<PAGE>
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549

                                   FORM 10-K
(Mark One)
( )  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
     OF THE SECURITIES EXCHANGE ACT OF 1934

                                       OR

(X)  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
     OF THE SECURITIES EXCHANGE ACT OF 1934

        For the transition period from July 1, 1997 to December 31, 1997

                         Commission File Number 0-9498

                         BELLWETHER EXPLORATION COMPANY
             (Exact name of registrant as specified in its charter)

               Delaware                             76-0437769
     (State or other jurisdiction of    (I.R.S. Employer Identification No.)
     incorporation or organization)

 1331 Lamar, Suite 1455, Houston, Texas                 77010
(Address of principal executive offices)             (Zip Code)

       Registrant's telephone number, including area code: (713) 650-1025

        SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
                                        


          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                                        
     Common Stock, $0.01 par value                            NASDAQ/NMS
     Preferred Stock purchase rights

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

     Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this 10-K or any amendment to this Form
10-K. [X]

     The aggregate market value of the voting stock held by non-affiliates of
the registrant at March 20, 1998 was approximately $124,608,080.
     As of March 20, 1998, the number of outstanding shares of the registrant's
common stock was 14,139,924.

     Documents Incorporated by Reference:  Portions of the registrant's annual
proxy statement, to be filed within 120 days after December 31, 1997, are
incorporated by reference into Part III.
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES


                           ANNUAL REPORT ON FORM 10-K
            Transition Period from July 1, 1997 to December 31, 1997

                               TABLE OF CONTENTS
 
                                                                 Page
                                                                Number
                                                                ------
PART I
 
 Item 1.     Business...........................................   3
 Item 2.     Properties.........................................  11
 Item 3.     Legal Proceedings..................................  22
 Item 4.     Submission of Matters to a Vote of Security Holders  22
 
PART II
 
 Item 5.     Market for the Registrant's Common Equity and
              Related Stockholder Matters.......................  23
 Item 6.     Selected Financial Data............................  24
 Item 7.     Management's Discussion and Analysis of Financial
              Condition and Results of Operations...............  25
 Item 8.     Financial Statements and Supplementary Data........  35
 Item 9.     Changes in and Disagreements with Accountants on
              Accounting and Financial Disclosure...............  70
 
PART III
 
 Item 10.    Directors and Executive Officers of the Registrant.  70
 Item 11.    Executive Compensation.............................  70
 Item 12.    Security Ownership of Certain Beneficial Owners and
              Management........................................  70
 Item 13.    Certain Relationships and Related Transactions.....  70
 
PART IV
 
 Item 14.    Exhibits, Financial Statement Schedules and Reports
              on Form 8-K.......................................  70

  --   Signatures
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                                     PART I

Item 1.  Business

     This annual report on Form 10-K includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934
("Exchange Act"). All statements other than statements of historical fact
included herein regarding the Company's financial position, estimated quantities
and net present values of reserves, business strategy, plans and objectives for
future operations and covenant compliance, are forward-looking statements.
Although the Company believes that the assumptions upon which such forward-
looking statements are based are reasonable, it can give no assurances that such
assumptions will prove to have been correct. Important factors that could cause
actual results to differ materially from the Company's expectations ("cautionary
statements") are disclosed under Risk Factors and elsewhere herein. All
subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified by the
cautionary statements.

General

     Bellwether Exploration Company ("Bellwether" or the "Company") is an
independent energy company engaged in the acquisition, exploitation,
development, exploration and production of oil and gas properties and the
gathering and processing of natural gas.  The Company's principal properties are
located in Texas, Louisiana, Alabama, offshore California and the Gulf of
Mexico.  At December 31, 1997, the Company's estimated net proved reserves
totaled 12.2 MMBbl of oil, 2.6 MMBbl of natural gas liquids ("NGL"), and 126.0
Bcf of natural gas for a total of 35.8 million barrels of oil equivalent
("BOE").  On a BOE basis, approximately 59% of the Company's estimated net
proved reserves were natural gas at such date.  In addition, the Company has
interests in natural gas processing plants in California and West Texas.

     The Company was formed as a Delaware corporation in 1994 to succeed to the
business and properties of its predecessor company pursuant to a merger, the
primary purpose of which was to change the predecessor company's state of
incorporation from Colorado to Delaware.  The predecessor company was formed in
1980 from the consolidation of the business and properties of related oil and
gas limited partnerships.  References to Bellwether or the Company include the
predecessor company, unless the context requires otherwise.

     In order to facilitate greater comparability with its peer group by the
financial community, the Company changed its fiscal year to align with the
calendar year, beginning January 1, 1998.  The six-month transition period of
July 1, 1997 through December 31, 1997 ("transition period") precedes the start
of the new fiscal year.  The unaudited financial information for the six months
ended December 31, 1996 ("prior period") is presented for comparative purposes
and includes any adjustments (consisting of normal, recurring adjustments) which
are, in the opinion of management, necessary for fair presentation.

                                       3
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

Oil and Gas Activities

     In 1987 and 1988, the Company merged with two independent oil and gas
companies owned by institutional investors and managed by Torch Energy Advisors
Incorporated ("Torch").  Since those mergers, the Company has operated under
agreements, pursuant to which the Company outsources certain administrative
functions to Torch.

     In August 1994, Bellwether acquired, by merger, certain of the assets,
liabilities and properties of Odyssey Partners, Ltd. ("Odyssey"), an exploration
company specializing in 3-D seismic and computer-aided exploration ("CAEX")
technology, in exchange for 0.9 million shares of Common Stock and $5.6 million
in cash. The Odyssey merger provided the Company with significant expertise in
3-D seismic and CAEX technology.

     On February 28, 1995, Bellwether acquired Hampton Resources Corporation
("Hampton") by merger for $17.0 million in cash and approximately 1.0 million
shares of Common Stock.  Hampton was a publicly held oil and gas company based
in Houston, Texas.

     In April 1997, the Company acquired oil and gas properties and $13.9
million of working capital from affiliates of Torch ("Partnership
Transactions"), for $145.2 million, including a contingent payment of $3.4
million, the amount of which was based on 1997 gas prices.  The Company financed
the Partnership Transactions and related fees, with $34.1 million net proceeds
of a Common Stock offering, $97.0 million net proceeds of $100.0 million
offering of 10 7/8% Senior Subordinated Notes due 2007 (the "Offerings")and
advances under a new credit facility ("New Credit Facility" or "Senior Credit
Facility").  In addition, as consideration for advisory services, Torch was
issued 150,000 shares of the Company's common stock and a warrant to purchase
100,000 shares of common stock at $9.90 per share.  The warrant and shares were
valued at $1.5 million and recorded as a cost of the Partnership Transactions.

     Subsequent to the Partnership Transaction, the Company identified for
divestiture non-core properties including approximately 10% of the estimated net
proved reserves attributable to the Partnership Transactions.  These properties
were primarily small working interests in geographically diverse locations, with
generally lower operating margins and limited development potential.  Such
properties were sold in a series of transactions from May 1997 to December 1997
for aggregate consideration of $24 million.  The net proceeds from these
divestitures were used to repay indebtedness.

Business Strategy

     Bellwether's strategy is to grow its reserves, production and cash flow
through a balanced program of producing property acquisitions and technology
driven exploratory drilling focused within core operating areas.  The key
elements of this strategy are as follows:

     Core Areas Development  The Company will develop core operating areas by
increasing its geographic concentration and focusing its activities and
ownership on a smaller number of higher value operated properties.  The 

                                       4
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

Company considers its primary core area to be the Texas  Louisiana Gulf Coast.

     Exploration - The Company's exploration activities will be focused
primarily along the Texas Louisiana Gulf Coast, both on and offshore, and in
areas where the Company has significant existing assets and infrastructure.
Emphasis will be placed on internal prospect generation and strategic
relationships with prospect generators who have a demonstrated expertise within
a play type or area of interest. The Company will employ the latest technology
including advanced 3-D seismic and computer added exploration and will leverage
its exploration through play types which allow multiple application of
successful exploration concepts.

     Acquisition - The Company will pursue acquisitions of producing oil and gas
properties which increase its interests or concentration in its existing
properties and operating areas or which advance its strategic goals.  The
Company will seek to acquire properties within its core Texas-Louisiana Gulf
Coast area and properties which would assist in establishing new core areas.
Emphasis will be placed on high quality, high margin properties which are
operated, have significant exploitation potential and are on trend with existing
exploration concepts.

     Exploitation - The Company will aggressively exploit its properties to
maximize their economic value employing the latest technology including 3-D
seismic evaluation, horizontal drilling, enhanced recovery methods and advanced
completion and production techniques.

     Low Cost Structure - The Company will constantly seek to reduce costs and
maintain a competitive cost structure.  The Company will continually review its
property base, divesting non-core or lower margin assets and redeploying capital
to a higher use.

Markets

     Bellwether's ability to market oil and gas from the Company's wells depends
upon numerous factors beyond the Company's control, including the extent of
domestic production and imports of oil and gas, the proximity of the gas
production to gas pipelines, the availability of capacity in such pipelines, the
demand for oil and gas by utilities and other end users, the availability of
alternate fuel sources, the effects of inclement weather, state and federal
regulation of oil and gas production and federal regulation of gas sold or
transported in interstate commerce. No assurances can be given that Bellwether
will be able to market all of the oil or gas produced by the Company or that
favorable prices can be obtained for the oil and gas Bellwether produces.

     In view of the many uncertainties affecting the supply of and demand for
oil, gas and refined petroleum products, the Company is unable to predict future
oil and gas prices and demand or the overall effect such prices and demand will
have on the Company. The marketing of oil and gas by Bellwether can be affected
by a number of factors which are beyond the Company's control, the exact effects
of which cannot be accurately predicted.

     Sales to Torch Co-Energy LLC accounted for 22% of transition period 1997
revenues.  Sales to Valero Industrial Gas, L.P. accounted for 18.0% of 

                                       5
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

fiscal 1997 revenues. Sales to Texas Gas Transmission Corporation, Warren
Petroleum Corporation and Koch Industries Inc. accounted for 32.9% of fiscal
1996 revenues. Sales to Texas Gas Transmission Corporation and Warren Petroleum
Corporation accounted for 42% of fiscal 1995 revenues. Management of the Company
does not believe that the loss of any single customer or contract would
materially affect the Company's business. There are no other significant
delivery commitments and substantially all of the Company's oil and gas
production is sold at market responsive pricing through a marketing affiliate of
Torch. The Company from time to time may enter into crude oil and natural gas
price swaps or other similar hedge transactions to reduce its exposure to price
fluctuations.

Regulation

     Federal Regulations

     Sales of Gas.  Effective January 1, 1993, the Natural Gas Wellhead
Decontrol Act deregulated prices for all "first sales" of gas.  Thus, all sales
of gas by the Company may be made at market prices, subject to applicable
contract provisions.

     Transportation of Gas.  The Company's sales of natural gas are affected by
the availability, terms and cost of transportation.  The rates, terms and
conditions applicable to the interstate transportation of gas by pipelines are
regulated by the Federal Energy Regulatory Commission ("FERC") under the Natural
Gas Act ("NGA"), as well as under section 311 of the Natural Gas Policy Act
("NGPA").  Since 1985, the FERC has implemented regulations intended to increase
competition within the gas industry by making gas transportation more accessible
to gas buyers and sellers on an open-access, non-discriminatory basis.

     Most recently, in Order No. 636, et seq., the FERC promulgated an extensive
set of new regulations requiring all interstate pipelines to "restructure" their
services.  The most significant provisions of Order No. 636 require that
interstate pipelines provide firm and interruptible transportation solely on an
"unbundled" basis, separate from their sales service, and convert each
pipeline's bundled firm city-gate sales service into unbundled firm
transportation service and require that pipelines provide firm and interruptible
transportation service on a basis that is equal in quality for all gas supplies,
whether purchased from the pipeline or elsewhere.  The order also recognized
that the elimination of city-gate sales service and the implementation of
unbundled transportation service would result in considerable costs being
incurred by the pipelines.  Therefore, Order No. 636 provided mechanisms for the
recovery by pipelines from present, former and future customers of certain types
of "transition" costs likely to occur due to these new regulations.

     In subsequent orders, the FERC and the appellate court have substantially
upheld the requirements imposed by Order No. 636, although numerous court
appeals in which parties have sought review of separate FERC orders implementing
Order No. 636 on individual pipeline systems are still pending.  In many
instances, the result of Order No. 636 and related initiatives has been to
substantially reduce or eliminate the interstate 

                                       6
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

pipelines' traditional role as wholesalers of natural gas in favor of providing
only storage and transportation services.

     The FERC has announced several important transportation-related policy
statements and proposed rule changes, including a statement of policy and
request for comments concerning alternatives to its traditional cost-of-service
ratemaking methodology to establish the rates interstate pipelines may charge
for their services.  A number of pipelines have obtained FERC authorization to
charge negotiated rates as one such alternative.  While the changes being
considered would affect the Company only indirectly, they are intended to
further enhance competition in natural gas markets.  The Company cannot predict
what further action the FERC will take on these matters; however, the Company
does not believe that it will be affected by any action taken materially
differently than other natural gas producers.

     Sales and Transportation of Oil.  Sales of oil and condensate can be made
by the Company at market prices not subject at this time to price controls.  The
price that the Company receives from the sale of these products will be affected
by the cost of transporting the products to market.  As required by the Energy
Policy Act of 1992, the FERC has revised its regulations governing the rates
that may be charged by oil pipelines.  The new rules, which were effective
January 1, 1995, provide a simplified, generally applicable method of regulating
such rates by use of an indexing system for setting transportation rate
ceilings.  In certain circumstances, the new rules permit oil pipelines to
establish rates using traditional cost of service and other methods of rate
making.

     Legislative Proposals.  In the past, Congress has been very active in the
area of gas regulation.  There are legislative proposals pending in the state
legislatures of various states, which, if enacted, could significantly affect
the petroleum industry.  At the present time it is impossible to predict what
proposals, if any, might actually be enacted by Congress or the various state
legislatures and what effect, if any, such proposals might have on the Company's
operations.

     Federal, State or Indian Leases.  In the event the Company conducts
operations on federal, state or Indian oil and gas leases, such operations must
comply with numerous regulatory restrictions, including various
nondiscrimination statutes, and certain of such operations must be conducted
pursuant to certain on-site security regulations and other appropriate permits
issued by the Bureau of Land Management ("BLM") or, in the case of the Company's
OCS leases in federal waters, Minerals Management Service ("MMS") or other
appropriate federal or state agencies.  The Company's OCS leases in federal
waters are administered by the MMS and require compliance with detailed MMS
regulations and orders.  The MMS has promulgated regulations implementing
restrictions on various production-related activities, including restricting the
flaring or venting of natural gas.  In addition, the MMS has proposed to amend
its regulations to prohibit the flaring of liquid hydrocarbons and oil without
prior authorization.  Under certain circumstances, the MMS may require any
Company operations on federal leases to be suspended or terminated.  Any such
suspension or termination could materially and adversely affect the Company's
financial condition and operations.  The MMS has issued a notice of proposed
rule making in which it 

                                       7
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

proposes to amend its regulations governing the calculation of royalties and the
valuation of crude oil produced from federal leases. Among other matters, this
proposed rule would amend the valuation procedure for the sale of federal
royalty oil. The Company cannot predict what action the MMS will take on this
matter, nor can it predict at this stage of the proceeding how the Company might
be affected by this proposed amendment to the MMS' royalty regulations.

     The Mineral Leasing Act of 1920 (the "Mineral Act") prohibits direct or
indirect ownership of any interest in federal onshore oil and gas leases by a
foreign citizen of a country that denies "similar or like privileges" to
citizens of the United States.  Such restrictions on citizens of a "non-
reciprocal" country include ownership or holding or controlling stock in a
corporation that holds a federal onshore oil and gas lease.  If this restriction
is violated, the corporation's lease can be canceled in a proceeding instituted
by the United States Attorney General.  Although the regulations of the BLM
(which administers the Mineral Act) provide for agency designations of non-
reciprocal countries, there are presently no such designations in effect.  The
Company owns interests in numerous federal onshore oil and gas leases.  It is
possible that the Common Stock will be acquired by citizens of foreign
countries, which at some time in the future might be determined to be non-
reciprocal under the Mineral Act.

     State Regulations.  Most states regulate the production and sale of oil and
gas, including requirements for obtaining drilling permits, the method of
developing new fields, the spacing and operation of wells and the prevention of
waste of oil and gas resources.  The rate of production may be regulated and the
maximum daily production allowable from both oil and gas wells may be
established on a market demand or conservation basis or both.

     The Company owns certain natural gas pipeline facilities that it believes
meet the traditional tests the FERC has used to establish a pipeline's status as
a gatherer not subject to FERC jurisdiction under the NGA.  State regulation of
gathering facilities generally includes various safety, environmental, and in
some circumstances, nondiscriminatory take requirements, but does not generally
entail rate regulation.  Natural gas gathering may receive greater regulatory
scrutiny at both state and federal levels in the post-Order No. 636 environment.

     The Company may enter into agreements relating to the construction or
operation of a pipeline system for the transportation of gas.  To the extent
that such gas is produced, transported and consumed wholly within one state,
such operations may, in certain instances, be subject to the jurisdiction of
such state's administrative authority charged with the responsibility of
regulating intrastate pipelines.  In such event, the rates which the Company
could charge for gas, the transportation of gas, and the construction and
operation of such pipeline would be subject to the rules and regulations
governing such matters, if any, of such administrative authority.

     Environmental Regulations

     General.  The Company's activities are subject to existing federal, state
and local laws and regulations governing environmental quality and 

                                       8
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

pollution control. Activities of the Company with respect to gas facilities,
including the operation and construction of pipelines, plants and other
facilities for transporting, processing, treating or storing gas and other
products, are also subject to stringent environmental regulation by state and
federal authorities including the Environmental Protection Agency ("EPA"). Risks
are inherent in oil and gas exploration and production operations, and no
assurance can be given that significant costs and liabilities will not be
incurred in connection with environmental compliance issues. The Company cannot
predict what effect future regulation or legislation, enforcement policies
issued thereunder, and claims for damages to property, employees, other persons
and the environment resulting from the Company's operations could have on its
activities.

     Solid and Hazardous Waste.  The Company currently owns or leases, and has
in the past owned or leased, numerous properties that for many years have been
used for the exploration and production of oil and gas. Although the Company
believes it has utilized operating and waste disposal practices that were
standard in the industry at the time, hydrocarbons or other solid wastes may
have been disposed or released on or under the properties owned or leased by the
Company or on or under locations where such wastes have been taken for disposal.
In addition, many of these properties have been owned or operated by third
parties.  The Company had no control over such parties' treatment of
hydrocarbons or other solid wastes and the manner in which such substances may
have been disposed or released.  State and federal laws applicable to oil and
gas wastes and properties have gradually become stricter over time.  Under these
new laws, the Company could be required to remove or remediate previously
disposed wastes (including wastes disposed or released by prior owners or
operators) or property contamination (including groundwater contamination by
prior owners or operators) or to perform remedial plugging operations to prevent
future contamination.

     The Company generates wastes, including hazardous wastes, that are subject
to the federal Resource Conservation and Recovery Act ("RCRA") and comparable
state statutes.  The EPA and various state agencies have limited the approved
methods of disposal for certain hazardous and non-hazardous wastes. Furthermore,
it is possible that certain wastes generated by the Company's oil and gas
operations that are currently exempt from treatment as "hazardous wastes" may in
the future be designated as "hazardous wastes" under RCRA or other applicable
statutes, and therefore be subject to more rigorous and costly operating and
disposal requirements.

     Superfund.  The Comprehensive Environmental Response, Compensation and
Liability Act ("CERCLA"), also known as the "Superfund" law, imposes liability,
without regard to fault or the legality of the original conduct, on certain
classes of persons with respect to the release of a "hazardous substance" into
the environment.  These persons include the owner and operator of a disposal
site where a release occurred and any company that disposed or arranged for the
disposal of the hazardous substance released at the site.  CERCLA also
authorizes the EPA and, in some cases, third parties, to take actions in
response to threats to the public health or the environment and to seek to
recover from the responsible classes of persons the costs of such action.  In
the course of its operations, the Company has generated and will generate wastes
that may fall within CERCLA's definition 

                                       9
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

of "hazardous substances." The Company may also be an owner of sites on which
"hazardous substances" have been released. The Company may be responsible under
CERCLA for all or part of the costs to clean up sites at which such wastes have
been disposed.

     Oil Pollution Act.  The Oil Pollution Act of 1990 (the "OPA") and
regulations thereunder impose certain duties and liabilities on "responsible
parties" related to the prevention of oil spills and damages resulting from such
spills in United States waters.  A "responsible party" includes the owner or
operator of an onshore facility, vessel or pipeline, or the lessee or permittee
of the area in which an offshore facility is located.  The OPA assigns liability
to each responsible party for oil removal costs and a variety of public and
private damages.  While liability limits apply in some circumstances, a party
cannot take advantage of liability limits if the spill was caused by gross
negligence or willful misconduct or resulted from violation of a federal safety,
construction or operating regulation.  If the party fails to report a spill or
to cooperate fully in the cleanup, liability limits also do not apply.  Few
defenses exist to the liability imposed by the OPA.  The failure to comply with
OPA requirements may subject a responsible party to civil or even criminal
liability.

     The OPA also imposes ongoing requirements on a responsible party, including
proof of financial responsibility to cover at least some costs in a potential
spill.  Certain amendments to the OPA that were enacted in 1996 require owners
and operators of offshore facilities that have a worst case oil spill potential
of more than 1,000 barrels to demonstrate financial responsibility in amounts
ranging from $10 million in specified state waters to $35 million in federal OCS
waters, with higher amounts, up to $150 million in certain limited
circumstances, where the MMS believes such a level is justified by the risks
posed by the quantity or quality of oil that is handled by the facility.  On
March 25, 1997, the MMS promulgated a proposed rule implementing these OPA
financial responsibility requirements.  The Company believes that it currently
has established adequate proof of financial responsibility for its offshore
facilities.  However, the Company cannot predict whether the financial
responsibility requirements under the OPA amendments or the proposed rule will
result in the imposition of substantial additional annual costs to the Company
in the future or otherwise materially adversely affect the Company.  The impact
of the financial responsibility requirements is not expected to be any more
burdensome to the Company than it will be to other similarly or less capitalized
owners or operators in the Gulf of Mexico and offshore California.

     Air Emissions.  The operations of the Company are subject to local, state
and federal laws and regulations for the control of emissions from sources of
air pollution.  Administrative enforcement actions for failure to comply
strictly with air regulations or permits may result in the payment of civil
penalties and, in extreme cases, the shutdown of air emission sources.  The
Company believes it is in compliance with all air emission regulations.

     OSHA and other Regulations.  The Company is subject to the requirements of
the federal Occupational Safety and Health Act ("OSHA") and comparable state
statutes.  The OSHA hazard communication standard, the EPA community right-to-
know regulations under Title III of CERCLA and similar state 

                                       10
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

statutes require the Company to organize and/or disclose information about
hazardous materials used or produced in the Company's operations. The Company
believes that it is in substantial compliance with these applicable
requirements.

Competition

     The oil and gas industry is highly competitive in all of its phases.
Bellwether encounters competition from other oil and gas companies in all areas
of the Company's operations, including the acquisition of reserves and producing
properties and the marketing of oil and gas. Many of these companies possess
greater financial and other resources than Bellwether. Competition for producing
properties is affected by the amount of funds available to the Company,
information about a producing property available to the Company and any
standards established by the Company for the minimum projected return on
investment. Because gathering systems and related facilities are the only
practical method for the intermediate transportation of gas, competition for gas
delivery is presented by other pipelines and gas gathering systems. Competition
may also be presented by alternate fuel sources.

ITEM 2.  PROPERTIES

Reserves

     The Company holds interests in oil and gas properties, all of which are
located in the United States.  The Company's principal developed properties are
located in Texas, Louisiana, Alabama, offshore California and the Gulf of
Mexico.  Estimated net proved oil and gas reserves at December 31, 1997
decreased approximately 4% from June 30, 1997, primarily as a result of the sale
of non-core oil and gas properties containing approximately 800,000 BOE of
associated reserves and a downward revision of 1.0 million BOE due to an error
in the calculation of reserves at June 30, 1997.  The Company has not filed oil
or gas reserve information with any foreign government or Federal authority or
agency.

                                       11
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

     The following table sets forth certain information, as of December 31,
1997, which relates to fields which hold approximately 75% of the Company's
proved oil and gas reserves:

<TABLE>
<CAPTION>
                                                                                   Six Month Transition
                                                  Net Proved Reserves              Period Net Production
                                         ------------------------------------------------------------------
                                              OIL &                             OIL &
                                               NGL        GAS         BOE        NGL        GAS        BOE
FIELD                                        (MBBLS)     (MMCF)     (MBBLS)    (MBBLS)    (MMCF)     (MBBLS)
-----------------------------------------------------------------------------------------------------------
<S>                                          <C>        <C>         <C>        <C>        <C>        <C>
Waddell Ranch field, TX                       6,137       9,833      7,775        230        394        296
Point Pedernales field,              
  offshore CA                                 3,873       1,486      4,121        191         80        204
Blue Creek field, AL                            ---      11,072      1,845        ---        474         79
Robinson's Bend field, AL                       ---       5,466        911        ---        203         34
Ship Shoal Complex,                  
  Gulf of Mexico                                940       6,400      2,006        164        929        319
High Island Block A-334              
  field, Gulf of Mexico                         260       7,769      1,555         19      1,109        204
Cove field, offshore TX                          14       7,012      1,183          6      1,278        219
Giddings field, TX                              358       4,574      1,120         65        678        178
Reddell field, LA                                72       4,127        760          6        264         50
South Marsh Island Block             
  269 field, Gulf of                 
  Mexico                                        184       2,748        642         16        218         52
Porters Creek field, TX                          61       4,348        786          5        341         62
La Rica field, TX                                 3       6,223      1,040          1        243         42
West Chalkley field, LA                          19       3,484        600          2        244         43
East Cameron Block 17,               
  offshore LA                                    15       3,245        556          3        503         87
Fort Trinidad field, TX                         634         899        784         30        114         49
Rocky Creek field, TX                             7       3,945        665          1        326         55
Happy field, TX                                 409          80        422         56          3         56
Others                                        1,823      43,249      9,031        259      3,792        891
                                         ---------------------------------    -----------------------------
                                             14,809     125,960     35,802      1,054     11,193      2,920
                                         =================================    =============================
</TABLE>

   In general, estimates of economically recoverable oil and natural gas
reserves and of the future net cash flows therefrom are based upon a number of
variable factors and assumptions, such as historical production from the
properties, assumptions concerning future oil and natural gas prices and future
operating costs and the assumed effects of regulation by governmental agencies,
all of which may vary considerably from actual results. All such estimates are
to some degree speculative, and classifications of reserves are only attempts to
define the degree of speculation involved. Estimates of the economically
recoverable oil and natural gas reserves attributable to any particular group of
properties, classifications of such reserves based on risk of recovery and
estimates of future net cash flows expected therefrom, prepared by different
engineers or by the same engineers at different times, may vary substantially.
The Company's actual production, revenues, severance and excise taxes and
development and operating expenditures with respect to its reserves will vary
from such estimates, and such variances could be material.

   Estimates with respect to proved reserves that may be developed and produced
in the future are often based upon volumetric calculations and upon analogy to
similar types of reserves rather than actual production history.

                                       12
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

     Estimates based on these methods are generally less reliable than those
based on actual production history. Subsequent evaluation of the same reserves
based upon production history will result in variations, which may be
substantial, in the estimated reserves.

     In accordance with applicable requirements of the Securities and Exchange
Commission ("SEC"), the estimated discounted future net cash flows from
estimated proved reserves are based on prices and costs as of the date of the
estimate unless such prices or costs are contractually determined at such date.
Actual future prices and costs may be materially higher or lower. Actual future
net cash flows also will be affected by factors such as actual production,
supply and demand for oil and natural gas, curtailments or increases in
consumption by natural gas purchasers, changes in governmental regulations or
taxation and the impact of inflation on costs.

Acreage

      The following table sets forth the acres of developed and undeveloped oil
and gas properties in which the Company held an interest as of December 31,
1997.  Undeveloped acreage is considered to be those leased acres on which wells
have not been drilled or completed to a point that would permit the production
of commercial quantities of oil and gas, regardless of whether or not such
acreage contains proved reserves.  A gross acre in the following table refers to
the number of acres in which a working interest is owned directly by the
Company.  The number of net acres is the sum of the fractional ownership of
working interests owned directly by the Company in the gross acres expressed as
a whole number and percentages thereof.  A net acre is deemed to exist when the
sum of fractional ownership of working interests in gross acres equals one.
<TABLE>
<CAPTION>
                              Gross     Net
                             -------  -------
<S>                          <C>      <C>
 
      Developed Acreage....  455,581  109,134
      Undeveloped Acreage..  122,352   43,387
                             -------  -------
          Total............  577,933  152,521
                             =======  =======
</TABLE>

     Bellwether believes that the title to its oil and gas properties is good
and defensible in accordance with standards generally accepted in the oil and
gas industry, subject to such exceptions which, in the opinion of the Company,
are not so material as to detract substantially from the use or value of such
properties. The Company's properties are typically subject, in one degree or
another, to one or more of the following: royalties and other burdens and
obligations, express or implied, under oil and gas leases; overriding royalties
and other burdens created by the Company or its predecessors in title; a variety
of contractual obligations (including, in some cases, development obligations)
arising under operating agreements, farmout agreements, production sales
contracts and other agreements that may affect the properties or their titles;
back-ins and reversionary interests arising under purchase agreements and
leasehold assignments; liens that arise in the normal course of operations, such
as those for unpaid taxes, statutory liens securing obligations to unpaid
suppliers and contractors and contractual liens under operating agreements;
pooling, unitization and communitization agreements, declarations and orders;
and easements, restrictions, rights-of-way and other matters that commonly
affect oil and gas producing property. To the extent that such burdens and
obligations 

                                       13
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

affect the Company's rights to production revenues, they have been taken into
account in calculating the Company's net revenue interests and in estimating the
size and value of the Company's reserves. Bellwether believes that the burdens
and obligations affecting the Company's properties are conventional in the
industry for properties of the kind owned by the Company.

Productive Wells

     The following table sets forth Bellwether's gross and net interests in
productive oil and gas wells as of December 31, 1997.  Productive wells are
defined as producing wells and wells capable of production.
<TABLE>
<CAPTION>
                    Gross     Net
                   --------  ------
<S>                <C>       <C>
 
      Oil Wells..  1,192.00  169.79
      Gas Wells..    809.00  142.13
                   --------  ------
          Total..   2001.00  311.92
                   ========  ======
</TABLE>

Production

     The Company's principal production volumes during the transition period
ended December 31, 1997 were from the states of Louisiana, Texas, Alabama and
offshore California in federal waters and from the Gulf of Mexico in federal and
state waters.

     Data relating to production volumes, average sales prices, average unit
production costs and oil and gas reserve information appear in Note 13 of the
Notes to Consolidated Financial Statements-Supplemental Information.

Drilling Activity and Present Activities

     During the three-year period ended June 30, 1997 and the transition period
ended December 31, 1997, the Company's principal drilling activities occurred in
the continental United States and offshore Texas, Louisiana and California in
federal and state waters.

     The following table sets forth the results of drilling activity for the
last three fiscal years and the transition period.  Gross wells, as it applies
to wells in the following tables, refers to the number of wells in which a
working interest is owned directly by the Company.  A "net well" is deemed to
exist when the sum of fractional ownership working interests in gross wells
equals one.  The number of net wells is the sum of the fractional ownership of
working interests owned directly by the Company in gross wells expressed as
whole numbers and percentages thereof.

<TABLE>
<CAPTION>
                                                Exploratory Wells
                         ---------------------------------------------------------
                                      Gross                         Net
                         ---------------------------------------------------------
                                         Dry                           Dry
                           Productive   Holes    Total    Productive  Holes  Total
                         ---------------------------------------------------------
 
<S>                        <C>         <C>       <C>      <C>         <C>    <C>
Fiscal 1995                      3         4(1)      7           .27    .65    .92
Fiscal 1996                      1         3         4           .06    .24    .30
Fiscal 1997                      3         4         7           .75    .74   1.49
Six Month Transition 1997            
                                 2         2         4           .28    .78   1.06
</TABLE>

                                       14
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

<TABLE>
<CAPTION>
                                               Development Wells
                          ------------------------------------------------------
                                     Gross                        Net
                          ------------------------------------------------------
                                         Dry                         Dry
                            Productive  Holes  Total    Productive  Holes  Total
                          ------------------------------------------------------
<S>                         <C>         <C>    <C>      <C>         <C>    <C>
Fiscal 1995                      1         2      3           .30    .18    .48
Fiscal 1996                     21         1     22          1.66    .90   2.56
Fiscal 1997                     52         2     54          5.34    .63   5.97
Six Month Transition 1997              
                                30         5     35          2.40   1.19   3.59
</TABLE>

(1) Includes well drilled on the Serj Permit in Tunisia.

The Company had 18 wells in the process of being drilled as of December 31,
1997.

Gas Plant and Gas Gathering Facilities

        As of December 31, 1997 the Comapany owned interests in the following 
gas plants and gas gathering system:


<TABLE>
<CAPTION>
                                                                                      Transition Period 1997
                                                                    --------------------------------------------------------
                                                                          Capacity          Throughput          Ownership
Facility                 State                 Operator                    MMCFD              MMCFD             Interest
---------------------  ----------  -------------------------------  --------------------------------------------------------
<S>                    <C>         <C>                                <C>               <C>                 <C>
Point Pedernales Gas
 Plant                     CA      Torch Energy Marketing Inc                 13                 4.5              19.70%
 
 
Snyder Gas                         Torch Energy
Plant                      TX      Marketing Inc.                             60                  12              11.98%
 
Diamond M-                         Exxon Company,
Sharon Ridge                       U.S.A.
Gas Plant (1)              TX                                                 (1)                 (1)                (1)
 
Monroe Gas                         West Monroe Gas
Gathering                          Gathering Corp., a
System(2)                  LA      Subsidiary of the                          (2)                 (2)               100%
                                   Company
</TABLE>

(1) The Company has a 35.78% interest in the operations of the former Diamond M-
Sharon Ridge Gas Plant.  This plant was dismantled in December 1993, and the gas
is being processed by Snyder Gas Plant pursuant to a processing agreement.

(2) The Company owns a gas gathering system in Union Parish, Louisiana. In March
1996, the liability for a gas purchase contract covering natural gas owned by
the Company and others was assumed by the Company. All operations from that date
are recorded as a reduction to the liability.

                                       15
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

Risk Factors

    Volatility of Oil and Gas Prices and Markets

     The Company's financial condition, operating results, future growth and the
carrying value of its oil and gas properties are substantially dependent on
prevailing prices of oil and gas. The Company's ability to maintain or increase
its borrowing capacity and to obtain additional capital on attractive terms is
also substantially dependent upon oil and gas prices. Prices for oil and gas are
subject to large fluctuations in response to relatively minor changes in the
supply of and demand for oil and gas, market uncertainty and a variety of
additional factors beyond the control of the Company. These factors include
weather conditions in the United States, the condition of the United States
economy, the actions of the Organization of Petroleum Exporting Countries,
governmental regulation, political stability in the Middle East and elsewhere,
the foreign supply of oil and gas, the price of foreign imports and the
availability of alternate fuel sources. Any substantial and extended decline in
the price of oil or gas would have an adverse effect on the Company's carrying
value of its proved reserves, its borrowing capacity, its ability to obtain
additional capital, and its revenues, profitability and cash flows.

     Volatile oil and gas prices make it difficult to estimate the value of
producing properties in connection with acquisitions and often cause disruption
in the market for oil and gas producing properties, as buyers and sellers have
difficulty agreeing on such value. Price volatility also makes it difficult to
budget for and project the return on acquisitions and exploitation, development
and exploration projects.

     The availability of a ready market for the Company's oil and natural gas
production also depends on a number of factors, including the demand for and
supply of oil and natural gas and the proximity of reserves to, and the capacity
of, oil and natural gas gathering systems, pipelines or trucking and terminal
facilities. Wells may temporarily be shut-in for lack of a market or due to
inadequacy or unavailability of pipeline or gathering system capacity.

    Ability to Replace Reserves

     The Company's future performance depends upon its ability to find, develop
and acquire additional oil and gas reserves that are economically recoverable.
The proved reserves of Bellwether will generally decline as reserves are
depleted. The Company therefore must locate and develop or acquire new oil and
gas reserves to replace those being depleted by production. Because the
Company's reserves are characterized by relatively rapid decline rates, without
successful exploration, development or acquisition activities, the Company's
revenues will decline rapidly. No assurances can be given that the Company will
be able to find and develop or acquire additional reserves at an acceptable
cost.

    Acquisition Risks

     The Company's rapid growth in recent years has been attributable in
significant part to acquisitions of oil and gas properties. The Company expects
to continue to evaluate and, where appropriate, pursue acquisition 

                                       16
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

opportunities on terms management considers favorable to the Company. There can
be no assurance that suitable acquisition candidates will be identified in the
future, or that the Company will be able to finance such acquisitions on
favorable terms. In addition, the Company competes against other companies for
acquisitions, and there can be no assurances that the Company will be successful
in the acquisition of any material property interests. Further, there can be no
assurances that any future acquisitions made by the Company will be integrated
successfully into the Company's operations or will achieve desired profitability
objectives.

     The successful acquisition of producing properties requires an assessment
of recoverable reserves, exploration and exploitation potential, future oil and
natural gas prices, operating costs, potential environmental and other
liabilities and other factors beyond the Company's control. In connection with
such an assessment, the Company performs a review of the properties that it
believes to be generally consistent with industry practices. Nonetheless, the
resulting assessments are inexact and their accuracy is inherently uncertain,
and such a review may not reveal all existing or potential problems, nor will it
necessarily permit the Company to become sufficiently familiar with the
properties to fully assess their merits and deficiencies. Inspections may not
always be performed on every well, and structural and environmental problems are
not necessarily observable even when an inspection is undertaken. In addition,
sellers of properties may be unwilling or financially unable to indemnify the
Company for known liabilities at the time of an acquisition.

     Additionally, significant acquisitions can change the nature of the
operations and business of the Company depending upon the character of the
acquired properties, which may be substantially different in operating and
geologic characteristics or geographic location than existing properties. While
the Company's operations are focused in Texas, Louisiana, Alabama, offshore
California and the Gulf of Mexico, there is no assurance that the Company will
not pursue acquisitions or properties located in other geographic areas.

     In connection with the Partnership Transactions, Bellwether assumed or
otherwise became liable for all obligations with respect to operations of the
properties acquired in such transactions, including environmental and
operational liabilities, unknown liabilities, and liabilities arising prior to
the closing date.

    Drilling Risks

     Drilling activities are subject to many risks, including the risk that no
commercially productive reservoirs will be encountered. There can be no
assurance that new wells drilled by the Company will be productive or that the
Company will recover all or any portion of its investment. Drilling for oil and
natural gas may involve unprofitable efforts, not only from dry wells, but from
wells that are productive but do not produce sufficient net revenues to return a
profit after drilling, operating and other costs. The cost of drilling,
completing and operating wells is often uncertain and cost overruns are common.
The Company's drilling operations may be curtailed, delayed or canceled as a
result of numerous factors, many of which are beyond 

                                       17
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

the Company's control, including title problems, weather conditions, compliance
with governmental requirements and shortages or delays in the delivery of
equipment and services.

    Substantial Capital Requirements

     The Company makes, and will continue to make, substantial capital
expenditures for the exploitation, exploration, acquisition and production of
oil and gas reserves. Historically, the Company has financed these expenditures
primarily with cash generated by operations, proceeds from bank borrowings and
sales of its Common Stock. The Company believes that it will have sufficient
cash flows provided by operating activities, the proceeds of the equity
offerings and borrowings under the Senior Credit Facility to fund such planned
capital expenditures. If revenues or the Company's borrowing base decrease as a
result of lower oil and gas prices, operating difficulties or declines in
reserves, the Company may have limited ability to expend the capital necessary
to undertake or complete future drilling programs. There can assurance that
additional debt or equity financing or cash generated by operations will be
available to meet these requirements.

    Significant Leverage and Debt Service

     The Company's level of indebtedness has several important effects on its
future operations, including (i) a substantial portion of the Company's cash
flow from operations must be dedicated to the payment of interest on its
indebtedness and will not be available for other purposes, (ii) covenants
contained in the Company's debt obligations require the Company to meet certain
financial tests, and other restrictions limit its ability to borrow additional
funds or to dispose of assets and may affect the Company's flexibility in
planning for, and reacting to, changes in its business, including possible
acquisition activities and (iii) the Company's ability to obtain financing in
the future for working capital, capital expenditures, acquisitions, general
corporate purposes or other purposes may be impaired. The Company's ability to
meet its debt service obligations and to reduce its total indebtedness will be
dependent upon the Company's future performance, which will be subject to
general economic conditions and to financial, business and other factors
affecting the operations of the Company, many of which are beyond its control.
There can be no assurance that the Company's future performance will not be
adversely affected by such economic conditions and financial, business and other
factors.

    Administrative Services Agreement; Reliance on Torch

     The Company currently has nine employees. The Company is party to an
administrative services agreement ("Administrative Services Agreement") with
Torch, pursuant to which Torch performs certain administrative and technical
functions for the Company, including financial, accounting, legal, geological,
engineering and technical support. The Company believes that its relationship
with Torch provides the Company with access to professional, technical and
administrative personnel not otherwise available to a company of its size.
Bellwether believes that if the Administrative Services Agreement were
terminated Bellwether could, over time, hire experienced personnel and acquire
the accounting and reporting systems and other assets 

                                       18
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

necessary to replace Torch. However, the unanticipated termination of the
Administrative Services Agreement could have a material adverse effect upon the
Company. The Administrative Services Agreement may be terminated by Bellwether
upon one year's prior notice and may not be terminated by Torch prior to
December 31, 1999.

    Conflicts of Interest

     Torch also renders administrative services to Nuevo Energy Company
("Nuevo"), a publicly traded independent oil and gas company and may manage or
render management or administrative services for other energy companies in the
future. These services may include the review and recommendation of potential
acquisitions. It is possible that conflicts may occur between Nuevo and
Bellwether in connection with possible acquisitions or otherwise in connection
with the services rendered by Torch. Although the Administrative Services
Agreement provides for procedures to reconcile conflicts of interest between
Nuevo and the Company, no assurances can be made that such procedures will fully
protect the Company from losses which may occur if a conflict between the
Company and Nuevo arises.

    Estimates of Oil and Gas Reserves

     This document contains estimates of oil and gas reserves owned by the
Company, and the future net cash flows attributable to those reserves. There are
numerous uncertainties inherent in estimating quantities of proved reserves and
cash flows attributable to such reserves, including factors beyond the control
of the Company and the reserve engineers. Reserve engineering is a subjective
process of estimating underground accumulations of oil and gas that cannot be
measured in an exact manner. The accuracy of an estimate of quantities of
reserves, or of cash flows attributable to such reserves, is a function of the
available data, assumptions regarding future oil and gas prices and expenditures
for future development and exploitation activities, and of engineering and
geological interpretation and judgment. Additionally, reserves and future cash
flows may be subject to material downward or upward revisions based upon
production history, development and exploitation activities and prices of oil
and gas. Actual future production, revenue, taxes, development expenditures,
operating expenses, quantities of recoverable reserves and the value of cash
flows from such reserves may vary significantly from the assumptions and
estimates set forth herein. In addition, reserve engineers may make different
estimates of reserves and cash flows based on the same available data. In
calculating reserves on an oil equivalent basis, gas was converted to oil
equivalent at the ratio of six Mcf of gas to one Bbl of oil. While this ratio
approximates the energy equivalency of gas to oil on a Btu basis, it may not
represent the relative prices received by the Company on the sale of its oil and
gas production.

     The estimated quantities of proved reserves and the discounted present
value of future net cash flows attributable to estimated proved reserves set
forth herein were prepared in accordance with the rules of the SEC, and are not
intended to represent the fair market value of such reserves.

                                       19
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

    Hedging of Production

     Part of the Company's business strategy is to reduce its exposure to the
volatility of oil and gas prices by hedging a portion of its production. In a
typical hedge transaction, the Company will have the right to receive from the
counterparty to the hedge, the excess of the fixed price specified in the hedge
over a floating price based on a market index, multiplied by the quantity
hedged. If the floating price exceeds the fixed price, the Company is required
to pay the counterparty this difference multiplied by the quantity hedged. In
such case, the Company is required to pay the difference regardless of whether
the Company has sufficient production to cover the quantities specified in the
hedge. Significant reductions in production at times when the floating price
exceeds the fixed price could require the Company to make payments under the
hedge agreements even though such payments are not offset by sales of
production. Hedging will also prevent the Company from receiving the full
advantage of increases in oil or gas prices above the fixed amount specified in
the hedge.

    Operating Hazards, Offshore Operations and Uninsured Risks

     Bellwether's operations are subject to risks inherent in the oil and gas
industry, such as blowouts, cratering, explosions, uncontrollable flows of oil,
gas or well fluids, fires, pollution, earthquakes and environmental risks. These
risks could result in substantial losses to the Company due to injury and loss
of life, severe damage to and destruction of property and equipment, pollution
and other environmental damage and suspension of operations. Moreover, a portion
of the Company's operations are offshore and therefore are subject to a variety
of operating risks peculiar to the marine environment, such as hurricanes or
other adverse weather conditions, to more extensive governmental regulation,
including regulations that may, in certain circumstances, impose strict
liability for pollution damage, and to interruption or termination of operations
by governmental authorities based on environmental or other considerations.

     The Company's operations could result in liability for personal injuries,
property damage, oil spills, discharge of hazardous materials, remediation and
clean-up costs and other environmental damages. The Company could be liable for
environmental damages caused by previous property owners. As a result,
substantial liabilities to third parties or governmental entities may be
incurred, the payment of which could have a material adverse effect on the
Company's financial condition and results of operations. The Company maintains
insurance coverage for its operations, including limited coverage for sudden
environmental damages, but does not believe that insurance coverage for
environmental damages that occur over time is available at a reasonable cost.
Moreover, the Company does not believe that insurance coverage for the full
potential liability that could be caused by sudden environmental damages is
available at a reasonable cost. Accordingly, the Company may be subject to
liability or may lose substantial portions of its properties in the event of
certain environmental damages.

                                       20
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

    Environmental and Other Regulation

     The Company's operations are subject to numerous laws and regulations
governing the discharge of materials into the environment or otherwise relating
to environmental protection. These laws and regulations require the acquisition
of a permit before drilling commences, restrict the types, quantities and
concentration of various substances that can be released into the environment in
connection with drilling and production activities, limit or prohibit drilling
activities on certain lands lying within wilderness, wetlands and other
protected areas, and impose substantial liabilities for pollution resulting from
the Company's operations. Moreover, the recent trend toward stricter standards
in environmental legislation and regulation is likely to continue. For instance,
legislation has been proposed in Congress from time to time that would
reclassify certain oil and gas exploration and production wastes as "hazardous
wastes" which would make the reclassified wastes subject to much more stringent
handling, disposal and clean-up requirements. If such legislation were to be
enacted, it could have a significant impact on the operating costs of the
Company, as well as the oil and gas industry in general. Initiatives to further
regulate the disposal of oil and gas wastes are also pending in certain states,
and these various initiatives could have a similar impact on the Company.
Management believes that the Company is in substantial compliance with current
applicable environmental laws and regulations.

     The Oil Pollution Act of 1990 imposes a variety of regulations on
"responsible parties" related to the prevention of oil spills. The
implementation of new, or the modification of existing, environmental laws or
regulations, including regulations promulgated pursuant to the Oil Pollution Act
of 1990, could have a material adverse impact on the Company.

    Competition

     The Company operates in the highly competitive areas of oil and gas
exploration, development and production. The Company's competitors include major
integrated oil and gas companies and substantial independent energy companies,
many of which possess greater financial and other resources than the Company.

    Shortages of Rigs, Equipment, Supplies and Personnel

    Currently, there is a general shortage of drilling rigs, equipment and
supplies which the Company believes may intensify.  The costs and delivery times
of rigs, equipment and supplies are substantially greater than in prior periods
and are currently escalating.  Shortages of drilling rigs, equipment or supplies
could delay and adversely affect the Company's exploration and development
operations, which could have a material adverse effect on its financial
condition and results of operation.

    The demand for, and wage rates of, qualified rig crews have begun to rise in
the drilling industry in response to the increasing number of active rigs in
service.  Such shortages have in the past occurred in the industry in times of
increasing demand for drilling services.  If the number of active drilling rigs
continues to increase, the oil and gas industry may experience 

                                       21
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

shortages of qualified personnel to operate drilling rigs, which could delay the
Company's drilling operations and adversely effect the Company's financial
condition and results of operations.

ITEM 3.  LEGAL PROCEEDINGS

    Cause No. C-4417-96-G; A.R. Guerra, et al. V. Eastern Exploration, Inc., et
al.; In the 370th Judicial District Court of Hidalgo County, Texas

    On October 11, 1996, Plaintiffs filed suit in Hidalgo County, Texas, naming
Eastern Exploration, Inc., ("Eastern"), Rebel Drilling, L.P., Southwest Gas
Supply, Inc., and Bellwether Exploration Company (the "Company") as Defendants.
Plaintiffs seek recovery of compensatory royalties in the amount of $3.3 million
under the offset and compensatory royalty provisions of a 648-Acre Lease entered
into between Plaintiffs, as Lessors, and Eastern, as Lessee, a lease in which
the Company's predecessor, Hampton Resources Corporation, acquired a partial
interest by assignment.  Plaintiffs also included a separate claim for damages
from an alleged breach of the bonus provisions of an entirely distinct and
unrelated Top Lease Agreement.  The Company believes that Plaintiffs claims for
compensatory royalties under the 648-Acre Lease, and Plaintiffs' claims for
recovery of damages for alleged breach of the bonus provisions of the Top Lease
Agreement, are without merit, and the Company has filed a Motion for Summary
Judgement with the Court seeking dismissal of the claims.  The Company's Motion
for Summary Judgement is pending.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    A Proxy statement was sent to all shareholders of record on October 10, 1997
for the following matters which were voted on at the Annual Meeting of
Stockholders held on November 21, 1997:

1.  To elect the nominees of the Board of Directors to serve until their
    successors are duly elected and qualified. The following sets forth the
    votes cast for each director:

<TABLE>
<CAPTION>

      DIRECTORS                        FOR                   WITHHOLD
--------------------------    ---------------------     -------------------
<S>                             <C>                       <C>
J. P. Bryan                          10,776,441                  98,557
J. Darby Sere'                       10,776,441                  98,557
C. Barton Groves                     10,775,641                  99,357
Dr. Jack Birks                       10,781,341                  98,657
Vincent H. Buckley                   10,781,341                  98,657
Habib Kairouz                        10,775,141                  99,857
A. K. McLanahan                      10,780,841                  94,157
Townes G. Pressler                   10,775,641                  99,357
Charles C. Green, III                10,775,141                  99,857
</TABLE>

2.  To consider and act upon a proposal to ratify and approve the Board of
    Directors' adoption of an amendment to increase the number of shares of the
    Company's Common Stock available for distribution under the Bellwether
    Exploration Company 1996 Stock Incentive Plan. There were 9,110,937 votes
    for the proposal, 1,740,106 against the proposal and 23,955 abstained.

3.  To consider and act upon a proposal to ratify the appointment of KPMG Peat
    Marwick LLP as the independent auditors of the Company 

                                       22
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

    for the period ending December 31, 1997. There were 10,841,978 votes cast
    for the proposal, 25,374 against the proposal and 7,646 abstained.

    No other matters were brought before the meeting.

    A copy of the Proxy Statement was filed with the Securities and Exchange
    Commission on October 22, 1997 and is incorporated herein by reference.


                                    PART II
                                        
ITEM  5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

     The Company's common stock is traded on the NASDAQ National Market (Symbol:
BELW).  There were approximately 1,095 stockholders of record as of March 20,
1998.  The Company has not paid dividends on its common stock and does not
anticipate the payment of cash dividends in the immediate future as it
contemplates that cash flows will be used for continued growth in Company
operations.  In addition, certain covenants contained in the Company's financing
arrangements restrict the payment of dividends (See Management's Discussion and
Analysis of Financial Condition and Results of Operations - Financing Activities
and Note 8 of the Notes to Consolidated Financial Statements).  The following
table sets forth the range of the high and low sales prices, as reported by the
NASDAQ for Bellwether common stock for the periods indicated.

<TABLE>
<CAPTION>
                             Sales Price
                         -------------------
                          High       Low
                         ------  -----------
<S>                      <C>     <C>
  Quarter Ended:
 
   September 30, 1995    $ 6.25        $5.00
   December 31, 1995     $ 6.13        $4.06
   March 31, 1996        $ 7.00        $5.00
   June 30, 1996         $ 8.00        $5.50
 
   September 30, 1996    $ 6.88        $4.38
   December 31, 1996     $ 9.00        $5.63
   March 31, 1997        $11.50        $7.88
   June 30, 1997         $10.25        $7.25
 
   September 30, 1997    $15.38        $9.08
   December 31, 1997     $14.88        $9.75
 
</TABLE>

                                       23
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

ITEM 6.  SELECTED FINANCIAL DATA

     The following selected financial data with respect to the Company should be
read in conjunction with the Consolidated Financial Statements and supplementary
information included in Item 8 (amounts in thousands, except per share data).

<TABLE>
<CAPTION>
                                                       (Unaudited)                                                            
                                         Six Month      Six Month                                                             
                                         Transition      Period                                                               
                                        Period Ended     Ended                                                                
                                          Dec. 31,      Dec. 31,                  Fiscal Years Ended June 30,                 
                                          ---------     -------     ----------------------------------------------------------
                                             1997         1996       1997(1)       1996       1995(2)      1994(3)      1993  
                                          ---------     -------     --------     -------     --------     --------     -------
<S>                                       <C>           <C>          <C>         <C>          <C>         <C>          <C>    
Gas revenues...........                    $ 26,755     $ 6,759     $ 24,202     $ 9,856      $ 4,864     $  2,620     $ 1,807
Oil revenues...........                      17,408       3,087       14,865       5,810        3,643        1,086       1,708
Gas plant and gas                                                                                                              
  gathering revenues, 
  net..................                         804       2,052        3,330       3,534        4,627        2,917          23 
Interest and other                                                                                                             
  income..............                          609          54          363         116           97           63         116 
                                          ---------     -------     --------     -------     --------     --------     -------  
 Total revenues.......                       45,576      11,952       42,760      19,316       13,231        6,686       3,654 
                                                                                                                               
Production expenses...                       13,836       3,061       11,437       5,317        2,856        1,294       1,273 
General and
  administrative
  expenses............                        3,748       1,452        4,042       3,013        2,739        1,234         787
Depreciation,
  depletion and
  amortization........                       16,352       4,167        15,574      8,148        5,269        2,489       1,455
Interest expense......                        5,978         520         4,477      1,657        1,245          721          77
Provision for income
  taxes...............                        2,114       1,018         2,585         46            9          ---          21
Other expenses........                          ---         ---           ---        153          172          134         ---
                                          ---------     -------     --------     -------     --------     --------     -------  
 Total expenses.......                       42,028      10,218       38,115      18,334       12,290        5,872       3,613
                                          ---------     -------     --------     -------     --------     --------     -------  
 
Net income............                    $   3,548     $ 1,734     $  4,645     $   982     $    941     $    814     $    41
                                          =========     =======     ========     =======     ========     ========     =======  
 
Earnings per  common 
  share...............                    $    0.26     $  0.19     $   0.46     $  0.11     $   0.12     $   0.35     $  0.02
Earnings per common 
  share- diluted......                    $    0.25     $  0.19     $   0.45     $  0.11     $   0.12     $   0.33     $  0.02
 
Working capital.......                    $  13,964     $ 4,357     $ 22,783     $ 5,168     $ (1,246)    $   (249)    $   415
 
Long-term debt, net
  of current maturities                   $ 100,000     $11,000     $115,300     $13,048     $ 18,525     $ 12,797     $ 1,000
 
Stockholders equity...                    $  91,669     $48,751     $ 87,924     $46,597     $ 45,447     $ 18,372     $10,770
 
Total assets..........                    $ 214,757     $68,982     $222,648     $67,225     $ 74,650     $ 35,870     $12,480
</TABLE>
________________
(1)  Includes operations of the Partnership Transactions beginning April 1,
     1997.
(2)  Reflects operations from Odyssey and Hampton mergers beginning August 1994
     and February 1995, respectively.
(3)  Includes operations of the gas plant and Associated Gas Resources Inc. from
     dates of acquisition in July and December 1993, respectively.

                                       24
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

      Bellwether is an independent energy company primarily engaged in the
acquisition, exploitation, development and exploration of oil and gas
properties. The Company has grown and diversified its operations primarily
through acquisitions and the subsequent development of the acquired properties.
The Company's results of operations have been significantly affected by its
success in acquiring oil and gas properties and its ability to maintain or
increase production through its exploitation activities.

      In April 1997, the Company purchased oil and gas properties and $13.9
million of working capital from affiliates of Torch for an adjusted purchase
price at closing of $145.2 million, including a contingent payment of $3.4
million, the amount of which was based on 1997 gas prices.  The acquisition was
recorded effective April 1, 1997 and the operations of the Company include the
Partnership Transactions from that date.  The Partnership Transactions were
financed with $34.1 million of net proceeds of a Common Stock offering, $97.0
million net proceeds of 10 7/8% Senior Subordinated Notes due 2007 (the
"Offerings") and borrowings under a new credit facility ("New Credit Facility").
In addition, Torch was issued 150,000 shares of the Company's common stock and a
warrant to purchase 100,000 shares at $9.90 per share for advisory services
rendered the Partnership Transactions.  The warrant and shares were valued at
$1.5 million and recorded as a cost of the Partnership Transactions.

      On February 28, 1995, Bellwether acquired Hampton Resources Corporation
("Hampton") by merger for $17.0 million in cash and approximately 1.0 million
shares of Common Stock.

      In August 1994, Bellwether acquired, by merger, certain of the assets,
liabilities and properties of Odyssey Partners, Ltd. ("Odyssey"), in exchange
for 0.9 million shares of Common Stock and $5.6 million in cash.

      In order to facilitate greater comparability with its peer group by the
financial community, the Company changed its fiscal year to align with the
calendar year, beginning January 1, 1998.  The six-month transition period of
July 1, 1997 through December 31, 1997 ("transition period") precedes the start
of the new fiscal year.  The unaudited financial information for the six months
ended December 31, 1996 ("prior period") is presented for comparative purposes
and includes any adjustments (consisting of normal, recurring adjustments) which
are, in the opinion of management, necessary for fair presentation.

  The Company uses the full cost method of accounting for its investment in oil
and gas properties. Under the full cost method of accounting, all costs of
acquisition, exploration and development of oil and gas reserves are capitalized
in a "full cost pool" as incurred. Oil and gas properties in the pool, plus
estimated future expenditures to develop proved reserves and future abandonment,
site reclamation and dismantlement costs, are depleted and charged to operations
using the unit of production method based on the ratio of current production to
total proved recoverable oil and gas reserves. To the extent that such
capitalized costs (net of depreciation, depletion and amortization) exceed the
discounted future net revenues on an after-tax basis of estimated proved oil and
gas reserves, such excess costs are charged to operations. Once incurred, the
writedown of oil and gas properties is not reversible at a later date even if

                                       25
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES


oil and gas prices increase. Sharp declines in oil and gas prices may cause
companies who report on the full cost method, such as Bellwether, to write down
their oil and gas properties, thereby decreasing earnings during such period.

  The Company periodically uses derivative financial instruments to manage oil
and gas price risk. Settlements of gains and losses on price swap contracts are
generally based upon the difference between the contract price and the average
closing NYMEX or other floating index price and are reported as a component of
oil and gas revenue. Gains or losses attributable to the termination of swap
contracts are deferred and recognized in revenue when the hedged oil and gas is
sold.

Financing Activities

  The Company's outstanding indebtedness totals $100 million at December 31,
1997; all 10 7/8% Senior Subordinated Notes due in 2007.

          In April 1997, the Company entered into a senior revolving unsecured
credit facility in an amount up to $90.0 million, with a current borrowing base
of $75.0 million, and a maturity date of March 31, 2002.  Bellwether may elect
an interest rate based either on a margin plus London Interbank Offered Rate
("LIBOR") or the higher of the prime rate or the sum of  1/2 of 1% plus the
Federal Funds Rate.  For LIBOR borrowings, the interest rate will vary from
LIBOR plus 0.875% to LIBOR plus 1.25% based upon the borrowing base usage.  In
connection with the acquisition of oil and gas properties, $33.3 million was
drawn under this facility, including $22.0 million to retire indebtedness
previously outstanding.  As of December 31, 1997, no amounts were outstanding
under the Senior Credit Facility.  The Senior Credit Facility contains various
covenants including certain required financial measurements for current ratio,
consolidated tangible net worth and interest coverage ratio.  In addition, the
Senior Credit Facility includes certain limitations on restricted payments,
dividends, incurrence of additional funded indebtedness and asset sales.

          In October 1996, the Company entered into a syndicated credit facility
in an amount up to $50.0 million with an initial borrowing base of $27.0
million, to be re-determined semi-annually.  This credit facility was unsecured
and was retired in April 1997.  In February 1995, the Company entered into a
credit facility with a commercial bank providing an initial borrowing base of
$29.8 million.  The borrowings under the credit facility were secured by the
Company's interest in oil and gas properties, a gathering system and two gas
plants.  The Credit Facility was retired in October 1996.

          In April 1997, the Company issued $100.0 million of 10 7/8% senior
subordinated notes ("Notes") that mature April 1, 2007.  Interest on the Notes
is payable semi-annually on April 1 and October 1 commencing on October 1, 1997.
The Notes contain certain covenants, including limitations on indebtedness by
subsidiaries, dividends and other payment restrictions affecting restricted
subsidiaries, issuance and sales of restricted subsidiary stock, dispositions of
proceeds of asset sales and restrictions on mergers, and consolidations or sales
of assets.

          In April 1997, the Company issued 4.4 million common shares in a
public offering.  The net proceeds of the offering were $34.1 million.

                                       26
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

          The net proceeds from the issuance of the Notes and the common stock
and advances under the Senior Credit Facility of $33.3 million were used to
finance the acquisition of oil and gas properties in the amount of $145.2
million, including $13.9 million in working capital, and to retire $22.0 million
of the Company's existing debt.

Liquidity and Capital Resources

          The Company's principal sources of capital for the last three years
and for the six month transition period have been the sale of Notes, borrowings
under bank credit facilities, the public sale of common stock and cash flow from
operations.  The Company sold $100 million in Notes in fiscal 1997.  Borrowings
from banks were $1.5 million, $57.3 million and $26.8 million for the transition
period 1997 and fiscal years ended June 30, 1997 and 1995, respectively.  The
Company issued 4.4 million shares of common stock in a public offering in April
1997 for net proceeds of $34.1 million and 3.4 million shares in a public
offering in fiscal 1995 for net proceeds of $17.2 million.  Cash flow from
operations before change in assets and liabilities totaled $21.8 million, $23.3
million, $9.1 million and $6.4 million for the transition period 1997 and fiscal
years 1997, 1996 and 1995, respectively.  The increase in cash flow from
operations before changes in assets and liabilities resulted primarily from
acquisitions made since 1994.  In addition, during March 1996, the Company
agreed to assume the purchase obligation under a gas contract in the West Monroe
field in Louisiana in exchange for a cash payment of $9.9 million.  In a series
of transactions from May through December 1997, the Company divested non-core
assets representing approximately 10% of its estimated net proved reserves for
$24.3 million.

          The Company's primary uses of capital have been to fund acquisitions
and to fund its exploration and development projects.  Acquisitions, net of
working capital acquired, totaled $5.5 million, $140 million and $38.3 million
for transition period 1997, fiscal 1997 and fiscal 1995, respectively.  The
Company's expenditures for exploration and development of its oil and gas
properties totaled $13.7 million, $15.6 million, $6.4 million and $3.4 million
for the transition period ended December 31, 1997 and the fiscal years ended
June 30, 1997, 1996 and 1995, respectively.

          Outlook

          The Company has adopted a $42 million capital budget for the year
ending December 31, 1998 primarily for development and exploratory drilling
activities.  The Company believes its working capital and net cash flows
provided by operating activities are sufficient to meet these capital
commitments.  Additionally, the Company currently has a $75.0 million borrowing
base under its Senior Credit Facility with no outstanding borrowings at December
31, 1997.  The Company is reviewing several acquisitions, any one of which could
materially exceed the planned capital expenditure levels.  It is anticipated
that such acquisitions, if consummated, would be funded through additional
borrowings and/or the issuance of securities.

          Currently, there is a general shortage of drilling rigs, equipment and
supplies which the Company believes may intensify.  The costs and delivery times
of rigs, equipment and supplies are substantially greater than in prior periods
and are currently escalating.  Shortages of drilling rigs, equipment or supplies
could delay and adversely affect the Company's exploration and development

                                       27
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

operations, which could have a material adverse effect on its financial
condition and results of operation.

          The demand for, and wage rates of, qualified rig crews have begun to
rise in the drilling industry in response to the increasing number of active
rigs in service. Such shortages have in the past occurred in the industry in
times of increasing demand for drilling services. If the number of active
drilling rigs continues to increase, the oil and gas industry may experience
shortages of qualified personnel to operate drilling rigs, which could delay the
Company's drilling operations and adversely effect the Company's financial
condition and results of operations.

          The Company's results of operations and cash flow are affected by
changing oil and gas prices.  Increases in oil and gas prices often result in
increased drilling activity, which in turn increases the demand for and cost of
exploration and development.  Thus, increased prices may generate increased
revenue without necessarily increasing profitability.  These industry market
conditions have been far more significant determinants of Company earnings than
have macroeconomic factors such as inflation, which has had only minimal impact
of Company activities in recent years.  While it is impossible to predict the
precise effect of changing prices and inflation on future Company operations,
the short-lived nature of the Company's gas reserves makes it more possible to
match development costs with predictable revenue streams than would long-lived
reserves.  No assurance can be given as to the Company's future success at
reducing the impact of price changes in the Company's operation results.
 
          World crude prices have declined significantly, although world
production is operating at 97% of capacity.  The primary reasons for this
decline are 1) increased Organization of Petroleum Exporting Countries ("OPEC")
production, 2) increased non-OPEC production, 3) decreased demand due to
Southeast Asia economic collapse and 4) decreased demand resulting from a mild
winter in the Northern Hemisphere.  West Texas Intermediate (NYMEX) has declined
by 31% from the 1997 average and heavy crude postings in California have
declined by 53% from the 1997 average.  During the first quarter of 1998,
California has been impacted more than the rest of the United States by refining
turnarounds and the Southeast Asia economy.  At this time the Company does not
feel a write-down in the book value of capitalized costs of oil and gas
properties will be necessary at the end of the first quarter of 1998; however,
if oil prices continue this decline a write-down may be necessary in future
periods.

          The Company's technical services provider, Torch, plans to upgrade all
major financial and administrative systems to ensure that such systems are Year
2000 compliant.  The Year 2000 problem results from data storage of date
information truncating to two places, i.e. 1998 stored as 98.  Currently all
programs storing year information as such recognize the year 2000 as 00 (or
1900).  Torch is approaching the Year 2000 project in three steps:  1) awareness
and assessment, 2) conversion or implementation and 3) validation and testing.
Management does not believe that costs incurred to address the Year 2000 issue
with respect to its financial and administrative systems will have a material
impact on the Company's future financial results or operations.  At this time,
the Company is uncertain as to the impact that the Year 2000 issue will have on
its operational information systems and as to how the Company will be indirectly
affected by the impact that the Year 2000 issue will have on the companies with
which it conducts business.

                                       28
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

RESULTS OF OPERATIONS

     For comparability with annual periods, amounts discussed in this section
regarding the six month transition period 1997 have been annualized.  These
amounts are only estimates and may not be indicative of twelve month's operating
results.  The table below recaps the major components of financial and operating
performance to be discussed (amounts in thousands):

<TABLE>
<CAPTION>
                                                   Annualized (1)
                                                    Transition                 Fiscal              Fiscal              Fiscal
                                                    Period 1997                 1997                1996                1995
                                             -----------------------      ---------------     ---------------     ---------------
<S>                                            <C>                          <C>                 <C>                 <C>
Oil and gas revenues                                         $88,326              $39,067             $15,666          $    8,507
Gas plant revenues,net                                         1,608                3,330               2,577               2,674
Gas gathering revenue, net                                       ---                  ---                 957               1,953
Interest and other                                             1,218                  363                 116                  97
                                             -----------------------      ---------------     ---------------     ---------------
 
Total revenue                                                 91,152               42,760              19,316              13,231
 
Production expenses                                           27,672               11,437               5,317               2,856
Depreciation,depletion and
 amortization                                                 32,704               15,574               8,148               5,269
General and administrative
 expenses                                                      7,496                4,042               3,013               2,739
Income taxes and other                                         4,228                2,585                 199                 181
Interest expense                                              11,956                4,477               1,657               1,245
                                             -----------------------      ---------------     ---------------     ---------------
Net income                                                   $ 7,096              $ 4,645             $   982          $      941
                                             =======================      ===============     ===============     ===============
 
Production
 Oil and condensate(MBBLS)                                     2,108                  854                 334                 216
 Natural gas (MMCF)                                           22,386               10,552               5,099               2,932
 Oil equivalent (MBBLS)                                        5,839                2,613               1,184                 705
 
Average sales price (2)
 Oil and condensate (per
 barrel)                                                     $ 16.34              $ 17.41             $ 17.81          $    16.89
 Natural gas (per MCF)                                       $  2.55              $  2.29             $  2.02          $     1.66
 
Average unit production
 costs per equivalent
 barrel (6 MCF equal 1
 barrel)                                                     $  4.74              $  4.38             $  4.49          $     4.05
 
Average unit general and
 administrative expense
 per equivalent barrel (3)                                   $  1.28              $  1.38             $  2.04          $     2.49
 
Average unit depletion rate
 per equivalent barrel(4)                                    $  5.42              $  5.62             $  5.86          $     5.52
_________
</TABLE>
(1)  Annualized amounts were computed by multiplying Transition Period 1997
     components by 2
(2)  Average sales price is exclusive of the effect of natural gas and crude oil
     price hedges
(3)  Exclusive of general and administrative expenses allocated to gas plants
     and gas gathering facilities
(4)  Exclusive of depreciation on gas plants

                                       29
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

     Operations of the gas plant and the gathering system are summarized as
follows:
<TABLE>
<CAPTION>
                                                                                                                                 
                                                         Annualized                                                              
                                                     Transition Period            Fiscal         Fiscal          Fiscal 
                                                             1997                  1997           1996            1995           
                                                    -------------------          --------       --------         -------         
<S>                                                 <C>                          <C>            <C>              <C>             
Plant product sales volume (MBBLS)....                            218                319                321         382          
Average product sales price per                                                                                                  
  barrel..............................                         $14.45             $16.77             $13.01      $11.96          
Gathering system throughput (MMCF per                                                                                            
  day)................................                            ---                ---                4.0(1)      4.1          
</TABLE>
___________
(1)  Represents operations from July 1995 through February 1996. Subsequent to
     February 1996, the Company ceased recognition of such operations following
     the Company's assumption of a gas purchase contract and receipt of $9.9
     million. (See Note 2 of Notes to Consolidated Financial Statements).

     Annualized Transition Period 1997 Compared with Fiscal 1997:

     Oil and gas revenues were $88.3 million for the annualized transition
period 1997, an increase of 126% over the fiscal year ended June 30, 1997.  This
increase is due to a full year of production from the Partnership Transaction
which closed in the fourth quarter of fiscal 1997.  Annualized production on a
BOE basis increased 124% to 5,839 equivalent barrels in the transition period
compared to 2,613 equivalent barrels of production in fiscal 1997.

     During the period, the volatility of oil and gas prices also directly
impacted revenues.  Most significantly, natural gas prices increased in the
transition period 1997 to $2.55 per Mcf from $2.29 per Mcf in fiscal 1997.
During the transition period 1997 and fiscal 1997, the Company utilized various
hedging transactions to manage a portion of the risks associated with natural
gas and crude oil price volatility.  As a result of these hedges, oil and gas
revenues were reduced by $1.6 million in the transition period 1997 and by
$18,000 in fiscal 1997.

     Gas plant revenues were $4.1 million in the annualized transition period
1997, a decrease of 39% from fiscal 1997 gas plant revenues.  The decrease,
prior to annualization, was due to a 10 day shut-down of the plant in September
to install an amine unit and a two week shut-down in December to repair the
insulation in the incinerator.  Gas plant throughput is currently back to 10
MMCFD and no material future shut-downs are anticipated.  Also, contributing to
the decline in the annualized transition period 1997 gas plant revenues was a
14% decline from fiscal 1997 in plant liquids prices. Annualized gas plant
expenses were $2.5 million in the transition period 1997 as compared to $3.3
million during fiscal 1997.  The decrease in expenses is attributable to the
plant shut-downs.

     Production expenses for the annualized transition period 1997 were $27.7
million, an increase of 142% over the fiscal 1997 amount.  Primarily, the
increase is due to inclusion of the Partnership Transaction for all of
transition 1997, while fiscal 1997 amounts reflect only one quarter for the
Partnership Transaction.  In addition, production expenses for the annualized
transition period increased to $4.74 per equivalent barrel versus $4.38 per
equivalent barrel in fiscal 1997.  The increase in the per unit rate results
from the suspension of production, but not production expenses, at the Point

                                       30
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

Pedernales field for most of the last quarter of the transition period and from
out of period expenses recorded within the annualized 1997 transition period.

     Depreciation, depletion and amortization for the annualized transition
period 1997 increased 110% to $32.7 million.  Increased production due to the
Partnership Transaction, partially offset by a $.20 decrease in the depletion
rate, in transition period 1997 caused the variance to fiscal 1997 depreciation,
depletion and amortization.
 
     General and administrative expenses increased from $4.0 million in fiscal
1997 to $7.5 million in annualized transition period 1997.  The increase is
primarily due to increased management fees resulting from the Partnership
Transaction.  Management fees are based on the Company's net assets and
operating cash flows.

     Annualized interest expense increased 167% to $12 million from $4.5 million
in fiscal 1997.  The increase is primarily due to interest attributable to the
$100 million of 10 7/8% Senior Subordinated Notes issued April 1997.

     Fiscal 1997 Compared to Fiscal 1996:

     Oil and gas revenues were $39.1 million in fiscal 1997, an increase of 149%
over the fiscal year ended June 30, 1996.  This increase is largely attributable
to a 120.6% increase in equivalent production in 1997 resulting primarily from
the Partnership Transaction.

     In addition, natural gas prices increased 13% to $2.29 per Mcf in fiscal
1997 as compared to $2.02 per Mcf in fiscal 1996.  As a result of natural gas
and crude oil hedging activities, oil and gas revenues were reduced by $18,000
in fiscal 1997 and by $560,000 in fiscal 1996.

     Gas plant revenues were $6.7 million in fiscal 1997, an increase of 26%
over prior year revenues of $5.3 million.  Contributing to this increase were
increases in plant liquid prices of 29% over the prior year.

     There were no gas gathering revenues in fiscal 1997 due to the Company's
agreement in February 1996 to assume payment obligations under a gas purchase
contract and its decision to cease recognition of income from gas gathering
operations.

     Production expenses for fiscal 1997 totaled $11.4 million, as compared to
$5.3 million in fiscal 1996.  The 115% increase in production expenses in fiscal
1997 was attributable to increased production from the Partnership Transaction.

     Depreciation, depletion and amortization increased 93% to $15.6 million in
fiscal 1997 versus $8.1 million in fiscal 1996.  Such increase was attributable
to higher production from the Partnership Transaction, offset by a 4% decrease
in the depletion rate per net equivalent barrel as a result of the Partnership
Transaction.

     General and administrative expenses increased in 1997 to $4.0 million from
$3.0 million in fiscal 1996.  The absolute increase is attributable to the
increased management fee resulting from the April 1997 Partnership 

                                       31
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES


Transaction. General and administrative expenses on an equivalent basis actually
decreased from $2.04 per equivalent barrel in fiscal 1996 to $1.38 per
equivalent barrel in fiscal 1997.

     Interest expense increased 170% to $4.5 million in fiscal 1997 from $1.7
million in fiscal 1996.  The increase is due to the Company issuing $100 million
of 10 7/8% Senior Subordinated Notes in April 1997.

     Fiscal 1996 Compared to Fiscal 1995:

     Oil and gas revenues for fiscal 1996 were $15.7 million, or 85% higher than
fiscal 1995 oil and gas revenues of $8.5 million.  Higher equivalent production
of 68% in 1996 was principally responsible for the increase.  The increased
production was attributable to the Company's mergers with Odyssey and Hampton
completed during fiscal 1995.

     Volatility of oil and gas prices also directly impacted revenues.  Crude
oil prices increased 5% to 17.81 per barrel in fiscal 1996 compared to $16.89
per barrel in fiscal 1995.  Natural gas prices increased 22% to $2.02 per Mcf in
fiscal 1996 compared to $1.66 per Mcf in fiscal 1995.

     Gas plant revenues were $5.3 million in fiscal 1996, or 7% lower than
fiscal 1995 revenues of $5.7 million due primarily to decreased throughput,
partially offset by a 7% increase in natural gas liquids prices. Gas plant
expenses were $2.8 million or 7% lower in fiscal 1996 than in fiscal 1995 as a
result of decreased throughput, offset partially by higher costs for natural
gas.

     Gas gathering revenues decreased to $3.4 million in fiscal 1996, or 32%
under fiscal 1995 revenues of $5.0 million due to the Company's agreement in
February 1996 to assume payment obligations under a gas purchase contract and
its decision to cease recognition of income from gas gathering operations.  Gas
gathering expenses in fiscal 1996 of $2.4 million were 23% under the prior year
total of $3.1 million, due to the Company's agreement in February 1996 to assume
payment obligations under a gas purchase contract and its decision to cease gas
gathering operations.

     The 86% increase in production expenses in fiscal 1996 over fiscal 1995 was
attributable to the Odyssey and Hampton mergers.  Such mergers were included in
operations for only ten and four months, respectively, in fiscal 1995.

     Depreciation, depletion and amortization increased in fiscal 1996 to $8.1
million from $5.3 million in fiscal 1995 as a result of increased production
from the Odyssey and Hampton mergers mentioned above.  In addition, the rate
increased $.34 to $5.86 per BOE for fiscal 1996.

Net Income

     Annualized net income of $7.1 million was generated in transition 1997 as
compared to $4.6 million, $1 million, and $.9 million in fiscal 1997, 1996, and
1995, respectively.

                                       32
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

Other Matters

     Dividends

     At present, there is no plan to pay dividends on common stock.  Certain
restrictions contained in the Company's loan agreements limit the amount of
dividends which may be declared.  The Company maintains a policy of reinvesting
its discretionary cash flows for the continued growth in Company operations.

     Gas Balancing Positions

     It is customary in the industry for various working interest partners to
sell more or less than their entitled share of natural gas.  The Company uses
the sales method of accounting for gas imbalances.  Under this method, gas sales
are recorded when revenue checks are received or are receivable on the accrual
basis.  The settlement or disposition of gas balancing positions as of December
31, 1997 is not anticipated to adversely impact the financial condition of the
Company.

     Derivative Financial Instruments

     The Company periodically uses derivative financial instruments to manage
oil and gas price risk. At December 31, 1997, the Company has entered into a
contract to hedge 1,000 barrels of crude oil per day at a Nymex price of $21.80
per barrel for January through March 1998.

     Financial Accounting Standards Board Statement No. 128

     Effective December 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128
introduces the concept of basic earnings per share, which represents net income
divided by the weighted average common shares outstanding without the dilutive
effects of common stock equivalents (options, warrants, etc.). Additionally,
SFAS No. 128 replaces fully diluted EPS with diluted EPS. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the entity. The
Company's dilutive securities include stock options and warrants. The assumed
conversion of these securities is anti-dilutive for a period if the option or
warrant exercise price exceeds the average market price for the periods. SFAS
No. 128 also requires a reconciliation of the numerator and denominator of the
basic EPS computation to the numerator and denominator of the diluted EPS
computation. The Company's reconciliation is included in Note 6 of Notes to
Consolidated Financial Statements. In accordance with SFAS No. 128, the Company
retroactively restated all prior period EPS data (including interim EPS)
included in these financial statements and footnotes. The retroactive impact of
adopting SFAS 128 is immaterial.

     Financial Accounting Standards Board Statement No. 130

     In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"), which establishes standards for reporting and display of
comprehensive income and its components. The components of comprehensive

                                       33
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

income refer to revenues, expenses, gains and losses that are excluded from net
income under current accounting standards, including unrecognized foreign
currency translation items, minimum pension liability adjustments and unrealized
gains and losses on certain investments in debt and equity securities. SFAS 130
requires that all items that are recognized under accounting standards as
components of comprehensive income be reported in a financial statement
displayed in equal prominence with other financial statements; the total of
other comprehensive income for a period is required to be transferred to a
component of equity that is separately displayed in a statement of financial
position at the end of an accounting period. SFAS 130 is effective for both
interim and annual periods beginning after December 15, 1997, at which time the
Company will adopt the provisions.

     Financial Accounting Standards Board Statement No. 131

     In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"). SFAS 131 establishes standards for the manner in which public
enterprises are to report information about operating segments in annual
financial statements and requires the reporting of selected information about
operating segments in interim financial reports issued to shareholders. SFAS 131
also establishes standards for related disclosures about products and services,
geographic areas, and major customers. SFAS 131 is effective for periods
beginning after December 15, 1997, at which time the Company will adopt the
provisions. The Company does not expect SFAS 131 to have a material effect on
its reported results.

                                       34
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                  INDEX TO FINANCIAL STATEMENTS AND SCHEDULES


<TABLE>
<CAPTION>
                                                                       PAGE 
                                                                      NUMBER
                                                                      ------
<S>                                                                    <C>
Independent Auditors' Report.........................................  36
 
Financial Statements:
 
 Consolidated Balance Sheets as of December 31, 1997,
  June 30, 1997 and 1996.............................................  37
 
 Consolidated Statements of Operations for the Periods Ended
  December 31, 1997, December 31, 1996 (unaudited), June 30, 1997,
  1996 and 1995......................................................  39
 
 Consolidated Statements of Changes in Stockholders' Equity for the
  Periods Ended December 31, 1997, June 30, 1997, 1996 and 1995......  40
 
 Consolidated Statements of Cash Flows for the Periods Ended
  December 31, 1997, June 30, 1997, 1996 and 1995....................  41
 
 Notes to Consolidated Financial Statements..........................  43
</TABLE>

                                       35
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                         INDEPENDENT AUDITORS' REPORT



The Board of Directors and Stockholders of
Bellwether Exploration Company and Subsidiaries:



We have audited the accompanying consolidated balance sheets of Bellwether
Exploration Company and subsidiaries as of December 31, 1997 and June 30, 1997
and 1996, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for the six month period ended December 31,
1997 and for each of the years in the three year period ended June 30, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Bellwether Exploration Company and
subsidiaries as of December 31, 1997 and June 30, 1997 and 1996, and the results
of their operations and their cash flows for the period ended December 31, 1997
and each of the years in the three year period ended June 30, 1997, in
conformity with generally accepted accounting principles.



KPMG PEAT MARWICK LLP

Houston, Texas
February 24, 1998

                                       36
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES


                          CONSOLIDATED BALANCE SHEETS
                                        
                                     ASSETS
                             (Amounts in thousands)



<TABLE>
<CAPTION>
 
 
                                                         DECEMBER 31,                   JUNE 30,                  JUNE 30,
                                                             1997                         1997                      1996
                                                     ----------------------      --------------------      --------------------
<S>                                                    <C>                         <C>                       <C>
CURRENT ASSETS:
 
Cash and cash equivalents.......................                   $  2,699                  $ 15,341                  $    783
Accounts receivable and accrued
   revenues.....................................                     18,293                    16,795                     5,990
Accounts receivable  related parties............                      4,645                     1,836                     1,417
Prepaid expenses................................                      3,240                     1,759                       314
                                                     ----------------------      --------------------      --------------------
    Total current assets........................                     28,877                    35,731                     8,504
                                                     ----------------------      --------------------      --------------------
 
PROPERTY, PLANT AND EQUIPMENT, AT
   COST:
 
Oil and gas properties (full cost)  method)
 including
   Unproved properties of $6,469,
   $4,500, and $13,453 excluded from
   amortization as of December 31,
   1997 and June 30, 1997 and 1996,                                 250,227                   233,175                    76,043
   respectively.................................
Gas plant facilities............................                     16,717                    12,924                    12,840
                                                     ----------------------      --------------------      --------------------
                                                                    266,944                   246,099                    88,883
Less accumulated depreciation,
   depletion and amortization...................                    (86,811)                  (65,097)                  (30,748)
                                                     ----------------------      --------------------      --------------------
                                                                    180,133                   181,002                    58,135
                                                     ----------------------      --------------------      --------------------
 
OTHER ASSETS....................................                      5,747                     5,915                       586
                                                     ----------------------      --------------------      --------------------
 
                                                                   $214,757                  $222,648                  $ 67,225
                                                     ======================      ====================      ====================
</TABLE>



                See Notes to Consolidated Financial Statements.

                                       37
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES


                          CONSOLIDATED BALANCE SHEETS
                      LIABILITIES AND STOCKHOLDERS' EQUITY
                (Amounts in thousands, except share information)
<TABLE>
<CAPTION>
 
                                                       DECEMBER 31,                June 30,                  June 30,
                                                           1997                      1997                      1996
                                                 ----------------------     ---------------------     ---------------------
<S>                                                <C>                        <C>                       <C>
CURRENT LIABILITIES:
 
Accounts payable and accrued        
   liabilities...................................              $ 14,241                  $ 12,739                   $ 2,634
Accounts payable  related parties................                   672                       209                       702
                                                    -------------------     ---------------------     ---------------------
     Total current liabilities...................                14,913                    12,948                     3,336
                                                    -------------------     ---------------------     ---------------------
                                                    
LONG-TERM DEBT...................................               100,000                   115,300                    13,048
                                                    
DEFERRED INCOME TAXES............................                 7,106                     5,521                     2,861
                                                    
OTHER LIABILITIES................................                 1,069                       955                     1,383
                                                    
CONTINGENCIES....................................                   ---                       ---                       ---
                                                    
STOCKHOLDERS' EQUITY:                               
                                                    
Preferred stock, $0.01 par value,                   
   1,000,000 shares authorized, none                
   issued or outstanding.........................                   ---                       ---                       ---
                                                    
Common stock, $0.01 par value,                      
   30,000,000 shares authorized,                    
   13,891,465, 13,844,965 and                       
   9,075,479 shares issued and                      
   outstanding at December 31, 1997                 
   and at June 30, 1997 and 1996,                   
   respectively..................................                   139                       139                        91
Additional paid-in capital.......................                78,470                    78,273                    41,639
Retained earnings................................                13,060                     9,512                     4,867
                                                    -------------------     ---------------------     ---------------------
Total stockholders' equity.......................                91,669                    87,924                    46,597
                                                    -------------------     ---------------------     ---------------------
                                                    
                                                               $214,757                  $222,648                   $67,225
                                                    ===================     =====================     =====================
</TABLE>



                See Notes to Consolidated Financial Statements.

                                       38
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES


                     CONSOLIDATED STATEMENTS OF OPERATIONS
                 (Amounts in thousands, except per share data)
                                        
<TABLE>
<CAPTION>
                                            Six Month          (Unaudited)
                                            Transition          Six Month
                                           Period Ended        Period Ended
                                           December 31,        December 31,       Fiscal Year Ended June 30,
                                       --------------------   -------------  ---------------------------------
                                              1997                 1996           1997       1996       1995
                                       --------------------  --------------  -----------  ---------  ---------  
<S>                                    <C>                     <C>              <C>         <C>        <C>
REVENUES:
  Gas revenues....................                  $26,755         $ 6,759      $24,202    $ 9,856    $ 4,864
  Oil revenues....................                   17,408           3,087       14,865      5,810      3,643
  Gas plant revenues, net.........                      804           2,052        3,330      2,577      2,674
  Gas gathering revenues, net.....                      ---             ---          ---        957      1,953
  Interest and other income.......                      609              54          363        116         97
                                       --------------------  --------------  -----------  ---------  ---------  
                                                     45,576          11,952       42,760     19,316     13,231
                                       --------------------  --------------  -----------  ---------  ---------  
 
COSTS AND EXPENSES:
 
  Production expenses.............                   13,836           3,061       11,437      5,317      2,856
  General and administrative                                                                                   
      expenses....................                    3,748           1,452        4,042      3,013      2,739 
  Depreciation, depletion and
    amortization..................                   16,352           4,167       15,574      8,148      5,269
  Interest expense................                    5,978             520        4,477      1,657      1,245
  Other expenses..................                      ---             ---          ---        153        ---
                                       --------------------  --------------  -----------  ---------  ---------  
                                                     39,914           9,200       35,530     18,288     12,109
                                       --------------------  --------------  -----------  ---------  ---------  
 
Income before income taxes and
        minority interest.........                    5,662           2,752        7,230      1,028      1,122
 
Provision for income taxes........                    2,114           1,018        2,585         46          9
 
Minority interest in gas plant                                                                                 
      ventures....................                      ---             ---          ---        ---        172 
                                       --------------------  --------------  -----------  ---------  ---------  
 
Net income........................                  $ 3,548         $ 1,734      $ 4,645    $   982    $   941
                                       ====================  ==============  ===========  =========  =========   
 
Net income per share..............                    $0.26           $0.19        $0.46      $0.11      $0.12
                                       ====================  ==============  ===========  =========  =========   
 
Net income per share-diluted                                                                                   
 diluted..........................                    $0.25           $0.19        $0.45      $0.11      $0.12 
                                       ====================  ==============  ===========  =========  =========   
 
Weighted average common shares
      outstanding  primary........                   13,876           9,118       10,201      9,052      7,716
                                       ====================  ==============  ===========  =========  =========   
 
Weighted average common shares
      outstanding  diluted........                   14,446           9,139       10,261      9,114      7,734
                                       ====================  ==============  ===========  =========  =========   
</TABLE>



                See Notes to Consolidated Financial Statements.

                                       39
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES



                       CONSOLIDATED STATEMENTS OF CHANGES
                            IN STOCKHOLDERS' EQUITY
                             (Amounts in thousands)
<TABLE>
<CAPTION>
 
                                                                                
                            COMMON STOCK           PREFERRED STOCK   ADDITIONAL                   TREASURY STOCK 
                           ---------------         ---------------     PAID-IN    RETAINED        --------------- 
                           SHARES   AMOUNT      SHARES       AMOUNT    CAPITAL    EARNINGS      SHARES       AMOUNT      TOTAL 
                           ------   ------      ------       ------  ----------   --------      ------       ------     -------    
<S>                        <C>      <C>         <C>          <C>     <C>          <C>           <C>          <C>         <C>    
Balance June 30, 1994....   3,737     $ 37         ---          ---     $15,490    $ 2,944          15         $(99)    $18,372
Shares issued in public                                                                                                        
 stock offering..........   3,400       34         ---          ---      17,204        ---         ---          ---      17,238
Cancellation of                                                                                                                
 treasury stock..........     (15)     ---         ---          ---         ---        ---         (15)          99          99
Shares issued in merger                                                                                                        
 with Odyssey Partners,                                                                                                        
 Ltd.....................     917        9         ---          ---       3,944        ---         ---          ---       3,953
Shares issued in merger                                                                                                        
 with Hampton                                                                                                                  
 Resources Corporation...   1,006       10         ---          ---       4,834        ---         ---          ---       4,844
Net earnings.............     ---      ---         ---          ---         ---        941         ---          ---         941
                           ------   ------      ------       ------  ----------   --------      ------       ------     -------    
                                                                                                                               
Balance June 30, 1995....   9,045       90         ---          ---      41,472      3,885         ---          ---      45,447
Stock options                                                                                                                  
 exercised...............      30        1         ---          ---         167        ---         ---          ---         168
Net earnings.............     ---      ---         ---          ---         ---        982         ---          ---         982
                           ------   ------      ------       ------  ----------   --------      ------       ------     -------    
                                                                                                                               
Balance June 30, 1996....   9,075       91         ---          ---      41,639      4,867         ---          ---      46,597
Shares issued in public                                                                                                        
 stock offering, net of                                                                                                        
 offering costs..........   4,687       47         ---          ---      36,169        ---         ---          ---      36,216
Stock options                                                                                                                  
 exercised...............      83        1         ---          ---         465        ---         ---          ---         466
Net earnings.............     ---      ---         ---          ---         ---      4,645         ---          ---       4,645
                           ------   ------      ------       ------  ----------   --------      ------       ------     -------    
                                                                                                                               
Balance June 30, 1997....  13,845      139         ---          ---      78,273      9,512         ---          ---      87,924
                                                                                                                               
Offering costs...........     ---      ---         ---          ---         (96)       ---         ---          ---         (96)
Stock options                                                                                                                  
 exercised...............      47      ---         ---          ---         293        ---         ---          ---         293
Net earnings.............     ---      ---         ---          ---         ---      3,548         ---          ---       3,548
                           ------   ------      ------       ------  ----------   --------      ------       ------     -------    
                                                                                                                               
Balance                                                                                                                        
  December 31, 1997......  13,892     $139         ---          ---     $78,470    $13,060         ---         $---     $91,669
                           ======   ======      ======       ======  ==========   ========      ======       ======     =======   
 
</TABLE>
                See Notes to Consolidated Financial Statements.

                                       40
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES



                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Amounts in Thousands)

<TABLE>
<CAPTION>
                                                                                  
                                                                 Six Month        
                                                                 Transition       
                                                                Period Ended                                          
                                                                December 31,              Fiscal Years Ended June 30, 
                                                         -------------------------  ------------------------------------
                                                                     1997                1997         1996        1995
                                                         -------------------------  ------------  ------------  --------  
<S>                                                          <C>                      <C>           <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income...............................................                $  3,548     $   4,645     $   982     $    941
Adjustments to reconcile net income to
  net cash provided by operating
  activities:
  Depreciation, depletion and
    amortization.........................................                  16,708        16,044       8,273        5,382
  Minority interest in gas plant
    ventures.............................................                     ---           ---         ---          120
  Deferred taxes.........................................                   1,585         2,562        (183)         ---
                                                         -------------------------  ------------  ------------  -------- 
 
                                                                           21,841        23,251       9,072        6,443
 
Change in assets and liabilities,
  net of acquisition effects:
  Accounts receivable and accrued
    revenues.............................................                  (1,498)        2,941        (668)       1,548
  Prepaid expenses.......................................                  (1,481)         (638)         25          117
  Accounts payable and accrued expenses..................                   1,502         4,438          84       (2,047)
  Due (to) from affiliates...............................                  (2,346)        5,738        (791)        (633)
  Other..................................................                     (57)       (6,447)       (237)        (145)
                                                         -------------------------  ------------  ------------  --------  
 
 
NET CASH FLOWS PROVIDED BY OPERATING
  ACTIVITIES.............................................                  17,961        29,283       7,485        5,283
                                                         -------------------------  ------------  ------------  --------  
 
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of oil and gas properties,
  including working capital of $13,914
  and $5,816 in fiscal years ended June
  30, 1997 and June 30, 1995,
  respectively
  -  Partnership Transactions............................                     ---      (147,909)        ---          ---
  -  Odyssey Petroleum...................................                     ---           ---         ---       (5,374)
  -  Hampton Resources...................................                     ---           ---         ---      (18,168)
  -  Other acquisitions..................................                  (5,486)       (2,005)        ---          ---
Additions to oil and gas properties......................                 (13,727)      (20,811)     (6,934)      (3,497)
Proceeds from sales of properties........................                   5,362        18,775         644          265
Additions to gas plant facilities........................                  (1,632)          (84)        (44)         (87)
Proceeds from gas contract assignment....................                     ---           ---       9,875          ---
Other....................................................                     (17)          (88)          1         (428)
                                                         -------------------------  ------------  ------------  --------  
 
NET CASH FLOWS PROVIDED BY (USED IN)
  INVESTING ACTIVITIES...................................                 (15,500)     (152,122)      3,542      (27,289)
                                                         =========================  ============  ============  ========  
</TABLE>


                See Notes to Consolidated Financial Statements.

                                       41
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES



               CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
                             (Amounts in Thousands)
                                        
<TABLE>
<CAPTION>
                                                     Six Month                       
                                                    Transition                       
                                                   Period Ended                                                                  
                                                   December 31,                     Fiscal Year Ended June 30, 
                                                  -------------     ------------------------------------------------------
                                                       1997              1997                1996                1995           
                                                  -------------     --------------        ----------          ------------      
CASH FLOWS FROM FINANCING ACTIVITIES:                                                                                           
<S>                                                <C>                   <C>               <C>                   <C>            
Proceeds from borrowings.......................       $  1,500           $157,300            $  ---               $ 26,773      
Net proceeds from issuance of common                                                                                            
  stock........................................            197             35,145               168                 17,238      
Payments of long-term debt.....................        (16,800)           (55,048)          (11,500)               (22,369)     
                                                  -------------     --------------        ----------          ------------      
NET CASH FLOWS PROVIDED BY (USED IN)                                                                                            
  FINANCING ACTIVITIES.........................     (15,103)              137,397           (11,332)                21,642      
                                                  -------------     --------------        ----------          ------------       
                                           
Net increase (decrease) in cash and        
  cash equivalents.............................     (12,642)               14,558              (305)                  (364)
Cash and cash equivalents at beginning     
  of period....................................      15,341                   783             1,088                  1,452
                                                  -------------     --------------        ----------          ------------        
 CASH AND CASH EQUIVALENTS AT END          
  OF PERIOD....................................    $  2,699              $ 15,341          $    783                  1,088
                                                  =============     ==============        ==========          ============        
</TABLE>


                See Notes to Consolidated Financial Statements.

                                       42
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   ORGANIZATION

          Bellwether Exploration Company ("the Company") was formed as a
     Delaware corporation in 1994 to succeed to the business and properties of
     its predecessor company pursuant to a merger, the primary purpose of which
     was to change the predecessor company's state of incorporation from
     Colorado to Delaware.  The predecessor company was formed in 1980 from the
     consolidation of the business and properties of related oil and gas limited
     partnerships.  References to Bellwether or the Company include the
     predecessor company, unless the context requires otherwise.

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Principles of Consolidation

          The consolidated financial statements include the accounts of
     Bellwether Exploration Company and its wholly-owned subsidiaries.  Snyder
     Gas Plant Venture and NGL/Torch Gas Plant Venture and their 11.98% and
     35.78% investments in the Snyder and Diamond M-Sharon Ridge Gas Plants have
     been pro rata consolidated.  All significant intercompany accounts and
     transactions have been eliminated in consolidation.

     Fiscal Year Change

          In order to facilitate greater comparability with its peer group by
     the financial community, the Company changed its fiscal year to align with
     the calendar year, beginning January 1, 1998.  The six-month transition
     period of July 1, 1997 through December 31, 1997 ("transition period")
     precedes the start of the new fiscal year.  The unaudited financial
     information for the six months ended December 31, 1996 ("prior period") is
     presented for comparative purposes and includes any adjustments (consisting
     of normal, recurring adjustments) which are, in the opinion of management,
     necessary for fair presentation.


     Oil and Gas Properties

          The Company utilizes the full cost method to account for its
     investment in oil and gas properties.  Under this method, all costs of
     acquisition, exploration and development of oil and gas reserves (including
     such costs as leasehold acquisition costs, geological expenditures, dry
     hole costs and tangible and intangible development costs and direct
     internal costs) are capitalized as incurred.  The cost of oil and gas
     properties, the estimated  future expenditures to develop proved reserves,
     and estimated future abandonment, site remediation and dismantlement costs
     are depleted and charged to operations using the unit-of-production method
     based on the ratio of current production to proved oil and gas reserves as
     estimated by 

                                       43
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     independent engineering consultants. Costs directly associated with the
     acquisition and evaluation of unproved properties are excluded from the
     amortization computation until it is determined whether or not proved
     reserves can be assigned to the properties or whether impairment has
     occurred. Depletion expense per equivalent barrel of production was
     approximately $5.42 in transition period 1997, $5.62 in fiscal 1997, $5.86
     in fiscal 1996 and $5.52 in fiscal 1995. Dispositions of oil and gas
     properties are recorded as adjustments to capitalized costs, with no gain
     or loss recognized unless such adjustments would significantly alter the
     relationship between capitalized costs and proved reserves of oil and gas.
     To the extent that capitalized costs of oil and gas properties, net of
     accumulated depreciation, depletion and amortization, exceed the discounted
     future net revenues of proved oil and gas reserves net of deferred taxes,
     such excess capitalized costs would be charged to operations. No such
     write-down in book value was required at December 1997, June 1997, 1996 or
     1995.

          Any reference to oil and gas reserve information in the Notes to
     Consolidated Financial Statements is unaudited.

     Gas Plants and Gas Gathering System

          Gas plant facilities include the costs to acquire certain gas plants
     and to secure rights-of-way.  Capitalized costs associated with gas plants
     facilities are amortized primarily over the estimated useful lives of the
     various components of the facilities utilizing the straight-line method.
     The estimated useful lives of such assets range from four to fifteen years.

          The Company's gas gathering subsidiary and certain third parties were
     the beneficiaries of an agreement whereby another party had an obligation
     to purchase, until May 31, 1999, the gas produced by the Company and such
     third parties from the West Monroe field in Union Parish, Louisiana at a
     price of $4.50 per MMBTU.  Bellwether owned a large majority of the gas
     produced and sold pursuant to the Purchase Agreement.  In March 1996, in
     exchange for Bellwether's agreement to assume the purchase obligations
     under the gas purchase contract, Bellwether was paid $9.9 million.  As a
     result of this transaction, the Company has written off the remaining book
     value of the gas gathering system and has recorded a liability to cover the
     estimated future losses under the contract.  Gas gathering operations of
     the subsidiary and payments to third parties are charged to the liability
     as incurred.  From the proceeds, $9.5 million was paid on the Company's
     credit facility.

     Gas Imbalances

          The Company uses the sales method of accounting for gas imbalances.
     Under this method, gas sales are recorded when revenue checks are received
     or are receivable on the accrual basis.  The Company had a net imbalance
     liability, at fair value of $1.7 million 

                                       44
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     and $1.6 million at December 31, 1997 and June 30, 1997, respectively. The
     Company's net imbalance was immaterial at June 30, 1996 and 1995.

     Financial Accounting Standards Board Statement No. 121

          In March 1995, the Financial Accounting Standards Board ("FASB")
     issued Statement No. 121 ("SFAS 121") "Accounting for the Impairment of
     Long-Lived Assets and for Long-Lived Assets to Be Disposed Of".  SFAS 121
     is effective beginning July 1, 1996 and establishes guidelines for
     determining and measuring asset impairment and the required timing of asset
     impairment evaluations.  The impact of implementing SFAS 121 was
     immaterial.

     Financial Accounting Standards Board Statement No. 123

          In October 1995, the FASB issued Statement No. 123 ("SFAS 123"),
     "Accounting for Stock-Based Compensation" which is effective for the
     Company beginning July 1, 1996. SFAS 123 permits, but does not require, a
     fair-value-based method of accounting for employee stock option plans which
     results in compensation expense being recognized in the results of
     operations when stock options are granted.  The Company plans to continue
     to use the current intrinsic-value-based method of accounting for such
     plans where no compensation expense is recognized.  However, as required by
     SFAS 123, the Company has provided pro forma disclosure of net income and
     earnings per share in the notes to the consolidated financial statements as
     if the fair-value-based method of accounting had been applied.

     Financial Accounting Standards Board Statement No. 128

          Effective December 1997, the Company retroactively adopted Statement
     of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS
     128").  SFAS 128 introduces the concept of basic earnings per share, which
     represents net income divided by the weighted average common shares
     outstanding  without the dilutive effects of common stock equivalents
     (options, warrants, etc.) Additionally, SFAS No. 128 replaces fully diluted
     EPS with diluted EPS.  Diluted EPS reflects the potential dilution that
     could occur if securities or other contracts to issue common stock were
     exercised or converted into common stock or resulted in the issuance of
     common stock that then shared in the earnings of the entity.  The Company's
     dilutive securities include stock options and warrants.  The assumed
     conversion of these securities is anti-dilutive for a period if the option
     or warrant exercise price exceeds the average market price for the periods.
     SFAS No. 128 also requires a reconciliation of the numerator and
     denominator of the basic EPS computation to the numerator and denominator
     of the diluted EPS computation.  The Company's reconciliation is included
     in Note 6.  In accordance with SFAS No. 128, the Company retroactively
     restated all prior period EPS data (including interim EPS) included in
     these financial statements and footnotes.  The impact of adopting SFAS 128
     is immaterial.

                                       45
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     Natural Gas and Crude Oil Hedging

          Commodity derivatives utilized as hedges include swap contracts.  In
     order to qualify as a hedge, price movements in the underlying commodity
     derivative must be sufficiently correlated with the hedged commodity.  When
     a commodity derivative ceases to qualify as a hedge, the change in its fair
     value is recognized in income currently.  Settlement of gains and losses on
     price swap contracts are realized monthly, generally based upon the
     difference between the contract price and the average closing New York
     Mercantile Exchange ("NYMEX") price and are reported as a component of oil
     and gas revenues and operating cash flows in the period realized.  Gains
     and losses attributable to the termination of a swap contract are deferred
     on the balance sheet and recognized in revenue when the hedged crude oil
     and natural gas is sold.  There were no such deferred gains or losses at
     December 31, 1997 or at June 30, 1997, 1996 or 1995.

          Oil and gas revenues were decreased by $1.6 million in the six month
     transition period ended December 1997, and by $18,000 and $0.6 million in
     the fiscal years ended June 1997 and 1996, as a result of such hedging
     activity.  There was no hedging in 1995.

     Income Taxes

          Deferred taxes are accounted for under the asset and liability method
     of accounting for income taxes.  Under this method, deferred income taxes
     are recognized for the tax consequences of "temporary differences" by
     applying enacted statutory tax rates applicable to future years to
     differences between the financial statement carrying amounts and the tax
     basis of existing assets and liabilities.  The effect on deferred taxes of
     a change in tax rates is recognized in income in the period the change
     occurs.

     Statements of Cash Flows

          For cash flow presentation purposes, the Company considers all highly
     liquid debt instruments purchased with an original maturity of three months
     or less to be cash equivalents.  Interest paid in cash for the six month
     transition period ended December 31, 1997, and the fiscal years ended June
     30, 1997, 1996 and 1995, was $5.4 million, $1.5 million, $1.6 million and
     $1.2 million, respectively.  Income taxes paid in cash for the transition
     period ended December 31, 1997 and the fiscal years ended June 30, 1997,
     1996, and 1995 were $41,000, $198,000, $126,000, and $9,000, respectively.
     A portion of the purchase price of the Partnership Transactions included
     the issuance to Torch, as consideration for advisory services, 150,000
     shares of the Company's common stock valued at $1.2 million and a warrant
     to purchase 100,000 shares of common stock at $9.90 per share valued at
     $300,000.  During 1995, a portion of the consideration for the merger of
     Odyssey Partners, Ltd. and Hampton Resources Corporation, collectively
     ("the Mergers"), was the assumption of debt of $1.4 million and $4.1
     million, 

                                       46
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     respectively. Additionally, common stock with a value of $4.0 million and
     $4.8 million, respectively, was issued in the Mergers.

     Use of estimates

          Management of the Company has made a number of estimates and
     assumptions relating to the reporting of assets and liabilities and the
     disclosure of contingent assets and liabilities as well as reserve
     information which affects the depletion calculation and the computation

     of the full cost ceiling limitation to prepare these financial statements
     in conformity with generally accepted accounting principles. Actual results
     could differ from these estimates.

     Reclassifications

          Certain reclassifications of prior period statements have been made to
     conform with current reporting practices.

3.   ACQUISITIONS AND MERGERS

          During the last three fiscal years, the Company has completed the
     following mergers and acquisitions, all of which were recorded using the
     purchase method of accounting:

          In April 1997, the Company closed acquisitions of oil and gas
     properties, totaling $145.2 million including working capital of $13.9
     million, from certain partnerships and other entities managed or sponsored
     by Torch Energy Advisors Incorporated ("Torch").  The acquisitions were
     financed by the sale of 4.4 million shares of common stock, the sale of
     $100.0 million of 10-7/8% senior subordinated notes due in 2007 and the use
     of $33.3 million of a new $90.0 million senior unsecured credit facility
     (including the repayment of $22.0 million on a then existing credit
     facility).

          On February 28, 1995 the Company acquired Hampton in exchange for
     $17.0 million in cash and 1,006,458 shares of the Company's common stock.
     The Company had paid previous to the merger $2.7 million to acquire common
     and preferred stock of Hampton and incurred $1.4 million in expenses in
     arranging the merger.  The total cost of the Hampton acquisition was $25.9
     million, consisting of $21.1 million in cash and $4.8 million in common
     stock.  Hampton was an energy company engaged in the exploration,
     acquisition and production of oil and natural gas, primarily in the onshore
     Gulf Coast region and offshore in Texas state waters.

          On August 26, 1994 the Company acquired Odyssey in exchange for $5.6
     million in cash (funded from a common stock offering which closed on the
     same date) and 916,665 shares of the Company's common stock, for a total
     cost of $9.6 million.  Odyssey is an exploration company which assembles,
     exploits and operates oil and gas properties using state-of-the-art 3-D
     seismic and computer-aided exploration technology.  

                                       47
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     Odyssey's primary areas of operation have been the onshore Gulf Coast
     region and the Permian Basin area of West Texas and Southeast New Mexico.

          The following table presents the unaudited pro forma results of
     operations as if the Partnership Transactions had all occurred on July 1,
     1995 and July 1, 1996.  The Partnership Transactions were accounted for as
     purchases, and their results of operations are included in the Company's
     results of operations from the date of acquisition.  The Company's pro
     forma results are based on assumptions and estimates and are not
     necessarily indicative of the Company's results of operations had the
     transaction occurred as of July 1, 1995 or 1996, or those in the future (in
     thousands, except earnings per share).

<TABLE>
<CAPTION>
                                                                        (Unaudited)
                                                        --------------------------------------------- 
                                                          Six Month  
                                                         Prior Period
                                                            Ended    
                                                         December 31,      Fiscal Year Ended June 30, 
                                                             1996             1997           1996
                                                        ----------------  -------------  ------------ 
<S>                                                      <C>               <C>            <C>
Revenues.......................                                 $63,311       $120,384       $140,969
                                                
Expenses.......................                                  47,689         90,024        104,629
                                                        ----------------  -------------  ------------  
                                             
Earnings before                                          
  income taxes.................                                  15,622         30,360         36,340
                                             
Income taxes...................                                   5,780         11,143         13,112
                                                        ----------------  -------------  ------------  
                                             
Net earnings...................                                 $ 9,842       $ 19,217       $ 23,228
                                                        ================  =============  ============   
                                             
Net earnings per                                
  common share................                                  $  0.71       $   1.40       $   1.68
                                                        ================  =============  ============   
                                             
Net earnings per   
  common share - 
  diluted.....................                                  $  0.71       $   1.38       $   1.68
                                                        ================  =============  ============   
</TABLE>

                                       48
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


4.   GUARANTOR FINANCIAL STATEMENTS

     Consolidating financial statements of the Company and the Guarantor
Subsidiaries, (Odyssey Petroleum Company, Black Hawk Oil Company, and 1989-I
TEAI Limited Partnership), as guarantors of the Company's 10-7/8% Senior
Subordinate Notes due 2007 are presented as follows (See Note 8):

               CONDENSED CONSOLIDATING BALANCE SHEETS  UNAUDITED
                            AS OF DECEMBER 31, 1997
                                 (IN THOUSANDS)
                                        
<TABLE>
<CAPTION>
 
                                                     GUARANTOR      NONGUARANTOR
                                      BELLWETHER    SUBSIDIARIES    SUBSIDIARIES     ELIMINATIONS     CONSOLIDATED
                                  ---------------  --------------  ---------------  ---------------  ------------- 
 
<S>                                   <C>           <C>             <C>              <C>              <C>
Current assets                          $ 20,135         $ 2,409         $ 1,688         $  4,645         $ 28,877
Property, plant and
  equipment, net                         160,988          15,139          23,174          (19,168)         180,133
Other assets                              48,751             495              33          (43,532)           5,747
                                  ---------------  --------------  ---------------  ---------------  ------------- 
Total assets                            $229,874         $18,043         $24,895         $(58,055)        $214,757
                                  ===============  ==============  ===============  ===============  =============  
 
Current liabilities                     $  9,851         $ 4,715         $(4,273)        $  4,620         $ 14,913
Long-term debt                           100,000             ---             ---              ---          100,000
Deferred taxes                             6,606             363             137              ---            7,106
Other long-term
  liabilities                              1,488             ---             ---             (419)           1,069
Stockholders' equity
  (deficit)                              111,929          12,965          29,031          (62,256)          91,669
                                  ---------------  --------------  ---------------  ---------------  -------------  
Total liabilities and
  stockholders' equity
  (deficit)                             $229,874         $18,043         $24,895         $(58,055)        $214,757
                                  ===============  ==============  ===============  ===============  =============  
</TABLE>

              CONDENSED CONSOLIDATING INCOME STATEMENTS  UNAUDITED
                   FOR THE SIX MONTHS ENDED DECEMBER 31, 1997
                                 (IN THOUSANDS)
                                        
<TABLE>
<CAPTION>
                                                      GUARANTOR      NONGUARANTOR
                                      BELLWETHER    SUBSIDIARIES     SUBSIDIARIES    ELIMINATIONS     CONSOLIDATED
                                  ---------------  --------------  ---------------  ---------------  -------------  
 
<S>                                   <C>           <C>              <C>             <C>              <C>
Revenues                                 $32,858         $ 6,704           $5,446          $  568          $45,576
Expenses                                  19,462          16,233            4,927            (708)          39,914
 
Net earnings (loss)
  before income taxes                     13,396          (9,529)             519           1,276            5,662
Income taxes                               1,988             (11)             137             ---            2,114
                                  ---------------  --------------  ---------------  ---------------  -------------  
Net earnings (loss)                      $11,408         $(9,518)          $  382          $1,276          $ 3,548
                                  ===============  ==============  ===============  ===============  =============  
</TABLE>

                                       49
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

           CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS  UNAUDITED
                   FOR THE SIX MONTHS ENDED DECEMBER 31, 1997
                                 (IN THOUSANDS)
                                        
<TABLE>
<CAPTION>
                                                            GUARANTOR      NONGUARANTOR
                                           BELLWETHER     SUBSIDIARIES     SUBSIDIARIES     ELIMINATIONS     CONSOLIDATED
                                        ---------------  --------------  ---------------   ---------------   -------------  
<S>                                        <C>            <C>              <C>              <C>              <C>
Cash flows from operating
ACTIVITIES
Net income (loss)                            $ 11,408          $(9,518)         $   382          $ 1,276         $  3,548
Non-cash adjustments                             (531)          16,896            1,928              ---           18,293
Changes in assets and
 liabilities                                   (5,581)           2,058             (801)             444           (3,880)
                                        ---------------  --------------  ---------------   ---------------   -------------  
Net cash provided by
 operating activities                           5,296            9,436            1,509            1,720           17,961
                                        ---------------  --------------  ---------------   ---------------   -------------   

CASH FLOWS FROM INVESTING
 ACTIVITIES:
Additions to oil and
 gas properties and
 facilities                                    (8,444)          (9,454)          (1,244)          (1,720)         (20,862)
Proceeds from sales
 of properties                                  4,349              199              814              ---            5,362
                                        ---------------  --------------  ---------------   ---------------   -------------  
Net cash used in investing
 activities                                    (4,095)          (9,255)            (430)          (1,720)         (15,500)
                                        ---------------  --------------  ---------------   ---------------   -------------   
 
CASH FLOWS FROM FINANCING
 ACTIVITIES:
Proceeds from borrowings                        1,500              ---              ---              ---            1,500
Payments of long-term
 debt                                         (16,800)             ---              ---              ---          (16,800)
Net proceeds from
 issuance of common
 stock                                            197              ---              ---              ---              197
                                        ---------------  --------------  ---------------   ---------------   -------------  
Net cash provided by
 financing activities                         (15,103)             ---              ---              ---          (15,103)
                                        ---------------  --------------  ---------------   ---------------   -------------  
 
Net increase (decrease) in
 cash and cash
 equivalents                                  (13,902)             181            1,079              ---          (12,642)
Cash and cash equivalents
 at beginning of year                          15,170              160               11              ---           15,341
                                        ---------------  --------------  ---------------   ---------------   -------------  
Cash and cash equivalents
 at end of year                              $  1,268          $   341          $ 1,090          $   ---         $  2,699
                                        ===============  ==============  ===============   ===============   =============  
</TABLE>

                                       50
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


               CONDENSED CONSOLIDATING BALANCE SHEETS  UNAUDITED
                              AS OF JUNE 30, 1997
                                 (IN THOUSANDS)
                                        
<TABLE>
<CAPTION>
 
                                                     GUARANTOR      NONGUARANTOR
                                      BELLWETHER    SUBSIDIARIES    SUBSIDIARIES     ELIMINATIONS     CONSOLIDATED
                                  ---------------  --------------  --------------  ----------------  ------------- 
<S>                                   <C>           <C>             <C>              <C>              <C>
Current assets                          $ 30,446         $ 2,069         $ 1,380         $  1,836         $ 35,731
Property, plant and
  equipment, net                         158,407          20,800          25,087          (23,292)         181,002
Other assets                              20,780             346              39          (15,250)           5,915
                                  ---------------  --------------  --------------  ----------------  ------------- 
Total assets                            $209,633         $23,215         $26,506         $(36,706)        $222,648
                                  ===============  ==============  ==============  ================  =============  
 
Current liabilities                     $ 12,003         $ 2,383         $(3,927)        $  2,489         $ 12,948
Long-term debt                           115,300             ---             ---              ---          115,300
Deferred taxes                             5,127             363              31              ---            5,521
Other long-term
  liabilities                              1,910             ---             ---             (955)             955
Stockholders' equity (deficit)
                                          75,293          20,469          30,402          (38,240)          87,924
                                  ---------------  --------------  --------------  ----------------  -------------  
Total liabilities and
  stockholders' equity
  (deficit)                             $209,633         $23,215         $26,506         $(36,706)        $222,648
                                  ===============  ==============  ==============  ================  =============   
</TABLE>

              CONDENSED CONSOLIDATING INCOME STATEMENTS  UNAUDITED
                        FOR THE YEAR ENDED JUNE 30, 1997
                                 (IN THOUSANDS)
                                        
<TABLE>
<CAPTION>
                                                      GUARANTOR      NONGUARANTOR
                                      BELLWETHER    SUBSIDIARIES     SUBSIDIARIES    ELIMINATIONS     CONSOLIDATED
                                  ---------------  --------------  --------------  ----------------  -------------  
 
<S>                                   <C>           <C>              <C>             <C>              <C>
Revenues                                 $32,539         $ 5,260           $5,966         $(1,005)         $42,760
Expenses                                  26,153           6,979            3,762          (1,364)          35,530
                                  ---------------  --------------  --------------  ----------------  -------------  
Net earnings (loss)
  before income taxes                      6,386          (1,719)           2,204             359            7,230
Income taxes                               2,610             (57)               8              24            2,585
                                  ---------------  --------------  --------------  ----------------  -------------  
Net earnings (loss)                      $ 3,776         $(1,662)          $2,196         $   335          $ 4,645
                                  ===============  ==============  ==============  ================  =============   
</TABLE>

                                       51
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

           CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS  UNAUDITED
                        For the Year Ended June 30, 1997
                                 (IN THOUSANDS)
                                        
<TABLE>
<CAPTION>
                                                            GUARANTOR      NONGUARANTOR
                                           BELLWETHER     SUBSIDIARIES     SUBSIDIARIES     ELIMINATIONS     CONSOLIDATED
                                       ---------------  ---------------  ---------------  ----------------  ------------- 
Cash flows from operating
ACTIVITIES
<S>                                        <C>            <C>              <C>              <C>              <C>
Net income (loss)                           $   3,776          $(1,662)         $ 2,196            $ 335        $   4,645
Non-cash adjustments                           12,527            4,732            1,565             (218)          18,606
Changes in assets and
 liabilities                                    6,064            2,400           (2,315)            (117)           6,032
                                       ---------------  ---------------  ---------------  ----------------  ------------- 
Net cash provided by
 operating activities                          22,367            5,470            1,446              ---           29,283
                                       ---------------  ---------------  ---------------  ----------------  ------------- 
 
CASH FLOWS FROM INVESTING
 ACTIVITIES:
Additions to oil and
 gas properties and
 facilities                                   (12,083)          (7,894)          (1,006)             ---          (20,983)
Acquisitions of oil
 and gas properties                          (149,914)             ---              ---              ---         (149,914)
Proceeds from sales
 of properties                                 15,408            3,071              296              ---           18,775
                                       ---------------  ---------------  ---------------  ----------------  ------------- 
Net cash used in investing
 activities                                  (146,589)          (4,823)            (710)             ---         (152,122)
                                       ---------------  ---------------  ---------------  ----------------  ------------- 
 
CASH FLOWS FROM FINANCING
 ACTIVITIES:
Proceeds from borrowings                      157,300              ---              ---              ---          157,300
Payments of long-term
 debt                                         (55,048)             ---              ---              ---          (55,048)
Net proceeds from issuance
 of common stock                               35,145              ---              ---              ---           35,145
                                       ---------------  ---------------  ---------------  ----------------  ------------- 
Net cash provided by
 financing activities                         137,397              ---              ---              ---          137,397
                                       ---------------  ---------------  ---------------  ----------------  ------------- 
 
Net increase (decrease) in
 cash and cash
 equivalents                                   13,175              647              736              ---           14,558
Cash and cash equivalents
 at beginning of year                             588              191                4              ---              783
                                       ---------------  ---------------  ---------------  ----------------  ------------- 
Cash and cash equivalents
 at end of year                             $  13,763          $   838          $   740     $  ---              $  15,341
                                       ===============  ===============  ===============  ================  ============= 
</TABLE>

                                       52
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


               CONDENSED CONSOLIDATING BALANCE SHEETS  UNAUDITED
                              AS OF JUNE 30, 1996
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
 
                                                     GUARANTOR      NONGUARANTOR
                                      BELLWETHER    SUBSIDIARIES    SUBSIDIARIES     ELIMINATIONS     CONSOLIDATED
                                  ---------------  --------------  --------------  ----------------  -------------
 
<S>                                   <C>           <C>             <C>              <C>              <C>
Current assets                           $ 6,118         $   887         $   924         $    575          $ 8,504
Property, plant and
  equipment, net                          39,317          11,004          15,050           (7,236)          58,135
Other assets                              29,872              25              37          (29,348)             586
                                  ---------------  --------------  --------------  ----------------  -------------
Total assets                             $75,307         $11,916         $16,011         $(36,009)         $67,225
                                  ===============  ==============  ==============  ================  =============
 
Current liabilities                      $ 2,160         $ 1,044         $(1,207)        $  1,339          $ 3,336
Long-term debt                            13,048             ---             ---              ---           13,048
Deferred taxes                             5,096             407             ---           (2,642)           2,861
Other long-term
  liabilities                              2,115             ---             ---             (732)           1,383
Stockholders' equity
  (deficit)                               52,888          10,465          17,218          (33,974)          46,597
                                  ---------------  --------------  --------------  ----------------  -------------
Total liabilities and
  stockholders' equity
  (deficit)                              $75,307         $11,916         $16,011         $(36,009)         $67,225
                                  ===============  ==============  ==============  ================  =============
</TABLE>

              CONDENSED CONSOLIDATING INCOME STATEMENTS  UNAUDITED
                        FOR THE YEAR ENDED JUNE 30, 1996
                                 (IN THOUSANDS)
                                        
<TABLE>
<CAPTION>
                                                     GUARANTOR      NONGUARANTOR
                                    BELLWETHER      SUBSIDIARIES    SUBSIDIARIES     ELIMINATIONS    CONSOLIDATED
                                  ---------------  --------------  --------------  ----------------  -------------
 
<S>                                 <C>            <C>             <C>             <C>              <C>
Revenues                               $10,984           $3,600          $4,300           $ 432          $19,316
Expenses                                11,187            2,830           3,486             785           18,288
                                  ---------------  --------------  --------------  ----------------  -------------
Net earnings (loss)
  before income taxes                     (203)             770             814            (353)           1,028
Income taxes                              (404)             285             141              24               46
                                  ---------------  --------------  --------------  ----------------  -------------
Net earnings (loss)                    $   201           $  485          $  673           $(377)         $   982
                                  ===============  ==============  ==============  ================  =============
</TABLE>

                                       53
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


           CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS  UNAUDITED
                        For the Year Ended June 30, 1996
                                 (IN THOUSANDS)
                                        
<TABLE>
<CAPTION>
                                                               GUARANTOR      NONGUARANTOR
                                              BELLWETHER     SUBSIDIARIES     SUBSIDIARIES     ELIMINATIONS    CONSOLIDATED
                                          ----------------  --------------  ----------------  --------------  --------------
Cash flows from operating
ACTIVITIES
<S>                                           <C>            <C>              <C>              <C>              <C>
Net income (loss)                               $    201          $   485          $   673          $  (377)        $    982
Non-cash adjustments                               4,851            1,506            1,314              419            8,090
Changes in assets and
 liabilities                                         896             (244)             159           (2,398)          (1,587)
                                          ----------------  --------------  ----------------  --------------  --------------
Net cash provided by (used
 in)operating activities                           5,948            1,747            2,146           (2,356)           7,485
                                          ----------------  --------------  ----------------  --------------  --------------
 
CASH FLOWS FROM INVESTING
 ACTIVITIES:
Additions to oil and
 gas properties and
 facilities                                       (5,597)          (1,567)             187              ---           (6,977)
Acquisitions of oil
 and gas properties                                  644              ---              ---              ---              644
Proceeds from sales
 of properties                                     9,875              ---              ---              ---            9,875
                                          ----------------  --------------  ----------------  --------------  --------------
Net cash used in investing
activities                                         4,922           (1,567)             187              ---            3,542
                                          ----------------  --------------  ----------------  --------------  --------------
 
CASH FLOWS FROM FINANCING
 ACTIVITIES:                                         ---              ---              ---              ---              ---
Proceeds from borrowings                         (11,500)             ---              ---              ---          (11,500)
Payments of long-term
 debt                                                ---              ---           (2,356)           2,356              ---
Net proceeds from issuance
 of common stock                                     168              ---              ---              ---              168
                                          ----------------  --------------  ----------------  --------------  --------------
Net cash provided by (used
 in) financing activities                        (11,332)             ---           (2,356)           2,356          (11,332)
                                          ----------------  --------------  ----------------  --------------  --------------
 
Net increase (decrease) in
 cash and cash
 equivalents                                        (462)             180              (23)             ---             (305)
Cash and cash equivalents
 at beginning of year                              1,050               11               27              ---            1,088
                                          ----------------  --------------  ----------------  --------------  --------------
Cash and cash equivalents
 at end of year                                 $    588          $   191          $     4           $  ---         $    783
                                          ================  ==============  ================  ==============  ==============
</TABLE>

                                       54
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


5.   RELATED PARTY TRANSACTIONS

          The Company is a party to an administrative services agreement which
     requires Torch to administer certain business activities of the Company for
     a monthly fee equal to the sum of one-twelfth of 2% of the average of the
     book value of the Company's total assets, excluding cash, plus 2% of annual
     operating cash flows (as defined) during the period in which the services
     are rendered plus reimbursement of certain costs incurred on behalf of the
     Company.  The administrative services agreement, whose initial term ends
     December 31, 1999, renews automatically for successive one-year periods
     until terminated by either party in accordance with the applicable
     provisions of the agreement.  For the periods ended December 31, 1997, and
     June 30, 1997, 1996 and 1995, related fees paid to Torch amounted to $2.4
     million, $2.3 million, $1.5 million and $1.2 million, respectively.
     Additionally, in the ordinary course of business, the Company incurs
     intercompany balances resulting from the payment of costs and expenses by
     affiliated entities on behalf of the Company.  Torch may charge interest on
     any unpaid balances not paid within 30 days, however, no such interest has
     been charged by Torch since the inception of the agreement.

         In April, 1997, Torch was issued 150,000 shares of the Company's common
     stock and a warrant to purchase 100,000 shares at $9.90 per share for
     advisory services rendered in connection with the Partnership Transactions.
     The Company's stock was valued at $1.2 million, and the  warrant was valued
     at $300,000. In December 1993, Torch was issued a warrant to purchase
     187,500 shares of the Company's common stock at a price of $6.40 per share
     for its advisory services in identifying  and negotiating a merger; such
     warrants were exercised in connection with the Partnership Transactions
     with total proceeds to the Company of $684,000.

         Torch was also a selling partner in the Partnership Transactions
     through its ownership of general partnership and working interests in the
     partnerships programs.  As a result, Torch was paid $18.4 million for such
     interests.  Two of the Company's officers are officers of Torch and have an
     equity interest in Torch.  A director of the Company holds significant
     options to purchase stock in Torch, which if exercised would constitute a
     substantial equity interest in Torch.  Two of the directors of the Company
     were formerly officers of Odyssey.

          A subsidiary of Torch markets oil and natural gas production from
     certain oil and gas properties in which the Company owns an interest. The
     Company generally pays fees of 2% of revenues for such marketing services.
     Such charges were $757,000, $646,000, $114,000 and $12,000 in periods ended
     December 1997 and June 1997, 1996 and 1995, respectively.

         Costs of the evaluation of potential property acquisitions and due
     diligence conducted in conjunction with acquisitions closed are 

                                       55
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     incurred by Torch at the Company's request. The Company was charged
     $217,000, $650,000, $74,000, and $193,000 for these costs in periods ended
     December 1997 and June 1997, 1996, and 1995, respectively.

         Torch operates certain oil and gas interests owned by the Company.  The
     Company is charged, on the same basis as other third parties, for all
     customary expenses and cost reimbursements associated with these
     activities.  Operator's overhead charged for these activities for the
     periods ended December 31, 1997 and June 30, 1997, 1996 and 1995 was
     $698,000, $729,000, $367,000 and $164,000, respectively.

         Torch became the operator of the Snyder Gas Plant on December 1, 1993.
     In periods ended December 1997 and June 1997, 1996 and 1995, the fees paid
     by the Company to Torch were $42,000, $49,000, $83,000 and $71,000,
     respectively.

6.   STOCKHOLDERS' EQUITY

     Common and Preferred Stock

         The Certificate of Incorporation of the Company authorizes the issuance
     of up to 15,000,000 shares of common stock and 1,000,000 shares of
     preferred stock, the terms, preferences, rights and restrictions of which
     are established by the Board of Directors of the Company.  Certain
     restrictions contained in the Company's loan agreements limit the amount of
     dividends which may be declared.  There is no present plan to pay cash
     dividends on common stock as the Company intends to reinvest its cash flows
     for continued growth of the Company.

         In July, 1997 in a special meeting of Stockholders of the Company, the
     Company's Certificate of Incorporation was amended to increase the number
     of authorized shares of Common Stock from 15,000,000 to 30,000,000.

         On September 12, 1997, the Company authorized and declared a dividend
     of one preferred stock purchase right for each share of common stock, par
     value $.01 per share, of the Company.  The dividend was payable on
     September 26, 1997 to the holders of record of Common Shares as of the
     close of business on such date.

         In April 1997, the Company issued 4.4 million shares of common stock
     for net proceeds to the Company of $34.1 million.  Such proceeds were used
     in financing the Partnership Transactions.  Also included in the April
     Offering were 719,264 shares sold by certain shareholders.  Additional
     shares issued during fiscal 1997 included 125,000 shares issued upon
     exercise of a warrant and 150,000 shares issued to Torch for advisory
     services rendered in connection with the Partnership Transactions.

         In addition to stock options outstanding, the Company has 160,000
     warrants outstanding at exercise prices ranging from $6.90 per share to
     

                                       56
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     $9.90 per share.  The expiration date for 100,000 warrants is April 2002,
     while the expiration date for the remaining 60,000 warrants is August 1999.

         During the first quarter of fiscal 1995, the Company consummated the
     sale of 3,650,000 shares of common stock.  The net proceeds to the Company
     were $17.3 million which were used for the Odyssey and Hampton mergers and
     general corporate purposes.  Of the shares sold, 3,400,000 were newly-
     issued by the Company and 250,000 were sold by certain stockholders.

     Earnings Per Share
     
         SFAS No. 128 (see Note 2) requires the reconciliation of the numerator
     (income) and denominator (shares) of the earnings per share computation to
     the numerator and denominator of the diluted earnings per share
     computation.  The Company's reconciliation is as follows (amounts in
     thousands):

<TABLE>
<CAPTION>
 
                                              
                                                                    
                                                                                                                    
                                Six Month                           
                            Transition Period      Six Month Period                     Fiscal Year Ended June 30, 
                                  Ended                  Ended       ---------------------------------------------------------------
                            December 31, 1997      December 31, 1996            1997                  1996                1995
                          ----------------------------------------------------------------------------------------------------------
                            Income     Shares      Income     Shares      Income     Shares     Income    Shares    Income    Shares
                          ----------  --------    --------  ---------   ---------   --------  ---------  --------  --------  -------
<S>       <C>              <C>         <C>        <C>         <C>        <C>         <C>        <C>       <C>       <C>       <C>
          Net income         $3,458                 $1,734                 $4,645                 $982                $941
                             ------                 ------                 ------                 ----                ----
          Earnings per
          common share       $3,458     13,876      $1,734      9,118      $4,645     10,201      $982     9,052      $941     7,716

          Effect of
          Dilutive
          Securities:
          Options &                                                                                                                
          Warrants              ---        570         ---         21         ---         60       ---        62       ---        18
                             ------     ------      ------      -----      ------     ------      ----     -----      ----     -----
          Earnings per
          common
          share-diluted      $3,458     14,446      $1,734      9,139      $4,645     10,261      $982     9,114      $941     7,734
                             ======     ======      ======     ======      ======     ======      ====     =====      ====     =====
</TABLE>

     Stock Incentive Plans

         The Company has stock option plans that provide for granting of options
     for the purchase of common stock to directors, officers and key employees
     of the Company and Torch.  These stock options may be granted subject to
     terms ranging from 6 to 10 years at a price equal to the fair market value
     of the stock at the date of grant.  At December 31, 1997, options under the
     plans available for future grants were 421,000.

                                       57
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  A summary of activity in the stock option plans is set forth below:

<TABLE>
<CAPTION>
                                                                       Number                          Option
                                                                      Of shares                     Price Range
                                                             ------------------------     ------------------------------
<S>                                                            <C>                          <C>
Balance at June 30, 1994.................................                     471,325                   $3.00   -  $7.00
  Granted................................................                     450,000                   $5.56   -  $5.94
                                                             ------------------------     ------------------------------
Balance at June 30, 1995.................................                     921,325                   $3.00   -  $7.00
  Granted................................................                      27,000                   $4.375  -  $6.38
  Surrendered............................................                     (10,000)                  $5.75
  Exercised..............................................                     (30,000)                  $5.625
                                                             ------------------------     ------------------------------ 
Balance at June 30, 1996.................................                     908,325                   $3.00   -  $7.00
  Granted................................................                     378,500                   $6.25   - $10.19
  Surrendered............................................                     (12,000)                  $7.625  
  Exercised..............................................                     (82,500)                  $5.625  -  $5.75
                                                             ------------------------     ------------------------------ 
Balance at June 30, 1997.................................                   1,192,325                   $3.00  -  $10.88
  Granted................................................                     242,000                   $10.31 -  $12.38
  Exercised..............................................                     (46,500)                  $3.00  -  $10.00
                                                             ------------------------     ------------------------------
Balance at December 31, 1997.............................                   1,387,825                   $3.00  -  $12.38
                                                             ========================     ==============================
 
Exercisable at December 31, 1997.........................                   1,145,825                   $3.00  -  $12.38
                                                             ========================     ==============================
</TABLE>

     Detail of stock options outstanding and options exercisable at June 30,
1997 follows:

<TABLE>
<CAPTION>
                                                          Outstanding                                     Exercisable           
                                     ----------------------------------------------------     ---------------------------------- 
                                                            Weighted    
                                                            Average       Weighted                                 Weighted
                                                           Remaining      Average                                  Average  
                                                             Life         Exercise                                 Exercise 
      Range of Exercise Prices             Number           (Years)        Price                 Number             Price   
--------------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>              <C>               <C>                <C>                 <C>
1988 Plan $3.00 to $ 7.00                      131,325        0.74          $4.79                    108,435         $4.78
1994 Plan $4.38 to $ 7.63                      705,500        7.28           5.70                    705,500          5.70
1996 Plan $6.25 to $12.38                      355,500        9.41           7.76                    276,500          7.25
                                     -----------------                                     -----------------     
Total                                        1,192,325                                             1,090,435    
                                     =================                                     =================     
</TABLE>

     Detail of stock options outstanding and options exercisable at December 31,
1997 follows:

<TABLE>
<CAPTION>
                                                          Outstanding                                     Exercisable    
                                     ----------------------------------------------------     ----------------------------------
                                                            Weighted                                     
                                                            Average         Weighted                                  Weighted 
                                                           Remaining        Average                                   Average  
                                                             Life           Exercise                                  Exercise 
  Range of Exercise Prices                   Number         (Years)          Price                     Number          Price   
-------------------------------------------------------------------------------------------------------------------------------
<S>                                  <C>                    <C>             <C>              <C>                       <C> 
1988 Plan $3.00 to $ 7.00                      121,325             0.23           $4.82               121,325            $4.82
1994 Plan $4.38 to $ 7.63                      682,500             6.77            5.69               682,500             5.69
1996 Plan $6.25 to $12.38                      584,000             9.30            9.31               342,000             7.83
                                     -----------------                                      ----------------- 
Total                                        1,387,825                                              1,145,825
                                     =================                                      ================= 
</TABLE>

                                       58
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     The estimated weighted average fair value per share of options granted
during transition 1997, fiscal 1997 and fiscal 1996 was $6.73, $3.26 and $2.39,
respectively.  The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the following weighted-
average assumptions:  transition 1997, fiscal 1997 and fiscal 1996 expected
stock price volatility of 40%; and risk free interest rate of 6% and an average
expected option life of 5 years.  Had compensation expense for stock-based
compensation been determined based on the fair value at the date of grant, the
Company's net income and earnings per share would have been reduced to the pro
forma amounts indicated below (in thousands except share information):

<TABLE>
<CAPTION>
                                                                         
                                                                         
                                                              Six Month  
                                                             Transition                                                
                                                            Period Ended                   Fiscal Years Ended June 30, 
                                                            December 31,         ----------------------------------------------
                                                                1997                     1997                       1996
                                                       ---------------------     -------------------       --------------------
<S>                                                      <C>                       <C>                       <C>
Net income
     As Reported..................................                    $3,548                  $4,645                      $ 982
     Pro forma....................................                    $2,524                  $3,853                      $ 921
Earnings per share
     As reported..................................                    $ 0.26                  $ 0.46                      $0.11
     Pro forma....................................                      0.18                    0.38                       0.10
Diluted earnings per share
     As reported..................................                    $ 0.25                  $ 0.45                      $0.11
     Pro forma....................................                      0.17                    0.38                       0.10
</TABLE>

7.    DERIVATIVE FINANCIAL INSTRUMENTS

      The Company periodically uses derivative financial instruments to manage
oil and gas price risk; generally commodity price swap agreements which provide
for the Company to receive or make counterparty payments on the differential
between a fixed price and a variable indexed price for natural gas or crude oil.
Gains and losses from these hedging activities are included in oil and gas sales
at the time the related production is delivered. During the transition period
the Company hedged an aggregate of 6,888 MMBTU of natural gas at an average
Nymex quoted price of $2.25 per MMBTU, before transaction and transportation
costs, and an aggregate of 67,900 barrels of crude oil at an average Nymex
quoted price of $22.00 per barrel, before quality differentials and
transportation costs. At December 31, 1997 the Company was a party to an oil
price swap contract for January through March of 1998 for 90,000 barrels at a
Nymex quoted price of $21.80 per barrel, before quality differentials and
transportation costs. Hedging activities reduced revenues by $1.6 million,
$18,000 and $.6 million for the transition period and for the years ended June
30, 1997 and 1996, respectively. There was no hedging in 1995. At December 31,
1997 the Company had no unrealized hedging gains or losses.

     These energy swap agreements expose the Company to counterparty credit risk
to the extent the counterparty is unable to meet its monthly settlement
commitment to the Company.

                                       59
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


DETERMINATION OF FAIR VALUES OF FINANCIAL INSTRUMENTS

     Fair value for cash, short-term investments, receivables and payables
approximates carrying value.  The following table details the carrying values
and approximate fair values of the Company's other investments, derivative
financial instruments and long-term debt at December 31, 1997, June 30, 1997 and
1996 (in thousands).

<TABLE>
<CAPTION>
 
                        December 31, 1997                   June 30, 1997                    June 30, 1996
                 -----------------------------    -------------------------------   ------------------------------
                    Carrying       Approximate        Carrying       Approximate       Carrying       Approximate
                     Value         Fair Value          Value          Fair Value         Value         Fair Value
                 ------------   --------------    --------------   --------------   -------------   --------------
<S>                <C>            <C>               <C>              <C>              <C>             <C>
Liabilities/
 (Assets):
 
Swap Agreements    $  ---             $   (505)     $  ---               $    994     $  ---               $    28
 
Long-term debt       $100,000         $107,420          $115,300         $120,580         $13,048          $13,048
(See Note 8)
</TABLE>

<TABLE>
<S>   <C>
8.    LONG-TERM DEBT
      --------------
 
                 Long-term debt is comprised of the following at December 31, 1997, June 30, 1997 and 1996 (in
      thousands):
</TABLE>

<TABLE>
<CAPTION>
                                                                 December 31,          June 30,            June 30,
                                                            -------------------  ------------------  ------------------
                                                                     1997                1997                1996
                                                            -------------------  ------------------  ------------------
<S>                                                           <C>                   <C>                <C>
Bank credit facility....................................           $    ---                $ 15,300             $13,048
 
10-7/8% Senior Subordinated Notes.......................           $100,000                $100,000                 ---
                                                            -------------------  ------------------  -------------------
 
Long-term debt..........................................           $100,000                $115,300             $13,048
                                                            ===================  ==================  ==================
</TABLE>

     Debt maturities by fiscal year are as follows (amounts in thousands):


                    1998          $     ---
                    1999                ---
                    2000                ---
                    2001                ---
                    2002                ---
                    Thereafter      100,000
                                  ---------        
                                  $ 100,000
                                  =========

     On February 28, 1995, the Company entered into a credit facility ("Credit
Facility") with a commercial bank providing an initial borrowing base of $29.8
million.  The borrowings under the Credit Facility were secured by the Company's
interests in oil and gas properties, a gathering system and two gas plants.  The
Credit Facility was retired in October 1996.

                                       60
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     In October 1996, the Company entered into a syndicated credit facility
("Syndicated Credit Facility") in an amount up to $50.0 million with an initial
borrowing base of $27.0 million, to be re-determined semi-annually.  At
Bellwether's option, the interest rate varied, based upon borrowing base usage,
from London Interbank Offered Rate ("LIBOR") plus 7/8% to LIBOR plus 1-1/4%, or
the greater of the prime rate or Federal Funds rate plus  1/2%.  The Syndicated
Credit Facility was unsecured and was retired in April 1997.

     In April 1997, the Company entered into a senior revolving unsecured credit
facility ("Senior Credit Facility") in an amount up to $90.0 million, with a
borrowing base to be re-determined semi-annually, and a maturity date of March
31, 2002.  On December 20, 1997 the borrowing base was re-determined to be $75.0
million.  Bellwether may elect an interest rate based either on a margin plus
LIBOR or the higher of the prime rate or the sum of  1/2 of 1% plus the Federal
Funds Rate.  For LIBOR borrowings, the interest rate will vary from LIBOR plus
0.875% to LIBOR plus 1.25% based upon borrowing base usage.  In connection with
the acquisition of oil and gas properties, $33.3 million was drawn under this
facility, including $22 million used to retire outstandings under the Syndicated
Credit facility.  At December 31, 1997, there were no outstanding borrowings.

     The Senior Credit Facility contains various covenants including certain
required financial measurements for a current ratio, consolidated tangible net
worth and interest coverage ratio.  In addition, the Senior Credit Facility
includes certain limitations on restricted payments, dividends, incurrence of
additional funded indebtedness and asset sales.

     In April 1997, the Company issued $100.0 million of 10-7/8% senior
subordinated notes ("Notes") that mature April 1, 2007.  Interest on the Notes
is payable semi-annually on April 1 and October 1 commencing on October 1, 1997.
The Notes will be redeemable, in whole or in part, at the option of the Company
at any time on or after April 1, 2002 at 105.44% which decreases annually to
100.00% on April 1, 2005 and thereafter, plus accrued and unpaid interest.  In
the event of Change of Control of the Company, each holder of the Notes will
have the right to require the Company to repurchase all or part of such holder's
Notes at an offer price in cash equal to 101.0% of the aggregate principal
amount thereof, plus accrued and unpaid interest to the date of purchase.  The
Notes are guaranteed by the Company and its wholly owned subsidiaries, Odyssey
Petroleum Company, Black Hawk Oil Company and 1989-I TEAI Limited Partnership.
The Notes contain certain covenants, including  limitations on indebtedness,
restricted payments, transactions with affiliates, liens, guarantees of
indebtedness by subsidiaries, dividends and other payment restrictions affecting
restricted subsidiaries, issuance and sales of restricted subsidiary stock,
disposition of proceeds of asset sales, and restrictions on mergers, and
consolidations or sales of assets.

                                       61
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9.   INCOME TAXES (IN THOUSANDS)

         Income tax expense is summarized as follows:

<TABLE>
<CAPTION>
                                                                 
                                                  Six Month      
                                              Transition Period  
                                              Ended December 31,                     Fiscal Year Ended June 30,
                                           ----------------------   ----------------------------------------------------------
                                                     1997                   1997                1996                1995
                                           ----------------------   -----------------    ------------------   ----------------
<S>                                          <C>                      <C>                  <C>                <C>
Current
  Federal..............................                    $  400              $  (12)              $ 126                $   9
  State................................                       129                  35                 103                  ---
 
Deferred - Federal and State...........
                                                            1,585               2,562                (183)                 ---
                                           ----------------------   -----------------    ------------------   ----------------

Total income tax expense...............                    $2,114              $2,585               $  46                $   9
                                           ======================   =================    ==================   ================
</TABLE>


          The tax effect of temporary differences that give rise to significant
     portions of the deferred tax assets and liabilities at December 31, 1997,
     June 30, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
                                                          At December 31,                      At June 30,
                                                         -----------------        --------------------------------------------
                                                               1997                     1997                       1996            
                                                         -----------------        ------------------        ------------------      

<S>                                                        <C>                      <C>                       <C>
Net operating loss
  carryforwards.......................................      $  7,858                      $  8,668                  $  8,922
Percentage depletion
  carryforwards.......................................           271                           271                       271
Alternative minimum tax credit
carryforwards.........................................           513                           114                       126
                                                         -----------------        ------------------        ------------------      

  Total deferred income tax
   assets.............................................         8,642                         9,053                     9,319
                                                         -----------------        ------------------        ------------------      

 
Plant, property and equipment.........................       (12,106)                      (11,019)                   (8,840)
State income taxes....................................          (748)                         (661)                     (446)
                                                         -----------------        ------------------        ------------------ 
 
Total deferred income tax
  liabilities.........................................       (12,854)                      (11,680)                   (8,840)
                                                         -----------------        ------------------        ------------------      

 
Valuation allowances..................................        (2,894)                       (2,894)                   (2,894)
                                                         -----------------        ------------------        ------------------ 
Net deferred income tax
  liability...........................................      $ (7,106)                     $ (5,521)                   (2,861)
                                                         =================        ==================        ==================      

</TABLE>


          The Company files a consolidated federal income tax return.  Deferred
     income taxes are provided for transactions which are recognized in
     different periods for financial and tax reporting purposes.  Such temporary
     differences arise primarily from the deduction for tax purposes of certain
     oil and gas development costs which are capitalized for financial statement
     purposes.  Management believes it is more likely

                                       62
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     than not that the deferred tax assets, net of the valuation allowance, will
     be recovered.

          Total income tax differs from the amount computed by applying the
     Federal income tax rate to income before income taxes and minority
     interest.  The reasons for the differences are as follows:


<TABLE>
<CAPTION>
                                                                   Six Month
                                                                  Transition
                                                                  Period Ended                                        
                                                                   December 31,            Fiscal Year Ended June 30, 
                                                               ---------------    ----------------------------------------
                                                                   1997                1997           1996         1995 
                                                               ---------------    ------------     ----------    ---------   
<S>                                                            <C>                <C>           <C>              <C>
Statutory Federal income tax
  rate.................................................             34.0%           34.0%            34.0%          34.0%
 
Increase (Decrease) in tax rate
  resulting from:
  State income taxes, net of                                    
    federal benefit....................................              3.2%            1.3%             7.0%           ---
 
  Non-deductible travel and
    entertainment......................................               .1%            0.5%             0.3%           1.2%
 
  Reduction of valuation
    allowance due to
    utilization of net
    operating loss
    carryforwards......................................              ---             ---            (36.8%)        (34.4%)
                                                               ---------------    ------------     ----------    --------- 
                                                                    37.3%               35.8%         4.5%           0.8%
                                                               ===============    ============     ==========    =========
</TABLE>

          The Company issued 3,400,000 shares of its common stock on July 20,
     1994.  As a result of the common stock issuance, the Company has undergone
     an ownership change.  Therefore, the Company's ability to use its net
     operating loss ("NOL") carryforwards for federal income tax purposes is
     subject to significant restrictions.

          Section 382 of the Internal Revenue Code significantly limits the
     amount of NOL and investment tax credit carryforwards that are available to
     offset future taxable income and related tax liability when a change in
     ownership occurs after December 31, 1986.

          At December 31, 1997, the Company had net operating loss carryforwards
     of approximately $23.1 million which will expire in future years beginning
     in 1998.  Due to provisions of Section 382, the Company is limited to
     approximately $4.6 million utilization of NOL per year.

                                       63
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11.  CONTINGENCIES

          The Company has been named as a defendant in certain lawsuits
     incidental to its business.  Management does not believe that the outcome
     of such litigation will have a material adverse impact on the Company.

12.  SELECT QUARTERLY FINANCIAL DATA (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE
     DATA)  (Unaudited):

<TABLE>
<CAPTION>
                                                                Quarter Ended
                                   --------------------------------------------------------------------
                                        December       March        June      September        December
                                        31, 1996      31, 1997    30, 1997     30, 1997        31, 1997
                                   --------------------------------------------------------------------
<S>                                    <C>             <C>        <C>         <C>          <C> 
Revenues                                 $6,633      $7,294      $23,514      $21,177         $24,399
Operating income                         $1,771      $2,303      $ 2,175      $ 1,375         $ 4,287
Net income                               $1,116      $1,462      $ 1,449      $   857         $ 2,691
Earnings per common                                                                            
  share                                  $ 0.12      $ 0.16      $  0.11      $  0.06         $  0.19
Earnings per common   shares                                                                   
 diluted                                 $ 0.12      $ 0.16      $  0.11      $  0.06         $  0.19
 
                                   --------------------------------------------------------------------
                                      September      December      March          June        September 
                                       30, 1995      31,1995      31, 1996      30, 1996      30, 1996
                                   --------------------------------------------------------------------
Revenues                                 $4,221      $4,895     $ 4,887       $ 5,313         $ 5,319
Operating income                         $   38      $   95     $   542       $   353         $   981
Net income (loss)                        $   13      $  (12)    $   557       $   424         $   618
Earnings per common                                                                             
  share                                  $   --      $   --     $  0.06       $  0.05         $  0.07
Earnings per common   share                                                                     
 diluted                                 $   --      $   --     $  0.06       $  0.05         $  0.06
 
</TABLE>

13.    SUPPLEMENTAL INFORMATION - (Unaudited)
 
       OIL AND GAS PRODUCING ACTIVITIES:

          Included herein is information with respect to oil and gas
     acquisition, exploration, development and production activities, which is
     based on estimates of year-end oil and gas reserve quantities and estimates
     of future development costs and production schedules.  Reserve quantities
     and future production are based primarily upon reserve reports prepared by
     the independent petroleum engineering firms of Williamson Petroleum
     Consultants, Inc., for fiscal 1996 and 1995, R.T. Garcia & Co. Inc. for
     fiscal 1995, and Ryder Scott Company for fiscal 1997 and the transition
     period 1997.  These estimates are inherently imprecise and subject to
     substantial revision.

          Estimates of future net cash flows from proved reserves of gas, oil,
     condensate and natural gas liquids were made in accordance with Statement
     of Financial Accounting Standards No. 69, "Disclosures about Oil and Gas
     Producing Activities."  The estimates are based on prices at year-end.
     Estimated future cash inflows are reduced by estimated future 

                                       64
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     development and production costs based on year-end cost levels, assuming
     continuation of existing economic conditions, and by estimated future
     income tax expense. Tax expense is calculated by applying the existing
     statutory tax rates, including any known future changes, to the pre-tax net
     cash flows, less depreciation of the tax basis of the properties and
     depletion allowances applicable to the gas, oil, condensate and NGL
     production. Impact of net operating loss is considered in calculation of
     tax expense. The results of these disclosures should not be construed to
     represent the fair market value of the Company's oil and gas properties. A
     market value determination would include many additional factors including:
     (i) anticipated future increases or decreases in oil and gas prices and
     production and development costs; (ii) an allowance for return on
     investment; (iii) the value of additional reserves, not considered proved
     at the present, which may be recovered as a result of further exploration
     and development activities; and (iv) other business risks.

     Costs incurred (in thousands)

          The following table sets forth the costs incurred in property
     acquisition and development activities:

<TABLE>
<CAPTION>
                                                              
                                                              
                                                      Six Month      
                                                  Transition Period                                              
                                                        Ended        
                                                    December 31,                      Fiscal Year Ended June 30, 
                                               ---------------------   -------------------------------------------------------
                                                       1997                   1997               1996               1995
                                               ---------------------   -----------------   ----------------    ---------------
<S>                                            <C>                     <C>                 <C>                 <C>  
Property acquisition:                                                                                          
  Proved properties.....................             $ 3,281               $138,984             $  128            $25,072
  Unproved properties...................               2,205                  1,002                424             13,233
Exploration.............................               3,274                  1,576                824                530
Development.............................              10,453                 14,032              5,558              2,841
                                                     -------               --------             ------            -------           
                                                     $19,213               $155,594             $6,934            $41,676
                                                     =======               ========             =======           =======
</TABLE>

                                       65
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Capitalized costs (in thousands)
-----------------               

          The following table sets forth the capitalized costs relating to oil
     and gas activities and the associated accumulated depreciation, depletion
     and amortization:

<TABLE>
<CAPTION>
                                                Six Month
                                            Transition Period
                                                  Ended
                                              December 31,                       Fiscal Year Ended June 30,
                                            -----------------    -----------------------------------------------------------
                                                  1997                 1997                   1996                   1995     
                                            -----------------    ---------------        -------------           ------------
<S>                                        <C>                     <C>                    <C>                   <C>           
Proved properties.....................          $243,758              $228,675              $ 62,590                $ 56,300  
Unproved properties...................             6,469                 4,500                13,453                  15,125  
                                            ------------         -------------           -----------             -----------  
Total capitalized costs...............           250,227               233,175                76,043                  71,425  
Accumulated depreciation,                                                                                                     
  depletion and amortization..........           (82,975)              (61,783)              (28,316)                (20,983)  
                                            ------------          ------------           -----------             -----------  
Net capitalized costs.................          $167,252              $171,392              $ 47,727                $ 50,442  
                                            ============          ============           ===========             ===========  
</TABLE>


Results of operations for producing activities (in thousands):

<TABLE>
<CAPTION>
                                                    Six Month       
                                                    Transition      
                                                   Period Ended     
                                                    December 31,                       Fiscal Year Ended June 30,
                                                  ------------          ----------------------------------------------------------
                                                      1997                   1997                 1996 (1)              1995 (1)
                                                 --------------         --------------        ---------------        --------------
<S>                                            <C>                      <C>                   <C>                   <C>
Revenues from oil and gas                                                                                        
 producing activities.....................           $44,163               $39,067                $15,666               $ 8,507    
Production costs..........................            13,836                11,437                  5,317                 2,856
Income tax................................             5,379                 4,529                     --                    --
Depreciation, depletion and                                                                                      
 amortization.............................            15,831                14,691                  6,933                 3,893
                                                  ------------          -----------           ------------             ---------
Results of operations from                                                                                       
 producing activities                                                                                                  
 (excluding corporate                                                                                                  
 overhead and interest costs).............           $ 9,117               $ 8,410                $ 3,416              $  1,758
                                                  ============          ===========           ============             =========
</TABLE>                
_________               
(1)  Net operating loss carryfowards were sufficient to offset income. 

                                       66
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                    
Per unit sales prices and costs:    
------------------------------- 

<TABLE>
<CAPTION>

                                                    Six Month       
                                                    Transition      
                                                   Period Ended     
                                                    December 31,                       Fiscal Year Ended June 30,
                                                  ------------          ----------------------------------------------------------
                                                      1997                   1997                 1996 (1)              1995 (1)
                                                 --------------         --------------        ---------------        --------------
<S>                                            <C>                      <C>                   <C>                   <C>
Average sales price: (1)
  Oil (per barrel)........................             $16.34                 $17.41                $17.81               $16.89
  Gas (per MCF)...........................             $ 2.55                 $ 2.29                $ 2.02               $ 1.66
 
Average production cost per
  equivalent barrel.......................             $ 4.74                 $ 4.38                $ 4.49               $ 4.05
 
Average unit depletion rate
  per equivalent barrel...................             $ 5.42                 $ 5.62                $ 5.86               $ 5.52
</TABLE>
_________
(1) Average sales price is exclusive of the effect of natural gas and crude oil
price swaps, which decreased revenues $1.6 million in transition period 1997 and
$18,000 and $.6 million in fiscal years ended June 30, 1997 and 1996,
respectively.

                                       67
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Reserves
--------

     The Company's estimated total proved and proved developed reserves of oil
and
gas are as follows:


<TABLE>
<CAPTION>
                                                                            Six Month Transition Period Ended
                    Description                                                     December 31, 1997
----------------------------------------------------     --------------------------------------------------------------------
                                                                   Oil                      NGL                     Gas
                                                                 (MBBL)                   (MBBL)                  (MMCF)
                                                         --------------------      ------------------      ------------------
<S>                                                        <C>                       <C>                     <C>
Proved reserves at beginning of
  period                                                               12,007                   4,023                 127,940
Revisions of previous estimates                                         1,246                  (1,417)                  1,599
Extensions and discoveries                                                641                      52                   4,869
Production                                                               (967)                    (87)                (11,193)
Sales of reserves in-place                                               (694)                    ---                    (642)
Purchase of reserves in-place                                               5                     ---                   3,387
Reserves added in Merger                                                  ---                     ---                     ---
                                                         --------------------      ------------------      ------------------
Proved reserves at end of period                                       12,238                   2,571                 125,960
                                                         ====================      ==================      ==================
Proved developed reserves -
          Beginning of period                                          10,162                   3,705                 117,914
                                                         ====================      ==================      ==================
          End of period                                                11,153                   2,460                 119,270
                                                         ====================      ==================      ==================
</TABLE>


<TABLE>
<CAPTION>
                                                         Fiscal Year Ended June 30,
                               --------------------------------------------------------------------------
          Description                          1997                       1996                 1995
--------------------------     --------------------------------------------------------------------------
                                     Oil       NGL        Gas        Oil        Gas       Oil        Gas
                                   (MBBL)     (MBBL)     (MMCF)     (MBBL)    (MMCF)     (MBBL)    (MMCF)
                               ------------  --------  ----------  --------  --------  ---------  -------
<S>                                <C>        <C>       <C>         <C>       <C>        <C>       <C>
Proved reserves at
 beginning of year                  1,808       ---      33,194     2,597     30,159       393     10,671
Revisions of previous
 estimates                         (1,187)    2,435      (2,773)     (534)     2,853       (61)      (988)
Extensions and
 discoveries                          658        52       4,202        89      7,128       724      1,179
Production                           (854)      ---     (10,552)     (334)    (5,099)     (216)    (2,932)
Sales of reserves in-
 place                             (1,260)      ---     (16,194)      (14)    (2,023)       (1)        (3)
Purchase of reserves
 in-place                          12,842     1,536     120,063         4        176       ---        163
Reserves added in
 Mergers                              ---       ---         ---       ---        ---     1,758     22,069
                               ------------  --------  ----------  --------  --------  ---------  -------
Proved reserves at
 end of year                       12,007     4,023     127,940     1,808     33,194     2,597     30,159
                               ============  ========  ==========  ========  ========  =========  =======
Proved developed
 reserves-
   Beginning of year                1,494       ---      22,696     1,891     23,795       361      9,154
                               ============  ========  ==========  ========  ========  =========  =======

   End of year                     10,162     3,705     117,914     1,494     22,696     1,891     23,795
                               ============  ========  ==========  ========  ========  =========  =======

</TABLE>

                                       68
<PAGE>
 
Discounted future net cash flows (in thousands)
--------------------------------               

     The standardized measure of discounted future net cash flows and changes
therein related to proved oil and gas reserves are shown below:

<TABLE>
<CAPTION>
                                                                                               June 30,
                                                         December 31,          -------------------------------------------
                                                             1997                  1997              1996          1995
                                                       ----------------        -------------    --------------  ----------
<S>                                                   <C>                      <C>               <C>            <C>
Future cash inflows..............................              $ 517,323           $ 529,928       $113,550       $ 96,738
Future production costs..........................               (191,988)           (183,479)       (33,117)       (34,093)
Future income taxes..............................                (48,594)            (59,419)       (11,095)            ---
Future development costs.........................                (33,197)            (32,237)        (8,959)        (7,738)
                                                       ------------------      ---------------  --------------  -----------
Future net cash flows............................                243,544             254,793         60,379         54,907
10% discount factor..............................                (57,829)            (67,300)       (15,191)       (17,616)
                                                       ------------------      ---------------  --------------  -----------
Standardized measure of discounted future net                                                                   
 cash flows......................................              $ 185,715           $ 187,493       $ 45,188        $ 37,291
                                                       ==================      ===============  ==============  ===========
</TABLE>

    The following are the principal sources of change in the standardized
measure of discounted future net cash flows:
 
<TABLE>
<CAPTION>
                                                                    Six Month      
                                                                Transition Period  
                                                                      Ended        
                                                                  December 31,            Fiscal Year Ended June 30,
                                                              -------------------  -------------------------------------
                                                                      1997              1997         1996         1995
                                                              -------------------  ------------  ------------  ---------
<S>                                                            <C>                   <C>           <C>          <C>
Standardized measure - beginning of year................           $187,493           $ 45,188     $ 37,291      $12,044
Sales, net of production costs..........................            (30,327)           (27,630)     (10,349)      (5,651)
Purchases of reserves in-place..........................              4,117            151,836          246          162
Reserves added in Mergers...............................                ---                ---          ---       34,039
Net change in prices and production costs...............             (3,922)            22,599       11,458       (8,326)
Net change in income taxes..............................              8,706            (20,265)      (2,958)         ---
Extensions, discoveries and improved                                         
  recovery, net of future production and                                     
  development costs.....................................             10,769             12,555        7,709        5,085
Changes in estimated future development                                      
  costs.................................................             (3,588)            (3,034)         497       (3,148)
Development costs incurred during the                                 6,662              9,124          883          629
  period................................................                     
Revisions of quantity estimates.........................                569             27,102         (438)          (4)
Accretion of discount...................................             18,749              4,518        3,729        1,204
Sales of reserves in-place..............................             (4,602)           (16,140)      (1,614)          (5)
Changes in production rates and other...................             (8,911)           (18,360)      (1,266)       1,262
                                                              --------------       ------------  ------------  ---------
Standardized measure - end of year......................           $185,715           $187,493     $ 45,188      $37,291
                                                              ==============       ============  ============  =========
</TABLE>

     The discounted future cash flows above were calculated using NYMEX
equivalent prices of $18.32 and $19.80 per barrel and $2.58 and $2.35 per MMBTU,
for December 31, 1997 and June 30, 1997, respectively, adjusted to the wellhead
to reflect adjustments for transportation, quality and heating content.  Oil
prices have declined significantly since such time and gas prices have declined
approximately 11% since year end 1997.

                                       69
<PAGE>
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

    On or about June 18, 1997 the Company replaced the firm of Deloitte and
Touche LLP as its principal independent accountant and auditors to audit all the
Company's financial statements with the firm of KPMG Peat Marwick LLP.  The
decision to make this change was influenced by the acquisition of Partnership
properties and interests, which were previously audited by KPMG Peat Marwick
LLP.  The Company does not and has not during the past three years had
disagreements with Deloitte and Touche LLP concerning their audit or application
of accounting principles according to GAAP.

                                 PART III
                                 --------

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------------------------------

     Incorporated by reference to the Proxy Statement for the 1997 Transition
Period Annual Meeting of Shareholders to be held on May 22, 1998, pursuant to
Regulation 14A.

ITEM 11.  EXECUTIVE COMPENSATION
--------------------------------

     Incorporated by reference to the Proxy Statement for the 1997 Transition
Period Annual Meeting of Shareholders to be held on May 22, 1998, pursuant to
Regulation 14A.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------

     Incorporated by reference to the Proxy Statement for the 1997 Transition
Period Annual Meeting of Shareholders to be held on May 22, 1998, pursuant to
Regulation 14A.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------------

     Incorporated by reference to the Proxy Statement for the 1997 Transition
Period Annual Meeting of Shareholders to be held on May 22, 1998, pursuant to
Regulation 14A.


                                 PART IV
                                 -------

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
-------------------------------------------------------------------------

(a)  1. and 2. Financial Statements.  See index to Consolidated Financial
               Statements and Supplemental Information in Item 8, which
               information is incorporated herein by reference.

     3. Exhibits
        --------

     3.1  Certificate of Incorporation of Bellwether Exploration Company
          (incorporated by reference to Exhibit 3.1 to the Company's
          Registration Statement No. 33-76570)

                                       70
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES



     3.2  Certificate of Amendment to Certificate of Incorporation (incorporated
          by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-
          K for the fiscal year ended June 30, 1997)

     3.3  Certificate of Designation, Preferences and Rights of Series A
          Preferred Stock (incorporated by reference to Exhibit 3.3 to the
          Company's report on Form 8-K dated September 19, 1997.)

     3.4  By-laws of Bellwether Exploration Company (incorporated by reference
          to Exhibit 3.2 to the Company's Registration Statement No. 33-76570)

     3.5  Amendment to Article II, Section 2.2 of Bellwether Exploration
          Company's Bylaws
 
     3.6  Amendment to Bellwether Exploration Company's bylaws adopted on
          March 27, 1998.

     4.1  Specimen Stock Certificate (incorporated by reference to Exhibit 4.1
          to the Company's Registration Statement on Form S-1, File No. 33-
          76570)

     4.2  The Company's 1996 Stock Incentive Plan (incorporated by reference to
          Exhibit 10.20 to the Company's Registration Statement on Form S-1,
          File No. 33-21813)

     4.3  Indenture dated April 9, 1997 among the Company, a Subsidiary
          Guarantor and Bank of Montreal Trust Company (incorporated herein by
          reference to Exhibit 4.2 to the Company's Registration Statement on
          Form S-1, Registration No. 33-21813)

     4.4  First Supplemental Indenture dated April 21, 1997 among the Company,
          Odyssey Petroleum Company, Black Hawk Oil Company, 1989-I TEAI Limited
          Partnership and Bank of Montreal Trust Company, as Trustee
          (incorporated by reference to Exhibit 99.2 on the Company's Form 8-K
          Current Report filed on April 23, 1997)

     4.5  Shareholders Rights Agreement between the Company and American Stock
          Transfer & Trust Company (incorporated herein by reference to the
          Company's Registration Statement on Form 8-A as filed with the
          Securities and Exchange Commission on September 19, 1997)

     4.6  Warrant to Torch Energy Dated April 9. 1997 (incorporated by reference
          to Exhibit 4.6 to the Company's Annual Report on Form 10-K for the
          fiscal year ended June 30, 1997)

     10.1 1988 Non-qualified Stock Option Plan (incorporated by reference to
          Exhibit 10.37 to the Company's Annual Report on Form 10-K for the
          fiscal year ended June 30, 1988)

     10.2 Stock Option Agreement dated March 25, 1988 between the Company and
          J. Darby Sere' (incorporated by reference to Exhibit 10.38 to the
          Company's Annual Report on Form 10-K for the fiscal year ended June
          30, 1988)

                                       71
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES



     10.3  Administrative Services Agreement with Torch Energy Advisors
           Incorporated commencing January 1, 1994 (incorporated by reference to
           Exhibit 94-10-3 to the Company's Report on Form 10-Q for the quarter
           ended March 31, 1994)

     10.4  Amended Joint Venture Agreement dated July 29, 1993 between the
           Company and NGL Associates (incorporated by reference to Exhibit
           10.93.5 to the Company's Report on Form 10-K dated July 29, 1993)

     10.5  Amended Joint Venture dated July 15, 1993 between Torch Energy
           Marketing, Inc. and NGL Associates (incorporated by reference to
           Exhibit 10.93.8 to the Company's report on Form 8-K dated December
           31, 1993)

     10.6  Registration Rights Agreement dated December 31, 1993 among the
           Company and the Stockholders of Associated Gas Resources, Inc.
           (incorporated by reference to Exhibit 10.1 to the Company's
           Registration Statement No. 33-76570)

     10.7  1994 Stock Incentive Plan (incorporated by reference to Exhibit 10.9
           to the Company's Registration Statement No. 33-76570)

     10.8  Amendment dated March 14, 1994 to the Amended Joint Venture Agreement
           dated as of July 29, 1993 between the Company and NGL Associates
           (incorporated by reference to Exhibit 10.11 to the Company's
           Registration Statement No. 33-76570)

     10.9  Amendment dated March 14, 1994 to the Amended Joint Venture Agreement
           dated as of July 15, 1993 between Torch Energy Marketing, Inc. and
           NGL Associates (incorporated by reference to Exhibit 10.12 to the
           Company's Registration Statement No. 33-76570)

     10.10 Registration Rights Agreement among the Company, Allstate Insurance
           Company and the former owners of Odyssey Partners, Ltd. (incorporated
           by reference to Exhibit 10.4 to the Company's Registration Statement
           No. 33-76570)

     10.11 Assignment of gas purchase contract from Texas Gas Transmission
           Corporation to Bellwether (incorporated by reference to Exhibit
           96-1 0-4 to the Company's Report on Form 10-Q for the quarter ended
           March 31, 1997)

     10.12 Credit Agreement among Bellwether Exploration Company as borrower
           and The Chase Manhattan Bank as agent(incorporated by reference to
           Exhibit 10.1 to the Company's Report on Form 10-Q for the quarter
           ended September 30, 1996)

     10.13 Acquisition Agreement dated March 31, 1997 among Bellwether
           Exploration Company, Program Acquisition Company and the other
           parties thereto. (incorporated by reference to Exhibit 2.2 of the
           Company's Registration Statement on Form S-1 (Registration No. 333-
           21813) filed on April 3, 1997)

                                       72
<PAGE>
 
                BELLWETHER EXPLORATION COMPANY AND SUBSIDIARIES


     10.14 Credit Agreement dated April 21, 1997 among the Company, Odyssey
           Petroleum Company, Black Hawk Oil Company, 1989-I TEAI Limited
           Partnership, Morgan Guarantee Trust Company of New York, as
           administrative Agent, and certain banking institutions (incorporated
           by reference to the Company's Form 8-K Current Report as filed with
           the Commission on April 23, 1997)

     10.15 Purchase and Sale Agreement dated June 9, 1997 among Bellwether
           Exploration Company, Black Hawk Oil Company, 1988-II TEAI Limited
           Partnership, 1989-I TEAI Limited Partnership, TEAI Oil and Gas
           Company, and the other parties thereto as Sellers, and Jay Resources
           Corporation as Buyer (incorporated by reference to Exhibit 10.18 to
           the Company's Annual Report on Form 10-K for the fiscal year ended
           June 30, 1997).

     16.1  Letter from predecessor auditors regarding change in certifying
           accountant (incorporated by reference to Exhibit 16-1 to the
           Company's Form 8K/A-1 dated July 8, 1997)

     21.1  Subsidiaries of Bellwether Exploration Company - Included herewith.

     23    Consents of experts:

     23.1  Consent of Williamson Petroleum Consultants, Inc.

     23.2  Consent of R.T. Garcia & Co. Inc.

     23.3  Consent of Ryder Scott Company

     23.4  Consent of KPMG Peat Marwick LLP

     27    Financial Data Schedule

                                       73
<PAGE>
 
                                   SIGNATURES
                                        
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Company and in the
capacities and on the dates indicated.

                                         BELLWETHER EXPLORATION COMPANY

                                         /s/ J. DARBY SERE'
                                         ------------------
                                         J. Darby Sere'
                                         Chairman of Board of Directors and
                                         Chief Executive Officer


Dated March 27, 1998

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Company and in the
capacities and on the dates indicated.


<TABLE> 
<CAPTION> 

                  SIGNATURES                         TITLE               DATE
<S>                                           <C>                    <C>  
/s/ J. DARBY SERE'                            Chairman of Board of   March 27, 1998
--------------------------------------------   Directors and Chief   
J. Darby Sere'                                 Executive Officer   

 
/s/ C. BARTON GROVES                          Senior Vice President  March 27, 1998
--------------------------------------------   and Director
C. Barton Groves                                                     

 
/s/ WILLIAM C. RANKIN                         Senior Vice President  March 27, 1998
--------------------------------------------   and Chief Financial
William C. Rankin                              Officer
               
 
/s/ DR. JACK BIRKS                            Director               March 27, 1998
--------------------------------------------                                          
Dr. Jack Birks
 
/s/ J.P. BRYAN                                Director               March 27, 1998
--------------------------------------------                                             
J.P. Bryan
 
/s/ VINCENT H. BUCKLEY                        Director               March 27, 1998
--------------------------------------------                                              
Vincent H. Buckley
 
/s/ CHARLES C. GREEN                          Director               March 27, 1998
--------------------------------------------                                          
Charles C. Green
 
/s/ HABIB KAIROUZ                             Director               March 27, 1998
--------------------------------------------                                             
Habib Kairouz
 
/s/ A. K. MCLANAHAN                           Director               March 27, 1998
--------------------------------------------                                           
A. K. McLanahan
 
/s/ TOWNES G. PRESSLER                        Director               March 27, 1998
--------------------------------------------                                           
Townes G. Pressler
</TABLE>

                                       74