prices and costs and the use of a 10% discountrate, and is not necessarily appropriate for determining fair value (Table 2).

 

F-29

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Table of Contents

 

**CUBIC ENERGY, INC.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

Thefollowing is the estimated standardized measure relating to proved oil and gasreserves at June 30, 2007, 2006 and 2005:

 

**Table 1**

 
| ** **                                                          | ** ** | **2007**    | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|---------------------------------------------------------------------|------------|-------------|------------|------------|------------|------------|------------|
| Future cash  flows                                                  |       | $           | 30,768,518 |       | $          | 16,139,781 |       | $ | 3,443,400 |   |
| Future  production costs                                            |       | (5,601,924  | )          | (2,975,063 | )          | (1,303,300 | )          |
| Future  development costs                                           |       | (11,832,100 | )          | (3,453,350 | )          | (23,900    | )          |
| Future severance  tax expense                                       |       | (1,713,562  | )          | (819,785   | )          | (213,900   | )          |
| Future income  taxes                                                |       | —      |       | —     |       | —     |       |
| Future net cash  flows                                              |       | $           | 11,620,932 |       | $          | 8,891,583  |       | $ | 1,902,300 |   |
| Ten percent  annual discount for estimated timing of net cash flows |       | (4,791,222  | )          | (2,444,198 | )          | (831,200   | )          |
| Standardized  measure of discounted future net cash flows           |       | $           | 6,829,710  |       | $          | 6,447,385  |       | $ | 1,071,100 |   |

 

Thefollowing is an analysis of changes in the estimated standardized measure ofproved reserves during the years ended June 30, 2007, 2006 and 2005:

 

**Table 2**

 
| ** **                                                        | ** ** | **2007**   | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|
| Changes from  sale of oil and gas produced                        |       | $          | (102,271   | )         | $          | (170,596  | )          | $ | (196,368 | ) |
| Net changes in  prices and production costs                       |       | 1,474,742  |       | 18,591    |       | (165,199  | )          |
| Extensions and  discoveries                                       |       | 4,073,195  |       | 4,288,891 |       | 493,500   |       |
| Revision of  previous quantity estimates                          |       | (4,559,850 | )          | 508,762   |       | (42,290   | )          |
| Accretion of  discounts                                           |       | 644,739    |       | 107,110   |       | 73,191    |       |
| Net change in  income taxes                                       |       | —     |       | —    |       | —    |       |
| Purchases of  reserves in place                                   |       | —     |       | —    |       | 197,300   |       |
| Disposals of  reserves in place                                   |       | —     |       | —    |       | —    |       |
| Development  costs incurred that reduced future development costs |       | (339,500   | )          | (11,300   | )          | —    |       |
| Changes in  future development costs                              |       | 324,717    |       | 69,210    |       | —    |       |
| Other                                                             |       | (1,133,447 | )          | 565,617   |       | (20,947   | )          |
| Change in  standardized measure                                   |       | $          | 382,325    |      | $          | 5,376,285 |       | $ | 339,187 |   |

 

**Note K – Subsequent events:**

 

On August 27, 2007, twowarrant holders of the Company exercised warrants for an aggregate of 200,000shares of Company common stock, through the payment of $100,000 to theCompany.  On September 17, 2007, onewarrant holder of the Company exercised warrants for 25,000 shares of Companycommon stock, through the payment of $17,500 to the Company.

 

On September 7, 2007,Wells Fargo increased the Company’s borrowing base to $8,600,000 under therevolving line of credit component of the Credit Facility in order to fund thedrilling of new wells.

 

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