UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





xQuarterly Report Pursuant to Section
13 or 15(d) of the Securities Exchange Act of 1934





For the quarterly period ended
June 30,
2009 or





oTransition Report Pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934





For
the transition period from _____________ to _____________





Commission
file number 001-33777








SOUTH
TEXAS OIL COMPANY


(Exact
Name of Registrant as Specified in its Charter)





Nevada
            
            74-2949620(State
      or Other Jurisdiction of
            
            (I.R.S.
      EmployerIncorporation
      or Organization)
            
            Identification
      No.)





300
East Sonterra Boulevard, Suite 1220


San
Antonio, Texas


(Address
of Principal Executive Offices)


78258


(Zip
Code)





(210)
545-5994


(Registrant’s
Telephone Number, Including Area Code)





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





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





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





Large
      accelerated filer o
            Accelerated
      filer oNon-accelerated
      filer o
            Smaller
      reporting company x





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





The
issuer had 22,647,075 shares of common stock outstanding as of August 12,
2009.










TABLE OF
CONTENTS




PagePART
      I - FINANCIAL INFORMATIONItem
      1. Financial Statements (Unaudited)
            
            1Consolidated
      Balance Sheets as of June 30, 2009 and December 31, 2008
            
            2Consolidated
      Statements of Operations for the Three and Six Months Ended June 30, 2009
      and 2008
            
            3Consolidated
      Statements of Stockholders’ Equity for the Six Months Ended June 30,
      2009
            
            4Consolidated
      Statements of Cash Flows for the Six Months Ended June 30, 2009 and
      2008
            
            5Notes
      to Consolidated Financial Statements
            
            6Item
      2. Management's Discussion and Analysis of Financial Condition and Results
      of Operations
            
            13Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk
            
            24Item
      4T. Controls and Procedures
            
            24PART
      II - OTHER INFORMATION
            
            25Item
      1. Legal Proceedings
            
            25Item
      1A.  Risk Factors
            
            25Item
      2.  Unregistered Sales of Equity Securities and Use of
      Proceeds
            
            26Item
      3.  Defaults Upon Senior Securities
            
            26Item
      4.  Submission of Matters to a Vote of Security
      Holders
            
            26Item
      5.  Other Information
            
            26Item
      6. Exhibits
            
            27









PART I.   FINANCIAL INFORMATION





Item
1. Financial Statements.





The
consolidated financial statements of South Texas Oil Company (the “Company” or
“we”, “us” or “our”) included herein have been prepared in accordance with the
instructions to quarterly reports for a smaller reporting company, as defined in
Exchange Act Rule 12b-2, on Form 10-Q pursuant to the rules and regulations of
the United States Securities and Exchange Commission (the
“SEC”).  Certain information and footnote data necessary for fair
presentation of financial position and results of operations in conformity with
accounting principles generally accepted in the United States of America
(“GAAP”) have been condensed or omitted.  We suggest that these
financial statements be read in conjunction with the summary of significant
accounting policies and notes to financial statements included in our Annual
Report on


Form 10-K
for the year ended December 31, 2008.





In the
opinion of management, all adjustments necessary in order to make our financial
position, results of operations and changes in financial position at June 30,
2009, and for all periods presented, not misleading, have been
made.  The results of operations for the three and six months ended
June 30, 2009 are not necessarily indicative of the Company’s actual operating
results for the full year ending December 31, 2009.




1





SOUTH TEXAS OIL COMPANYConsolidated
      Balance Sheets




June
      30,
              2009
            
            
            December
      31,
              2008(Unaudited)
            
            
            (Audited)ASSETSCurrent
      AssetsCash
      and equivalents
            
            $
            1,444,342
            
            
            $
            4,254,642Accounts
      receivable
            
            
            1,170,036
            
            
            
            3,084,498Prepaid
      expenses and other
            
            
            368,673
            
            
            
            279,574Assets
      held for sale
            
            
            1,168,375
            
            
            
            9,520,109Total
      current assets
            
            
            4,151,426
            
            
            
            17,138,823Property
      and Equipment:Oil
      and gas properties, successful efforts methodProved
      properties
            
            
            49,648,172
            
            
            
            49,489,536Unproved
      properties
            
            
            4,957,530
            
            
            
            5,868,754Less
      accumulated depreciation, depletion and amortization
            
            
            (10,638,328
            )
            
            
            (9,656,545
            )Total
      oil and gas properties, net
            
            
            43,967,374
            
            
            
            45,701,745Other
      property and equipmentDrilling
      equipment
            
            
            -
            
            
            
            1,300,000Vehicles
            
            
            271,412
            
            
            
            288,632Other
            
            
            189,811
            
            
            
            189,811Less
      accumulated depreciation and amortization
            
            
            (111,163
            )
            
            
            (173,522
            )Total
      other property and equipment, net
            
            
            350,060
            
            
            
            1,604,921Total
      property and equipment, net
            
            
            44,317,434
            
            
            
            47,306,666Debt
      issuance costs, net of amortization
            
            
            604,541
            
            
            
            3,456,094Total
      Assets
            
            $
            49,073,401
            
            
            $
            67,901,583LIABILITIES
      AND SHAREHOLDER'S EQUITYCurrent
      LiabilitiesAccounts
      payable, trade
            
            $
            6,613,737
            
            
            $
            7,628,453Other
      payables and accrued liabilities
            
            
            1,068,287
            
            
            
            1,598,994Participant
      advances received
            
            
            73,203
            
            
            
            69,313Current
      maturities of notes payable and long-term debt
            
            
            16,805,721
            
            
            
            17,146,710Current
      maturities of notes payable and long-term debt, related
    party
            
            
            -
            
            
            
            25,325,341Current
      portion of deferred liability
            
            
            1,500,000
            
            
            
            1,000,000Total
      current liabilities
            
            
            26,060,948
            
            
            
            52,768,811Noncurrent
      LiabilitiesNotes
      payable and long-term debt
            
            
            928,227
            
            
            
            727,128Asset
      retirement obligation, net of current portion
            
            
            908,746
            
            
            
            948,821Deferred
      liability, net of current portion
            
            
            -
            
            
            
            500,000Total
      noncurrent liabilities
            
            
            1,836,973
            
            
            
            2,175,949Stockholders'
      EquityPreferred
      stock, $0.001 par value, 5,000,000 sharesauthorized,
      1,755,325 issued or outstanding
            
            
            16,215,009
            
            
            
            -Common
      stock, $0.001 par value, 200,000,000 shares authorized,23,255.408
      shares issued, 22,247,075 shares outstanding (2009)and
      17,738,862 shares issued, 16,730,529 shares outstanding
    (2008)
            
            
            23,256
            
            
            
            17,740Additional
      paid-in capital
            
            
            46,991,514
            
            
            
            44,321,215Accumulated
      deficit
            
            
            (39,152,289
            )
            
            
            (28,480,122
            )Less
      treasury stock, at cost, 1,008,333 shares
            
            
            (2,902,010
            )
            
            
            (2,902,010
            )Total
      stockholders' equity
            
            
            21,175,480
            
            
            
            12,956,823Total
      Liabilities and Stockholders' Equity
            
            $
            49,073,401
            
            
            $
            67,901,583See
      notes to consolidated financial statements.




2


SOUTH
TEXAS OIL COMPANY
 Consolidated
Statements of Operations
 (Unaudited)
 
 Three
      Months
                Ended
      June 30,
                2009
              
              
              Three
      Months
                Ended
      June 30,
                2008
              
              
              Six
      Months
                Ended
      June 30,
                2009
              
              
              Six
      Months
                Ended
      June 30,
                2008RevenuesOil
      and gas sales
              
              $
              774,231
              
              
              $
              3,846,610
              
              
              $
              1,386,825
              
              
              $
              5,724,245Total
      revenues
              
              
              774,231
              
              
              
              3,846,610
              
              
              
              1,386,825
              
              
              
              5,724,245Costs
      and ExpensesProduction
      expenses
              
              
              509,597
              
              
              
              1,014,589
              
              
              
              982,491
              
              
              
              1,722,854Production
      taxes
              
              
              33,772
              
              
              
              118,867
              
              
              
              62,919
              
              
              
              203,667General
      and administrative expenses
              
              
              1,430,017
              
              
              
              1,843,693
              
              
              
              4,159,593
              
              
              
              3,087,758Exploration
      expense
              
              
              1,478,273
              
              
              
              -
              
              
              
              1,711,072
              
              
              
              -Depreciation,
      depletion and amortization
              
              
              586,003
              
              
              
              1,554,667
              
              
              
              1,249,127
              
              
              
              2,639,035Total
      costs and expenses
              
              
              4,037,662
              
              
              
              4,531,816
              
              
              
              8,165,202
              
              
              
              7,653,314Loss
      from Operations
              
              
              (3,263,431
              )
              
              
              (685,206
              )
              
              
              (6,778,377
              )
              
              
              (1,929,069
              )Other
      Income (Expense)Interest
      income
              
              
              1,349
              
              
              
              3,572
              
              
              
              3,075
              
              
              
              7,946Loss
      from derivatives
              
              
              -
              
              
              
              (4,306,038
              )
              
              
              -
              
              
              
              (5,356,038
              )Interest
      expense
              
              
              (1,071,027
              )
              
              
              (1,171,706
              )
              
              
              (2,476,106
              )
              
              
              (1,608,769
              )Debt
      issuance costs amortization
              
              
              (643,853
              )
              
              
              (635,793
              )
              
              
              (1,513,310
              )
              
              
              (1,271,586
              )Gain
      on sale of assets, net
              
              
              217,551
              
              
              
              -
              
              
              
              217,551
              
              
              
              -Loss
      on extinguishment of debt
              
              
              (125,000
              )
              
              
              -
              
              
              
              (125,000
              )
              
              
              -Other
      income (expense), net
              
              
              (1,620,980
              )
              
              
              (6,109,965
              )
              
              
              (3,893,790
              )
              
              
              (8,228,447
              )Net
      Loss Before Tax
              
              
              (4,884,411
              )
              
              
              (6,795,171
              )
              
              
              (10,672,167
              )
              
              
              (10,157,516
              )Income
      tax expense (benefit)
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Net
      Loss
              
              $
              (4,884,411
              )
              
              $
              (6,795,171
              )
              
              $
              (10,672,167
              )
              
              $
              (10,157,516
              )Loss
      Per Common Share:Basic
      and Diluted
              
              $
              (0.28
              )
              
              $
              (0.42
              )
              
              $
              (0.63
              )
              
              $
              (0.63
              )Weighted
      average number of commonshares
      outstanding:Basic
      and Diluted
              
              
              17,244,423
              
              
              
              16,017,736
              
              
              
              16,986,245
              
              
              
              16,250,153
  See
notes to consolidated financial statements.
  3
  SOUTH
TEXAS OIL COMPANY
 Consolidated
Statements of Stockholders' Equity
 (Unaudited)
  Common
      Stock
                        
                        
                        Series
      A Convertible
                          Preferred
      Stock
                        
                        
                        Additional
                          Paid-In
                        
                        
                        Accumulated
                        
                        
                        Treasury
                        
                        
                        Total
                          Stockholders'Shares
                        
                        
                        Amount
                        
                        
                        Shares
                        
                        
                        Amount
                        
                        
                        Capital
                        
                        
                        Deficit
                        
                        
                        Stock
                        
                        
                        EquityBalance,
      December 31, 2008
                        
                        
                        16,730,529
                        
                        
                        $
                        17,740
                        
                        
                        
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        44,321,215
                        
                        
                        $
                        (28,480,122
                        )
                        
                        $
                        (2,902,010
                        )
                        
                        $
                        12,956,823Stock
      grants
                        
                        
                        62,000
                        
                        
                        
                        61
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        255,639
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        255,700Non-cash
      stock compensation
                        
                        
                        5,454,546
                        
                        
                        
                        5,455
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,927,434
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,932,889Warrants
      issued for the
                            purchase
      of555,000
                            shares of common
      stock
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        154,813
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        154,813Beneficial
      common stock conversion featureof debt issued
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        332,413
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        332,413Series
      A convertible preferred shares issued
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,755,325
                        
                        
                        
                        16,215,009
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        16,215,009Net
      loss for the six months
                            endedJune 30, 2009
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (10,672,167
                        )
                        
                        
                        -
                        
                        
                        
                        (10,672,167
                        )Balance,
      June 30, 2009
                        
                        
                        22,247,075
                        
                        
                        $
                        23,256
                        
                        
                        
                        1,755,325
                        
                        
                        $
                        16,215,009
                        
                        
                        $
                        46,991,514
                        
                        
                        $
                        (39,152,289
                        )
                        
                        $
                        (2,902,010
                        )
                        
                        $
                        21,175,480
  See
notes to consolidated financial statements.
 
 4
 SOUTH
TEXAS OIL COMPANY
 Consolidated
Statements of Cash Flows
 (Unaudited)
  Six
      Months
                  Ended
                  June
      30, 2009
                
                
                SixMonths
                  Ended
                  June
      30, 2008Operating
      ActivitiesNet
      loss
                
                $
                (10,672,167
                )
                
                $
                (10,157,516
                )Adjustments
      to reconcile net loss tonet
      cash used in operating activities:Derivative
      loss and revenue reduction
                
                
                -Depreciation,
      depletion and amortization
                
                
                1,249,127
                
                
                
                2,639,035Debt
      issuance costs amortization
                
                
                1,513,310
                
                
                
                1,271,585Amortization
      of deferred stock compensation
                
                
                1,932,889
                
                
                
                374,234Amortization
      of debt discount
                
                
                207,210
                
                
                
                185,272Compensatory
      common stock and option issuances
                
                
                255,700
                
                
                
                -Accretion
      of discount on asset retirement obligation
                
                
                36,813
                
                
                
                -Prior
      year drilling in progress charged to exploration expense
                
                
                1,401,678
                
                
                
                -(Gain)
      loss on sale of other property and equipment
                
                
                (217,551
                )
                
                
                1,162Changes
      in operating assets and liabilities:Accounts
      receivable
                
                
                1,914,462
                
                
                
                2,685,008Prepaid
      expenses and other
                
                
                (89,099
                )
                
                
                (116,353
                )Accounts
      payable and accrued liabilities
                
                
                482,488
                
                
                
                624,030Participant
      advances received
                
                
                3,890
                
                
                
                2,317,135Net
      cash used in operating activities
                
                
                (1,981,250
                )
                
                
                (176,408
                )Investing
      ActivitiesPurchases
      and development of oil and gas properties
                
                
                (1,051,175
                )
                
                
                (4,920,174
                )Proceeds
      from disposition of other property and equipment
                
                
                82,000
                
                
                
                83,182Purchase
      of other property and equipment
                
                
                -
                
                
                
                (216,443
                )Net
      cash used in investing activities
                
                
                (969,175
                )
                
                
                (5,053,435
                )Financing
      ActivitiesProceeds
      from notes payable and long-term debt
                
                
                555,000
                
                
                
                12,020,313Payments
      of notes payable and long-term debt
                
                
                (414,875
                )
                
                
                (3,189,596
                )Payments
      of related party notes payable
                
                
                -
                
                
                
                (7,655
                )Purchase
      of treasury shares
                
                
                -
                
                
                
                (902,010
                )Net
      cash provided by financing activities
                
                
                140,125
                
                
                
                7,921,052Net
      Increase (Decrease) in Cash and Equivalents
                
                
                (2,810,300
                )
                
                
                2,691,209Cash
      and equivalents at beginning of period
                
                
                4,254,642
                
                
                
                2,186,428Cash
      and Equivalents at End of Period
                
                $
                1,444,342
                
                
                $
                4,877,637
  See
notes to consolidated financial statements.
  5
  Note
1 – Basis of Presentation
 
 The
accompanying unaudited consolidated financial statements report interim
information for South Texas Oil Company, a Nevada corporation, and its wholly
owned subsidiaries Southern Texas Oil Company, a Texas corporation, STO
Operating Company, a Texas corporation, STO Drilling Company, a Texas
corporation, and STO Properties LLC, a Texas limited liability company.
References to “the Company” indicate South Texas Oil Company or South Texas Oil
Company and its wholly owned subsidiaries.
 
 These
financial statements have been prepared in accordance with U.S. generally
accepted accounting principles (“GAAP”) for interim financial information and
with the instructions for Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by GAAP for complete financial statements. The accounting policies followed by
the Company are described in Note 2 to the audited consolidated financial
statements for the year ended December 31, 2008. These financial statements
should be read in conjunction with the Company’s Annual Report on Form 10-K for
the year ended December 31, 2008.
 
 Certain
reclassification entries have been reflected on the June 30, 2008 financial
statements to conform to the June 30, 2009 presentation.
 
 In the
opinion of management, all normal, recurring adjustments considered necessary
for the fair statement of the results for the interim period on a basis
consistent with the annual audited financial statements have been
included.
 
 Note
2 – Notes Payable and Long-Term Debt
 
 As of
June 30, 2009, the Company’s notes payable and long-term debt consisted of debt
issued pursuant to the Company’s credit facility with The Longview Fund, L.P.
(“Longview”) and Longview Marquis Master Fund, L.P. (“Marquis”) (the
“Longview/Marquis/Summerview Notes”), the Marquis/Summerview Senior Secured Debt
(as defined below), the June 2008 Convertible Notes (as defined below) and
various notes payable related to certain purchases of oil and gas properties and
other property and equipment.
 
 Longview/Marquis/Summerview
Notes
 
 As of
June 30, 2009, the Company had Longview/Marquis/Summerview Notes
outstanding in the principal amount of $9.0 million issued pursuant to its
$32.5 million credit facility with Longview and Marquis.
 
 The
Company originally obtained a credit facility from Longview in January
2007.  Certain terms of the facility were amended in September 2007,
in connection with which the Company agreed to grant to Longview a perpetual
overriding royalty interest in the oil and gas production of certain of the
Company’s properties.  Also in connection with the September 2007
amendment, the Company granted security and pledge agreements that provided
Longview with first priority security interests in substantially all of the
Company’s assets.  In April 2008, Marquis joined Longview as creditor,
and the credit facility was amended and restated in its entirety.  The
Company agreed to grant to Longview and Marquis certain mortgages in oil and gas
producing properties and a perpetual 2% overriding royalty interest in the oil
and gas production of all of the Company’s current and future interests in the
real property then owned by the Company.  In September 2008, in
connection with the Company’s issuance of the Senior Secured Notes described
below, Longview agreed to subordinate its security interests related to the
notes held by Longview to the senior security interests held by
Marquis.
 
 On
February 23, 2009, the Company announced a comprehensive debt restructuring and
related agreements with Longview.  The agreements with Longview
provided for the restructure of $26.1 million of debt (plus accrued interest)
through (i) the payment of $16.3 million in debt (plus accrued interest) held by
Longview in exchange for 1.6 million shares of the Company’s Series A
Convertible Preferred Stock (“Series A Preferred”) and (ii) a debt/non-core
asset exchange between the Company and Longview valued at $9.8
million.
 
 Upon the
effectiveness of stockholder approval and consent for the debt restructuring
transactions, on May 18, 2009, the Company issued to Longview 1,755,325 shares
of Series A Preferred in exchange for the surrender and cancellation of
$17,553,252 of Longview/Marquis/Summerview Notes held by Longview, which
included $1,220,852 for all unpaid interest accrued on the notes through the
closing date of the restructure transactions at the facility’s effective rate
for the period of 12.5%.  Each share of Series A Preferred has a
stated value equal to $10.00 per share, has no coupon rate, does not pay
dividends, and has no voting rights. The shares of Series A Preferred are
convertible into shares of our common stock at any time subsequent to 90 days
after the issuance of the shares at a conversion price of $0.50 per share of
common stock; however, the right to convert the Series A Preferred is subject to
Longview holding no more than 9.99% of the Company’s common stock at any one
time.
  6
 
 Also
effective May 18, 2009, the Company closed the sale to Longview of the Company’s
interest in Colorado DJ Basin oil and gas properties and a drilling rig and
associated assets for combined total proceeds of $9.8 million. On the closing
date, these assets were conveyed to Longview in exchange for Longview’s
discharge and satisfaction of $9.8 million in debt.  The Colorado
property disposition included approximately 217,000 Boe of proved reserves and
an estimated 18 Boe equivalent per day of net production.
 
 The debt
restructuring transactions in May 2009 resulted in the recognition of a $125,000
loss on the extinguishment of debt and a $356,947 gain on the sale of
assets.  The issuance of the Series A Preferred was recorded
at the fair market value of $16.2 million, estimated to be equivalent to
the value of the Longview/Marquis/Summerview Notes surrendered in exchange for
the issuance of the Series A Preferred, net of unamortized debt issuance costs
related to the Longview/Marquis/Summerview Notes exchanged.   The
loss recognized on the sale of the assets was the excess of the net book value
of the assets sold compared to the value of the debt satisfied by the sale of
the assets.  After these debt restructuring transactions, the Company
had no remaining note payable or related accrued interest payable balances with
Longview.
 
 On May
29, 2009, Marquis provided the Company with notice that Marquis had transferred
to Summerview Marquis Fund, L.P. (“Summerview”), an entity affiliated with
Marquis, 25% of  the Company’s Longview/Marquis/Summerview Notes held
by Marquis, 25% of the overriding royalty interests that had been assigned by
the Company to Marquis in connection with the original issuance of the
Longview/Marquis/Summerview Notes, and 25% of the outstanding warrants for the
purchase of shares of the Company’s common stock that were issued to Marquis in
connection with the Company’s original issuance of Longview/Marquis/Summerview
Notes.
 
 Concurrent
with the issuance of the June 2009 Convertible Notes described below, the
Company entered into Waiver and Amendment Agreements with Marquis and
Summerview, pursuant to which the parties amended and waived certain provisions
and covenants specified therein, including the increase in the annual interest
rate of the Longview/Marquis/Summerview Notes from 12.5% to 13%, an
amendment to the interest payment schedule requiring monthly, rather than
quarterly, interest payments, and the extension of the maturity date of the
Longview/Marquis/Summerview Notes from December 31, 2009 to March 31,
2010.  Additionally provided was a waiver to restrictive covenants
that would have otherwise impeded the Company’s ability to incur additional
debt.
 
 As of
June 30, 2009, the Company’s remaining total $9.0 million outstanding of
Longview/Marquis/Summerview Notes was comprised of $6,710,039 payable to Marquis
and $2,252,995 payable to Summerview.  Longview and Marquis have
informed the Company that no additional borrowings may be made pursuant to the
credit facility.
 
 Marquis/Summerview
Senior Secured Debt
 
 On
September 19, 2008, the Company entered into a Securities Purchase Agreement
with Marquis, pursuant to which on such date, among other things, the Company
issued and sold to Marquis a senior secured note in an original principal amount
of $7,000,000 (the “Marquis/Summerview Senior Secured Debt”), for gross proceeds
of $6,750,000, prior to the Company’s payment of expenses incurred by the
Company and Marquis in connection with the transactions under the Securities
Purchase Agreement. The Marquis/Summerview Senior Secured Debt was issued with
an interest rate of 12.5% per annum payable quarterly in cash and a maturity
date of September 2009, but was amended concurrently with the June 2009
Convertible Notes transaction described below to extend the maturity date to
March 31, 2010, and to increase the annual interest rate to 13.0% in order to be
consistent with the terms of the Longview/Marquis/Summerview Notes. Upon the
Company’s prepayment of all or any portion of the Marquis/Summerview Senior
Secured Debt or at maturity, Marquis has the option to convert up to 50% of the
principal (and interest relating thereto) to be paid by the Company on such date
of prepayment or maturity, into shares of the Company’s common stock at a
conversion rate of $4.00 per share (subject to adjustment for stock splits and
other events).
 
 Additionally,
the Company conveyed to Marquis a 1.0% perpetual overriding royalty interest in
the oil and gas production of all of the Company’s current and future interests
in the real property then owned by the Company. Pursuant to the terms of the
overriding royalty conveyance, the Company has the conditional option, beginning
on September 19, 2009 and terminating on September 19, 2010, to repurchase the
overriding royalty interests conveyed in exchange for a number of shares of the
Company’s common stock equal to the adjusted fair market value of the conveyed
overriding royalty interests, based upon an independent appraisal at the time
the election is made by the Company, divided by a 20-day average trading price
of the Company’s common stock at the time of repurchase, and subject to certain
conditions, including without limitation, that (i) the Company’s average prior
20-day trading volume is at least 125,000 shares, (ii) the prior 20-day average
price per share of its common stock is at least $3.00 per share, and (iii) the
shares to be exchanged are registered for public resale pursuant to an effective
registration statement.
  7
  The
Marquis/Summerview Senior Secured Debt is secured by a general security interest
in all of the tangible and intangible current and future assets owned or
acquired by the Company and its subsidiaries (including mortgages on the
Company’s real property interests), which have guaranteed the Company’s
obligations under the Marquis/Summerview Senior Secured Debt and other
transaction documents.  Marquis’ secured position in this transaction
is senior to the rights of all other secured parties, except for the previously
secured rights of Marquis under the Longview/Marquis/Summerview Notes and the
secured rights of the Buyers of the June 2009 Convertible Notes, each of which
rank pari passu with the rights granted to Marquis under the Marquis/Summerview
Senior Secured Debt.
  On May
29, 2009, Marquis provided the Company with notice that Marquis had transferred
to Summerview 25% of each of the Marquis/Summerview Senior Secured Debt and the
overriding royalty interests that had originally been assigned by the Company to
Marquis in connection with the issuance of the Marquis/Summerview Senior Secured
Debt.
 
 As of
June 30, 2009, the Company had $7.0 million of Marquis/Summerview Senior Secured
Debt outstanding.  The total outstanding was comprised of $5.2 million
payable to Marquis and $1.8 million payable to Summerview.
 
 The
Longview/Marquis/Summerview Notes and the Marquis/Summerview Senior Secured Debt
contain various restrictive covenants, which, among other things, limit the
incurrence of additional debt, investments, liens, dividends, prepayments of
indebtedness, asset divestitures, mergers and consolidations, transactions with
affiliates and other matters customarily restricted in such
agreements.  Further, these notes require the maintenance of certain
average daily rates of barrels of oil equivalent production, measured on a
calendar quarterly basis.
 
 As of
June 30, 2009, the Company was not in compliance with the average daily
production rate covenants, and had not made scheduled interests payments due on
July 1 and August 1, 2009.  As a result of these events, the Company
has agreed with Marquis and Summerview as follows:
 ·
                going
      forward, to amend the production covenant on a mutually agreed upon
      basis;
  ·
                to
      waive the production covenants for the quarter ended June 30,
      2009;
  ·
                to
      waive any breach resulting from our failure to pay interest payments due
      on July 1 and August 1, 2009;
  ·
                to
      waive the increase in interest rate resulting from our failure to pay
      interests payments described above;
  ·
                to
      amend the interest payment schedule going forward to provide for payment
      on a quarterly basis; and
  ·
                to
      amend the interest payment provisions for the quarter commencing July 1,
      2009 to provide for payment by adding interest amount to the principal
      (i.e., by capitalizing such interest
amount).
 
 June
2009 Convertible Notes
 
 On June
10 and June 16, 2009, the Company entered into securities purchase agreements
with eight individual investors (the “Buyers”), pursuant to which, among other
things, the Company issued and sold to the Buyers convertible notes in an
aggregate original principal amount of $555,000 (the “June 2009 Convertible
Notes”). The June 2009 Convertible Notes carry an interest rate of 14% per annum
payable monthly in cash and mature in June 2011.
 
 In
connection with the issuance of the June 2009 Convertible Notes, the Company
also issued to the Buyers five-year warrants (the “Warrants”) to purchase an
aggregate number of shares of the Company’s common stock equal to one share
for each $1.00 of principal amount of the June 2009 Convertible Notes
purchased.  The exercise price for the warrants is fixed at $0.50 per
share.
 
 The June
2009 Convertible Notes are convertible by the holders thereof, 90 days after
their original issuance, into shares of common stock at a fixed conversion price
equal to $0.50 per share.  The number of shares of common stock
issuable upon conversion of each $1.00 of principal of the June 2009 Convertible
Notes shall equal (i) $1.00 (ii) divided by the conversion price, or
$0.50.  The June 2009 Convertible Notes are secured by certain real
property interests of the Company and its subsidiaries in specified wells (the
“Collateral Assets”). The Buyers’ security interests in the Collateral Assets
rank pari passu with the security interests in the Collateral Assets of the
Company’s existing senior secured debt holders, Marquis and
Summerview.  Subject to certain conditions, including a condition
relating to requirements of the NASDAQ Global Market, the Company will have a
call option to convert the June 2009 Convertible Notes into common stock at the
fixed conversion price at any time after the Company’s common stock (i) closes
at a price exceeding $1.00 for any 20 consecutive trading days (the “Lookback
Period”), and (ii) the reported daily trading volume of the common stock during
each trading day during the Lookback Period is not less than 100,000 shares of
common stock per day.  The Company further has the option to redeem
the same percentage of the outstanding principal balance of each June 2009
Convertible Note, plus accrued interest on the redeemed principal amount for
each such June 2009 Convertible Note, upon five days notice to the
Buyers.
  8
 
 The
Collateral Assets are subject to mortgages.  Certain subsidiaries of
the Company have guaranteed the obligations of the Company under the June 2009
Convertible Notes and other transaction documents.
 
 Other
Notes Payable
 
 The total
of the Company’s other notes payable and long-term debt at June 30, 2009 was
$2.3 million and comprised of amounts due to various parties as a result of oil
and gas and other property purchases. Repayment of these obligations is due over
a period ranging from one year to greater than five years. Effective annual
interest rates for these obligations range from 4.9% to 12.25%.
 
 A
component of other notes payable and long-term debt at June 30, 2009 includes a
principle balance of $391,266 payable to Granite Energy Inc. (“Granite”) related
to a transaction dated September 17, 2007, whereby the Company
purchased  a drilling rig and associated equipment from
Granite.  In February 2009, the Company ceased making payments, as a
result of Granite failing to deliver title to the assets.  On February
26, 2009, Granite commenced a lawsuit against the Company to recover the balance
of the purchase price allegedly owed by the Company to Granite.  The
Company purchased the assets for $1.3 million.  As of June 30, 2009,
the Company had paid an aggregate of $944,751 to Granite.  Refer to
Note 7 – Subsequent Events for a description of a settlement agreement entered
into with Granite, effective as of August 3, 2009.
 
 The
following table provides a schedule of estimated principal maturities during
each calendar year under all of the Company’s notes payable and long-term debt
as of June 30, 2009:
 
 As
      ofJune
      30, 20092009
              
              $
              707,0572010
              
              
              16,283,5692011
              
              
              593,0972012
              
              
              150,9302013
              
              
              133,865Thereafter
              
              
              939,375$
              18,807,893
 
 Note
3 – Deferred Liability
 
 Settlement
Agreement
  On May
15, 2008, the Company settled a lawsuit and counter-lawsuit between Leexus Oil
& Gas, LLP, Mark Jaehne, and Bennie Jaehne regarding certain disputes. The
settlement agreement provided for the Company’s payment on the settlement date
of $2.0 million and future payments totaling $2.0 million, payable in four
future installments. The settlement agreement also provided for the return of
1,333,333 shares of the Company’s common stock previously issued to the Jaehnes,
of which 900,000 shares were returned on the settlement date.  The
first of the four installments was paid during the fourth quarter of 2008, and
108,333 additional shares of the Company’s common stock became due to be
returned to the Company.  As of June 30, 2009, a total liability of
$1.5 million is included on the Company’s balance sheet as a deferred liability,
all of which is classified as current.  The schedule outlined in the
settlement agreement provides for the Company’s purchase of the remaining
325,000 shares of common stock in three remaining installments during 2009 and
2010.
 On May
15, 2009, the Company did not make a scheduled payment of  $500,000 to
the Jaehnes.  On July 15, 2009, the Company commenced a lawsuit
against Leexus and its three individual partners, Mark Jaehne, Bennie Jaehne,
and William Zeltwanger (the “Defendants”).  In this new lawsuit, the
Company alleges, among other things, the existence of certain post-merger
fraudulent assignments of merger assets by the Defendants, rescission and breach
of the May 15, 2008 settlement agreement, incorrect calculation of overriding
royalty interests, and misrepresentations by the Defendants with respect to
certain merger assets.  Leexus, Mark Jaehne, and Bennie Jaehne have
filed a counterclaim against the Company, alleging the Company breached the May
15, 2008 settlement agreement due to non-payment of the May 15, 2009 scheduled
installment payment.
 9
 
 Note
4 – Stock Based Compensation
 
 The
Company has stock-based employee compensation plans as described in Note 7 to
the audited financial statements contained in the Company’s Annual Report on
Form 10-K for the year ended December 31, 2008. Total stock compensation expense
related to employee stock options was reported as part of the Company’s general
and administrative expenses, and was $1,932,889 and $295,231 for the first six
months of 2009 and 2008, respectively.
 
 In
accordance with Statement of Financial Accounting Standards 123R, the Company
measures the value of the stock based compensation granted to it employees by
use of a Black-Scholes valuation model in the case of stock options, and in the
case of restricted stock grants, the value of the compensation is based on the
number of shares issued and the per share value of the Company’s stock on the
date of issuance. That value is recognized as stock compensation expense over
the expected life of the underlying options, in the case of stock options, and
over the period between the issuance of restricted shares and the lapse of the
restrictions in the case of stock grants. Total stock-based compensation expense
related to employee stock grants was reported as part of the Company’s general
and administrative expenses, and was $139,167 for the first six months of
2009.
 
 Stock
Options:  In prior years, the Company issued stock options as
compensation to its management, employees and directors pursuant to the 2007 Stock Compensation
Plan.  Generally, these options had a five-year life and vested
over four years for management and employees, and one year for
directors.  Upon exercise, newly issued shares of common stock are
issued to the exercising party.  No options have been granted pursuant
to this plan since 2007.
 
 During
2008, the Company adopted its Equity Incentive Compensation
Plan to provide for the issuance of stock awards to Company employees,
officers, and consultants and non-employee directors.   Stock
options issued pursuant to this plan generally have a 10-year life and vest over
three years for management and employees and less than one year for non-employee
directors.  Upon exercise, newly issued shares of common stock are
issued to the exercising party.  Stock options were granted pursuant
to this plan in 2008 to employees, a consultant, and non-employee
directors.  Additionally this plan allowed for the granting of
incentive stock options as compensation to the officers who joined the Company
in June 2008.  The vesting provisions for these incentive stock
options are based upon achievement of certain Company performance
goals.  During the first three months of 2009, certain of these
Company performance goals were reached, and the related portion of the stock
options granted vested to the interests of the officer grantees.
 
 As of
June 30, 2009, the Company had total outstanding options to purchase 2,025,501
shares of common stock at prices ranging from $0.47 to $9.45 per
share.  Of the total outstanding, 1,381,376 were exercisable at June
30, 2009 at prices ranging from $0.47 to $9.45 per share.
 
 10
 
 Stock
Option Activity For the Six Months Ended June 30, 2009:
 
 WeightedWeighted
                
                
                AverageAverage
                
                
                Remaining
                
                
                TotalNumber
                
                
                Exercise
                
                
                Contractual
                
                
                IntrinsicOutstanding
                
                
                Price
                
                
                Term
                
                
                Value(in
      years)2007 Stock
      Compensation Plan:Outstanding
      at December 31, 2008
                
                
                245,500
                
                
                $
                9.45
                
                
                
                3.75
                
                
                $
                1,399,764Exercised
                
                
                (
      -
                )Outstanding,
      unvested at June 30, 2009
                
                
                154,125
                
                
                $
                9.45
                
                
                
                3.25
                
                
                $
                895,201Outstanding,
      exercisable at June 30, 2009
                
                
                91,375
                
                
                $
                9.45
                
                
                
                3.25
                
                
                $
                504,563Equity
      Incentive Compensation Plan:Outstanding
      at December 31, 2008
                
                
                530,000
                
                
                $
                0.47
                
                
                
                10.00
                
                
                $
                249,100Issued
                
                
                1,250,001
                
                
                $
                2.00
                
                
                
                9.21
                
                
                $
                1,509,087Outstanding,
      unvested at June 30, 2009
                
                
                490,000
                
                
                $
                0.47
                
                
                
                9.50
                
                
                $
                230,300Outstanding,
      exercisable at June 30, 2009
                
                
                1,290,001
                
                
                $
                1.95
                
                
                
                9.26
                
                
                $
                1,527,887Company
      TotalOutstanding,
      unvested at June 30, 2009
                
                
                644,125
                
                
                $
                2.62
                
                
                
                8.00
                
                
                $
                1,125,501Outstanding,
      exercisable at June 30, 2009
                
                
                1,381,376
                
                
                $
                2.45
                
                
                
                8.86
                
                
                $
                2,032,450
 
 Restricted
Stock:During 2008, the
Company granted Stock Award Rights under the Equity Incentive Compensation Plan,
to provide for the issuance of stock grants as compensation to the officers who
joined the Company in June 2008.  The Stock Awards Rights provide for
the granting of restricted shares of the Company’s common stock at specified
intervals and in amounts equal to specified values on the issuance dates. During
2008 and the second quarter of 2009, the first and second, respectively, of
three tranches of shares of common stock were issued.
  Restricted Stock Activity For the Six
Months Ended June 30, 2009:
 
 SharesEquity Incentive
      Compensation PlanUnvested
      restricted stock at December 31, 2008
                
                
                774,792Vested
                
                
                ( 774,792
                )Granted
                
                
                5,454,546Unvested
      restricted stock at June 30, 2009
                
                
                5,454,546
 
 Stock Used to
Acquire Goods or Services:During the first six months of
2009, the Company issued 62,000 shares of its common stock, with an aggregate
fair value of $255,700 as compensation for certain services provided to the
Company by third parties.
 
 Note 5 – Derivative
Contracts
 
 The
Company previously entered into a derivative instrument covering the period
January 1, 2008 to December 31, 2008.  For the first six months of
2008, all of the activity related to the instrument received derivative
accounting treatment.  This resulted, for the first six months of
2008, in a $5,356,038 derivative loss.  All derivative contracts were
terminated and balances settled with the contract counter-party by December 31,
2008. The Company has not engaged in derivative transactions during
2009.
 
 11
 
 Note
6 – Related Parties
 
 The
Company is deemed to have a related party relationship with Longview because
Longview is the beneficial owner of an amount in excess of 10% of the Company’s
issued and outstanding common stock.  Refer to Note 2 – Long-Term Debt
for a description of the Company’s credit facility with Longview and the related
notes payable.  Interest accrued during the six months ended June 30,
2009 and 2008, by the Company on notes payable to Longview was $1,229,990 and
$1,122,842, respectively.
 
 The
Company is deemed to have a related party relationship with a third party who
operates and is a joint interest owner in the Company’s oil and gas properties
located in the DJ Basin in Colorado.  This party is the beneficial
owner of an amount in excess of 10% of the Company’s issued and outstanding
common stock.  As part of the Longview debt restructure transactions
described at Note 2 – Notes Payable and Long-Term Debt, the Company sold its
interests in these properties effective May 18, 2009.  The Company
received approximately $41,644 and $183,224 in net oil and gas revenue
distributions for the properties from the related party during the year to date
period ended May 18, 2009, and during the first six months of 2008,
respectively.  The Company paid to the related party approximately
$31,421 and $44,474 for capital expenditures and lease operating expenses,
respectively, during the year to date period ended May 18, 2009, and
approximately $0 and $24,029 for capital expenditures and lease operating
expense, respectively, during the first six months of 2008.
 
 During
the first six months of 2008, the Company made payments of $7,655 on notes
payable to former executive officers of the Company.  These notes were
no longer outstanding at December 31, 2008.
 
 During
the first six months of 2008, the Company leased for $750 per month
approximately four acres of land from a former executive officer of the Company
to use for a field office and to store certain vehicles and equipment belonging
to the Company.  Also during the same period, the Company paid $1,286
per month for the use of equipment belonging to a former executive
officer.  Both of these arrangements were terminated during the second
and third quarters of 2008.
 
 Note
7 – Subsequent Events
 
 On August
3, 2009, the Company entered into a Release and Settlement Agreement with
Granite Energy, Inc. and one of its subsidiary entities (collectively “Granite”)
to resolve disputes that had arisen between the Company and
Granite.   In September 2007, the Company purchased a drilling
rig and associated equipment from Granite. In February 2009, the Company ceased
making payments, as a result of Granite failing to deliver title to the
assets.  On February 26, 2009, Granite commenced a lawsuit against the
Company to recover the balance of the purchase price allegedly owed by the
Company to Granite.  The Company originally purchased the assets for
$1.3 million.  As of June 30, 2009, the Company reported a remaining
balance due to Granite of $391,266.  The settlement agreement provided
that in exchange for Granite providing title to the assets and acknowledging as
fully paid the Company’s balance with Granite, the Company would pay to Granite
$200,000 in cash plus 400,000 shares of the Company’s common
stock.  The Company and Granite also agreed that all claims that the
parties may have had against the other were resolved by the settlement
agreement.
 
 Concurrent
with the closing of the Granite Release and Settlement Agreement, the Company
sold the drilling rig it had originally purchased from Granite, and selected
pieces of associated equipment to a third party for net cash proceeds totaling
approximately $650,000.
 
 Subsequent
events have been reviewed through the date on which these financial statements
were filed with the SEC.
 
 12
 
 Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
 
 SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
 This Quarterly Report on Form 10-Q
contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
In some cases, forward-looking statements are identified by terms such as “may,”
“will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,”
“believes,” “estimates,” “projects,” “predicts,” “potential,” and similar
expressions intended to identify forward-looking statements. Such statements
include, without limitation, statements regarding:
  ·
                fluctuations
      in oil or gas production or in oil or gas
  prices;
  ·
                estimates
      of required capital expenditures;
  ·
                fluctuations
      in the cost of drilling, completion and oil production or other costs of
      production and operations;
  ·
                our
      inability to meet growth
projections;
  ·
                our
      plans and expectations with respect to future acquisitions of oil and gas
      rights leases;
  ·
                the
      expected benefits and results from our geophysical research and
      development efforts;
  ·
                our
      belief that we will have sufficient liquidity to finance operations into
      early 2009;
  ·
                the
      amount of cash necessary to operate our
  business;
  ·
                our
      ability to raise additional capital when
needed;
  ·
                general
      economic conditions; and
  ·
                the
      anticipated future financial performance and business operations of our
      company.
  These forward-looking statements are
only predictions and involve known and unknown risks, uncertainties, and other
factors that may cause our actual results, levels of activity, performance, or
achievements to be materially different from any future results, levels of
activity, performance, or achievements expressed or implied by such
forward-looking statements. Also, these forward-looking statements represent our
estimates and assumptions only as of the date of this Report.  Except
as otherwise required by law, we expressly disclaim any obligation or
undertaking to release publicly any updates or revisions to any forward-looking
statement contained in this Report to reflect any change in our expectations or
any change in events, conditions, or circumstances on which any of our
forward-looking statements are based or to conform to actual
results.  Factors that could cause or contribute to differences in our
future financial and operating results include those discussed in the risk
factors set forth in our Annual Report on Form 10-KSB for the year ended
December 31, 2008, as well as those discussed elsewhere in this Report. We
qualify all of our forward-looking statements by these cautionary
statements.
 
 You should read this section in
combination with the section entitled Management’s Discussion and Analysis of
Financial Condition and Results of Operations for the year ended December 31,
2008 included in our Annual Report on Form 10-K for the year ended
December 31, 2008.
 
 Overview
 
 When
referring to South Texas Oil Company (“South Texas,” the “Company,” “we,” “us,”
and “our”), the intent is to refer to South Texas and its consolidated
subsidiaries as a whole or on an individual basis, depending on the context in
which the statements are made.  The following discussion of our
financial condition and results of operations should be read in conjunction with
our consolidated financial statements and the notes thereto included in this
Form 10-Q.
 
 South Texas Oil Company is an
independent oil and natural gas company engaged in the acquisition, production,
exploration and development of oil and natural gas. Our management team has
extensive technical and operating expertise in all areas of our geographic
focus, which are primarily located in Texas, Louisiana and the Gulf Coast. Our
producing properties are located in highly prolific fields with long histories
of oil and natural gas operations.
 
 We generate revenue primarily from our
working interests in producing oil and gas properties, the majority of which are
located in south and central Texas.  We have obtained capital for
investment in producing oil and gas properties primarily through the sale of our
common stock to existing stockholders, a $32.5 million credit facility that has
been reduced to an outstanding balance of $9.0 million and which has no
remaining borrowing availability, and a $7.0 million senior secured note
financing.
  13
 
 Our
strategy is to focus on the acquisition and development of properties that have
proved oil and gas reserves and to acquire interests in proven fields and
attempt to increase production by exploring other formations in the same fields
where others have obtained production. Our primary operational strategy includes
the operation of our own projects, which provides us substantial control over
drilling and production costs and in the timing and amount of capital
expenditures.  We believe that operating our properties in this manner
is cost-effective, as the range of expertise and services required varies by
project and time duration.
 
 Results
of Operations
 
 The
following table highlights the change for 2009 from the comparable period in
2008 for significant items from our Consolidated Statements of
Operations:
 
 Change
      in Selected Statement of Operations
                
                Three
      Months
                
                
                Six
      MonthsItems
      for the Periods Ended June 30
                
                $
                
                
                
                %(1)
                
                
                $
                
                
                
                %(1)Oil
      and gas sales
                
                
                (3,072,379
                )
                
                
                -80
                %
                
                
                (4,337,420
                )
                
                
                -76
                %Production
      expenses
                
                
                (504,992
                )
                
                
                -50
                %
                
                
                (740,363
                )
                
                
                -43
                %Production
      taxes
                
                
                (85,095
                )
                
                
                -72
                %
                
                
                (140,748
                )
                
                
                -69
                %General
      and administrative expenses
                
                
                (413,676
                )
                
                
                -22
                %
                
                
                1,071,835
                
                
                
                35
                %Exploration
      expense
                
                
                1,478,273
                
                
                
                n/m
                
                
                
                1,711,072
                
                
                
                n/mDepreciation,
      depletion and amortization
                
                
                (968,665
                )
                
                
                -62
                %
                
                
                (1,389,908
                )
                
                
                -53
                %Loss
      from derivatives
                
                
                (4,306,038
                )
                
                
                -100
                %
                
                
                (5,356,038
                )
                
                
                -100
                %Interest
      expense
                
                
                (100,679
                )
                
                
                -9
                %
                
                
                867,337
                
                
                
                54
                %Debt
      issuance costs amortization
                
                
                8,060
                
                
                
                1
                %
                
                
                241,724
                
                
                
                19
                %Gain
      on sale of assets, net
                
                
                217,551
                
                
                
                n/m
                
                
                
                217,551
                
                
                
                n/mLoss
      on extinguishment of debt
                
                
                125,000
                
                
                
                n/m
                
                
                
                125,000
                
                
                
                n/mNet
      loss
                
                
                (1,910,761
                )
                
                
                -28
                %
                
                
                514,651
                
                
                
                5
                %Net
      loss per common share
                
                
                (0.14
                )
                
                
                -33
                %
                
                
                0.00
                
                
                
                0
                %
 
 (1)  “n/m”
indicates that the calculated percentage change is not meaningful since there
was no 2008 value to which the net change could be compared
 
 The
following table presents selected operating items and highlights the percentage
change for the periods indicated:
  Three
      Months
              
              Six
      MonthsOperational
      Data
                For
      the Periods Ended June 30
              
              2009
              
              
              2008
              
              %
                Change
      (1)
              
              2009
              
              
              2008
              
              %
                Change
      (1)Oil
      sales volumes, Bbl except %change
              
              
              11,407
              
              
              
              20,338
              
              -44
              %
              
              
              24,852
              
              
              
              44,279
              
              -44
              %Gas
      sales volumes, Mcf except % change
              
              
              35,133
              
              
              
              37,529
              
              -6
              %
              
              
              69,793
              
              
              
              84,007
              
              -17
              %Combined
      sales volumes, Boe except % change
              
              
              17,263
              
              
              
              26,593
              
              -35
              %
              
              
              36,484
              
              
              
              58,280
              
              -37
              %Average
      oil sales price per Bbl
              
              $
              54.25
              
              
              $
              159.47
              
              -66
              %
              
              $
              42.77
              
              
              $
              110.26
              
              -61
              %Average
      gas sales price per Mcf
              
              $
              4.42
              
              
              $
              16.07
              
              -72
              %
              
              $
              4.64
              
              
              $
              10.02
              
              -54
              %
  14
  Three
Months Ended June 30, 2009 Compared with Three Months Ended June 30,
2008
 
 Revenues
 
 Oil and
gas sales decreased 80% from $3,846,610 to $774,231 for the three months ended
June 30, 2008 and 2009, respectively, as a result of significantly lower average
realized prices for oil and natural gas combined with decreased volumes during
the second quarter of 2009. Realized prices for oil and natural gas on an
equivalent unit basis decreased during the three months ended June 30, 2009,
compared to the same period during 2008, by approximately 66% and 72%,
respectively, and had an approximate combined $1.6 million negative impact on
revenues.  The combined 35% decrease in volumes had an approximate
$1.5 million negative impact on revenues.  The decreased volumes were
largely the result of natural decline in the production of our oil and gas
properties.  There was no significant new production in the second
quarter of 2009 added as a result of exploration or development activities
conducted, compared to the second quarter of 2008.
 
 Production
Expenses
 
 The 50%
decrease in production expenses from $1,014,589 to $509,597 for the three months
ended June 30, 2008 and 2009, respectively, resulted from the combined effect of
decreased activity related to workovers and enhanced recovery methods that
became marginal or uneconomic due to lower oil and gas prices, coupled with the
results of strategy implementations intended to improve cost efficiencies in the
field.
 
 Production
Taxes
 
 The 72% decrease in production tax
expense is a direct result of the 80% decrease in oil and gas sales for the
second quarter of 2009, compared with the second quarter of 2008.
 
 General
and Administrative Expenses
 
 General
and administrative expenses were $1,430,017 for three months ended June 30, 2009
compared to $1,843,693 for the same period in 2008, a decrease of 22%. This
decrease was mainly attributable to an approximate $425,000 reduction in fees
paid to third parties for management, accounting and other consulting services
during the second quarter of 2009 compared to the second quarter of
2008.
 
 Exploration
Expense
 
 Exploration expense was $1,478,273 for
the second quarter of 2009, compared to zero for the same period in
2008.  During the second quarter of 2009, an exploratory well that we
began drilling in 2008 was determined to be a dry hole.  The costs
associated with this well totaled approximately $1.4
million.  Consistent with the successful efforts method of accounting
we have adopted, our costs incurred for this well are charged to exploration
expense in the period the well was determined to be unsuccessful.
 
 Depreciation,
Depletion and Amortization (DD&A)
 
 The 62%
decrease in DD&A to $586,003 for the three months ended June 30, 2009 from
$1,554,667 for the same period in 2008 results mainly from the 35% decrease in
combined sales volumes for the second quarter of 2009, compared to the second
quarter of 2008.  Additionally, during the second quarter of 2009, a
lower per barrel of production DD&A rate was used to calculate the DD&A
provision for the period.  The change in DD&A rates from 2008 to
2009 are the result of revised engineering estimates of the oil and gas reserve
quantities attributable to our producing and non-producing oil and gas
properties.
 
 Loss
from Derivatives
 
 A net
loss from derivatives of $4.3 million was recognized during the three months
ended June 30, 2008, compared to $0 for the same period in
2009.  We entered into a derivative instrument covering the period
January 1, 2008 to December 31, 2008.  All derivative contracts were
terminated and balances settled with the contract counter-party by December 31,
2008. We have not engaged in derivative transactions during 2009.
 
 15
 
 Interest
Expense
 
 Interest
expense recognized for the three months ended June 30, 2009 was $1,071,027
compared to $1,171,706 for the same period in 2008, a decrease of 9%. This net
decrease is primarily the result of an approximate $397,000 reduction in
interest expense for the second quarter of 2009 as a result of the termination
on May 18, 2009 of the notes payable to Longview in connection with the debt
restructure transactions described at Note 2 to the financial
statements.  This decrease was partially offset by increase in debt
outstanding under the Longview and Marquis credit facility during the second
quarter of 2009, compared to the second quarter of 2008, the senior
secured note issued to Marquis during the third quarter of 2008, and the
$555,000 ofconvertible
notes we issued in June 2009, as described in Note 2 to the financial
statements.  Borrowings were higher during the three months ended June
30, 2009 compared to the same period of 2008 because the facility was used to
finance capital spending, operating cash flow deficits and losses incurred from
derivative transactions during 2008.
 
 Debt
Issuance Costs Amortization
 
 Debt
issuance costs amortization increased 1% for the three months ended June 30,
2009, compared to the three months ended June 30, 2008.  The $8,060
increase reflects the net effect of a $234,000 increase during the second
quarter of 2009 in amortization for debt issuance costs incurred in connection
with senior secured notes we issued in September 2008.  This increase
was nearly entirely offset by a reduction in amortization of debt issuance costs
related to the Longview notes restructured during the second quarter of 2009, as
described in Note 2 to the financial statements.  In connection with
recording the Longview notes restructuring transaction, all then unamortized
debt issuance costs were eliminated from our balance sheet.
 
 Net
Loss / Net Loss per Share
 
 We
reported a net loss for the three months ended June 30, 2009 of $4.9 million, or
$(0.28) per common share.  This compares to a net loss for the three
months ended June 30, 2008, of $6.8 million, or $(0.42) per common
share.
 
 Six
Months Ended June 30, 2009 Compared with Six Months Ended June 30,
2008
 
 Revenues
 
 Oil and
gas sales decreased 76% from $5,724,245 to $1,386,825 for the six months ended
June 30, 2008 and 2009, respectively, as a result of lower average realized
prices for oil and natural gas combined with decreased volumes during 2009.
Realized prices for oil and natural gas on an equivalent unit basis decreased
for 2009, compared to 2008, by approximately 61% and 54%, respectively, and had
an approximate combined $2.1 million negative impact on revenues.  The
combined 37% decrease in volumes had an approximate $2.3 million negative impact
on revenues.  The decreased volumes were largely the result of natural
decline in the production of our oil and gas properties.  No
significant new production occurred during the second quarter of 2009 as a
result of exploration or development activities conducted, when compared to the
second quarter of 2008.
 
 Production
Expenses
 
 The 43%
decrease in production expenses from $1,722,854 to $982,491 for the six months
ended June 30, 2008 and 2009, respectively, resulted from the combined effect of
decreased activity related to workovers and enhanced recovery methods that
became marginal or uneconomic due to lower oil and gas prices.
 
 Production
Taxes
 
 The 69% decrease in production tax
expense is a direct result of the 76% decrease in oil and gas sales for the
first six months of 2009, compared with the first six months of
2008.
 
 General
and Administrative Expenses
 
 General
and administrative expenses were $4,159,593 for the six months ended June 30,
2009 compared to $3,087,758 for the same period in 2008, an increase of
35%.  This net increase was the result of an increase of approximately
$1.5 million in non-cash stock compensation expense recognized in connection
with restricted stock grants and stock options issued to management and
employees during the last half of 2008 and in 2009.  This increase was
partially offset by an approximate $443,000 decrease in fees paid to third
parties for management, accounting and other consulting services during 2009
compared to the first six months of 2008.
  16
 
 Exploration
Expense
 
 Exploration expense was $1,711,072 for
the second quarter of 2009, compared to zero for the same period in
2008.  During the second quarter of 2009, we evaluated an exploratory
well that we drilled beginning in 2008 to be a dry hole.  The costs
associated with this well totaled approximately $1.4
million.  Additionally, we participated in a well drilled by a third
party that was determined to be a dry hole in the first quarter of
2009.  Costs incurred on this well totaled approximately
$175,000.  Consistent with the successful efforts method of accounting
we have adopted, our costs incurred for these wells are charged to exploration
expense in the period the well was determined to be unsuccessful.
 
 Depreciation,
Depletion and Amortization (DD&A)
 
 The 53%
decrease in DD&A to $1,249,127 for the six months ended June 30, 2009 from
$2,639,035 for the same period in 2008 is largely a reflection of the 37%
decrease in combined sales volumes for 2009.  Additionally, during the
six months ended June 30, 2009, a lower per barrel of production DD&A rate
was used to calculate the DD&A provision for the period.  The
change in DD&A rates from 2008 to 2009 are the result of revised engineering
estimates of the oil and gas reserve quantities attributable to our producing
and non-producing oil and gas properties.
 
 
 Loss
from Derivatives
 
 A net
loss from derivatives of $5.4 million was recognized for the six months ended
June 30, 2008, compared to $0 for the same period in 2009.  We
entered into a derivative instrument covering the period January 1, 2008 to
December 31, 2008.  All derivative contracts were terminated and
balances settled with the contract counter-party by December 31, 2008. We have
not engaged in derivative transactions during 2009.
 
 Interest
Expense
 
 Interest
expense recognized for the six months ended June 30, 2009 was $2,476,106
compared to $1,608,769 for the same period in 2008, an increase of 54%. This
increase is the result of an increase in debt outstanding under the Longview and
Marquis credit facility and the senior secured note issued to Marquis
during the third quarter of 2008 as described in Note 2 to the financial
statements, combined with an increased average interest rate on the notes
outstanding under the Longview and Marquis credit facility for the first six
months of 2009. The average interest paid on the credit facility notes during
the first six months of 2008 was 11.9%, compared with 12.6% for the first six
months of 2009.  Also contributing to the net increase in interest
expense for 2009 was the $555,000 of convertible notes issued in June 2009, as
described in Note 2 to the financial statements.  These combined
increases were partially offset by an approximate $397,000 reduction in interest
expense for the second quarter of 2009 as a result of the termination on May 18,
2009, of the notes payable to Longview in connection with the debt restructure
transactions described at Note 2 to the financial
statements.  Borrowings were higher during the six months ended June
30, 2009 compared to the same period in 2008 because we borrowed additional
funds to finance capital spending, operating cash flow deficits and losses
incurred from derivative transactions during 2008.
 
 Debt
Issuance Costs Amortization
 
 Debt
issuance costs amortization increased 19% for the six months ended June 30,
2009, compared to the same period in 2008.  The $241,724 increase
reflects the net effect of a $467,328 increase during 2009 in amortization of
debt issuance costs incurred in connection with senior secured notes we issued
in September 2008.  This increase was partially offset by a reduction
in amortization of debt issuance costs related to the Longview notes
restructured during the second quarter of 2009, as described in Note 2 to the
financial statements.  In connection with recording the Longview notes
restructuring transaction, all then unamortized debt issuance costs were
eliminated from our balance sheet.
 
 Net
Loss / Net Loss per Share
 
 We
reported a net loss for the six months ended June 30, 2009 of $10.7 million, or
$(0.63) per common share.  This compares to a net loss for the six
months ended June 30, 2008, of $10.2 million, or $(0.63) per common
share.
 
 17
 
 Liquidity
and Capital Resources
 
 We
require cash to fund our exploration and development activities and the
acquisition of oil and natural gas properties, to make payments required
pursuant to our long-term debt and other contractual obligations and fund our
working capital requirements.  At June 30, 2009, we had a working
capital deficit of $21.9 million, including $16.8 million currently due related
to long-term debt.  Our net working capital balance also included $1.4
million in cash, $1.2 million in accounts receivable and a total of $9.3 million
in accounts payable, other accrued liabilities and the current portion of
deferred liabilities.  If we are unable to pay, or otherwise resolve,
our accounts payable balances in a timely manner, the vendors to whom we owe
unpaid balances may cause liens to be filed against our
properties.  We may also suffer the refusal or withdrawal of trade
credit from vendors as a consequence of non-timely accounts payable
payment.  These factors could disrupt our ability to conduct
operations on our properties and affect our ability to initiate and/or complete
the capital expenditure activities budgeted for 2009.
 
 Historically
our revenues have not been sufficient to provide all of our cash needs, and we
have relied on borrowings from private investors to provide the cash needed to
meet both short and long-term liquidity
requirements.    During the second of quarter of 2009, we
restructured $26.1 million of our current debt outstanding, plus related accrued
interest, through (i) the payment of $16.3 million in debt and related accrued
interest in exchange for 1.8 million shares of our Series A Convertible
Preferred Stock and (ii) a debt/non-core asset exchange between valued at $9.8
million.  Also during the second quarter of 2009, we entered into and
closed securities purchase agreements with eight individual investors, pursuant
to which, among other things, we issued and sold convertible notes in an
aggregate original principal amount of $555,000.
 
 We do not
believe that our current cash balances and cash flows from operations during
2009 will be sufficient to fund our cash requirements and we need to raise
additional capital.  We continue to pursue additional debt and/or
equity financing, and we are evaluating other alternatives, such as joint
ventures with third parties or sales of interests in certain of our
assets.  Due to current capital and credit market conditions in which
numerous financial institutions have effectively restricted current liquidity
within the capital markets throughout the United States and the world, we cannot
be certain that funding will be available to us in required amounts or on
acceptable terms.  If we are not successful in obtaining sufficient
funding or completing an alternative transaction or transactions on a timely
basis on terms acceptable to us, we could be required to curtail our
expenditures or restructure our operations, and we would be unable to implement
our capital expenditure program, either of which could have a material adverse
affect on our business.
 
 Credit Facility
and Notes Payable
  Longview/Marquis/Summerview
Notes
  As of
June 30, 2009, we had notes outstanding in the principal amount
of $9.0 million issued pursuant to our credit facility with The Longview
Fund, L.P. (“Longview”) and Longview Marquis Master Fund, L.P. (“Marquis”) (the
“Longview/Marquis/Summerview Notes”).
  We
originally obtained a credit facility from Longview in January
2007.  Certain terms of the facility were amended in September 2007,
in connection with which we agreed to grant to Longview a perpetual overriding
royalty interest in the oil and gas production of certain of our
properties.  Also in connection with the September 2007 amendment, we
granted security and pledge agreements that provided Longview with first
priority security interests in substantially all of our assets.  In
April 2008, Marquis joined Longview as creditor, and the credit facility was
amended and restated in its entirety.  We agreed to grant to Longview
and Marquis certain mortgages in oil and gas producing properties and a
perpetual 2% overriding royalty interest in the oil and gas production of all of
our current and future interests in the real property then owned by
us.  In September 2008, in connection with our issuance of the
Marquis/Summerview Senior Secured Debt described below, Longview agreed to
subordinate its security interests related to the notes held by Longview to the
senior security interests held by Marquis.
 
 On
February 23, 2009, we announced a comprehensive debt restructuring and related
agreements with Longview.  Upon the effectiveness of stockholder
approval and consent for the debt restructuring transactions, on May 18, 2009,we
issued to Longview 1,755,325 shares of Series A Preferred in exchange for the
surrender and cancellation of $17,553,252 of Longview/Marquis/Summerview Notes
held by Longview, which included $1,220,852 for all unpaid interest accrued on
the notes through the closing date of the restructure transactions at the
facility’s effective rate for the period of 12.5%.  Each share of
Series A Preferred has a stated value equal to $10.00 per share, has no coupon
rate, does not pay dividends, and has no voting rights. The shares of Series A
Preferred are convertible into shares of our common stock at any time subsequent
to 90 days after the issuance of the shares at a conversion price of $0.50 per
share of common stock; however, the right to convert the Series A Preferred is
subject to Longview holding no more than 9.99% of our common stock at any one
time.  Also effective May 18, 2009, we closed the sale to Longview
of  our interest in Colorado DJ Basin oil and gas properties and a
drilling rig and associated assets for combined total proceeds of $9.8 million.
On the closing date, these assets were conveyed to Longview in exchange for
Longview’s discharge and satisfaction of $9.8 million in debt.  The
debt restructuring transactions in May 2009 resulted in the recognition of a
$125,000 loss on the extinguishment of debt and a $356,947 gain on the sale of
assets.  After these debt restructuring transactions, we had no
remaining note payable or related accrued interest payable balances with
Longview.
  18
 
 On May
29, 2009, Marquis provided us with notice that Marquis had transferred to
Summerview Marquis Fund, L.P. (“Summerview”), an entity affiliated with Marquis,
25% of  our Longview/Marquis/Summerview Notes held by Marquis, 25% of
the overriding royalty interests that had been assigned by us to Marquis in
connection with the original issuance of the Longview/Marquis/Summerview Notes,
and 25% of the outstanding warrants for the purchase of shares of our common
stock that were issued to Marquis in connection with our original issuance of
Longview/Marquis/Summerview Notes.
 
 Concurrent
with the issuance of the June 2009 Convertible Notes described below, we entered
into Waiver and Amendment Agreements with Marquis and Summerview, pursuant to
which the parties amended and waived certain provisions and covenants specified
therein, including the increase in the annual interest rate of the
Longview/Marquis/Summerview Notes from 12.5% to 13%, an amendment to the
interest payment schedule requiring monthly, rather than quarterly, interest
payments, and the extension of the maturity date of the
Longview/Marquis/Summerview Notes from December 31, 2009 to March 31,
2010.  Additionally provided was a waiver to restrictive covenants
that would have otherwise impeded our ability to incur additional
debt.
 
 As of
June 30, 2009, our remaining total $9.0 million outstanding of
Longview/Marquis/Summerview Notes was comprised of $6,710,039 payable to Marquis
and $2,252,995 payable to Summerview.  Longview and Marquis have
informed us that no additional borrowings may be made pursuant to the credit
facility.
 
 Marquis/Summerview Senior
Secured Debt
 
 On
September 19, 2008, we entered into a Securities Purchase Agreement with
Marquis, pursuant to which on such date, among other things, we issued and sold
to Marquis a senior secured note in an original principal amount of $7,000,000
(the “Marquis/Summerview Senior Secured Debt”), for gross proceeds of
$6,750,000, prior to our payment of expenses incurred by us and Marquis in
connection with the transactions under the Securities Purchase Agreement. The
Marquis/Summerview Senior Secured Debt was issued with an interest rate of 12.5%
per annum payable quarterly in cash and a maturity date of September 2009, but
was amended concurrently with the June 2009 Convertible Notes transaction
described below to extend the maturity date to March 31, 2010, and to increase
the annual interest rate to 13.0% in order to be consistent with the terms of
the Longview/Marquis/Summerview Notes. Upon our prepayment of all or any portion
of the Marquis/Summerview Senior Secured Debt or at maturity, Marquis has the
option to convert up to 50% of the principal (and interest relating thereto) to
be paid by us on such date of prepayment or maturity, into shares of our common
stock at a conversion rate of $4.00 per share (subject to adjustment for stock
splits and other events).
 
 Additionally,
we conveyed to Marquis a 1.0% perpetual overriding royalty interest in the oil
and gas production of all of our current and future interests in the real
property then owned by us. Pursuant to the terms of the overriding royalty
conveyance, we have the conditional option, beginning on September 19, 2009 and
terminating on September 19, 2010, to repurchase the overriding royalty
interests conveyed in exchange for a number of shares of our common stock equal
to the adjusted fair market value of the conveyed overriding royalty interests,
based upon an independent appraisal at the time the election is made by us,
divided by a 20-day average trading price of our common stock at the time of
repurchase, and subject to certain conditions, including without limitation,
that (i) our average prior 20-day trading volume is at least 125,000 shares,
(ii) the prior 20-day average price per share of its common stock is at least
$3.00 per share, and (iii) the shares to be exchanged are registered for public
resale pursuant to an effective registration statement.
  The
Marquis/Summerview Senior Secured Debt is secured by a general security interest
in all of the tangible and intangible current and future assets owned or
acquired by us and our subsidiaries (including mortgages on our real property
interests), which have guaranteed our obligations under the Marquis/Summerview
Senior Secured Debt and other transaction documents.  Marquis’ secured
position in this transaction is senior to the rights of all other secured
parties, except for the previously secured rights of Marquis under the
Longview/Marquis/Summerview Notes and the secured rights of the Buyers of the
June 2009 Convertible Notes, each of which rank pari passu with the rights
granted to Marquis under the Marquis/Summerview Senior Secured
Debt.
 
 19
 
 On May
29, 2009, Marquis provided us with notice that Marquis had transferred to
Summerview 25% of each of the Marquis/Summerview Senior Secured Debt and the
overriding royalty interests that had originally been assigned by us to Marquis
in connection with the issuance of the Marquis/Summerview Senior Secured
Debt.
 
 As of
June 30, 2009, we had $7.0 million of Marquis/Summerview Senior Secured Debt
outstanding.  The total outstanding was comprised of $5.2 million
payable to Marquis and $1.8 million payable to Summerview.
 
 The
Longview/Marquis/Summerview Notes and the Marquis/Summerview Senior Secured Debt
contain various restrictive covenants, which, among other things, limit the
incurrence of additional debt, investments, liens, dividends, prepayments of
indebtedness, asset divestitures, mergers and consolidations, transactions with
affiliates and other matters customarily restricted in such
agreements.  Further, these notes require the maintenance of certain
average daily rates of barrels of oil equivalent production, measured on a
calendar quarterly basis.
 
 As of
June 30, 2009, we were not in compliance with the average daily production rate
covenants, and had not made scheduled interests payments due on July 1 and
August 1, 2009.  As a result of these events, we have agreed with
Marquis and Summerview as follows:
  ·
              going
      forward, to amend the production covenant on a mutually agreed upon
      basis;
  ·
              to
      waive the production covenants for the quarter ended June 30,
      2009;
  ·
              to
      waive any breach resulting from our failure to pay interest payments due
      on July 1 and August 1, 2009;
  ·
              to
      waive the increase in interest rate resulting from our failure to pay
      interests payments described above;
  ·
              to
      amend the interest payment schedule going forward to provide for payment
      on a quarterly basis; and
  ·
              to
      amend the interest payment provisions for the quarter commencing July 1,
      2009 to provide for payment by adding interest amount to the principal
      (i.e., by capitalizing such interest
amount).


June 2009 Convertible
Notes
 
 On June
10 and June 16, 2009, we entered into securities purchase agreements with eight
individual investors (the “Buyers”), pursuant to which, among other things, we
issued and sold to the Buyers convertible notes in an aggregate original
principal amount of $555,000 (the “June 2009 Convertible Notes”). The June 2009
Convertible Notes carry an interest rate of 14% per annum payable monthly in
cash and mature in June 2011.
 
 In
connection with the issuance of the June 2009 Convertible Notes, we also issued
to the Buyers five-year warrants (the “Warrants”) to purchase an
aggregate number of shares of our common stock equal to one share for each
$1.00 of principal amount of the June 2009 Convertible Notes
purchased.  The exercise price for the warrants is fixed at $0.50 per
share.
 
 The June
2009 Convertible Notes are convertible by the holders thereof, 90 days after
their original issuance, into shares of common stock at a fixed conversion price
equal to $0.50 per share.  The number of shares of common stock
issuable upon conversion of each $1.00 of principal of the June 2009 Convertible
Notes shall equal (i) $1.00 (ii) divided by the conversion price, or
$0.50.  The June 2009 Convertible Notes are secured by certain real
property interests of the Company and its subsidiaries in specified wells (the
“Collateral Assets”). The Buyers’ security interests in the Collateral Assets
rank pari passu with the security interests in the Collateral Assets of our
existing senior secured debt holders, Marquis and Summerview.  Subject
to certain conditions, including a condition relating to requirements of the
NASDAQ Global Market, we will have a call option to convert the June 2009
Convertible Notes into common stock at the fixed conversion price at any time
after our common stock (i) closes at a price exceeding $1.00 for any 20
consecutive trading days (the “Lookback Period”), and (ii) the reported daily
trading volume of the common stock during each trading day during the Lookback
Period is not less than 100,000 shares of common stock per day.  We
further have the option to redeem the same percentage of the outstanding
principal balance of each June 2009 Convertible Note, plus accrued interest on
the redeemed principal amount for each such June 2009 Convertible Note, upon
five days notice to the Buyers.
 
 The
Collateral Assets are subject to mortgages.  Certain of our
subsidiaries have guaranteed our obligations under the June 2009 Convertible
Notes and other transaction documents.
 
 Other Notes
Payable
 
 The total
of the our other notes payable and long-term debt at June 30, 2009 was $1.8
million and comprised of amounts due to various parties as a result of oil and
gas and other property purchases. Repayment of these obligations is due over a
period ranging from one year to greater than five years. Effective annual
interest rates for these obligations range from 4.9% to 12.25%.
  20
 
 Deferred
Liability
  Settlement
Agreement
  On May
15, 2008, the Company settled a lawsuit and counter-lawsuit between Leexus Oil
& Gas, LLP, Mark Jaehne, and Bennie Jaehne regarding certain
disputes.
 The
settlement agreement provided for our payment on the settlement date of $2.0
million and future payments totaling $2.0 million, payable in four future
installments. The settlement agreement also provided for the return of 1,333,333
shares of our common stock previously issued to the Jaehnes, of which 900,000
shares were returned on the settlement date.  The first of the four
installments was paid during the fourth quarter of 2008, and 108,333 additional
shares of our common stock was returned to us.  As of June 30, 2009, a
total liability of $1.5 million is included on the Company’s balance sheet as a
deferred liability, all of which is classified as current.
  On July 15, 2009, the Company commenced
a lawsuit against Leexus and its three individual partners, Mark Jaehne, Bennie
Jaehne, and William Zeltwanger (the “Defendants”).  In this new
lawsuit, the Company alleges, among other things, the existence of certain
post-merger fraudulent assignments of merger assets by the Defendants,
rescission and breach of the May 15, 2008 settlement agreement, incorrect
calculation of overriding royalty interests, and misrepresentations by the
Defendants with respect to certain merger assets.  Leexus, Mark
Jaehne, and Bennie Jaehne have filed a counterclaim against the Company,
alleging the Company breached the May 15, 2008 settlement agreement due to
non-payment of a May 15, 2009 scheduled installment payment.
 Sources
and Uses of Cash
 
 The
following table sets forth our sources and uses of cash for the six months ended
June 30, 2009 and 2009.
 
 Six
      Months Ended
                  June
      30,
                
                
                Change
                  2009
      vs.2009
                
                
                2008
                
                
                2008Net
      cash used in operating activities
                
                $
                (1,981,250
                )
                
                $
                (176,408
                )
                
                $
                1,804,842Net
      cash used in investingNet
      cash used in investing
                
                
                (969,175
                )
                
                
                (5,053,435
                )
                
                
                (4,084,260
                )Net
      cash  provided by financingactivities
                
                
                140,125
                
                
                
                7,921,052
                
                
                
                (7,780,927
                )Net
      increase (decrease) in cash andcash
      equivalents
                
                $
                (2,810,300
                )
                
                $
                2,691,209
                
                
                $
                (5,501,509
                )
 
 Net cash used in operating activities
increased by $1.8 million for the first six months of 2009 compared to the first
six months of 2008.  This increase was the net effect of a $3.2
million decrease in net cash provided by operating activities attributable to
changes in operating assets and liabilities, partially offset by a $1.4 million
decrease in net cash used by net loss, adjusted for non-cash components of net
loss.
 
 Net cash used in investing activities
decreased by $4.1 million for the first six months of 2009 compared to the same
period in 2008.  This decrease reflects reduced capital spending for
lease acquisition and drilling activities during 2009.
 
 Net cash provided by financing
activities decreased by $7.8 million for the first six months of 2009 compared
to the same period in 2008.  During the first six months of 2008, we
issued new debt totaling approximately $12 million and made debt payments of
approximately $3.2 million.  During 2009, we received cash totaling
$555,000 for the issuance of new debt, and used cash of $414,875 for the payment
of debt.   Also during the first six months of 2009, we
eliminated an additional $27.4 million of our debt and related accrued interest
payable through non-cash debt restructuring transactions as described at Note 2
to the financial statements.
  21
 
 New
Accounting Standards
  FASB Statement of Accounting
Standard No. 157, “Fair Value Measurement” (“SFAS 157”):  SFAS
157, issued in September 2006, defines fair value, provides guidance for using
fair value to measure assets and liabilities. It applies whenever other
standards require or permit assets or liabilities to be measured at fair value
but it does not expand the use of fair value in any new circumstances. In
November 2008, the effective date was deferred for all non-financial assets and
liabilities, except those that are recognized or disclosed at fair value on a
recurring basis. The provisions of SFAS No. 157 that were not deferred are
effective for financial statements issued for fiscal three months beginning
after November 15, 2008. The adoption of SFAS No. 157, effective January 1,
2009, did not have a significant effect on our financial position or results of
operations.
 
 FASB Statement of Accounting
Standards No. 159, “The Fair Value Option for Financial Assets and Financial
Liabilities” (“SFAS 159”):SFAS 159, issued in February 2008,
allows entities the option to measure the eligible financial instruments at fair
value as of specified dates.  Such election, which may be applied on
an instrument by instrument basis, is typically irrevocable once
elected.  SFAS No. 159 is effective fiscal three months beginning
after November 15, 2008, and early application is allowed under certain
circumstances.  The adoption of SFAS No. 159, effective January 1,
2009, did not have a significant effect on our financial position or results of
operations.
  FASB Statement of Accounting
Standards No. 141 (R), “Business Combinations” (“SFAS 141
(R)”): SFAS No. 141(R) was issued in December 2008 to replace
SFAS 141.  SFAS 141 (R) establishes principles and requirements for
how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, any non-controlling
interest in the acquire and the goodwill acquired.  The Statement also
establishes disclosure requirements, which will enable users to evaluate the
nature and financial effects of the business combination.  SFAS 141
(R) is effective for fiscal three months beginning after December 15,
2009.  The adoption of SFAS 141 (R) will have an impact on accounting
for business combinations, but the effect is dependent upon acquisitions at the
time they occur.
  FASB Statement of Accounting
Standards No. 160, “Noncontrolling Interests in Consolidated Financial
Statements – an amendment of Accounting Research Bulletin No. 51” (“SFAS 160”):SFAS 160, issued in December 2008, establishes accounting and reporting
standards for ownership interests in subsidiaries held by parties other than the
parent, the amount of consolidated net income attributable to the parent and to
the non-controlling interest, changes in a parent’s ownership interest and the
valuation of retained noncontrolling equity investments when a subsidiary is
deconsolidated.  The Statement also establishes reporting requirements
that provide sufficient disclosures that clearly identify and distinguish
between the interests of the parent and the interests of the non-controlling
owners.  SFAS 160 is effective for fiscal three months beginning after
December 15, 2009.  We do not currently have any non-controlling
interests and do not believe that the adoption of SFAS No. 160 will have an
effect on its financial position or results of operations.
  FASB Statement of Accounting
Standards No. 161, “Disclosures about Derivative Instruments and Hedging
Activities – an amendment of FASB Statement No. 133” (“SFAS
161”):SFAS 161, issued in March 2009, requires new and
expanded disclosures regarding hedging activities. These disclosures include,
but are not limited to, a tabular presentation of derivative data; financial
statement presentation of fair values on a gross basis, including those that
currently qualify for netting under FASB Interpretation No. 39; and specific
footnote narrative regarding how and why derivatives are used. The disclosures
are required in all interim and annual reports. SFAS No. 161 is effective for
fiscal and interim periods beginning after November 15, 2009.  The
adoption of SFAS No. 159, effective January 1, 2009, did not have a significant
effect on our financial position or results of operations
  Securities and Exchange Commission
(“SEC”) Release No. 33-8995, “Modernization of Oil and Gas
Reporting”:Issued March 31, 2009, SEC Release
No. 33-8995 revised disclosure requirements for oil and gas companies. In
addition to changing the definition and disclosure requirements for oil and gas
reserves, the new rules change the requirements for determining oil and gas
reserve quantities. These rules permit the use of new technologies to determine
proved reserves under certain criteria and allow companies to disclose their
probable and possible reserves. The new rules also require companies to report
the independence and qualifications of their reserves preparer or auditor and
file reports when a third party is relied upon to prepare reserves estimates or
conducts a reserves audit. The new rules also require that oil and gas reserves
be reported and the full cost ceiling limitation be calculated using a
twelve-month average price rather than period-end prices. The use of a
twelve-month average price could have an effect on our depletion rates for its
natural gas and crude oil properties. The pronouncement is effective January 1,
2010 and will be effective for annual reports on Form 10-K for fiscal years
ending after December 31, 2009, pending the potential alignment of certain
accounting standards by the FASB with the new rule.  The Company is
currently evaluating the impact of SEC Release No. 33-8995 on its consolidated
financial statements and related disclosures.
  22
 
 FASB Staff Position 107-1(“FSP”) FAS
107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial
Instruments”:The FSP, issued in April 2009, enhances
consistency in financial reporting by increasing the frequency of fair value
disclosures, and is effective for interim and annual periods ending after June
15, 2009, with early adoption permitted for periods ending after March 15,
2009.  The Company does not believe that the adoption of this FSP will
have a material effect on its financial statements.
 
 FASB Statement of Accounting
Standards No. 165, “Subsequent Events” (“SFAS 165”):  SFAS 165,
issued in May 2009, establishes general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued.  This
standard will not have an effect on the Company’s financial position or results
of operations.
 
 FASB Statement of Accounting
Standards No. 168, “The FASB Accounting Standards Codification and the Hierarchy
of Generally Accepted Accounting Principles – a replacement of FASB Statement
No. 162” (“SFAS 168”):SFAS 168, issued in June 2009,
describes that the FASB Accounting Standards Codification will become the source
of authoritative U.S. generally accepted accounting principles (GAAP) recognized
by the FASB to be applied by nongovernmental entities.  Rules and
interpretive releases of the Securities and Exchange Commission (SEC) under
authority of federal securities laws are also sources of authoritative GAAP for
SEC registrants.  All other nongrandfathered non-SEC accounting
literature not included in the Codification will become nonauthoritative.  
This Statement is effective for financial statements issued for interim and
annual periods ending after September 15, 2009.   The Company
does not believe this standard will have an effect on the Company’s financial
position or results of operations.
 
 23
 
 Item
3. Quantitative and Qualitative Disclosures About Market Risk.
 
 Not
applicable.
 
 Item
4T. Controls and Procedures.
 
 Disclosure
Controls and Procedures
 
 We
maintain disclosure controls and procedures designed to ensure that information
required to be disclosed in reports filed under the Securities Exchange Act of
1934 (“Exchange Act”) is recorded, processed, summarized and reported within the
specified time periods. Our Chief Executive Officer and our Chief Financial
Officer are responsible for maintaining our disclosure controls and procedures.
The controls and procedures established by us are designed to provide reasonable
assurance that information required to be disclosed by the issuer in the reports
that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and
forms.
 
 As
required by Rule 13a-15 under the Exchange Act, our management, including, our
Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness
of the design and operation of our disclosure controls and procedures as of June
30, 2009. Based on that evaluation, management concluded that as of June 30,
2009, and as of the date that the evaluation of the effectiveness of our
disclosure controls and procedures was completed, our disclosure controls and
procedures were effective to satisfy the objectives for which they are
intended.
 
 Changes
in Internal Control Over Financial Reporting
 
 There was
no change in our internal control over financial reporting during the period
ended June 30, 2009, that has affected materially, or is reasonably likely to
affect materially, our internal control over financial reporting.
 
 24
 
 PART
II – OTHER INFORMATION
 
 Item
1.  Legal Proceedings.
 
 Granite
Lawsuit
 
 On February 26, 2009, Granite Energy
Inc. commenced a lawsuit against the Company in Bexar County, Texas, to recover
the balance of the purchase price allegedly owed by the Company to Granite for
our purchase of a certain drilling rig and associated equipment.  We
purchased the rig and equipment from Granite, pursuant to a Purchase and Sale
Agreement, dated September 17, 2007, for $1,300,000.  As of June 30,
2009, we have paid an aggregate of $944,751 to Granite.  In February
2009, we stopped making payments for the rig and equipment, owing to Granite’s
failure to deliver title to the assets, despite our repeated demands for
same.
 
 The parties have agreed to settle
Granite’s lawsuit with the payment by the Company of $200,000 and the issuance
of 400,000 shares of its restricted common stock in exchange for title to the
assets.
  Lawsuit Against
Leexus
 On July 15, 2009, the Company commenced
a lawsuit against Leexus Oil & Gas, LLP and its three individual partners,
Mark Jaehne, Bennie Jaehne, and William Zeltwanger (the “Defendants”). In this
new lawsuit, the Company alleges, among other things, the existence of certain
post-merger fraudulent assignments of merger assets by the Defendants,
rescission and breach of the May 15, 2008 settlement agreement, incorrect
calculation of overriding royalty interests, and misrepresentations by the
Defendants with respect to certain merger assets.  Leexus, Mark
Jaehne, and Bennie Jaehne filed a counterclaim against the Company, alleging the
Company breached the May 15, 2008 settlement agreement due to non-payment of a
May 15, 2009 scheduled installment payment.
  Zeltwanger
Lawsuit
 
 On July 13, 2009, William Zeltwanger
commenced a lawsuit against the Company, alleging the Company breached the
previously reported Agreement and Plan of Merger dated April 20, 2007 by failing
to make installment payments allegedly due under the Agreement and Plan of
Merger and by failing to lift alleged restrictions on his right to transfer his
shares of the Company’s common stock.  As discussed above, William
Zeltwanger is a defendant in the lawsuit commenced by the Company on July 15,
2009.
 Item
1A.  Risk Factors.
 
 There
have been no material changes to the risk factors disclosed in our annual
report on Form 10-K for the year ended December 31, 2008, and our
quarterly report on Form 10-Q for the quarter ended March 31, 2009.
  25
 
 Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
 
 In the period ending June 30, 2009, we
issued an aggregate 12,000 shares of our common stock to two individuals for
services rendered to us under consulting agreements, in transactions not
involving a public offering, pursuant to Section 4(2) of the Securities Act of
1933.
 
 Subsequent
Events
 
 On August
3, 2009, we issued 400,000 shares of our common stock to Granite Energy, Inc. in
partial payment of the settlement of a lawsuit with Granite Energy, Inc. in a
transaction not involving a public offering, pursuant to Section 4(2) of the
Securities Act of 1933 (see Note 7 to Consolidated Financial Statements for a
full description of the settlement).
 
 Item
3. Defaults Upon Senior Securities.
 
 None.
 
 Item
4. Submission of Matters to a Vote of Security Holders.
 
 On March 5, 2009, we received written
consents from a majority of our stockholders holding or able to direct the vote
of 9,949,725 shares of our common stock, representing approximately 59.36% of
the then total issued and outstanding Common Stock, to take the following
stockholder actions by written consent:
 
 ·
              to
      approve the issuance of approximately 1.6 million shares of the Company’s
      newly designated Series A Convertible Preferred Stock, plus such
      additional shares as may result from interest accrued through the
      effective date of the Stockholder Consents (as defined below), to The
      Longview Fund, L.P., a California limited partnership (“Longview”), in
      exchange for the surrender and cancellation of approximately $16.3 million
      (plus accrued interest) of the Company’s secured debt held by Longview;
      and
 
 ·
              to
      amend the Company’s Articles of Incorporation to increase our authorized
      common stock, par value $0.001 per share, from 50,000,000 shares to
      200,000,000 shares.
 
 The stockholder consent actions were
effective 20 days after the Definitive Information Statement on Schedule 14C was
first mailed to our stockholders, which mailing occurred on April 24,
2009.  The closing of the Series A Convertible Preferred transaction
occurred on May 18, 2009.
 
 Item
5.  Other Information.
 
 None.
  26
 
 Item
6. Exhibits.
  Exhibit
      No.
                                    
                                    Description4.1
                                    
                                    Securities
      Exchange Agreement dated February 20, 2009 among the Company and its
      Subsidiaries, and The Longview Fund, L.P. (incorporated by reference to
      Appendix B to the Information Statement on Schedule 14C filed on April 24,
      2009).4.2
                                    
                                    Securities
      Purchase Agreement dated June 10, 2009 and June 16, 2009 by and among the
      Company and the investors listed on the Schedule of Buyers attached
      thereto (incorporated by reference to Exhibits 99.1 and 99.2 to the
      Current Report on Form 8-K filed on June 16, 2009).4.3
                                    
                                    Form
      of Convertible Note (incorporated by reference to Exhibit 99.3 to the
      Current Report on Form 8-K filed on June 16, 2009).4.4
                                    
                                    Form
      of Warrant (incorporated by reference to Exhibit 99.4 to the Current
      Report on Form 8-K filed on June 16, 2009).10.1
                                    
                                    August
      2009 Waiver and Amendment Agreement dated August 14, 2009, among South
      Texas Oil Company, the Subsidiaries, Longview Marquis Master Fund, L.P.,
      and Summerview Marquis Fund,
L.P.
  31.1
                  
                  Principal
      Executive Officer Certification Pursuant to Item 601(b)(31) of Regulation
      S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      200231.2
                  
                  Principal
      Financial Officer Certification Pursuant to Item 601(b)(31) of Regulation
      S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      200232.1
                  
                  Principal
      Executive Officer Certification Pursuant to Item 601(b)(32) of Regulation
      S-K, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      200232.2
                  
                  Principal
      Financial Officer Certification Pursuant to Item 601(b)(32) of Regulation
      S-K, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002
 
 27
 
 SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
  SOUTH
      TEXAS OIL COMPANYDate: August
      14, 2009
                By:
                /s/  Sherry L.
      SpurlockSherry
      L. Spurlock
                  Executive
      Vice President and Chief Financial Officer
                  (Principle
      Financial Officer)
  28
  EXHIBIT
INDEX
  Exhibit
      No.
              
              Description4.1
              
              Securities
      Exchange Agreement dated February 20, 2009 among the Company and its
      Subsidiaries, and The Longview Fund, L.P. (incorporated by reference to
      Appendix B to the Information Statement on Schedule 14C filed on April 24,
      2009).4.2
              
              Securities
      Purchase Agreement dated June 10, 2009 and June 16, 2009 by and among the
      Company and the investors listed on the Schedule of Buyers attached
      thereto (incorporated by reference to Exhibits 99.1 and 99.2 to the
      Current Report on Form 8-K filed on June 16, 2009).4.3
              
              Form
      of Convertible Note (incorporated by reference to Exhibit 99.3 to the
      Current Report on Form 8-K filed on June 16, 2009).4.4
              
              Form
      of Warrant (incorporated by reference to Exhibit 99.4 to the Current
      Report on Form 8-K filed on June 16, 2009).10.1
              
              August
      2009 Waiver and Amendment Agreement dated August 14, 2009, among South
      Texas Oil Company, the Subsidiaries, Longview Marquis Master Fund, L.P.,
      and Summerview Marquis Fund, L.P.
  31.1
                
                Principal
      Executive Officer Certification Pursuant to Item 601(b)(31) of Regulation
      S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      200231.2
                
                Principal
      Financial Officer Certification Pursuant to Item 601(b)(31) of Regulation
      S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      200232.1
                
                Principal
      Executive Officer Certification Pursuant to Item 601(b)(32) of Regulation
      S-K, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      200232.2
                
                Principal
      Financial Officer Certification Pursuant to Item 601(b)(32) of Regulation
      S-K, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002
 
 29