**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

 

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**WASHINGTON, D.C.  20549**

 

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**FORM 10-Q**

 

| **ý** | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                                                                                                                                     |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                   |
| ** ** | ** ** | **For the Quarter Ended June 30, 2004**                                                                                                                                                                                                                                                           |
|       | ** ** | ** **                                                                                                                                                                                                                                                                                             |
| **or**     |
|       |       |                                                                                                                                                                                                                                                                                                   |
| o          |       | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                                                                                                                                    |
|       |       |                                                                                                                                                                                                                                                                                                   |
|       |       | **For the Transition Period From                         to                       ** |

 

**Commission File Number:  000-25717**

 

 

**PETROHAWK ENERGY CORPORATION**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                | ** ** | **86-0876964**                       |
|---------------------------------------------|------------|--------------------------------------|
| (State of Incorporation)                    |       | (I.R.S. Employer Identification No.) |
|                                        |       |                                 |
| **1100 Louisiana, Suite 4400, Houston, TX** |       | **77002**                            |
| (Address of principal executive offices)    |       | (Zip Code)                           |

 

**(832) 204-2700**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes  ý  No  o

 

Indicate by check mark whether the Registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

 

Yes  o  No  ý

 

As of August 1, 2004, the Registrant had 13,791,757 shares ofCommon Stock, $.001 par value, outstanding.

 

 

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**INDEX**

 
| **PART I - FINANCIAL INFORMATION** |                                                                                        |
|------------------------------------|---------------------------------------------------------------------------------------------|
|                               |                                                                                        |   |   |
| **ITEM 1.**                        | Financial Statements                                                                        |   |
|                               |                                                                                        | Condensed Consolidated Balance Sheets as of  June 30, 2004 and December 31, 2003 (unaudited) |   |
|                               |                                                                                        | Condensed  Consolidated Statements of Operations and Comprehensive Income (Loss) for the  three and six months ended June 30, 2004 and June 30, 2003  (unaudited) |   |
|                               |                                                                                        | Condensed Consolidated Statements of Cash  Flows for the six months ended June 30, 2004 and June 30, 2003  (unaudited) |   |
|                               |                                                                                        | Notes to Condensed Consolidated Financial  Statements (unaudited) |   |
|                               |                                                                                        |   |   |
| **ITEM 2.**                        | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|                               |                                                                                        | Disclosure Regarding Forward-Looking  Statements |   |
|                               |                                                                                        | PHAWK, LLC Transaction |   |
|                               |                                                                                        | Overview |   |
|                               |                                                                                        | Liquidity and Capital Resources |   |
|                               |                                                                                        | Capital Expenditures |   |
|                               |                                                                                        | Significant Accounting Policies |   |
|                               |                                                                                        | Comparison of Results of Operations for the  three and six months ended June 30, 2004 and 2003 |   |
|                               |                                                                                        |   |   |
| **ITEM 3.**                        | Quantitative and Qualitative Disclosures  About Market Risk                                 |   |
|                               |                                                                                        |   |   |
| **ITEM 4.**                        | Controls and Procedures                                                                     |   |
|                               | ** **                                                                                  | ** ** | ** ** |
| **PART II.  - OTHER INFORMATION**  | ** **                                                                                  |
|                               | ** **                                                                                  | ** ** | ** ** |
| **ITEM 2.**                        | Changes in Securities, Use of Proceeds and  Issuer Purchases of Equity Securities           |   |
|                               |                                                                                        |   |   |
| **ITEM 4.**                        | Submission of Matters to a Vote of Security  Holders                                        |   |
|                               |                                                                                        |   |
| **ITEM 6.**                        | Exhibits and Reports on Form 8-K                                                            |   |
|                               |                                                                                        |   |   |
| Signatures                         |                                                                                        |   |
|                                    |                                                                                             |  |  |  |

 

2

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**PART I**

**ITEM 1.** FINANCIAL STATEMENTS

**PETROHAWK ENERGY CORPORATION**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

(unaudited)

 
| ** **                                                                                                                                                                                                                                                                                     | ** ** | **JUNE 30,  2004** | ** ** | **DECEMBER 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **CURRENT ASSETS**:                                                                                                                                                                                                                                                                            | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Cash                                                                                                                                                                                                                                                                                           |       | $                       | 45,789,000 |                        | $          | 2,109,681 |   |
| Accounts receivable                                                                                                                                                                                                                                                                            |       |                    |       |                        |       |
| Oil and gas sales                                                                                                                                                                                                                                                                              |       | 3,356,191               |       | 1,898,746                   |       |
| Other                                                                                                                                                                                                                                                                                          |       | 312,665                 |       | 113,529                     |       |
| Prepaid expenses and other                                                                                                                                                                                                                                                                     |       | 937,893                 |       | 564,980                     |       |
| Total current assets                                                                                                                                                                                                                                                                           |       | 50,395,749              |       | 4,686,936                   |       |
|                                                                                                                                                                                                                                                                                           |       |                    |       |                        |       |
| **OIL AND GAS  PROPERTIES,**at cost (full cost method)                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Evaluated properties                                                                                                                                                                                                                                                                           |       | 82,235,358              |       | 78,717,380                  |       |
| Unevaluated properties                                                                                                                                                                                                                                                                         |       | 1,213,034               |       | 1,294,212                   |       |
| Less – accumulated amortization of full  cost pool                                                                                                                                                                                                                                        |       | (41,908,317             | )          | (39,740,116                 | )          |
| Net oil and gas properties                                                                                                                                                                                                                                                                     |       | 41,540,075              |       | 40,271,476                  |       |
|                                                                                                                                                                                                                                                                                           |       |                    |       |                        |       |
| **OTHER OPERATING  PROPERTY AND EQUIPMENT**, at cost                                                                                                                                                                                                                                           |       |                    |       |                        |       |
| Gas gathering system and equipment                                                                                                                                                                                                                                                             |       | 1,502,692               |       | 1,496,404                   |       |
| Support equipment                                                                                                                                                                                                                                                                              |       | 197,379                 |       | 197,379                     |       |
| Other                                                                                                                                                                                                                                                                                          |       | 350,518                 |       | 276,498                     |       |
| Less – accumulated depreciation                                                                                                                                                                                                                                                           |       | (826,469                | )          | (813,450                    | )          |
| Net other operating property and equipment                                                                                                                                                                                                                                                     |       | 1,224,120               |       | 1,156,831                   |       |
|                                                                                                                                                                                                                                                                                           |       |                    |       |                        |       |
| **DEBT ISSUE COSTS,** net  of amortization                                                                                                                                                                                                                                                |       | 1,282,317               |       | —                      |       |
| ** **                                                                                                                                                                                                                                                                                     |       |                    |       |                        |       |
| **TOTAL ASSETS**                                                                                                                                                                                                                                                                               |       | $                       | 94,442,261 |                        | $          | 46,115,243 |   |
|                                                                                                                                                                                                                                                                                           |       |                    |       |                        |       |
| **CURRENT LIABILITIES**:                                                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Accounts payable, trade                                                                                                                                                                                                                                                                        |       | $                       | 2,578,491  |                        | $          | 1,646,559 |   |
| Dividends payable                                                                                                                                                                                                                                                                              |       | 110,375                 |       | 112,707                     |       |
| Asset retirement obligation – current  portion                                                                                                                                                                                                                                            |       | 171,860                 |       | 171,860                     |       |
| Income taxes payable                                                                                                                                                                                                                                                                           |       | 31,251                  |       | —                      |       |
| Other accrued liabilities                                                                                                                                                                                                                                                                      |       | 423,974                 |       | 566,990                     |       |
| Total current liabilities                                                                                                                                                                                                                                                                      |       | 3,315,951               |       | 2,498,116                   |       |
|                                                                                                                                                                                                                                                                                           |       |                    |       |                        |       |
| **LONG-TERM DEBT**                                                                                                                                                                                                                                                                             |       | —                  |       | 13,284,652                  |       |
| **SUBORDINATED  CONVERTIBLE NOTE PAYABLE**                                                                                                                                                                                                                                                     |       | 35,000,000              |       | —                      |       |
| **ASSET RETIREMENT  OBLIGATIONS,**less  current portion                                                                                                                                                                                                                                        |       | 1,106,386               |       | 1,062,860                   |       |
|                                                                                                                                                                                                                                                                                           |       |                    |       |                        |       |
| **STOCKHOLDERS’  EQUITY**                                                                                                                                                                                                                                                                 |       |                    |       |                        |       |
|  Preferred stock, $.001 par value,  5,000,000 shares authorized; 604,271issued and outstanding at June 30,  2004 and December 31, 2003. Liquidation value at June 30, 2004 of  $5,700,872.                                                                                 |       | 604                     |       | 604                         |       |
| Common stock, $.001 par value; 50,000,000  shares authorized; 13,800,139  and 6,223,036 shares issued at  June 30, 2004 and December 31, 2003, respectively; 13,791,757 and  6,214,654 shares outstanding at June 30, 2004  and December 31, 2003, respectively. |       | 13,800                  |       | 6,223                       |       |
|  Additional paid-in capital                                                                                                                                                                                                                                                               |       | 78,276,174              |       | 51,930,449                  |       |
| Treasury stock, at cost; 8,382 shares at  June 30, 2004 and December 31, 2003.                                                                                                                                                                                                       |       | (36,428                 | )          | (36,428                     | )          |
|  Accumulated deficit                                                                                                                                                                                                                                                                      |       | (23,234,226             | )          | (22,631,233                 | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                                |       | 55,019,924              |       | 29,269,615                  |       |
| **TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                           |       | $                       | 94,442,261 |                        | $          | 46,115,243 |   |

 

**Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements**

 

3

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**PETROHAWK ENERGY CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**AND COMPREHENSIVE INCOME (LOSS)**

**(unaudited)**

 
| ** **                                                                                                                                                   | ** ** | **FOR THE THREE MONTHS ENDED  JUNE 30,** | ** ** | **FOR THE SIX MONTHS ENDED  JUNE 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                                   | ** ** | **2004**                                      | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **REVENUES**:                                                                                                                                                |       |                                          |       |                                        |       |   |   |   |   |
|  Oil and gas                                                                                                                                            |       | $                                             | 4,892,646  |                                        | $          | 2,960,250 |   | $ | 8,846,853 |   | $ | 5,954,782 |   |
| Field services                                                                                                                                               |       | 95,171                                        |       | 82,445                                      |       | 193,358 |   | 189,148 |   |
| Total revenue                                                                                                                                                |       | 4,987,817                                     |       | 3,042,695                                   |       | 9,040,211 |   | 6,143,930 |   |
|                                                                                                                                                         |       |                                          |       |                                        |       |   |   |   |   |
| **COSTS AND EXPENSES**:                                                                                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| Production:                                                                                                                                                  |       |                                          |       |                                        |       |   |   |   |   |
|  Lease operations                                                                                                                                       |       | 860,584                                       |       | 555,398                                     |       | 1,577,481 |   | 1,134,120 |   |
| Production, severance and ad valorem taxes                                                                                                                   |       | 263,084                                       |       | 205,220                                     |       | 489,657 |   | 448,476 |   |
| Field services                                                                                                                                               |       | 42,972                                        |       | 41,431                                      |       | 88,273 |   | 93,268 |   |
| General and administrative                                                                                                                                   |       | 1,621,024                                     |       | 476,193                                     |       | 2,420,078 |   | 1,249,115 |   |
| Stock-based compensation                                                                                                                                     |       | 2,003,464                                     |       | 163,250                                     |       | 2,027,216 |   | 165,979 |   |
| Depreciation, depletion and amortization                                                                                                                     |       | 1,189,227                                     |       | 1,279,970                                   |       | 2,260,366 |   | 2,615,038 |   |
| Accretion of asset retirement obligations                                                                                                                    |       | 23,026                                        |       | 13,703                                      |       | 46,052 |   | 27,406 |   |
|  Total costs and expenses                                                                                                                               |       | 6,003,381                                     |       | 2,735,165                                   |       | 8,909,123 |   | 5,733,402 |   |
|                                                                                                                                                         |       |                                          |       |                                        |       |   |   |   |   |
| **INCOME (LOSS) FROM  OPERATIONS**                                                                                                                           |       | (1,015,564                                    | )          | 307,530                                     |       | 131,088 |   | 410,528 |   |
| **OTHER INCOME  (EXPENSE)**:                                                                                                                                 |       |                                          |       |                                        |       |   |   |   |   |
| Interest expense                                                                                                                                             |       | (381,312                                      | )          | (122,043                                    | )          | (493,939 | ) | (244,335 | ) |
| Interest income and other                                                                                                                                    |       | 17,475                                        |       | 1,483                                       |       | 18,900 |   | 2,356 |   |
|  Total other income (expense)                                                                                                                           |       | (363,837                                      | )          | (120,560                                    | )          | (475,039 | ) | (241,979 | ) |
|                                                                                                                                                         |       |                                          |       |                                        |       |   |   |   |   |
| **INCOME (LOSS)  BEFORE INCOME TAX PROVISION**                                                                                                               |       | (1,379,401                                    | )          | 186,970                                     |       | (343,951 | ) | 168,549 |   |
| **INCOME TAX PROVISION**                                                                                                                                     |       | 13,960                                        |       | —                                      |       | 37,185 |   | — |   |
| **INCOME (LOSS)  BEFORE CUMULATIVE EFFECT OF A CHANGE IN**  **ACCOUNTNG PRINCIPLE**                                                                     |       | (1,393,361                                    | )          | 186,970                                     |       | (381,136 | ) | 168,549 |   |
| **CUMULATIVE EFFECT  ON PRIOR YEARS FROM ADOPTION OF**  **FASB STATEMENT NO. 143, *ACCOUNTING FOR ASSET***  ***RETIREMENT OBLIGATION,*NET OF TAX** |       | —                                        |       | —                                      |       | — |   | 1,640 |   |
| **NET INCOME (LOSS)**                                                                                                                                        |       | (1,393,361                                    | )          | 186,970                                     |       | (381,136 | ) | 170,189 |   |
| **PREFERRED DIVIDENDS**                                                                                                                                      |       | (110,375                                      | )          | (111,482                                    | )          | (221,857 | ) | (221,738 | ) |
| **NET INCOME (LOSS)  APPLICABLE TO COMMON STOCKHOLDERS**                                                                                                     |       | $                                             | (1,503,736 | )                                           | $          | 75,488 |   | $ | (602,993 | ) | $ | (51,549 | ) |
|                                                                                                                                                         |       |                                          |       |                                        |       |   |   |   |   |
| **BASIC NET INCOME  (LOSS) PER COMMON SHARE**                                                                                                                |       | $                                             | (0.16      | )                                           | $          | 0.01 |   | $ | (0.08 | ) | $ | (0.01 | ) |
|                                                                                                                                                         |       |                                          |       |                                        |       |   |   |   |   |
| **DILUTED NET INCOME  (LOSS) PER COMMON SHARE**                                                                                                              |       | $                                             | (0.16      | )                                           | $          | 0.01 |   | $ | (0.08 | ) | $ | (0.01 | ) |
|                                                                                                                                                         |       |                                          |       |                                        |       |   |   |   |   |
| **WEIGTHED AVERAGE  SHARES OUTSTANDING:**                                                                                                                    |       |                                          |       |                                        |       |   |   |   |   |
| Basic                                                                                                                                                        |       | 9,211,657                                     |       | 6,214,661                                   |       | 7,713,155 |   | 6,216,896 |   |
| Fully Diluted                                                                                                                                                |       | 9,211,657                                     |       | 6,238,420                                   |       | 7,713,155 |   | 6,216,896 |   |
|                                                                                                                                                         |       |                                          |       |                                        |       |   |   |   |   |
| **COMPREHENSIVE  INCOME (LOSS):**                                                                                                                            |       |                                          |       |                                        |       |   |   |   |   |
| **NET INCOME (LOSS)**                                                                                                                                        |       | $                                             | (1,393,361 | )                                           | $          | 186,970 |   | $ | (381,136 | ) | $ | 170,189 |   |
| **OTHER COMPREHENSIVE  INCOME (LOSS):**                                                                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| Realized loss on qualifying cash flow  hedges                                                                                                                |       | —                                        |       | 205,046                                     |       | — |   | 1,236,055 |   |
| Unrealized loss on qualifying cash flow  hedges                                                                                                              |       | —                                        |       | (88,973                                     | )          | — |   | (629,255 | ) |
| **TOTAL COMPREHENSIVE  INCOME (LOSS)**                                                                                                                       |       | $                                             | (1,393,361 | )                                           | $          | 303,043 |   | $ | (381,136 | ) | $ | 776,989 |   |

 

**The accompanying notes are an integral partof these condensed consolidated financial statements**

 

4

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**PETROHAWK ENERGY CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited)**

 
| ** **                                                                                | ** ** | **FOR THE SIX MONTHS ENDED  JUNE 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
| **CASH FLOWS FROM  OPERATING ACTIVITIES:**                                                |       |                                        |       |   |   |
| Net income (loss) before cumulative effect  of change in accounting principle             |       | $                                           | (381,136   | ) | $ | 168,549 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |       |                                        |       |   |   |
| Depreciation, depletion and amortization                                                  |       | 2,260,366                                   |       | 2,615,038 |   |
| Amortization of debt issue costs                                                          |       | 21,648                                      |       | — |   |
| Accretion of asset retirement obligations                                                 |       | 46,052                                      |       | 27,406 |   |
| Stock-based compensation                                                                  |       | 2,027,216                                   |       | 165,979 |   |
| Common stock issued in lieu of directors’  fees                                      |       | 8,883                                       |       | — |   |
| Change in operating assets and liabilities:                                               |       |                                        |       |   |   |
| Accounts receivable                                                                       |       | (1,656,581                                  | )          | (21,203 | ) |
| Prepaid expenses and other                                                                |       | (372,913                                    | )          | (99,035 | ) |
| Accounts payable, trade                                                                   |       | 931,932                                     |       | (1,084,326 | ) |
| Income taxes payable                                                                      |       | 31,251                                      |       | — |   |
| Other accrued liabilities                                                                 |       | (143,016                                    | )          | 29,114 |   |
| Asset retirement obligations incurred                                                     |       | (2,526                                      | )          | (40,904 | ) |
|                                                                                      |       |                                        |       |   |   |
| Net cash provided by operating activities                                                 |       | 2,771,176                                   |       | 1,760,618 |   |
|                                                                                      |       |                                        |       |   |   |
| **CASH FLOWS FROM  INVESTING ACTIVITIES:**                                                |       |                                        |       |   |   |
| Oil and gas property expenditures                                                         |       | (4,169,531                                  | )          | (852,749 | ) |
| Proceeds from sale of oil and gas  properties                                             |       | 732,729                                     |       | 533,142 |   |
| Gas gathering and other equipment  expenditures                                           |       | (159,454                                    | )          | (34,879 | ) |
|                                                                                      |       |                                        |       |   |   |
| Net cash used in investing activities                                                     |       | (3,596,256                                  | )          | (354,486 | ) |
|                                                                                      |       |                                        |       |   |   |
| **CASH FLOWS FROM  FINANCING ACTIVITIES:**                                                |       |                                        |       |   |   |
| Repayments of notes payable                                                               |       | (13,284,652                                 | )          | (6,882 | ) |
| Proceeds from issuance of common stock and  warrants                                      |       | 25,000,000                                  |       | — |   |
| Proceeds from issuance of subordinated  convertible note payable                          |       | 35,000,000                                  |       | — |   |
| Debt issue costs related to PHAWK, LLC  Transaction                                       |       | (1,303,965                                  | )          | — |   |
| Equity offering costs related to PHAWK, LLC  Transaction                                  |       | (682,797                                    | )          | — |   |
| Preferred stock dividends paid                                                            |       | (224,187                                    | )          | (222,964 | ) |
| Acquisition of treasury stock                                                             |       | —                                      |       | (8,255 | ) |
|                                                                                      |       |                                        |       |   |   |
| Net cash provided by (used in) financing  activities                                      |       | 44,504,399                                  |       | (238,101 | ) |
|                                                                                      |       |                                        |       |   |   |
| **NET INCREASE IN  CASH AND CASH EQUIVALENTS**                                            |       | 43,679,319                                  |       | 1,168,031 |   |
|                                                                                      |       |                                        |       |   |   |
| **CASH AND CASH  EQUIVALENTS**, at beginning of period                                    |       | 2,109,681                                   |       | 927,313 |   |
|                                                                                      |       |                                        |       |   |   |
| **CASH AND CASH  EQUIVALENTS**, at end of period                                          |       | $                                           | 45,789,000 |   | $ | 2,095,344 |   |
|                                                                                      |       |                                        |       |   |   |
| **SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION**                                     |       |                                        |       |   |   |
| Cash paid for:                                                                            |       |                                        |       |   |   |
| Interest                                                                                  |       | $                                           | 472,291    |   | $ | 287,057 |   |
| Income taxes                                                                              |       | $                                           | —     |   | $ | 20,500 |   |

 

**The accompanying notes are an integral partto these condensed consolidated financial statements**

 

5

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**CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

** **

**PETROHAWKENERGY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

1.             **BASIS OF PRESENTATION**

 

The accompanying condensed consolidated financialstatements of Petrohawk Energy Corporation (formerly known as Beta Oil &Gas, Inc.) and subsidiaries (“Petrohawk” or “the Company”) have been preparedin accordance with accounting principles generally accepted in the UnitedStates for interim financial information and with the instructions of Form 10-Qand Rule 10-01 of Regulation S-X.  In theopinion of management, the accompanying unaudited financial statements containall adjustments necessary to present fairly the Company’s financial position asof June 30, 2004 and the results of its operations for the three and sixmonths ended June 30, 2004 and 2003 and cash flows for the six months endedJune 30, 2004 and 2003.  Managementbelieves all such adjustments are of a normal recurring nature.  The results of operations for interim periodsare not necessarily indicative of results to be expected for a full year.  Although we believe that the disclosures in thesefinancial statements are adequate to make the information presented notmisleading, certain information normally included in financial statements andrelated footnotes prepared in accordance with accounting principles generallyaccepted in the United States have been condensed or omitted pursuant to therules and regulations of the Securities and Exchange Commission (the“SEC”).  The December 31, 2003consolidated balance sheet was derived from audited financial statements, butdoes not include all disclosures required by accounting principles generallyaccepted in the United States.  Theaccompanying financial statements should be read in conjunction with theaudited financial statements as contained in our Annual Report on Form 10-K/Afor the fiscal year ended December 31, 2003 that was filed April 20,2004.

 

*PHAWK, LLC Transaction*

 

OnDecember 12, 2003, the Company entered into a securities purchaseagreement with PHAWK, LLC, formerly known as Petrohawk Energy, LLC (“PHAWK,LLC”), a privately-held independent exploration and production companyheadquartered in Houston, Texas, pursuant to which PHAWK, LLC agreed to a cashinvestment of $60,000,000 in the Company’s common stock, warrants and aconvertible note.  On May 25, 2004, theCompany’s stockholders approved the transaction with PHAWK, LLC (the “PHAWK,LLC Transaction”), whereby the Company received $25,000,000 for the issuance of7,575,757 shares of its common stock and 5,000,000 five-year common stock purchase warrants exercisable at a price of $3.30 pershare.  Additionally, the Company issueda $35,000,000 convertible note that is an unsecured five-year obligation thatafter two years will be convertible by the holder into the Company’s commonstock at a conversion price of $4.00 per share. Interest only will be payable under the note in quarterly installmentsat the rate of 8% per annum.  The fullamount of the principal and accrued and unpaid interest will be payable on thefifth anniversary of the date of the note.

 

TheCompany incurred approximately $2.2 million in offering costs related to thePHAWK, LLC Transaction.  Approximately$1.3 million of the costs were allocated to debt issue costs based upon theface value of the subordinated note payable to the total proceeds received bythe Company.  The debt issue costs arebeing amortized over a five-year period. The remaining $.9 million of costs, including $.2 million incurred in2003, are included as equity offering costs and are reflected as a reduction toStockholders’ Equity.

 

Futureuse of these proceeds will include acquisitions of oil and gas properties,future development and exploitation of existing and acquired oil and gasproperties and exploration activity.  Approximately $13.3million of these proceeds were used to repay all of the Company’s existinglong-term bank debt.

 

6

----

 

*Reclassifications*

 

Certain reclassifications of prior period amounts havebeen made to conform to current period presentation.

 

*Oil and Gas Properties*

 

The Company accounts for itsoil and gas producing activities using the full cost method of accounting asprescribed by the SEC. Accordingly, all costs incurred in the acquisition,exploration, and development of proved oil and gas properties, including thecosts of abandoned properties, dry holes, geophysical costs, and annual leaserentals are capitalized.  All generalcorporate costs are expensed as incurred. In general, sales or other dispositions of oil and gas properties areaccounted for as adjustments to capitalized costs, with no gain or lossrecorded; unless the adjustments would significantly alter the relationshipbetween capitalized costs and proved reserves. Amortization of evaluated oil and gas properties is computed on theunits of production method based on all proved reserves on a country-by-countrybasis.  Unevaluated oil and gasproperties are assessed at least annually for impairment either individually oron an aggregate basis, if the properties have similar characteristics.  The net capitalized costs of evaluated oiland gas properties are subject to a full cost ceiling limitation in which thecosts are not allowed to exceed their related estimated future net revenuesdiscounted at 10%, net of tax considerations. Any impairmentsto unevaluated properties are recorded as transfers to the full cost pool.

 

With the volatility of commodity prices and the possibility ofexploration expenditures resulting in no significant proved reserve additions,it is possible that future impairments of oil and gas properties couldoccur.  The price measurement date is onthe last day of the quarter or year-end as required by SEC rules.

 

2.             **ASSETRETIREMENT OBLIGATIONS**

 

TheCompany adopted SFAS No. 143 effective January 1, 2003.  SFAS No. 143 requires that the fair value ofan asset retirement cost, and corresponding liability, should be recorded aspart of the cost of the related long-lived asset and subsequently allocated toexpense using a systematic and rational method. Upon adoption, the Companyrecorded an asset retirement obligation of $913,560 to reflect the Company’slegal obligations related to future plugging and abandonment of its wells.  The Company estimated the expected cash flowassociated with the obligation and discounted the amount using a credit-adjusted,risk-free interest rate of 8%.  Thetransition adjustment resulting from the adoption of SFAS No. 143, and reportedas a cumulative effect of a change in accounting principle, was an increase toincome of $1,640 in 2003.  There was nocomparable adjustment in 2004.

 

TheCompany recorded the following activity related to the liability for the sixmonths ended June 30, 2004 and 2003:

 
| ** **                                                                     | ** ** | **FOR THE SIX MONTHS ENDED  June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
| Beginning balance – liability for asset  retirement obligations           |       | $                                           | 1,234,720  |   | $ | — |   |
| Initial liability for asset retirement  obligations as of January 1, 2003 |       | —                                      |       | 913,560 |   |
| Obligations incurred                                                           |       | (2,526                                      | )          | (40,904 | ) |
| Accretion expense                                                              |       | 46,052                                      |       | 27,406 |   |
|                                                                           |       |                                        |       |   |   |
| Ending balance – liability for asset  retirement obligations              |       | $                                           | 1,278,246  |   | $ | 900,062 |   |

 

7

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AtJune 30, 2004, $171,860 of the liability for asset retirement obligationsbalance is classified as current and presented as a separate line item on theconsolidated balance sheet.

 

3.             **STOCKHOLDERS’EQUITY**

 

***Stock Split***

On May 182004, the Company’s Board of Directors approved a one-for-two reverse stocksplit that was effective May 26, 2004. The reverse split was implemented toeffect the conditional approval by The NASDAQ National Market of the Company’slisting application, which was later formally approved.

 

Share andper share data (except par value) for periods presented have been restated toreflect the reverse stock split.

 

***Stock -BasedCompensation***

On January 1, 2003, the Company adopted Statement of FinancialAccounting Standards No. 123, *Accounting forStock-Based Compensation* (“SFAS No. 123”), as amended by Statementof Financial Accounting Standards No. 148 *Accountingfor Stock-Based Compensation – Transition and Disclosure*(“SFAS No.148”), in accounting for its employee and director stock options and appliesthe fair value based method of accounting to such options using the“prospective method” as defined by SFAS No. 148.  Under SFAS No. 123, the fair value of eachoption granted is estimated on the date of grant using the Black-Scholesoption-pricing model.  Previous to theadoption, the Company elected to follow Accounting Principles Board Opinion No.25, *Accounting for Stock Issued to Employees*(“APB 25”) and related interpretations in accounting for its employee stockoptions.  However, as required by SFASNo. 123, the Company disclosed on a pro forma basis the impact of the fairvalue accounting for employee stock options. Transactions in equity instruments with non-employees for goods orservices have been accounted for using the fair value method as prescribed bySFAS No. 123.

 

Sincethe Company adopted the fair value recognition provisions of SFAS No. 123prospectively for all employee awards granted, modified or settled afterJanuary 1, 2003, the cost related to stock-based compensation included inthe determination of income for the three and six month periods endedJune 30, 2004 and 2003 is less than that which would have been recognizedif the fair value method had been applied to all awards since the originaleffective date of SFAS No. 123.  Awardsvest over periods ranging from one to three years.  The following table illustrates the effect onnet income (loss) and earnings (loss) per share as if the fair value basedmethod had been applied to all outstanding and unvested awards in each period.

 
| ** **                                                                                        | ** ** | **FOR THE THREE MONTHS ENDED  JUNE 30,** | ** ** | **FOR THE SIX MONTHS ENDED  JUNE 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2004**                                      | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                              |       |                                          |       |                                        |       |   |   |   |   |
| Net income (loss) applicable to common stockholders  as reported                                  |       | $                                             | (1,503,736 | )                                           | $          | 75,488 |   | $ | (602,993 | ) | $ | (51,549 | ) |
| Add: Stock-based compensation expense  included in reported net income (loss)                     |       | 2,003,464                                     |       | 163,250                                     |       | 2,027,216 |   | 165,979 |   |
| Deduct: Total stock-based compensation  expense determined under fair value method for all awards |       | (668,037                                      | )          | (202,734                                    | )          | (725,389 | ) | (247,822 | ) |
|                                                                                              |       |                                          |       |                                        |       |   |   |   |   |
| Pro forma net income (loss) applicable to  common stockholders                                    |       | $                                             | (168,309   | )                                           | $          | 36,004 |   | $ | 698,834 |   | $ | (133,392 | ) |
|                                                                                              |       |                                          |       |                                        |       |   |   |   |   |
| Income (loss) per share:                                                                          |       |                                          |       |                                        |       |   |   |   |   |
| Basic – as reported                                                                          |       | $                                             | (0.16      | )                                           | $          | 0.01 |   | $ | (0.08 | ) | $ | (0.01 | ) |
| Basic – pro forma                                                                            |       | $                                             | (0.02      | )                                           | $          | 0.01 |   | $ | 0.09 |   | $ | (0.02 | ) |
|                                                                                              |       |                                          |       |                                        |       |   |   |   |   |
| Diluted – as reported                                                                        |       | $                                             | (0.16      | )                                           | $          | 0.01 |   | $ | (0.08 | ) | $ | (0.01 | ) |
| Diluted – pro forma                                                                          |       | $                                             | (0.02      | )                                           | $          | 0.01 |   | $ | 0.09 |   | $ | (0.02 | ) |

 

8

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The fair value of each grant is estimated on the date of grant usingthe Black-Scholes option-pricing model. The weighted average assumptions usedfor options granted in 2003 include expected volatility of approximately 61.3%,a risk-free interest rate of 3.15% and expected lives of 5.2 years.

 

During the second quarter of 2004, and in connection with the PHAWK,LLC Transaction, the Company recorded $1,979,712 of non-cash stock-basedcompensation expense related to employee stock options as follows:

 

•      $182,516 of stock-basedcompensation expense as a result of the accelerated vesting of certain stockoptions of employees who were employed on May 25, 2004 (closing of the PHAWK,LLC Transaction).

 

•      $1,797,196 of stock-basedcompensation expense as a result of the modification of certain stock optionsof employees whereby the period for which the employee has to exercise wasextended to the earlier of the option expiration date or five years from thedate of the closing of PHAWK, LLC Transaction.

 

Additionally, $47,504 of stock-based compensation was recorded duringthe six month period under the amortization of the certain employee stockoptions granted after the Company’s adoption of FAS 123 effectiveJanuary 1, 2003.

 

***Stock Options Grants***

No options were granted during the six months ended June 30, 2004.

 

***Common Stock Warrants***

During the second quarter of 2004, and in connection with the PHAWK,LLC Transaction, the Company issued PHAWK, LLC 5,000,000 five-year common stockpurchase warrants at a price of $3.30 per share. The warrants are exercisableat any time and expire on May 25, 2009.

 

***Treasury Stock***

EffectiveJanuary 14, 2003, the Company’s Board of Directorsauthorized a stock repurchase program for up to an aggregate of 50,000 sharesof the Company’s common stock.  Purchasesmay be made in the open market, at prevailing market prices, or in privatelynegotiated transactions from time to time, and will depend on marketconditions, business opportunities and other factors. Any purchases areexpected to be made in compliance with the safe harbor provisions of Rule10b-18 promulgated by the SEC under the Securities and Exchange Act of 1934.

 

9

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The Company did not purchaseany shares during the six months ended June 30, 2004.  During the six-month period endedJune 30, 2003, the Company purchased 5,375 shares for $8,255, or $1.54 pershare.  At June 30, 2004, theCompany held 8,382 treasury shares.

 

4 .            **NET INCOME (LOSS) PER COMMON SHARE**

 
| ** **                                                                                                       | ** ** | **FOR THE THREE MONTHS ENDED  JUNE 30,** | ** ** | **FOR THE SIX MONTHS ENDED  JUNE 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **2004**                                      | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Basic:                                                                                                           |       |                                          |       |                                        |       |   |   |   |   |
| Net income (loss)                                                                                                |       | $                                             | (1,393,361 | )                                           | $          | 186,970 |   | $ | (381,136 | ) | $ | 170,189 |   |
| Less:   Preferred dividends                                                                                 |       | (110,375                                      | )          | (111,482                                    | )          | (221,857 | ) | (221,738 | ) |
| Net income (loss) applicable to  common stockholders                                                        |       | $                                             | (1,503,736 | )                                           | $          | 75,488 |   | $ | (602,993 | ) | $ | (51,549 | ) |
|                                                                                                             |       |                                          |       |                                        |       |   |   |   |   |
| Weighted average number of  common shares                                                                   |       | 9,211,657                                     |       | 6,214,661                                   |       | 7,713,155 |   | 6,216,896 |   |
| Basic earnings (loss) per share                                                                                  |       | $                                             | (0.16      | )                                           | $          | 0.01 |   | $ | (0.08 | ) | $ | (0.01 | ) |
|                                                                                                             |       |                                          |       |                                        |       |   |   |   |   |
| Diluted:                                                                                                         |       |                                          |       |                                        |       |   |   |   |   |
| Net income (loss) applicable to  common stockholders                                                        |       | $                                             | (1,503,736 | )                                           | $          | 75,488 |   | $ | (602,993 | ) | $ | (51,549 | ) |
| Add:   Preferred dividends                                                                                  |       | —                                        |       | —                                      |       | — |   | — |   |
| Net income (loss) for diluted  earnings (loss) per share                                                    |       | $                                             | (1,503,736 | )                                           | $          | 75,488 |   | $ | (602,993 | ) | $ | (51,549 | ) |
|                                                                                                             |       |                                          |       |                                        |       |   |   |   |   |
| Weighted average number of  common shares                                                                   |       | 9,211,657                                     |       | 6,214,661                                   |       | 7,713,155 |   | 6,216,896 |   |
| Common stock equivalent shares  representing shares issuable upon exercise of stock options            |       | Antidilutive                                  |       | 23,759                                      |       | Antidilutive |   | Antidilutive |   |
| Common stock equivalent shares  representing shares issuable upon exercise of warrants                 |       | Antidilutive                                  |       | Antidilutive                                |       | Antidilutive |   | Antidilutive |   |
| Common stock equivalent shares  representing shares “as-if”  conversion  of preferred shares |       | Antidilutive                                  |       | Antidilutive                                |       | Antidilutive |   | Antidilutive |   |
| Weighted average number of  shares used in calculation of diluted income (loss) per share              |       | 9,211,657                                     |       | 6,238,420                                   |       | 7,713,155 |   | 6,216,896 |   |
| Diluted earnings (loss) per share                                                                                |       | $                                             | (0.16      | )                                           | $          | 0.01 |   | $ | (0.08 | ) | $ | (0.01 | ) |

 

The following common stock equivalents were not included in thecomputation for diluted loss per share because their effects were antidilutive.

 

10

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| ** **                                                 | ** ** | **JUNE 30,** | ** ** |
|------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                 | ** ** | **2004**          | ** ** | **2003** | ** ** |
|                                                       |       |              |       |   |   |
| Common Stock Equivalents:                                  |       |              |       |   |   |
|                                                       |       |              |       |   |   |
| Incentive stock options                                    |       | 396,292           |       | 362,291 |   |
| Non-qualified options                                      |       | 352,500           |       | 317,500 |   |
| Warrants                                                   |       | 5,919,500         |       | 919,500 |   |
| “As-if” conversion of subordinated note  payable |       | 8,750,000         |       | — |   |
| “As-if” conversion of preferred stock            |       | 604,271           |       | 604,271 |   |
|                                                       |       | 16,022,563        |       | 2,203,562 |   |

 

5.             **LONG-TERM DEBT**

 

On May 25, 2004, and in connection with the PHAWK, LLC Transaction, theCompany issued a $35,000,000, five-year unsecured subordinated note payable toPHAWK, LLC. The note payable bears interest at 8%, is payable quarterly untilmaturity and is convertible after two years to common stock of the Company at aconversion price of $4.00.  The fullamount of the principal and accrued and unpaid interest will be payable on May25, 2009.

 

During 2003, the Company’s revolving credit agreement with a commercialbank was re-determined and its maturity extended to April 1, 2005.  At June 30, 2004, the $25,000,000 creditfacility had a borrowing base of $13,444,000, which is subject to an automaticmonthly reduction of $88,000 that commenced July 31, 2003 and iscollateralized by the Company’s oil and gas properties and gas gathering systemand related assets.  At June 30,2004, there were no outstanding borrowings under the credit agreement. TheCompany pays a commitment fee equal to 0.25% (1/4 of a percentage point) on theunused portion of the borrowing base, which was approximately $223,000 atJune 30, 2004, due quarterly in arrears. The next re-determination for the borrowing base will occur inNovember 2004.

 

At June 30, 2004, the Company had various outstanding letters ofcredit of $201,000, which reduces the amount available under the borrowingbase.  The Company pays an annual renewalof 2.25% of the face amount of the letters of credit.

 

6.             **DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES**

 

***Natural Gas*** - During the six months ended June 30, 2004, the Company had nooutstanding commodity price hedging contracts. From time to time, the Company may hedge a portion of its natural gasproduction and use costless collars, swaps or a combination of thosederivatives when hedging

 

Forthe contracts settled during the three and six months ended June 30, 2003,the Company had realized losses of $185,107 and $1,034,332, respectively.  The impact of the natural gas hedges reducedthe Company’s average natural gas price received for the three and six months endedJune 30, 2003 by $0.39 per Mcf and $1.11 per Mcf, respectively.  Based on the actual average daily natural gasproduction for the six months ended June 30, 2003, approximately 48% ofthe Company’s natural gas production was hedged for this period.  Hedge ineffectiveness was not material duringthis period.

 

11

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***Crude Oil*** - During the six months ended June 30, 2004, the Company had nooutstanding commodity price hedging contracts. From time to time, the Company may hedge a portion of its crude oil productionand use costless collars, swaps or a combination of those derivatives whenhedging.

 

Forthe contracts settled during the three and six months ended June 30, 2003,the Company had realized losses of $19,939 and $201,723, respectively.  The impact of the crude oil hedges reducedthe Company’s average crude price received for the three and six months endedJune 30, 2003 by $0.71 per Bbl and 3.51 per Bbl, respectively.  Based on the actual average daily crude oilproduction for the six months ended June 30, 2003, approximately 39% ofthe Company’s crude oil production was hedged for this period.  Hedge ineffectiveness was not material duringthis period.

 

7.             **COMMITMENTSAND CONTINGENCIES**

 

Fromtime to time, the Company is a party to ordinary routine litigation incidentalto our business.  We are not currently aparty to any pending litigation, and we are not aware of any threatenedlitigation that would in the opinion of our legal counsel, have a significantimpact on the financial statements.  Wehave not been a party to any bankruptcy, receivership, reorganization,adjustment or similar proceeding.

 

8**.             SUBSEQUENT EVENT **

 

OnAugust 11, 2004, the Company purchased working interests in certain oil and gasproperties and various other assets from PHAWK, LLC for $8.5 million.  The effective date of the acquisition is June1, 2004 and the effects of this transaction will first be reported in theCompany’s financial statements for the quarter ending September 30, 2004.

 

ASpecial Committee of one disinterested director was formed by the Company’sboard of directors to evaluate, negotiate and complete the purchase.  The Special Committee hired an independentreservoir engineering firm to provide a reserve evaluation and engaged anindependent financial advisor to evaluate the fairness, from a financial pointof view, to the Company.  The independentfinancial advisor has rendered a fairness opinion to the Special Committee.

 

 

12

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## **Item 2.**            Management’s Discussion andAnalysis of Financial Condition and Results of Operations

 

The following discussion is to inform you about our financial position,liquidity and capital resources as of June 30, 2004 and December 31,2003 and the results of operations for the three and six month periods endedJune 30, 2004 and 2003.

 

**DisclosureRegarding Forward-Looking Statements**

Included in this report are forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended.  All statements, other than statements ofhistorical facts, included in this Form 10-Q that address activities, events ordevelopments that the Company expects or anticipates will or may occur in thefuture are forward-looking statements. The forward-looking statements speakonly as of the date made and the Company undertakes no obligation to updatesuch forward-looking statements. These forward-looking statements may beidentified by the use of the words “believes,” “intends,”  “expects,”  “anticipates,”  “projects,” “estimates,”  “predicts” andsimilar expressions that contemplate future events.

 

Thesefuture events include the following matters:

 

•      Estimates of proved reservequantities and net present values of those reserves

•      Reserve potential

•      Business strategy

•      Capital expenditures – amountand types

•      Financial position

•      Budgets

•      Expansion and growth of ourbusiness and operations

•      Expansion and development trendsof the oil and gas industry

•      Production of oil and gasreserves

•      Exploration prospects andproperty acquisitions

•      Wells to be drilled and drillingresults

•      Operating results and workingcapital

•      Marketing of natural gas and oil

 

Although we believe that the expectations reflected in such forward-lookingstatements are reasonable, we can give no assurance that such expectationsreflected in such forward-looking statements will prove to have been correct.

 

Allforward-looking statements contained in this report are based on assumptionsbelieved to be reasonable.

 

Wecan give no assurance that such expectations and assumptions will prove to becorrect.  Reserve estimates of oil andgas properties are generally different from the quantities of oil and naturalgas that are ultimately recovered or found. This is particularly true forestimates applied to exploratory prospects and new production. Additionally,any statements contained in this report regarding forward-looking statementsare subject to various known and unknown risks, uncertainties andcontingencies, many of which are beyond our control.

 

Numerousimportant factors, risks and uncertainties may affect the Company’s operatingresults, including:

 

•      the risks associated withexploration;

•      the ability to find, acquire,market, develop and produce new properties;

•      natural gas and oil price volatility;

•      uncertainties in the estimation of provedreserves and in the projection of production of proved reserves;

•      future rates of production and timingof development expenditures;

•      operating hazards attendant tothe natural gas and oil business;

 

13

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•      downhole drilling and completion risksthat are generally not recoverable from third parties or insurance;

•      potential mechanical failure or under-performanceof significant wells;

•      climatic conditions;

•      availability and cost of material andequipment;

•      delays in anticipated start-up dates;

•      actions or inactions of third-partyoperators of the Company’s properties;

•      the ability to find and retainskilled personnel;

•      availability of capital;

•      the strength and financialresources of competitors;

•      regulatory developments;

•      environmental risks; and

•      general economic conditions, includingwars and acts of terrorism.

 

Theseand other risks and uncertainties, which are more fully described in our AnnualReport on Form 10-K/A filed with the SEC, could cause actual results anddevelopments to be materially different from those expressed or implied by anyof these forward-looking statements. Such things may cause actual results, performance, achievements orexpectations to differ materially from the anticipated results, performance,achievements or expectations.

 

**PHAWK, LLC Transaction**

 

On December 12, 2003,we entered into a securities purchase agreement with PHAWK, LLC pursuant towhich we agreed to issue to PHAWK, LLC for an aggregate of $60,000,000 in cash:

 

•  7,575,757 shares of our commonstock;

 

•  five year warrants to purchase upto an additional 5,000,000 shares of our common stock at an exercise price of$3.30 per share; and

 

•  a convertible promissory note inthe face amount of $35,000,000 which will be convertible after two years intoshares of our common stock at a conversion price of $4.00 per share.

 

On May 25, 2004, thePHAWK, LLC Transaction was approved by the stockholders of the Company. Becauseissuance of the shares of common stock to PHAWK, LLC in connection with thistransaction resulted in a change of control of the Company as defined in theNASDAQ rules, we were required by the rules of The NasdaqStock Market to obtain stockholder approval of the issuance of the shares.

 

**Overview**

In the first six months of 2004, a sustained improvement in ourfinancial condition was a result of higher cash flows from operations.  A continuation of favorable commodity priceenvironment and increasing production rates were the primary factors for theimproving cash flow.  With the success ofour exploration, exploitation and development activity in the last half of 2003and first six months of 2004, our current production rates have increased.  Our net daily average production rate for thesix months ended June 30, 2004 was approximately 8.1 MMcfe compared to 7.0MMcfe for the same period ended in 2003, a 16% increase.  We continue to be optimistic about thelong-term outlook for natural gas and crude oil pricing, but realize that theoverall environment for commodity pricing is very volatile and can bematerially affected, favorably or unfavorably, by such factors as globaluncertainty, imports/exports, weather trends, power generation and industrialdemands.

 

**Liquidityand Capital Resources**

A company’s liquidity is the amount of time expected to elapse until anasset can be converted to cash or conversely until a liability has to bepaid.  Liquidity is one indication of acompany’s ability to meet its obligations or commitments.  Historically, our major sources of liquidityhave come from internally generated cash flow from operations and proceeds frompublic and private stock offerings.

 

14

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The following table represents the sources and uses of cash for theperiods indicated.

 
| ** **                                        | ** ** | **FOR THE SIX MONTHS ENDED  JUNE 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                        | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
| Beginning cash balance                            |       | $                                           | 2,109,681  |   | $ | 927,313 |   |
| Sources of cash:                                  |       |                                        |       |   |   |
| Cash provided by operations                       |       | 2,771,176                                   |       | 1,760,618 |   |
| Cash provided by sales of oil and gas  properties |       | 732,729                                     |       | 533,142 |   |
| Cash provided by financing activities             |       | 60,000,000                                  |       | — |   |
| Total sources of cash including cash on  hand     |       | 65,613,586                                  |       | 3,221,073 |   |
| Uses of cash:                                     |       |                                        |       |   |   |
| Oil and gas expenditures                          |       | (4,169,531                                  | )          | (852,749 | ) |
| Gas gathering and other equipment  expenditures   |       | (159,454                                    | )          | (34,879 | ) |
| Cash used by financing activities                 |       | (15,495,601                                 | )          | (238,101 | ) |
| Total uses of cash                                |       | (19,824,586                                 | )          | (1,125,729 | ) |
| Ending cash balance                               |       | $                                           | 45,789,000 |   | $ | 2,095,344 |   |

 

***Working capital and liquidity***

At June 30, 2004, the Company’s working capital was $47.1 million,compared to $2.2 million at December 31, 2003.  Our working capital and liquidity have showncontinual improvement as a result of the PHAWK, LLC Transaction and due tohigher cash flows from operations. Additionally, at June 30, 2004 and December 31, 2003, we hadno futures derivative liability associated with our future production volume.

 

Our principal source of short-term liquidity is frominternally-generated cash flow.  Shouldnatural gas and crude oil prices decrease materially, our current operatingcash flow would decrease and our liquidity and working capital position wouldbe negatively impacted and could adversely impact our growth capability.

 

***Current borrowing base***

The current credit agreement, which was re-determined and extendedduring the quarter ended June 30, 2003, has a maturity date ofApril 1, 2005 and at June 30, 2004, had a borrowing capacity of$13,444,000 subject to an automatic monthly reduction of $88,000, whichcommenced on July 31, 2003.  AtJune 30, 2004, there were no borrowings outstanding.

 

At June 30, 2004, the Company had various outstanding letters ofcredit of $201,000, which reduces the amount available under the borrowingbase.  The Company pays an annual renewalof 2.25% of the face amount of the letter of credit.

 

**Long Term Liquidity and Capital Resources**

We have no material long-term commitments associated with our capitalexpenditure plans or operating agreements. Consequently, we have a significantdegree of flexibility to adjust the level of such expenditures as circumstanceswarrant.  The level of capitalexpenditures will vary in future periods depending on the success we have withour exploitation, developmental and exploration activities in future periods,gas and oil price conditions and other related economic factors. Currently nosources of liquidity or financing are provided by off-balance sheetarrangements or transactions with unconsolidated, limited-purposeentities.  The following tables show ourcontractual obligations and commitments:

 
| ** **                   | ** ** | **Payments Due by Period** | ** ** |
|------------------------------|------------|----------------------------|------------|
| **Contractual  Obligations** | ** ** | **Total**                  | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **After 5 years** | ** ** |
|                         |       |                       |       |   |   |   |   |   |   |   |   |
| Subordinated Debt            |       | $                          | 35,000,000 |   | $ | — |   | $ | — |   | $ | 35,000,000 |   | $ | — |   |
| Operating Leases             |       | 50,116                     |       | 26,787 |   | 23,329 |   | — |   | — |   |
| Total Cash Obligations       |       | $                          | 35,050,116 |   | $ | 26,787 |   | $ | 23,329 |   | $ | 35,000,000 |   | $ | — |   |

 

15

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| ** **                         | ** ** | **Amount of Commitment Expiration per Period** | ** ** |
|------------------------------------|------------|------------------------------------------------|------------|
| **Other  Commercial  Commitments** | ** ** | **Total**                                      | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **After 5 years** | ** ** |
|                               |       |                                           |       |   |   |   |   |   |   |   |   |
| Standby letters of credit          |       | $                                              | 201,000    |   | $ | 201,000 |   | — |   | — |   | — |   |
|                                    |            |                                                |            |  |  |  |  |  |  |  |  |  |  |

 

We are obligated to pay dividends of approximately $110,000 per quarteron the 8% Convertible Preferred Stock.

 

**CapitalExpenditures**

For the six months ended June 30, 2004,we had capital expenditures of approximately $4.3 million.  The Company’s available capital as a resultof the PHAWK, LLC Transaction would allow for the additional capital deploymentshould drilling or other opportunities be presented to the Company forconsideration.

 

**SignificantAccounting Policies**

We rely on certain accounting policies in the preparation of ourfinancial statements.  Certain judgmentsand uncertainties affect the application of such policies.  Certain accounting principles are employed inthe adherence and implementation of these policies along with managementjudgments.  The following is a discussionof each policy and how certain judgments and/or uncertainties could materiallyimpact these policies:

 

*Use of Estimates* -The preparation of our condensed consolidated financial statements inconformity with generally accepted accounting principles requires ourmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilities,if any, at the date of the financial statements, and the reported amounts ofrevenues and expenses during the reporting period.  The estimates include oil and gas reservequantities, which form the basis for the calculation of amortization andimpairment of oil and gas properties.  Weemphasize that reserve estimates are inherently imprecise and that estimates ofmore recent discoveries are more imprecise than those for properties with longproduction histories. Actual results could materially differ from theseestimates. Volatility in commodity prices also impacts reserve estimates sincefuture revenues from production may decline significantly if there is amaterial decrease in natural gas and/or crude oil prices from the previousreserve estimation date, which is at each quarter end.

 

*Oil and gas properties* - Weaccount for our oil and gas producing activities using the full cost method ofaccounting.  Accordingly, all costsincurred in the acquisition, exploration, and development of proved oil and gasproperties, including the costs of abandoned properties, dry holes, geophysicalcosts, and annual lease rentals are capitalized.  All general corporate costs are expensed asincurred.  In general, sales or otherdispositions of oil and gas properties are accounted for as adjustments tocapitalized costs, with no gain or loss recorded, unless the adjustments wouldsignificantly alter the relationship between capitalized costs and provedreserves.  Amortization of evaluated oiland gas properties is computed on the units of production method based on allproved reserve quantities.  The net capitalizedcosts of evaluated oil and gas properties adjusted for deferred tax effects(full cost ceiling limitation) are not to exceed their related estimated futurenet revenues discounted at 10%, and the lower of cost or estimated fair valueof unevaluated properties, net of tax considerations. Unevaluated oil and gasproperties are assessed at least annually for impairment either individually oron an aggregate basis.  Unevaluatedleasehold costs, including brokerage costs, are individually assessed quarterlybased on the remaining primary term of the leasehold.  During the six month period endedJune 30, 2004, unevaluated leasehold costs and related brokerage fees of$149,190 were transferred to U.S. evaluated costs, or the full cost pool.  For the remaining costs, which includesseismic and geological and geophysical primarily related to Jackson County,Texas, historically we have estimated reserve potential for the unevaluatedproperties using comparable producing areas or wells and risk that estimate by50-75%.  As mentioned previously in *Use of Estimates*, reserve estimations are more imprecise fornew or unevaluated areas. Consequently, should certain geological conditions orfactors exist, such as reservoir depletion, reservoir faulting, reservoir qualityetc., but unknown to us at the time of our assessment, a materially differentresult could occur.

 

*Derivative instruments and hedging activity*– We use derivatives in a limited manner to protect against commodity pricevolatility.  Effectively, we sell aportion of our natural gas and crude oil based on a NYMEX based price with aset floor (bottom) and ceiling (top) price or a range.  Our derivatives are recorded on the balancesheet at fair value and changes in the fair value of derivatives are recordedeach period in current earnings or other comprehensive income, depending onwhether a derivative is designated as part of a hedge transaction and, if itis, depending on the

 

16

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type of transaction.  Typically, our derivative contract willconsist of a cash flow hedge transaction in which it hedges the variability ofcash flow related to a forecasted transaction. Changes in the fair value of these derivative instruments are recordedin other comprehensive income and reclassified as earnings in the periods inwhich earnings are impacted by the variability of the cash flows of the hedgeditem.  The fair value of these contractsmay vary materially with the fluctuations of natural gas and crude oilprices.  However, the fluctuation in fairvalue will be offset by the actual value received from the hedged volume.

 

*Stock-based compensation*- On January 1, 2003, the Company adopted Statement of FinancialAccounting Standards No. 123, *Accounting forStock-Based Compensation* (“SFAS No. 123”), as amended by Statementof Financial Accounting Standards No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure* (“SFAS No.148”), in accounting for our employee and director stock options using the“prospective method” as defined by SFAS No. 148.  Under SFAS No. 123, the fair value of eachoption granted is estimated on the date of grant using the Black-Scholesoption-pricing model.  Previous to theadoption, the Company elected to follow accounting Principles Board Opinion No.25, *Accounting for Stock Issued to Employees* (“APB No. 25”) and related interpretationsin accounting for its employee stock options. However, as required by SFAS No. 123, the Company disclosed on a proforma basis the impact of the fair value accounting for employee stockoptions.  Transactions in equityinstruments with non-employees for goods or services have been accounted forusing the fair value method as prescribed by SFAS No. 123.

 

**Comparisonof Results of Operations**

*Quarter ended June 30, 2004 and Compared to Quarter endedJune 30, 2003*

We had a net loss of $1.4 million for the three months endedJune 30, 2004 compared to net income of $0.2 million for the same periodended 2003.  Non-cash stock-basedcompensation expense of $2.0 million was offset by significantly higher naturalgas and crude oil price environment, higher natural gas and crude oil salesvolumes and lower depletion expense.  Theincrease was partially offset by higher lease operating expense and highergeneral and administrative expenses when compared to same period for last year.

 

The following table summarizes key items of comparison for the periodsindicated.  Dollars, except for per unitdata, and production data are in thousands.

 

| ** **                                        | ** ** | **Three Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                        | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|                                              |       |                                 |       |   |   |
| **Net Production  Data:**                         |       |                                 |       |   |   |
| Natural Gas (MMcf)                                |       | 577                                  |       | 471 |   |
| Crude Oil (MBbl)                                  |       | 36                                   |       | 28 |   |
| Equivalent Production (Mmcfe)                     |       | 795                                  |       | 640 |   |
| Average Daily Production (Mmcfe)                  |       | 8.7                                  |       | 7.0 |   |
|                                              |       |                                 |       |   |   |
| **Average Sales Price  (1):**                     |       |                                 |       |   |   |
| Natural Gas (per Mcf)                             |       | $                                    | 5.88       |   | $ | 4.53 |   |
| Crude Oil (per Bbl)                               |       | $                                    | 35.22      |   | $ | 26.49 |   |
| Equivalent price (per Mcfe)                       |       | $                                    | 6.16       |   | $ | 4.63 |   |
|                                              |       |                                 |       |   |   |
| **Expenses ($per  Mcfe):**                        |       |                                 |       |   |   |
| Lease Operations                                  |       | $                                    | 1.08       |   | $ | 0.87 |   |
| Production, severance and ad valorem taxes  $0.33 |       | $                                    | 0.32       |   |   |   |
| General and administrative (2)                    |       | $                                    | 2.04       |   | $ | 0.74 |   |
| DD&A (3)                                      |       | $                                    | 1.44       |   | $ | 1.91 |   |
| Interest                                          |       | $                                    | 0.48       |   | $ | 0.19 |   |

 

----

| (1) Includes impact of hedging                         |   |
|--------------------------------------------------------|--------|
| (2) Excludes Stock-based compensation  expense         |   |   |   |   |   |
| (3) Includes DD&A for oil and gas  properties only |   |   |   |   |   |

 

17

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*Oil and gas sales:*

For the three months ended June 30, 2004, oil and gas salesincreased $1.9 million or 65%, from the same period in 2002, to $4.9million.  The increase for the three monthswas a result of higher natural gas and crude oil prices received and highersales volumes during the quarter ended June 30, 2004.  Natural gas storage level concerns, crude oilsupply uncertainty due to global events and a weaker U.S. dollar, which impactsthe OPEC basket price, favorably impacted commodity prices during theperiod.  In turn, natural gas prices haveremained stronger due to the higher crude oil prices and seasonal demand duringthe quarter.  The prices received for ournatural gas and crude oil during the quarter ended June 30, 2003 were alsounfavorably impacted by our commodity hedges, as discussed further below under *Hedging*.

 

The higher commodity prices resulted in an increase in oil and gasrevenues. The increase in production was a result of our drilling activity inthe Broussard, Louisiana and Brookshire Dome, Texas properties and the drillingand recompletion activity during the last half of 2003 and this quarter on theWEHLU, Oklahoma properties.  Ourincremental increase in production from these areas was partially offset by thenatural decline in the production rates from our offshore Louisiana and SouthTexas properties.

 

*Hedging:*

Generally, we sell our natural gas and crude oil to various purchaserson an indexed-based or spot price.  Theindices for natural gas are generally affected by the NYMEX – Henry Hub spotprices while the posted prices for crude oil are generally affected by theNYMEX-Crude Oil West Texas Intermediate prices. From time to time, we use financial derivative instruments on a limitedbasis to lessen the impact of price volatility.

 

For the three months ended June 30, 2004, we had no hedges on ourproduction.  Oil and gas revenues for thethree months ended June 30, 2003 were reduced by approximately $205,000due to our oil and gas hedges.  For thethree months ended June 30, 2003, the average sales price received for ournatural gas was reduced by approximately $0.39 per Mcf from our natural gashedges and the average sales price received for our crude oil was reduced byapproximately $0.71 per Bbl from our crude oil hedges

 

*Lease operations expense and production tax expenses:*

Lease operations expense increased $0.3 million, or 55%, to $0.9million for the three months ended June 30, 2004 compared to the sameperiod for 2003.  The increase wasprimarily due to higher operating expense associated with our offshoreLouisiana properties, the Peace Creek and Zenith Field, Kansas properties andrecently drilled wells in South Central Kansas and WEHLU, Oklahoma.

 

Production severance and ad valorem taxes increased $57,900, or 28%,for the three months ended June 30, 2004 as compared to the same periodended in 2003, due to higher natural gas and crude oil revenues.  Production taxes are generally assessed as apercentage of gross oil and/or natural gas sales amounts or volumes.

 

*General and administrative expense:*

General and administrative expense for the three months endedJune 30, 2004 increased $1.1 million, or 240%, to $1.6 million compared to$0.5 million for the same period in 2003. The increase was due primarily to costs incurred as a result of theclosing of PHAWK, LLC Transaction.  Thesignificant components of the increase were $0.7 million of severance expense,$0.1 million of incremental salary and benefits for new employees and $0.1million of costs associated with the transition of the corporate headquartersfrom Tulsa, Oklahoma to Houston, Texas.

 

*Depreciation, depletion and amortization expense:*

Depletion, depreciation and amortization expense for oil and gasproperties decreased $0.1 million, or 6%, from the same period in 2003 to $1.1million for the three months ended June 30, 2004.  Depletion for oil and gas properties iscalculated using the “Unit of Production” method, which essentially amortizesthe capitalized costs associated with the evaluated properties based on theratio of production volume for the current period to total remaining reservevolume for the evaluated properties.  Thedecrease in oil and gas depletion was largely due to the increase in ourDecember 31, 2003 proved reserves. The depletion rates per Mcf for the three months ended June 30,2004 and 2003 were $1.44 per Mcf and $1.91 per Mcf, respectively.

 

Depreciation and amortization expense for other assets includesdepreciation associated with the gathering assets, which is calculated on a“unit of revenue” method.  The “unit ofrevenue” method amortizes the capitalized costs

 

18

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associated with the gathering assets basedon the ratio of gross actual revenues for the current period to the totalremaining gross revenues for the gathering assets.  Depreciation expense for the three monthperiods ended June 30, 2004 and 2003 was $43,700 and $56,200,respectively.

 

*Interest expense:*

Interest expense increased for three months ended June 30, 2004 ascompared to the same period 2003 by approximately $0.3 million due to a loweroutstanding commercial debt balance and the issuance of the $35 millionsubordinated 8% note issued in the PHAWK, LLC Transaction.

 

*Six months ended June 30, 2004 and Compared to Six months endedJune 30, 2003*

We had a net loss of $0.4 million for the six months endedJune 30, 2004 compared to a net income of $0.2 million for the same periodended 2003.  Non-cash stock-basedcompensation expense of $2.0 million was offset by significantly higher naturalgas and crude oil price environment, higher natural gas and crude oil salesvolumes and lower depletion expense.  Theincrease was partially offset by higher lease operating expense and highergeneral and administrative expenses when compared to same period for last year.

 

The following table summarizes key items of comparison for the periodsindicated.  Dollars, except for per unitdata, and production data are in thousands.

 

| ** **                                 | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------|------------|-------------------------------|------------|
| ** **                                 | ** ** | **2004**                      | ** ** | **2003** | ** ** |
|                                       |       |                          |       |   |   |
| **Net Production  Data:**                  |       |                          |       |   |   |
| Natural Gas (MMcf)                         |       | 1,058                         |       | 926 |   |
| Crude Oil (MBbl)                           |       | 70                            |       | 57 |   |
| Equivalent Production (Mmcfe)              |       | 1,478                         |       | 1,270 |   |
| Average Daily Production (Mmcfe)           |       | 8.1                           |       | 7.0 |   |
|                                       |       |                          |       |   |   |
| **Average Sales Price  (1):**              |       |                          |       |   |   |
| Natural Gas (per Mcf)                      |       | $                             | 6.03       |   | $ | 4.62 |   |
| Crude Oil (per Bbl)                        |       | $                             | 35.22      |   | $ | 26.10 |   |
| Equivalent price (per Mcfe)                |       | $                             | 5.99       |   | $ | 4.69 |   |
|                                       |       |                          |       |   |   |
| **Expenses ($per  Mcfe):**                 |       |                          |       |   |   |
| Lease Operations                           |       | $                             | 1.07       |   | $ | 0.89 |   |
| Production, severance and ad valorem taxes |       | $                             | 0.33       |   | $ | 0.35 |   |
| General and administrative (2)             |       | $                             | 1.64       |   | $ | 0.98 |   |
| DD&A (3)                               |       | $                             | 1.47       |   | $ | 1.97 |   |
| Interest                                   |       | $                             | 0.33       |   | $ | 0.19 |   |

 

----

| (1) Includes impact of hedging                         |   |   |   |
|--------------------------------------------------------|--------|--------|--------|
| (2) Excludes Stock-based compensation  expense         |   |   |   |   |   |
| (3) Includes DD&A for oil and gas  properties only |   |   |   |   |   |

 

*Oil and gas sales:*

For the six months ended June 30, 2004, oil and gas salesincreased $2.9 million, or 49%, from the same period in 2003, to $8.8million.  The increase for the six monthswas a result of higher natural gas and crude oil prices received and highersales volumes during the six months ended June 30, 2004.  Natural gas storage level concerns, crude oilsupply uncertainty due to global events and a weaker U.S. dollar, which impactsthe OPEC basket price, favorably impacted commodity prices during theperiod.  In turn, natural gas prices haveremained stronger due to the higher crude oil prices and seasonal demand duringthe quarter. The prices received for our natural gas and crude oil during thesix months ended June 30, 2003 were also unfavorably impacted by ourcommodity hedges, as discussed further below under *Hedging*.

 

19

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The higher commodity prices resulted in an increase in oil and gasrevenues of $2.9 million, with higher natural gas prices comprising 66% of theincrease. The increase in production was a result of our drilling activity inthe Broussard, Louisiana and Brookshire Dome, Texas properties and the drillingand recompletion activity during the last half of 2003 and this quarter on theWEHLU, Oklahoma properties.  Ourincremental increase in production from these areas was partially offset by thenatural decline in the production rates from our offshore Louisiana and SouthTexas properties.

 

*Hedging:*

Generally, we sell our natural gas and crude oil to various purchaserson an indexed-based or spot price.  Theindices for natural gas are generally affected by the NYMEX – Henry Hub spotprices while the posted prices for crude oil are generally affected by theNYMEX-Crude Oil West Texas Intermediate prices. From time to time, we use financial derivative instruments on a limitedbasis to lessen the impact of price volatility.

 

For the six months ended June 30, 2004, we had no hedges on ourproduction.  For the six months endedJune 30, 2003, hedges covered approximately 48% of the Company’s naturalgas production and 39% of the Company’s oil production.  Oil and gas revenues for the six months endedJune 30, 2003 were reduced by approximately $1,236,000 due to our oil andgas hedges.  For the six months endedJune 30, 2003, the average sales price received for our natural gas wasreduced by approximately $1.11 per Mcf from our natural gas hedges and theaverage sales price received for our crude oil was reduced by approximately$3.51 per Bbl from our crude oil hedges.

 

*Lease operations expense and production tax expenses:*

Lease operations expense, excluding production taxes, increased $0.4million, or 39%, to $1.6 million for the six months ended June 30, 2004compared to the same period for 2003. The increase was primarily due to higher operating expense associatedwith our offshore Louisiana properties, the Peace Creek and Zenith Field, Kansasproperties and recently drilled wells in South Central Kansas and WEHLU,Oklahoma.

 

Production tax expense increased $41,200, or 9%, for the six monthsended June 30, 2004 as compared to the same period ended in 2003, due tohigher natural gas and crude oil revenues. Production taxes are generally assessed as a percentage of gross oiland/or natural gas sales amounts or volumes.

 

*General and administrative expense:*

General and administrative expense for the six months endedJune 30, 2004 increased $1.2 million, or 94%, to $2.4 million compared to$1.2 million for the same period in 2003. The increase was due primarily to costs associated with the PHAWK, LLCTransaction. The significant components of the increase were $0.7 million ofseverance expense, $0.1 million of incremental salary and benefits for newemployees and $0.1 million of costs associated with the transition of thecorporate headquarters from Tulsa, Oklahoma to Houston, Texas.

 

*Depreciation, depletion and amortization expense:*

Depletion expense related to oil and gas properties decreased $0.3million, or 13%, from the same period in 2003 to $2.2 million for the sixmonths ended June 30, 2004. Depletion for oil and gas properties is calculated using the “Unit ofProduction” method, which essentially amortizes the capitalized costs associatedwith the evaluated properties based on the ratio of production volume for thecurrent period to total remaining reserve volume for the evaluatedproperties.  The decrease in oil and gasdepletion was due to a lower depletion rate for the six months endedJune 30, 2004, which resulted from an increase in our December 31,2003 proved reserves.  The depletionrates per Mcf for the six months ended June 30, 2004 and 2003 were $1.47per Mcf and $1.97 per Mcf, respectively.

 

Depreciation and amortization expense for other assets includesdepreciation associated with the gathering assets, which is calculated on a“unit of revenue” method.  The “unit ofrevenue” method amortizes the capitalized costs associated with the gatheringassets based on the ratio of gross actual revenues for the current period tothe total remaining gross revenues for the gathering assets.  Depreciation expense for the six monthperiods ended June 30, 2004 and 2003 was $46,100 and $27,400,respectively.

 

20

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*Interest expense:*

Interest expense increased for the six months ended June 30, 2004as compared to the same period 2003 by approximately $0.2 million due to theissuance of the $35 million subordinated 8% note issued in the PHAWK, LLCTransaction.

 

*Income Taxes*

As of June 30, 2004, we had available, to reduce future taxableincome, a U.S. federal regular net operating loss (“NOL”) carryforward ofapproximately $24.2 million and a U.S. federal alternative minimum tax NOLcarryforward of approximately $21.1 million, which expire in the years 2018through 2023.  We also had various stateNOL carryforwards at June 30, 2004, with varying lengths of allowablecarryforward periods ranging from five to 20 years and can be used to offsetfuture state taxable income. Based on past results and current forecasts, wehave established a valuation allowance to reduce net deferred taxes tozero.  We had $37,185 of alternativeminimum tax expense for the six months ended June 30, 2004.

 

As a result of the transaction with PHAWK, LLC and the resulting changeof control, the Company’s utilization of the NOL’s will be limited on an annualbasis to 10% of the NOL carryforward. Given that the expiration dates of the NOL’s are 14 to 19 years away,the Company believes that all NOL’s will be available in future periods toreduce the Company’s taxable income.

 

**Item 3.****  Quantitativeand Qualitative Disclosure About Market Risk**

 

We are exposed to market risk related to adverse changes in oil and gasprices.  Our oil and gas revenues can besignificantly affected by volatile oil and gas prices.  This volatility can be mitigated through theuse of oil and gas financial instruments. At June 30, 2004, we had no outstanding derivative financialinstruments.

 

###### **We are also exposed to market risk related toadverse changes in interest rates.  Ourinterest rate risk exposure results primarily from short-term rates, mainlyLIBOR-based on borrowing from our commercial bank.  At June 30, 2004, none of ouroutstanding debt was at variable rates. Any future volatility could bemitigated through the use of financial derivative instruments.  Currently, we do not have any derivativefinancial instruments in place to mitigate this potential risk.**

###### ** **

###### **Item 4.**  Controls andProcedures

###### ** **

Based on theirevaluation, our Chief Executive Officer and Principal Financial Officer haveconcluded that the Company’s disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of theperiod covered by this report on Form 10-Q are effective to ensure thatinformation required to be disclosed by the Company in reports that it files orsubmits under the Exchange Act are recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rulesand forms.

 

During the period coveredby this report on Form 10-Q, there have been no changes in the Company’sinternal control over financial reporting that have materially affected or arereasonably likely to materially affect the Company’s internal control overfinancial reporting.

 

21

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**PARTII.****OTHER INFORMATION**

 

**Item2 – Changes in Securities, Use of Proceeds and Issuer Purchases of EquitySecurities**

 

On May 25, 2004, the Company issued certainsecurities as part of a transaction with PHAWK, LLC. The following securities,which take into account the 1-for-2 reverse stock split implemented by theCompany on May 26, 2004, were issued by the Company pursuant to the PHAWK, LLCTransaction:

 

•      7,575,757 shares of common stock

•      5,000,000 stock purchase warrants at an exercise price of $3.30 per share

•      $35,000,000 subordinated note payable, convertible to common stock at$4.00 per share.

 

On July 15, 2004, Beta Oil & Gas,Inc. (a Nevada corporation) reincorporated into the Company (a Delawarecorporation).  The articles ofincorporation, the certificate of designation for the Company’s preferredstock, and the bylaws of the Company are substantially identical to the correspondingdocuments of Beta Oil & Gas, Inc. However, pursuant to stockholder approval obtained on July 15,2004, the Company instituted a classified board and cumulative voting rights ofstockholders were removed.  In addition,provisions in the certificate of incorporation relating to the indemnificationof officers and directors, as well as other differences, due to differing lawsin Nevada and Delaware were made.

 

**Item4 – Submission of Matters to a Vote of Security Holders**

 

At our special meeting of the stockholders onMay 25, 2004, the following items were voted upon:

1.     Consider proposal to approve the issuance ofcertain securities related to the PHAWK, LLC Transaction;

2.     To amend the articles of incorporation toincrease the authorized common stock from 50,000,000 to 100,000,000;

 

The following table summarizes the tabulationof votes with respect to the foregoing matters:

 
| ** **                                                                                           | ** ** | **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------|------------|-------------|------------|-------------|------------|
| Proposal 1:                                                                                          |       |      |       |        |       |        |       |
|                                                                                                 |       |      |       |        |       |        |       |
| PHAWK, LLC Transaction and related  securities issuance:                                             |       | 7,303,556 |       | 287,647     |       | 64,781      |       |
|                                                                                                 |       |      |       |        |       |        |       |
| Proposal 2:                                                                                          |       |      |       |        |       |        |       |
|                                                                                                 |       |      |       |        |       |        |       |
| Amend articles of incorporation to increase  authorized common stock from 50,000,000 to 100,000,000: |       | 6,922,882 |       | 659,881     |       | 73,221      |       |

 

The Annual Meeting of Stockholders of theCompany was held July 15, 2004 for the purpose of voting on the followingitems:

 
| ** **                                                                    | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|-------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|
| Proposal 1 – Election of Directors:                                      |       |       |       |        |       |        |       |
| Floyd C. Wilson                                                               |       | 13,168,075 |       | 222,536     |       | 0           |       |
| Tucker S. Bridwell                                                            |       | 13,075,600 |       | 313,511     |       | 0           |       |
| James L. Irish III                                                            |       | 12,990,649 |       | 398,462     |       | 0           |       |
| David B. Miller                                                               |       | 12,997,899 |       | 391,212     |       | 0           |       |
| D. Martin Phillips                                                            |       | 13,166,075 |       | 223,036     |       | 0           |       |
| Daniel Rioux                                                                  |       | 13,243,776 |       | 145,335     |       | 0           |       |
| Robert C. Stone, Jr.                                                          |       | 12,653,874 |       | 735,237     |       | 0           |       |
|                                                                          |       |       |       |        |       |        |       |
| Proposal 2 – Name change to Petrohawk  Energy Corporation:               |       | 13,337,044 |       | 38,770      |       | 13,297      |       |
|                                                                          |       |       |       |        |       |        |       |
| Proposal 3  – Reincorporation of the Company under the laws of Delaware: |       | 10,006,072 |       | 45,292      |       | 17,359      |       |

 

22

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| Proposal 4 – Elimination of Cumulative  Voting:                                                    |   | 9,270,080 |   | 766,330 |   | 32,313 |   |
|---------------------------------------------------------------------------------------------------------|--------|-----------|--------|---------|--------|--------|--------|
|                                                                                                    |   |      |   |    |   |   |   |
| Proposal 5 – Adoption of a classified board  of directors:                                         |   | 9,698,045 |   | 348,163 |   | 22,515 |   |
|                                                                                                    |   |      |   |    |   |   |   |
| Proposal 6 – Amendment of Stock Option  agreements existing on May 25, 2004 for certain employees: |   | 9,921,039 |   | 115,829 |   | 32,105 |   |
|                                                                                                    |   |      |   |    |   |   |   |
| Proposal 7 – Approval of 2004 Non-Employee  Incentive Plan:                                        |   | 9,683,685 |   | 309,907 |   | 75,131 |   |
|                                                                                                    |   |      |   |    |   |   |   |
| Proposal 8 – Approval of 2004 Employee  Incentive Plan:                                            |   | 9,672,891 |   | 321,616 |   | 74,216 |   |

 

**Item 6.****  Exhibits and Reports on Form 8-K**

 

(a)   Thefollowing documents are included as exhibits to this Form 10-Q.  Those exhibits incorporated by reference areso indicated by the information supplied with respect thereto.  Those exhibits which are not incorporated byreference are attached here to.

 

2.1           Agreementand Plan of Merger between Beta Oil & Gas, Inc. and Petrohawk EnergyCorporation (Form of Agreement and Plan of Merger between Beta Oil & Gas,Inc. and Petrohawk Energy Corporation was attached as Appendix F to theCompany’s Definitive Proxy Statement filed June 23, 2004 is incorporatedherein by reference);

 

3.1           Certificateof Incorporation for Petrohawk Energy Corporation (attaches as Exhibit 3.1 tothe Form S-8 that the Company filed on July 29, 2004, which isincorporated herein by reference);

 

3.2           Bylawsof Petrohawk Energy Corporation attached hereto as Exhibit 3.2;

 

31.1         Certificationof Periodic Report by the Chief Executive Officer under Section 302 of theSarbanes-Oxley Act of 2002

 

31.2         Certificationof Periodic Report by the Chief Financial Officer under Section 302 ofSarbanes-Oxley Act of 2002

 

32.1         Certificationof Periodic Report by the Chief Executive Officer and Chief Financial Officerunder Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)   Reportson Form 8-K

 

The followingreports were filed on Form 8-K during the second quarter of 2004:

 

On May 12, 2004,the Company filed a Form 8-K under items 7 & 12 describing the release ofits first quarter financial results and related press release.

 

On May 25, 2004,the Company filed a Form 8-K under items 1, 5 & 6 describing the change ofcontrol as a result of the completion of the transaction with PHAWK, LLC, theaddition of new board of directors and officers of the Company and theresignation of directors.

 

On July 16,2004, the Company filed a Form 8-K under items 5 & 6 describing thecompletion of the Company’s annual meeting and the resignation of one director.

 

On July 20,2004, the Company filed a Form 8-K under items 4 & 7 describing the changein the Company’s independent accountants.

 

23

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned who is duly authorized.

 
| ** **                       | **PETROHAWK ENERGY CORPORATION** |
|----------------------------------|----------------------------------|
|                             |                             |   |
| Date:  August 13, 2004 | By:                              |   | /s/ Shane M. Bayless |   |
|                             |                             | Shane M. Bayless |
|                             |                             | Vice President - Chief  Financial Officer  and Treasurer |
|                                  |                                  |  |  |  |

 

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