**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**Form 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended June 30, 2007**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**CommissionFile Number: 333-123711**

**Venoco, Inc.**

| **Delaware**                                                     |   | **77-0323555**                           |
|------------------------------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification Number) |
| **370 17****th Street, Suite 3900**                    |   | ** **                               |
| **Denver,  Colorado**                                            |   | **80202-1370**                           |
| (Address of  principal executive offices)                        |   | (Zip Code)                               |

 

Registrant’s telephonenumber, including area code: **(303) 626-8300**

**N/A**

(Former name or formeraddress, and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) hasfiled all reports required by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

YES  x  NO o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer (asdefined in Rule 12b-2 of the Exchange Act).
| Large Accelerated Filer o |   | Accelerated Filer o |   | Non-accelerated filer x |
|---------------------------|--------|---------------------|--------|-------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

YES  o  NO x

As of July 10, 2007, there were 49,460,432 sharesof the issuer’s common stock, par value $0.01 per share, issued andoutstanding.

 

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**CAUTIONARY NOTEREGARDING FORWARD-LOOKING STATEMENTS**

This report on Form 10-Qcontains “forward-looking statements” as that term is defined in thePrivate Securities Litigation Reform Act of 1995. The use of any statementscontaining the words “anticipate,” “intend,” “believe,” “estimate,” “project,” “expect,”“plan,” “should” or similar expressions are intended to identify suchstatements. Forward-looking statements included in this report relate to,among other things, (i) expected production, revenue and expenses in 2007,(ii) the nature, timing and results of capital expenditure projects, (iii) expectedaccess to a second barge to deliver crude oil from the South Ellwood field and (iv) ourplans with respect to a master limited partnership. Although we believe that the expectations reflected in such forward-lookingstatements are reasonable, those expectations may prove to be incorrect.Disclosure of important factors that could cause actual results to differmaterially from our expectations, or cautionary statements, are included underthe heading “Risk Factors” in this report and our Annual Report on Form 10-Kfor the year ended December 31, 2006. Certain cautionary statements arealso included elsewhere in this report, including, without limitation, in conjunctionwith the forward-looking statements. All forward-looking statementsspeak only as of the date made. All subsequent written and oral forward-lookingstatements attributable to us, or persons acting on our behalf, are expresslyqualified in their entirety by the cautionary statements. Except as required bylaw, we undertake no obligation to update any forward-looking statement.Factors that could cause actual results to differ materially from ourexpectations include, among others, those factors referenced in the “RiskFactors” section of this report and our Annual Report on Form 10-Kfor the year ended December 31, 2006 and such things as:

·       changesin oil and natural gas prices and general business and economic conditions;

·       problemswith accessing oil and natural gas markets due to operational impediments,including problems associated with the transportation of South Ellwood crudeoil;

·       unanticipatedincreases in production or other expenses;

·       inaccuracyin reserve estimates and expected production rates;

·       risksrelated to our level of indebtedness, including a potential lack of availablefinancing;

·       uninsuredor underinsured losses in, or operational problems affecting, our oil andnatural gas operations, including losses and problems relating to environmentalissues;

·       thepotential unavailability of drilling rigs and other field equipment andservices;

·       theexistence of unanticipated liabilities or problems relating to acquiredbusinesses or properties;

·       factorsaffecting the nature and timing of our capital expenditures, includingpermitting issues, weather and limits on the number of activities that can beconducted at any one time on our offshore platforms;

·       theimpact of and costs related to compliance with or changes in laws or regulationsgoverning our oil and natural gas operations;

·       difficultiesin obtaining, or the failure to obtain, permits and other governmentalauthorizations necessary to conduct and/or expand our operations; and

·       otherfactors, many of which are beyond our control.

2

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**VENOCO, INC.Form 10-Q for the Quarterly Period Ended June 30, 2007TABLE OF CONTENTS**
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                                                                                           | ** ** | ** ** |
|-------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| Item 1.           | Financial Statements  (Unaudited)                                                                                                                                                   |       |       |
|              | Condensed Consolidated  Balance Sheets at December 31, 2006 and June 30, 2007                                                                                             |       | 4          |
|              | Condensed Consolidated  Statements of Operations for the Three and Six Months Ended June 30,  2006 and the Three and Six Months Ended June 30, 2007                  |       | 5          |
|              | Condensed Consolidated Statements  of Comprehensive Income (Loss) for the Three and Six Months Ended  June 30, 2006 and the Three and Six Months Ended June 30, 2007 |       | 6          |
|              | Condensed Consolidated  Statements of Cash Flows for the Six Months Ended June 30, 2006 and the  Six Months Ended June 30, 2007                                           |       | 7          |
|              | Notes to Condensed  Consolidated Financial Statements                                                                                                                               |       | 8          |
| Item  2.          | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                                                                         |       | 27         |
| Item  3.          | Quantitative and Qualitative  Disclosures about Market Risk                                                                                                                         |       | 38         |
| Item  4.          | Controls and Procedures                                                                                                                                                             |       | 41         |
| **PART II.** | **OTHER INFORMATION**                                                                                                                                                               | ** ** | ** ** |
| Item 1.           | Legal Proceedings                                                                                                                                                                   |       | 43         |
| Item 1A.          | Risk Factors                                                                                                                                                                        |       | 43         |
| Item  2.          | Unregistered Sales of Equity  Securities and Use of Proceeds                                                                                                                        |       | 44         |
| Item  3.          | Defaults upon Senior  Securities                                                                                                                                                    |       | 44         |
| Item  4.          | Submission of Matters to a  Vote of Security Holders                                                                                                                                |       | 44         |
| Item 5.           | Other Information                                                                                                                                                                   |       | 44         |
| Item 6.           | Exhibits                                                                                                                                                                            |       | 44         |
| Signatures        |                                                                                                                                                                                | 45         |

 

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**PART I—FINANCIALINFORMATION**

**VENOCO, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)(In thousands, except shares and per share amounts)**

| ** **                                                                                                                                                                                              | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                              | ** ** | **2006**              | ** ** | **2007**          | ** ** |
| **ASSETS**                                                                                                                                                                                              |       |                  |       |              |       |   |   |
| CURRENT ASSETS:                                                                                                                                                                                         |       |                  |       |              |       |   |   |
| Cash and cash equivalents                                                                                                                                                                               |       |                  | $          | 8,364             |       |   | $ | 14,583 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $1,250 and $1,500 at  December 31, 2006 and June 30, 2007, respectively                                                       |       |                  | 48,042     |              |       | 54,690 |   |
| Inventories                                                                                                                                                                                             |       |                  | 3,211      |              |       | 2,637 |   |
| Prepaid expenses  and other current assets                                                                                                                                                              |       |                  | 7,226      |              |       | 4,178 |   |
| Income tax  receivable                                                                                                                                                                                  |       |                  | 8,098      |              |       | 3,276 |   |
| Deferred income  taxes                                                                                                                                                                                  |       |                  | 879        |              |       | 4,042 |   |
| Commodity  derivatives                                                                                                                                                                                  |       |                  | 10,348     |              |       | 7,133 |   |
| Total current  assets                                                                                                                                                                                   |       |                  | 86,168     |              |       | 90,539 |   |
| PROPERTY, PLANT AND EQUIPMENT, AT COST:                                                                                                                                                                 |       |                  |       |              |       |   |   |
| Oil and natural  gas properties (full cost method, of which $4,850 and $6,848 for unproved  properties were excluded from amortization at December 31, 2006 and  June 30, 2007, respectively) |       |                  | 881,570    |              |       | 1,154,440 |   |
| Drilling equipment                                                                                                                                                                                      |       |                  | 13,731     |              |       | 14,482 |   |
| Other property and  equipment                                                                                                                                                                           |       |                  | 12,380     |              |       | 15,668 |   |
| Total property,  plant and equipment                                                                                                                                                                    |       |                  | 907,681    |              |       | 1,184,590 |   |
| Accumulated  depletion, depreciation, amortization and impairment                                                                                                                                       |       |                  | (133,428   | )                 |       | (177,554 | ) |
| Net property,  plant and equipment                                                                                                                                                                      |       |                  | 774,253    |              |       | 1,007,036 |   |
| OTHER ASSETS:                                                                                                                                                                                           |       |                  |       |              |       |   |   |
| Commodity  derivatives                                                                                                                                                                                  |       |                  | 8,591      |              |       | 4,451 |   |
| Deferred loan  costs                                                                                                                                                                                    |       |                  | 17,318     |              |       | 11,464 |   |
| Other                                                                                                                                                                                                   |       |                  | 6,863      |              |       | 7,926 |   |
| Total other assets                                                                                                                                                                                      |       |                  | 32,772     |              |       | 23,841 |   |
| TOTAL ASSETS                                                                                                                                                                                            |       |                  | $          | 893,193           |       |   | $ | 1,121,416 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                           |       |                  |       |              |       |   |   |
| CURRENT LIABILITIES:                                                                                                                                                                                    |       |                  |       |              |       |   |   |
| Accounts payable  and accrued liabilities                                                                                                                                                               |       |                  | $          | 53,900            |       |   | $ | 68,671 |   |
| Undistributed  revenue payable                                                                                                                                                                          |       |                  | 15,596     |              |       | 13,823 |   |
| Interest payable                                                                                                                                                                                        |       |                  | 5,295      |              |       | 4,389 |   |
| Current maturities  of long-term debt                                                                                                                                                                   |       |                  | 3,557      |              |       | 2,885 |   |
| Commodity  derivatives                                                                                                                                                                                  |       |                  | 8,574      |              |       | 13,768 |   |
| Total current  liabilities                                                                                                                                                                              |       |                  | 86,922     |              |       | 103,536 |   |
| LONG-TERM DEBT                                                                                                                                                                                          |       |                  | 529,616    |              |       | 745,514 |   |
| DEFERRED INCOME  TAXES                                                                                                                                                                                  |       |                  | 40,424     |              |       | 27,866 |   |
| COMMODITY  DERIVATIVES                                                                                                                                                                                  |       |                  | 6,931      |              |       | 23,145 |   |
| ASSET RETIREMENT OBLIGATIONS                                                                                                                                                                            |       |                  | 38,984     |              |       | 42,921 |   |
| Total liabilities                                                                                                                                                                                       |       |                  | 702,877    |              |       | 942,982 |   |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                           |       |                  |       |              |       |   |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                              |       |                  |       |              |       |   |   |
| Common stock, $.01  par value (200,000,000 shares authorized; 42,783,300 and 43,020,332  shares issued and outstanding at December 31, 2006 and June 30,  2007, respectively)                 |       |                  | 428        |              |       | 430 |   |
| Additional paid-in  capital                                                                                                                                                                             |       |                  | 181,444    |              |       | 185,304 |   |
| Retained earnings  (accumulated deficit)                                                                                                                                                                |       |                  | 10,910     |              |       | (2,578 | ) |
| Accumulated other  comprehensive loss                                                                                                                                                                   |       |                  | (2,466     | )                 |       | (4,722 | ) |
| Total  stockholders’ equity                                                                                                                                                                        |       |                  | 190,316    |              |       | 178,434 |   |
| TOTAL LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                                                                        |       |                  | $          | 893,193           |       |   | $ | 1,121,416 |   |

 

See notes to condensed consolidated financial statements.

4

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**VENOCO, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)(In thousands, except per share amounts)**

| ** **                                              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                        | ** ** | **2007**                                      | ** ** | **2006** | ** ** | **2007** | ** ** |
| REVENUES:                                               |       |                                            |       |                                          |       |   |   |   |   |
| Oil and natural gas sales                               |       | $                                               | 76,103     |                                          | $          | 90,507 |   | $ | 127,374 |   | $ | 164,146 |   |
| Commodity derivative losses, net                        |       | (12,196                                         | )          | (8,431                                        | )          | (27,766 | ) | (27,145 | ) |
| Other                                                   |       | 1,666                                           |       | 752                                           |       | 3,380 |   | 1,565 |   |
| Total revenues                                          |       | 65,573                                          |       | 82,828                                        |       | 102,988 |   | 138,566 |   |
| EXPENSES:                                               |       |                                            |       |                                          |       |   |   |   |   |
| Oil and natural gas production                          |       | 23,196                                          |       | 25,946                                        |       | 35,518 |   | 51,033 |   |
| Transportation expense                                  |       | 805                                             |       | 1,407                                         |       | 1,610 |   | 3,284 |   |
| Depletion, depreciation and amortization                |       | 16,803                                          |       | 23,556                                        |       | 23,497 |   | 44,155 |   |
| Accretion of abandonment liability                      |       | 641                                             |       | 844                                           |       | 1,111 |   | 1,617 |   |
| General and administrative, net of amounts  capitalized |       | 7,715                                           |       | 7,238                                         |       | 12,121 |   | 17,033 |   |
| Amortization of deferred loan costs                     |       | 1,133                                           |       | 985                                           |       | 1,471 |   | 2,230 |   |
| Interest, net                                           |       | 14,856                                          |       | 16,012                                        |       | 18,629 |   | 29,339 |   |
| Loss on extinguishment of debt                          |       | —                                          |       | 12,063                                        |       | — |   | 12,063 |   |
| Total expenses                                          |       | 65,149                                          |       | 88,051                                        |       | 93,957 |   | 160,754 |   |
| Income (loss)  before income taxes                      |       | 424                                             |       | (5,223                                        | )          | 9,031 |   | (22,188 | ) |
| Income tax  provision (benefit)                         |       | 100                                             |       | (2,100                                        | )          | 3,600 |   | (8,700 | ) |
| Net income (loss)                                       |       | $                                               | 324        |                                          | $          | (3,123 | ) | $ | 5,431 |   | $ | (13,488 | ) |
| Earnings per  common share:                             |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                   |       | $                                               | 0.01       |                                          | $          | (0.07 | ) | $ | 0.17 |   | $ | (0.32 | ) |
| Diluted                                                 |       | $                                               | 0.01       |                                          | $          | (0.07 | ) | $ | 0.16 |   | $ | (0.32 | ) |
| Weighted average common  shares outstanding:            |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                   |       | 32,693                                          |       | 42,812                                        |       | 32,693 |   | 42,801 |   |
| Diluted                                                 |       | 34,170                                          |       | 42,812                                        |       | 34,022 |   | 42,801 |   |

 

See notes to condensed consolidated financial statements.

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**VENOCO, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)(In thousands)**

| ** **                                                                   | ** ** | **Three Months Ended  June 30,**          | ** ** | **Six Months Ended  June 30,**            | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **    2006    ** | ** ** | **    2007    ** | ** ** | **2006** | ** ** | **2007** | ** ** |
|                                                                         |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                                            |       |                                                     | $          | 324                                                      |       |   |   | $ | (3,123 | ) |   | $ | 5,431 |   | $ | (13,488 | ) |
| OTHER COMPREHENSIVE  INCOME (LOSS), NET OF INCOME TAX:                       |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Hedging activities:                                                          |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Reclassification adjustments for settled contracts                           |       |                                                     | 786        |                                                     |       |   | 354 |   |   | 1,808 |   | 484 |   |
| Changes in fair value of effective portion of  outstanding hedging positions |       |                                                     | (4,113     | )                                                        |       |   | — |   |   | (2,815 | ) | (2,740 | ) |
| Other  comprehensive income (loss)                                           |       |                                                     | (3,327     | )                                                        |       |   | 354 |   |   | (1,007 | ) | (2,256 | ) |
| Comprehensive income  (loss)                                                 |       |                                                     | $          | (3,003                                                   | )          |   |   | $ | (2,769 | ) |   | $ | 4,424 |   | $ | (15,744 | ) |

 

See notes to condensed consolidated financial statements.

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**VENOCO, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)(In thousands)**

| ** **                                                                                        | ** ** | **Six Months Ended June 30,**                    | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                                                        | ** ** | **     2006     ** | ** ** | **     2007     ** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                            |       |                                                                 |       |   |   |   |   |   |   |
| Net income (loss)                                                                                 |       |                                                                 | $          | 5,431 |   |   |   | $ | (13,488 | ) |   |
| Adjustments  to reconcile net income (loss) to net cash provided by operating activities:         |       |                                                                 |       |   |   |   |   |   |   |
| Depletion, depreciation  and amortization                                                         |       |                                                                 | 23,497     |   |   |   | 44,155 |   |   |
| Accretion of abandonment liability                                                                |       |                                                                 | 1,111      |   |   |   | 1,617 |   |   |
| Deferred income taxes (benefit)                                                                   |       |                                                                 | 658        |   |   |   | (8,800 | ) |   |
| Share-based compensation                                                                          |       |                                                                 | 1,309      |   |   |   | 2,600 |   |   |
| Amortization of deferred loan costs                                                               |       |                                                                 | 1,471      |   |   |   | 2,230 |   |   |
| Loss on extinguishment of debt                                                                    |       |                                                                 | —     |   |   |   | 12,063 |   |   |
| Amortization of bond discounts and other non-cash  interest                                       |       |                                                                 | 226        |   |   |   | 779 |   |   |
| Unrealized commodity derivative losses and  amortization of premiums and other comprehensive loss |       |                                                                 | 17,771     |   |   |   | 27,168 |   |   |
| Changes  in operating assets and liabilities:                                                     |       |                                                                 |       |   |   |   |   |   |   |
| Accounts receivable                                                                               |       |                                                                 | 3,407      |   |   |   | (6,648 | ) |   |
| Inventories                                                                                       |       |                                                                 | (424       | ) |   |   | 574 |   |   |
| Prepaid expenses and other current assets                                                         |       |                                                                 | 1,097      |   |   |   | 2,888 |   |   |
| Income tax receivable                                                                             |       |                                                                 | 241        |   |   |   | (680 | ) |   |
| Other assets                                                                                      |       |                                                                 | (736       | ) |   |   | (1,063 | ) |   |
| Accounts payable and accrued liabilities                                                          |       |                                                                 | 10,304     |   |   |   | 7,564 |   |   |
| Undistributed revenue payable                                                                     |       |                                                                 | (2,914     | ) |   |   | (1,773 | ) |   |
| Net premiums paid on derivative contracts                                                         |       |                                                                 | (5,982     | ) |   |   | (2,079 | ) |   |
| Net cash provided by operating activities                                                         |       |                                                                 | 56,467     |   |   |   | 67,107 |   |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                                            |       |                                                                 |       |   |   |   |   |   |   |
| Expenditures for oil and natural gas properties                                                   |       |                                                                 | (83,474    | ) |   |   | (149,024 | ) |   |
| Acquisitions of oil and natural gas properties                                                    |       |                                                                 | —     |   |   |   | (116,430 | ) |   |
| Expenditures for drilling equipment                                                               |       |                                                                 | (1,746     | ) |   |   | (129 | ) |   |
| Expenditures for other property and equipment                                                     |       |                                                                 | (1,554     | ) |   |   | (3,081 | ) |   |
| Proceeds from sale of oil and natural gas properties                                              |       |                                                                 | 3,031      |   |   |   | — |   |   |
| Acquisition of TexCal Energy, net of cash acquired                                                |       |                                                                 | (447,519   | ) |   |   | — |   |   |
| Net cash used in investing activities                                                             |       |                                                                 | (531,262   | ) |   |   | (268,664 | ) |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                                            |       |                                                                 |       |   |   |   |   |   |   |
| Proceeds from long-term debt                                                                      |       |                                                                 | 504,529    |   |   |   | 705,421 |   |   |
| Principal payments on long-term debt                                                              |       |                                                                 | (15,033    | ) |   |   | (492,303 | ) |   |
| Payments for deferred loan costs                                                                  |       |                                                                 | (14,180    | ) |   |   | (4,790 | ) |   |
| Premium to retire debt                                                                            |       |                                                                 | —     |   |   |   | (3,489 | ) |   |
| Proceeds from derivative premium financing                                                        |       |                                                                 | 3,903      |   |   |   | 1,676 |   |   |
| Proceeds from exercise of stock options                                                           |       |                                                                 | —     |   |   |   | 208 |   |   |
| Excess income tax benefits from share-based  compensation                                         |       |                                                                 | —     |   |   |   | 1,053 |   |   |
| Dividend paid to shareholder                                                                      |       |                                                                 | (426       | ) |   |   | — |   |   |
| Net cash provided by financing activities                                                         |       |                                                                 | 478,793    |   |   |   | 207,776 |   |   |
| Net (decrease) increase in cash and cash equivalents                                              |       |                                                                 | 3,998      |   |   |   | 6,219 |   |   |
| Cash and cash equivalents, beginning of period                                                    |       |                                                                 | 9,389      |   |   |   | 8,364 |   |   |
| Cash and cash equivalents, end of period                                                          |       |                                                                 | $          | 13,387 |   |   |   | $ | 14,583 |   |   |
| **Supplemental Disclosure of Cash  Flow Information—**                                       |       |                                                                 |       |   |   |   |   |   |   |
| Cash paid for interest                                                                            |       |                                                                 | $          | 8,239 |   |   |   | $ | 29,961 |   |   |
| Cash paid (received) for income taxes                                                             |       |                                                                 | $          | 2,702 |   |   |   | $ | 780 |   |   |
| **Supplemental Disclosure of  Noncash Activities—**                                          |       |                                                                 |       |   |   |   |   |   |   |
| Decrease (increase) in accrued capital expenditures                                               |       |                                                                 | $          | (355 | ) |   |   | $ | (3,210 | ) |   |
| Distribution of land and building                                                                 |       |                                                                 | $          | 13,399 |   |   |   | $ | — |   |   |
| Distribution of  building note payable                                                            |       |                                                                 | $          | 9,857 |   |   |   | $ | — |   |   |

 

See notes to condensed consolidated financial statements.

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**VENOCO, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

**1.**                 ORGANIZATIONAND NATURE OF OPERATIONS

***Description ofOperations—******Venoco,*** Inc. (the “Company”), a Delaware corporation, isengaged in the acquisition, exploration, exploitation and development of oiland natural gas properties with a focus offshore and onshore California and theGulf Coast of Texas.

***CondensedConsolidated Financial Statements—******The*** unauditedcondensed consolidated financial statements include the accounts of Venoco andits subsidiaries, all of which are wholly owned. The financial statements havebeen prepared in accordance with U.S. generally accepted accounting principlesfor interim financial reporting. All significant intercompany balances and transactionshave been eliminated in consolidation. In the opinion of management, allmaterial adjustments considered necessary for a fair presentation of theCompany’s interim results have been reflected. Venoco’s Annual Report on Form 10-Kfor the year ended December 31, 2006 includes certain definitions and asummary of significant accounting policies and should be read in conjunctionwith this report. The results for interim periods are not necessarilyindicative of annual results.

In the course of preparing the condensed consolidatedfinancial statements, management makes various assumptions, judgments andestimates to determine the reported amount of assets, liabilities, revenue andexpenses, and in the disclosures of commitments and contingencies. Changes inthese assumptions, judgments and estimates will occur as a result of thepassage of time and the occurrence of future events and, accordingly, actualresults could differ from amounts initially established. The more significantareas requiring the use of assumptions, judgments and estimates relate tovolumes of oil and gas reserves used in calculating depletion, the amount offuture net revenues used in computing the ceiling test limitations and theamount of future capital costs and abandonment obligations used in suchcalculations. Assumptions, judgments and estimates are also required indetermining impairments of undeveloped properties, valuing deferred tax assetsand estimating fair values of derivative instruments.

***Earnings Per Share—******Statement*** ofFinancial Accounting Standards No. 128, *EarningsPer Share,*requires presentation of “basic” and “diluted” earningsper share. Basic earnings per common share of stock is calculated by dividingnet income (loss) by the weighted average number of common shares outstandingduring each period. The weighted average number of common shares outstandingused to calculate basic net income (loss) per share excludes the effect ofnon-vested restricted shares subject to future vesting. As those restrictedshares vest, they will be included in the shares outstanding used to calculatebasic earnings per common share (although all restricted shares are issued andoutstanding upon grant). Diluted earnings per common share of stock iscalculated by dividing net income by the weighted average number of commonshares outstanding and other dilutive securities. The Company’s dilutivesecurities include non-qualified stock option awards.

The treasury stock method is used to measure thedilutive impact of stock options. The following table details the weightedaverage dilutive and anti-dilutive securities related to stock options for theperiods presented:

| ** **    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **    | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **    | ** ** | **2006**                         | ** ** | **2007**                       | ** ** | **2006** | ** ** | **2007** | ** ** |
| Dilutive      |       | 3,826,161                        |       | —                         |       | 3,556,161 |   | — |   |
| Anti-dilutive |       | 427,500                          |       | 4,765,913                      |       | 620,262 |   | 4,748,156 |   |

 

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Thefollowing table sets forth the calculation of basic and diluted earnings pershare (in thousands except per share amounts):

| ** **                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                   | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2007** | ** ** |
| Net income (loss)                                      |       | $                                          | 324        |                                     | $          | (3,123 | ) | $ | 5,431 |   | $ | (13,488 | ) |
| Adjustments to  net income for dilution                |       | —                                     |       | —                                   |       | — |   | — |   |
| Net income (loss) adjusted for the effect of  dilution |       | $                                          | 324        |                                     | $          | (3,123 | ) | $ | 5,431 |   | $ | (13,488 | ) |
| Basic weighted  average common shares outstanding      |       | 32,693                                     |       | 42,812                                   |       | 32,693 |   | 42,801 |   |
| Add: dilutive  effect of stock options                 |       | 1,477                                      |       | —                                   |       | 1,329 |   | — |   |
| Add: dilutive  effect of non-vested restricted stock   |       | —                                     |       | —                                   |       | — |   | — |   |
| Diluted weighted average common shares outstanding     |       | 34,170                                     |       | 42,812                                   |       | 34,022 |   | 42,801 |   |
| Basic earnings  per common share                       |       | $                                          | 0.01       |                                     | $          | (0.07 | ) | $ | 0.17 |   | $ | (0.32 | ) |
| Diluted earnings per  common share                     |       | $                                          | 0.01       |                                     | $          | (0.07 | ) | $ | 0.16 |   | $ | (0.32 | ) |

 

***Reclassifications—******The condensed***consolidatedstatements of operations were modified to combine commodity derivative gainsand losses into one caption. The components of the caption are disclosed in thefootnotes to the financial statements. This reclassification had no impact ontotal revenues. The condensed consolidated statement of cash flows was modifiedto segregate acquisitions of oil and natural gas properties from capitalexpenditures for oil and natural gas properties. This reclassification had noimpact on cash flows from operating, investing or financing activities.

***Recently AdoptedAccounting Pronouncement***

In June 2006, theFinancial Accounting Standards Board (“FASB”) issued Interpretation 48 (“FIN 48”),*Accounting for Uncertainties in Income Taxes*,an interpretation of FASB Statement No. 109,*Accounting for Income Taxes.*This interpretation addresseshow tax benefits claimed or expected to be claimed on a tax return should berecorded in the financial statements. Under FIN 48, the Company mayrecognize the tax benefit from an uncertain tax position only if it is morelikely than not that the tax position will be sustained on examination by thetaxing authorities based on the technical merits of the position. The taxbenefits recognized in the financial statements from such a position should bemeasured based on the largest benefit that has a greater than fifty percentlikelihood of being realized upon ultimate settlement. FIN 48 also providesguidance on derecognition, classification, interest and penalties on incometaxes, accounting in interim periods and requires increased disclosures.

The Company adopted theprovisions of FIN 48 as of January 1, 2007. As a result of theimplementation of FIN 48, the Company recognized a $3.8 millionreduction in prepaid income taxes for unrecognized tax benefits which wasoffset by a corresponding reduction to deferred income tax liabilities. Therewas no cumulative adjustment made to the opening balance of retained earningsat January 1, 2007. The Company had a liability for unrecognized taxbenefits of $3.8 million at January 1, 2007 and $4.5 million asof June 30, 2007. The Company’s uncertain tax positions relate primarilyto timing differences and management does not believe any such uncertain taxpositions will materially impact the Company’s effective tax rate in futureperiods.

The Company’s policy is torecognize interest and penalties related to uncertain tax positions as part ofincome tax expense. The Company has not incurred any significant interest andpenalties related to income tax filings.

The Company is subject totaxation at the federal and various state levels. The Company’s tax years 2002and forward are subject to examination by state tax authorities. The Company’sfederal income tax returns for the 2003 and 2004 tax years are currently underexamination by the Internal Revenue Service 

9

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(“IRS”)and tax years 2005 and 2006 remain open to examination. The Company hasreceived notices from the IRS relating to 2003 and 2004 in which the IRS hasindicated that it is seeking adjustments in an aggregate amount that wouldexceed the amounts accrued as of June 30, 2007. The Company is continuingto evaluate proposed adjustments from existing examinations and their effects inthe measurement of its uncertain tax positions. The Company does not believethat, when ultimately determined, the adjustments, if any, will materiallyexceed the accrued amount. The Company anticipates that approximately$1.3 million of uncertain tax positions will be recognized within the nexttwelve month period.

***New AccountingStandards***

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, “*Fair Value Measurements*” (“SFAS 157”).This statement clarifies the definition of fair value, establishes a frameworkfor measuring fair value, and expands the disclosures on fair valuemeasurements. SFAS 157 is effective for fiscal years beginning after November 15,2007. The Company has not determined the effect, if any, the adoption of thisstatement will have on its financial position or results of operations.

In February 2007, theFASB issued Statement of Financial Accounting Standards No. 159, “*The Fair Value Option for Financial Assets andFinancial Liabilities*” (“SFAS 159”). This statement permitsentities to choose to measure many financial instruments and certain otheritems at fair value. This statement expands the use of fair value measurementand applies to entities that elect the fair value option. The fair value optionestablished by this statement permits all entities to choose to measureeligible items at fair value at specified election dates. SFAS 159 is effectivefor fiscal years beginning after November 15, 2007. The Company has notdetermined the effect, if any, the adoption of this statement will have on itsfinancial position or results of operations.

**2.**                 ACQUISITIONS

*West Montalvo and Manvelacquisitions.**  *TheCompany acquired the West Montalvo field in Ventura County, California in May 2007for approximately $61.3 million. The Company acquired the Manvelfield in Brazoria County, Texas, and certain other fields in Texas, in April 2007 for$46.1 million.

*TexCal Energy Acquisition.**  *On March 31, 2006, the Companyacquired 100% of the members’ interest in TexCal Energy (LP) LLC (the “TexCalAcquisition”), an independent exploration and production company withproperties in Texas and California, for approximately $456.8 million incash and related financing costs of $14.4 million. TexCal’s operations arelocated entirely onshore and are concentrated in the Gulf Coast region of Texasand in the Sacramento Basin in California. The Company financed the acquisitionthrough loans advanced under a second amendment and restatement of its existingrevolving credit facility and a new senior secured second lien term loan facility.The purchase price was allocated to assets and liabilities, adjusted for taxeffects, based on their estimated fair values at the date of acquisition. Theacquisition was accounted for using the purchase method of accounting and hasbeen included in the Company’s consolidated financial statements as of the dateof the acquisition.

The cash considerationpaid for the TexCal Acquisition was allocated as follows (in thousands):

| ** **                              | ** ** | **Purchase Price  Allocation** | ** ** |
|-----------------------------------------|------------|-------------------------------------|------------|
| Current assets                          |       |                                | $          | 25,834 |   |   |
| Oil and natural  gas properties         |       |                                | 461,907    |   |   |
| Other non-current  assets               |       |                                | 1,018      |   |   |
| Current  liabilities                    |       |                                | (22,411    | ) |   |
| Long-term  asset retirement obligations |       |                                | (9,538     | ) |   |
| Cash consideration                      |       |                                | $          | 456,810 |   |   |

 

Thefollowing unaudited pro forma condensed consolidated operating results for thesix months ended June 30, 2006 and 2007 gives effect to the TexCalAcquisition (for the three months ended 

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March 31, 2006 only) and the West Montalvo andManvel acquisitions as if they had been completed as of January 1, 2006.The pro forma amounts shown below are not necessarily indicative of theoperating results that would have occurred if the transactions had occurred onsuch date. The pro forma adjustments made are based on certain assumptions thatthe Company believes are reasonable based on currently available information(in thousands except per share amounts) (unaudited).

| ** **                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                      | ** ** | **2007** | ** ** |
| ** **                         | ** ** | **Pro Forma**                            | ** ** | **Pro Forma** | ** ** |
| Total revenues                     |       | $                                             | 148,224    |   | $ | 147,911 |   |
| Net income (loss)                  |       | $                                             | 16,215     |   | $ | (11,431 | ) |
| Basic earnings  per common share   |       | $                                             | 0.50       |   | $ | (0.27 | ) |
| Diluted earnings per  common share |       | $                                             | 0.48       |   | $ | (0.27 | ) |

 

**3.**                 LONG-TERMDEBT

As ofthe dates indicated, the Company’s long-term debt consisted of thefollowing (in thousands):

| ** **                                      | ** ** | **December 31,  2006** | ** ** | **June 30,  2007** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Revolving credit  agreement due March 2009 |       |                        | $          | 30,579                  |       |   | $ | 95,000 |   |
| Second lien term  loan due March 2011      |       |                        | 348,882    |                    |       | — |   |
| New second lien  term loan due September 2011   |       |                        | —     |                    |       | 500,000 |   |
| 8.75% senior  notes due December 2011      |       |                        | 149,317    |                    |       | 149,385 |   |
| Financed  derivative premiums due 2008          |       |                        | 4,395      |                    |       | 4,014 |   |
| Total long-term debt                            |       |                        | 533,173    |                    |       | 748,399 |   |
| Less: current  portion of long-term debt        |       |                        | 3,557      |                    |       | 2,885 |   |
| Long-term debt,  net of current portion         |       |                        | $          | 529,616                 |       |   | $ | 745,514 |   |

 

*Seniornotes.**  *OnDecember 20, 2004, the Company issued $150.0 million in 8.75% seniornotes (the “senior notes”) due December 2011. Interest on the senior notesis due each June 15 and December 15. The senior notes are seniorobligations and contain covenants that, among other things, limit the Company’sability to make investments, incur additional debt, issue preferred stock,create liens or sell assets. The senior notes were issued as unsecured obligations,but became secured equally and ratably with the Company’s second lien term loanfacility on March 30, 2006. Upon the replacement of the Company’s secondlien term loan facility with a new second lien term loan facility in May 2007(see “—Second lien term loan facility”), the senior notes became securedequally and ratably with the new facility.

*Revolvingcredit facility.**  *TheCompany has a $300.0 million revolving credit facility with a syndicate ofbanks (“revolving credit facility”) with a maturity date of March 30,2009. At June 30, 2007, the revolving credit facility had a borrowing baseof $125.0 million, was secured by a first priority lien on substantially all ofthe Company’s oil and natural gas properties and other assets, including thestock of all of the Company’s subsidiaries, and was unconditionally guaranteedby each of the Company’s subsidiaries other than Ellwood Pipeline, Inc.The collateral also secured the Company’s obligations to hedging counterpartiesthat were also lenders, or affiliates of lenders, under the revolving creditagreement. Base Rate Loans under the revolving credit facility bear interest ata floating rate equal to (i) the greater of a market base rate and theovernight federal funds rate plus 0.50% plus (ii) an applicable marginranging from zero to 0.75%, based upon utilization. LIBO Rate Loans under therevolving credit facility bear interest at (i) LIBOR plus (ii) anapplicable margin ranging from 1.50% to 2.25%, based upon utilization. Acommitment fee ranging from 0.375% to 0.5% per annum is payable with respect tounused borrowing availability under the facility. The agreement governing thefacility contains customary representations, 

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warranties, events ofdefault, indemnities and covenants, including operational covenants thatrestrict the Company’s ability to incur indebtedness and financial covenantsthat require the Company to maintain specified ratios of EBITDA (as defined inthe agreement) to interest expense, current assets to current liabilities, debtto EBITDA and PV-10 to total debt. As of June 30, 2007, the Company hadavailable borrowing capacity of $29.3 million (net of $0.7 million inoutstanding letters of credit) under the revolving credit facility. A portionof the net proceeds from a public offering of common stock completed inJuly 2007 (See Note 6—Capital Stock and Stockholders’ Equity) wereused to repay the outstanding balance under the revolving credit facility of$95.0 million at June 30, 2007. After repayment of the outstandingbalance, the Company had available borrowing capacity of $124.3 million(net of $0.7 million in outstanding letters of credit).

*Secondlien term loan facility.**  *The Company entered into a $350.0 million seniorsecured second lien term loan facility in connection with the TexCalAcquisition. Principal on amounts borrowed under the facility was payable on March 30,2011. Optional prepayments were subject to a prepayment premium. In May 2007,the Company prepaid and replaced this facility with a new $500.0 million secondlien term loan facility. In connection with the settlement of the prior facility,the Company paid a prepayment premium of $3.5 million and wrote off relateddeferred loan costs of $8.6 million. Those amounts are reflected as loss onextinguishment of debt in the condensed consolidated statement of operations.

Of the total amount borrowed under the new facility,$350.5 million was used to repay all amounts outstanding under the priorfacility plus accrued interest, $3.5 million was used to pay a prepaymentpremium on those amounts and $4.6 million was used to pay transactioncosts associated with the new facility. The remaining borrowings were used toreduce amounts outstanding under the revolving credit facility.

Loans made under the new facility are designated, atthe Company’s option, as either “Base Rate Loans” or “LIBO Rate Loans.” BaseRate Loans bear interest at a floating rate equal to (i) the greater ofthe overnight federal funds rate plus 0.50% and a market base rate, plus (ii) 3.00%.LIBO Rate Loans bear interest at LIBOR plus 4.00%.

The new term loan agreement contains customaryrepresentations, warranties, events of default and indemnities and certaincustomary covenants, including covenants that restrict the Company’s ability toincur additional indebtedness. The new facility is secured by second priorityliens on substantially all of the Company’s oil and natural gas properties andother assets, including the stock of all of its subsidiaries, and isunconditionally guaranteed by each of the Company’s subsidiaries other thanEllwood Pipeline, Inc. Principal on the new facility is payable on May 8,2014. However, if the senior notes are not refinanced in full prior to September 20,2011, principal on the new facility will be payable on that date.

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The Company may from timeto time make optional prepayments of amounts borrowed under the new facility ifno amounts are outstanding under the revolving credit facility. Optionalprepayments made prior to May 8, 2008 are subject to a prepayment premiumof 2%. The premium will be reduced to 1% for prepayments made betweenMay 9, 2008 and May 8, 2009, after which no premium will be payablewith respect to any optional prepayment. Amounts prepaid under the new facilitymay not be reborrowed.

The Company was incompliance with all debt covenants at June 30, 2007, except that thepercentage of the Company’s 2008 and 2009 projected production from proveddeveloped properties that was hedged at June 30, 2007 exceeded limitationsin the Company’s credit facilities by 1% and 2%, respectively. Subsequent toJune 30, 2007 the Company settled certain hedge positions for these years(see Note 4) and is currently in compliance with the hedging limitationsin its credit facilities.

*Financed DerivativePremiums.**  *TheCompany entered into derivative contracts in 2006 and 2007 for options thatcontain provisions for the deferral of the payment or receipt of premiums untilthe period of production for which the derivative contract relates. Both the derivativeand the net liability for the payment of premiums were recorded at their fairvalues at the inception of the derivative contracts.

*Mortgage.**  *On December 9, 2004, 6267Carpinteria Avenue, LLC (“6267 Carpinteria”), which was then awholly-owned subsidiary of the Company, purchased an office building inCarpinteria, California for $14.2 million. The purchase was financed inpart by a secured 5.79% $10 million promissory note due January 1,2015. On March 22, 2006, the Company paid a dividend consisting of 100% ofthe membership interests in 6267 Carpinteria to its sole stockholder, atrust controlled by the Company’s CEO. The obligation for the 5.79% mortgage onthe office building owned by 6267 Carpinteria was transferred to the solestockholder in connection with the dividend.

**4.**                 HEDGING ANDDERIVATIVE FINANCIAL INSTRUMENTS

The Company utilizes swapand collar agreements and option contracts to hedge the effect of price changeson a portion of its future oil and natural gas production. The objective of theCompany’s hedging activities and the use of derivative financial instruments isto achieve more predictable cash flows. While the use of these derivativeinstruments limits the downside risk of adverse price movements, they alsolimit future revenues from favorable price movements. The use of derivativesalso involves the risk that the counterparties to such instruments will beunable to meet the financial terms of such contracts.

Thecomponents of commodity derivative losses in the condensed consolidated incomestatements are as follows (in thousands):

| ** **                                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                   | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2007** | ** ** |
| Realized  commodity derivative gains (losses)                                    |       | $                                          | (5,422     | )                                        | $          | (151 | ) | $ | (9,696 | ) | $ | 23 |   |
| Amortization of  commodity derivative premiums and other comprehensive loss |       | (1,305                                     | )          | (2,419                                   | )          | (3,093 | ) | (4,317 | ) |
| Unrealized commodity  derivative gains (losses):                                 |       |                                       |       |                                     |       |   |   |   |   |
| Change in fair value of derivatives that do not  qualify for hedge accounting    |       | (5,110                                     | )          | (5,861                                   | )          | (13,839 | ) | (22,964 | ) |
| Ineffective portion of derivatives qualifying for  hedge accounting              |       | (359                                       | )          | —                                   |       | (1,138 | ) | 113 |   |
| Total unrealized commodity derivative gains (losses)                             |       | (5,469                                     | )          | (5,861                                   | )          | (14,977 | ) | (22,851 | ) |
| Total realized and  unrealized commodity derivative gains (losses)               |       | $                                          | (12,196    | )                                        | $          | (8,431 | ) | $ | (27,766 | ) | $ | (27,145 | ) |

 

Theestimated fair values of derivatives included in the condensed consolidatedbalance sheets at December 31, 2006 and June 30, 2007 are summarizedbelow. The net fair value of the Company’s 

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derivatives decreased by $28.7 million from a netasset of $3.4 million at December 31, 2006 to a net liability of$25.3 million at June 30, 2007 due to higher prices for crude oil andnatural gas (in thousands):

| ** **                        | ** ** | **December 31,  2006** | ** ** | **June 30,  2007** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Derivative assets:                |       |                        |       |                    |       |   |   |
| Oil derivative  contracts         |       |                        | $          | 1,658                   |       |   | $ | 164 |   |
| Gas derivative  contracts         |       |                        | 17,281     |                    |       | 11,420 |   |
| Derivative liabilities:           |       |                        |       |                    |       |   |   |
| Oil derivative  contracts         |       |                        | (8,905     | )                       |       | (32,004 | ) |
| Gas derivative  contracts         |       |                        | (6,600     | )                       |       | (4,909 | ) |
| Net derivative asset  (liability) |       |                        | $          | 3,434                   |       |   | $ | (25,329 | ) |

 

Because a large portion ofthe Company’s commodity derivatives do not qualify for hedge accounting and toincrease clarity in its financial statements, the Company elected todiscontinue hedge accounting prospectively for its commodity derivativesbeginning April 1, 2007. Consequently, from that date forward, the Companywill recognize mark-to-market gains and losses in earnings currently, ratherthan deferring such amounts in accumulated other comprehensive income for thosecommodity derivatives that qualify as cash flow hedges. The net mark-to-marketloss on outstanding derivatives on the date the Company discontinued hedgeaccounting included in accumulated other comprehensive loss of$8.3 million ($5.1 million after tax) will be amortized into futureearnings as the original hedged transactions occur. This change in reportingwill have no impact on the Company’s reported cash flows, although futureresults of operations will be affected by mark-to-market gains andlosses which fluctuate with volatile oil and gas prices.

As of June 30, 2007,an unrealized derivative fair value loss of $7.7 million ($4.7 millionafter tax), related to derivative contracts previously designated as cash flowhedges, was recorded in accumulated other comprehensive loss. The Company willamortize net unrealized derivative losses of $4.5 million($2.8 million after tax) out of accumulated other comprehensive loss intoearnings during the next twelve months. 

*Crude Oil Agreements.**  *As of June 30, 2007, theCompany has entered into option, swap and collar agreements to receive averageminimum and maximum New York Mercantile Exchange (NYMEX) and West TexasIntermediate (WTI) prices as summarized below. Location and qualitydifferentials attributable to the Company’s properties are not included in thefollowing prices. The agreements provide for monthly settlement based on thedifferential between the agreement price and the actual NYMEX crude oil price.

| ** **                                                   | ** ** | **Minimum**     | ** ** | **Maximum**          | ** ** |
|--------------------------------------------------------------|------------|-----------------|------------|----------------------|------------|
| ** **                                                   | ** ** | **Barrels/day** | ** ** | **Avg. Prices** | ** ** | **Barrels/day** | ** ** | **Avg. Prices** | ** ** |
| Crude oil derivatives at June 30, 2007 for  production: |       |            |       |                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| July 1—December 31,  2007                     |       |            | 9,880      |                 |       |   | $ | 51.98 |   |   |   | 8,915 |   |   |   | $ | 73.08 |   |   |
| January 1—December 31,  2008                  |       |            | 8,250      |                 |       |   | $ | 58.85 |   |   |   | 8,250 |   |   |   | $ | 73.63 |   |   |
| January 1—December 31,  2009                  |       |            | 7,330      |                 |       |   | $ | 58.18 |   |   |   | 7,330 |   |   |   | $ | 74.78 |   |   |
| January 1—December 31, 2010                   |       |            | 6,150      |                 |       |   | $ | 61.10 |   |   |   | 6,150 |   |   |   | $ | 72.88 |   |   |
|                                                              |            |                 |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Natural Gas Agreements.**  *As of June 30, 2007, theCompany had entered into option, swap and collar agreements to receive averageminimum and maximum PG&E Citygate prices as follows:

| ** **                                                     | ** ** | **Minimum**   | ** ** | **Maximum**          | ** ** |
|----------------------------------------------------------------|------------|---------------|------------|----------------------|------------|
| ** **                                                     | ** ** | **MMBtu/Day** | ** ** | **Avg. Prices** | ** ** | **MMBtu/Day** | ** ** | **Avg. Prices** | ** ** |
| Natural gas derivatives at June 30, 2007 for  production: |       |          |       |                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| July 1—December 31,  2007                       |       |          | 34,375     |                 |       |   | $ | 6.74 |   |   |   | 28,685 |   |   |   | $ | 10.81 |   |   |
| January 1—December 31,  2008                    |       |          | 20,650     |                 |       |   | $ | 7.59 |   |   |   | 19,097 |   |   |   | $ | 11.27 |   |   |
| January 1—December 31,  2009                    |       |          | 14,625     |                 |       |   | $ | 7.65 |   |   |   | 14,625 |   |   |   | $ | 11.57 |   |   |
| January 1—December 31, 2010                     |       |          | 11,900     |                 |       |   | $ | 7.22 |   |   |   | 11,900 |   |   |   | $ | 10.57 |   |   |

 

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In August 2007, the Company reduced itsderivative position with respect to crude oil by 150 barrels per day in2008 and by 700 barrels per day in the first six months of 2009. The Companywill receive approximately $0.2 million from the counterparty related tothe settlement of these derivative contracts.

The Company entered intoan interest rate swap transaction during 2006 to lock in its interest cost on$200.0 million of borrowings under its second lien term loan facility throughMay 2008. The Company pays a fixed interest rate of 5.4225% and receives afloating interest rate based on the three-month LIBO rate. Settlementsare made quarterly. In June 2007, the Company entered into an additionalinterest rate swap relating to borrowings under the second lien term loan. Theswap fixes the interest rate on $300.0 million of borrowings through May 2008and on $500.0 million of borrowings from May 2008 through June 2010. TheCompany pays a fixed interest rate of 5.32% and receives a floating interestrate based on the three-month LIBO rate, with settlements made quarterly.As a result of these transactions, amounts borrowed under the second lien termloan facility will effectively bear interest at a fixed rate of approximately9.3% until June 2010 (including the 4.0% margin payable on borrowedamounts). The Company has not designated either interest rate swap as a hedge.The fair value liability of the interest rate swaps of $0.5 million at December 31,2006 and $0.7 million at June 30, 2007 has been recorded in accruedliabilities.

**5.      ASSET RETIREMENT OBLIGATIONS**

The Company’s asset retirement obligations primarilyrepresent the estimated present value of the amounts expected to be incurred toplug, abandon and remediate producing properties (including removal of certainonshore and offshore facilities) at the end of their productive lives inaccordance with applicable state and federal laws. The Company determines assetretirement obligations by calculating the present value of estimated cash flowsrelated to plugging and abandonment liabilities. The asset retirement liabilityis accreted to its present value each period and the capitalized assetretirement cost is depleted as a component of the full cost pool using theunits-of-production method.

The following table summarizes the activities for theCompany’s asset retirement obligations for the six months ended June 30,2006 and 2007 (in thousands):

| ** **                                                                                              | ** ** | **Six Months  Ended  June 30, 2006** | ** ** | **Six Months  Ended  June 30, 2007** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| Asset retirement  obligations at beginning of period                                                    |       |                                                | $          | 22,757                                              |       |   |   | $ | 42,049 |   |   |
| Revisions of  estimated liabilities                                                                     |       |                                                | 2,594      |                                                |       |   | 1,201 |   |   |
| Liabilities  incurred                                                                                   |       |                                                | 9,517      |                                                |       |   | 3,919 |   |   |
| Liabilities  settled                                                                                    |       |                                                | (5         | )                                                   |       |   | (52 | ) |   |
| Accretion expense                                                                                       |       |                                                | 1,111      |                                                |       |   | 1,617 |   |   |
| Asset retirement obligations at end of period                                                           |       |                                                | 35,974     |                                                |       |   | 48,734 |   |   |
| Less: current  asset retirement obligations (classified with accounts payable and accrued  liabilities) |       |                                                | (1,556     | )                                                   |       |   | (5,813 | ) |   |
| Long-term  asset retirement obligations                                                                 |       |                                                | $          | 34,418                                              |       |   |   | $ | 42,921 |   |   |

 

**6.      CAPITAL STOCK AND STOCKHOLDERS’ EQUITY**

All of the Company’s outstanding common stock wascontrolled by the Company’s CEO from December 2004 until August 2006, whenthe Company’s then sole stockholder, a trust affiliated with the CEO, donatedshares of stock to two charitable institutions. The Company issued and sold10,090,800 shares of its common stock in the fourth quarter of 2006 in aninitial public offering and received net proceeds of $160.4 million. TheCompany has 57.3 million shares of common stock issued or reserved for issuanceat June 30, 2007, including 7.5 million shares issued or reserved forissuance under the Company’s stock incentive plans. At June 30, 2007, theCompany has 43,020,332 common shares issued and 

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outstanding, of which212,882 shares are restricted stock granted under the Company’s 2005 stockincentive plan. At June 30, 2007, the Company had approximately 2.5million shares available to be issued pursuant to awards under its stockincentive plans.

In July 2007, the Company completed an additionalpublic offering of common stock in which it issued and sold 6,565,000 shares ofstock and received net proceeds of $116.1 million. The majority of the netproceeds from the offering were used to repay the outstanding balance under therevolving credit facility.

On March 22, 2006, the Company paid a dividendconsisting of 100% of its membership interest in 6267 Carpinteria to itsthen sole stockholder, a trust controlled by the Company’s CEO.6267 Carpinteria owns the office building and related land used by theCompany in Carpinteria, California. At the date of the dividend, 6267 Carpinteriahad net assets of $4.7 million, including $0.4 million in cash andland and building with a net book value of $13.4 million, and a notepayable of $9.9 million. The Company makes lease payments to 6267Carpinteria under a lease for the office building entered into prior to thedividend. The lease provides for minimum lease payments of approximately$1.1 million per year through 2019.

Venoco operates a property located in Carpinteria,California as a transit point for several of the Company’s offshore oil and gasproducing properties in the Santa Barbara Channel (the “Bluffs Property”).During the third quarter of 2006, the Company declared and paid a dividend onits common stock of 51 acres of real property at the Bluffs Property andentered into certain agreements with its then-sole stockholder and an affiliateof the stockholder, including a ground lease and a development agreementrelating to the property. Under the ground lease, which has a 20-year term, theCompany will lease the property for use in its oil and gas operations for rentof $1 per year. The stockholder’s affiliate has the right to require theCompany to consolidate its operations at a future date from an approximate 14 acrefootprint to 2 acres (the “consolidation”). If consolidation is requested, theCompany estimates that it will incur approximately $10 million in capitalcost to acquire and install new equipment to effect the consolidation. Afterthe consolidation is completed, the Company has the ability to enter into a newground lease for $1 per year for up to 99 years (effectively the remainingproductive life of the related offshore oil and gas producing properties).Independent third party appraisals were obtained which valued the unencumberedvalue of the land in excess of the Company’s historical cost of$10.3 million. In addition, the fair value of the property was appraisedat $5.0 million after taking into account the encumbrance for the groundlease and the time value of money for the consolidation. Therefore, the Companyrecorded a dividend of $5.0 million for the appraised value of theinterest conveyed and a retained leasehold interest of $5.3 million whichwill be amortized over the expected life of the ground lease of 20 years.

**7.      SHARE-BASED PAYMENTS**

The Company has granted options to directors, certainemployees and officers of the Company other than its CEO. As of June 30,2007, there are a total of 4,337,713 options outstanding with a weightedaverage exercise price of $9.06 ($6.00 to $20.00). The options vest over a fouryear period, with 20% vesting on the grant date and 20% vesting on eachsubsequent anniversary of the grant date. The options will generally vest upona change in control of the Company. The agreements with employee option holdersgenerally provide that all of the holder’s options will vest if the Companyterminates the holder’s employment, unless the termination is for specifiedtypes of misconduct. The agreements with director option holders provide thatany unvested options will terminate when the director’s service to the Companyceases.

During the quarter ended March 31, 2007, theCompany granted 212,882 shares of restricted stock under the Company’s 2005stock incentive plan, including 205,882 shares to its CEO. The restrictedshares have provisions similar to options granted under the Company’s stockincentive plan except that the restricted shares generally vest over a fouryear service period, subject to market conditions based on the Company’s totalshareholder return in comparison to peer group companies. At the end of thefour year service period, the Company may repurchase any unvested restrictedshares at $0.00001 per share.

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The following summarizes the Company’s stock optionactivity for the six months ended June 30, 2007:

| ** **                        | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-----------------------------------|------------|------------|------------|----------------------------------------|------------|
| Outstanding,  beginning of period |       | 4,740,663  |       |                                   | $          | 8.55 |   |   |
| Granted                           |       | 200,000    |       |                                   | 16.95      |   |   |
| Exercised                         |       | (487,850   | )          |                                   | 6.34       |   |   |
| Cancelled                         |       | (115,100   | )          |                                   | 12.97      |   |   |
| Outstanding, end  of period       |       | 4,337,713  |       |                                   | 9.06       |   |   |
| Exercisable, end of period        |       | 2,295,148  |       |                                   | $          | 7.96 |   |   |

 

The weighted average fair value of options grantedduring the six months ended June 30, 2007 was $7.58 per option. As of June 30,2007, there was $9.5 million of total unrecognized compensation cost related tostock options and restricted stock which is expected to be amortized over aweighted-average period of 3.0 years.

**8.      LITIGATION**

***Beverly Hills Litigation***

Between June 2003 and April 2005, sixlawsuits were filed against the Company and certain other energy companies inLos Angeles County Superior Court by persons who attended Beverly Hills HighSchool or who were or are citizens of Beverly Hills/Century City or visitors tothat area during the time period running from the 1930s to date. There areapproximately 1,000 plaintiffs (including plaintiffs in two related lawsuits inwhich the Company has not been named) who claim to be suffering from variousforms of cancer or other illnesses, fear they may suffer from such maladies inthe future, or are related to persons who have suffered from cancer or otherillnesses. Plaintiffs alleged that exposure to substances in the air, soil andwater that originated from either oil-field or other operations in the areawere the cause of the cancers and other maladies. The Company has owned an oiland natural gas facility adjacent to the school since 1995. For the majority ofthe plaintiffs, their alleged exposures occurred before the Company acquiredthe facility. All cases were consolidated before one judge. Twelve “representative”plaintiffs were selected to have their cases tried first, while all of theother plaintiffs’ cases were stayed. In November 2006, the judge enteredsummary judgment in favor of all defendants in the test cases, including theCompany. The judge dismissed all claims by the test case plaintiffs on theground that they offered no evidence of medical causation between the allegedemissions and the plaintiffs’ alleged injuries. Plaintiffs have appealed theruling. The Company vigorously defended the actions, and will continue to do sountil they are resolved. The Company also has defense and indemnity obligationsto certain other defendants in the actions who have asserted claims forindemnity for events occurring after the Company acquired the property in 1995.In addition, certain defendants have made claims for indemnity for eventsoccurring prior to 1995, which the Company is disputing. The Company cannotpredict the cost of defense and indemnity obligations at the present time.

One of the Company’s insurers currently is paying forthe defense of these lawsuits under a reservation of its rights. Three otherinsurers that provided insurance coverage to the Company (the “DecliningInsurers”) have taken the position that they are not required to providecoverage for losses arising out of, or to defend against, the lawsuits becauseof a pollution exclusion contained in their policies. The Beverly Hills UnifiedSchool District (the “District”), as an additional insured on those policies,brought a declaratory relief action against two of those insurers in LosAngeles County Superior Court. In November 2005, the court ruled in favorof one of the insurers and in February 2007, an appellate court affirmedthe decision of the Superior Court. In July 2006, the same Los AngelesCounty Superior Court 

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that ruled in favor of oneof the insurers denied a motion for summary judgment brought by another of theinsurers against the District on the issue of the insurer’s duty to defend. In February 2006,the Company filed its own declaratory relief action against the DecliningInsurers in Santa Barbara County Superior Court seeking a determination thatthose insurers have a duty to defend the Company in the lawsuits. The Companyhas entered into settlement agreements with two of the three DecliningInsurers. The action against the third Declining Insurer is ongoing. The policyissued by the insurer that currently is providing defense of the lawsuitscontains a pollution exclusion similar to that at issue in the actions broughtagainst the Declining Insurers. However, the Company has no reason to believethat the insurer currently providing defense of these actions will ceaseproviding such defense. If it does, and the Company is unsuccessful inenforcing its rights in any subsequent litigation, the Company may be requiredto bear the costs of the defense, and those costs may be material. If itultimately is determined that the pollution exclusion or another exclusion containedin one or more of the Company’s policies applies, it will not have theprotection of those policies with respect to any damages or settlement costsultimately incurred in the lawsuits.

In accordance with SFAS No. 5, Accounting forContingencies, the Company has not accrued for a loss contingency relating tothe Beverly Hills litigation because the Company believes that, althoughunfavorable outcomes in the proceedings may be reasonably possible, the Companydoes not consider them to be probable or reasonably estimable. If one or moreof these matters are resolved in a manner adverse to the Company, and ifinsurance coverage is determined not to be applicable, their impact on theCompany’s results of operations, financial position and/or liquidity could bematerial.

***Personal Injury Claim***

On March 31,2006, a complaint was filed in District Court in Madison County, Texas againsta subsidiary of the Company by the widow of an individual who was fatallyinjured while working as a gauger/pumper at a well operated by the subsidiary.The case as it relates to the Company and its subsidiary was settled in July 2007for an amount that was covered by the Company’s insurance. The Company paid animmaterial deductible in connection with the settlement.

***Landowner Dispute***

On May 28,1997, Arch W. Helton and Helton Properties, Inc. and later joined by LindaBarnhill (collectively “Helton parties”) filed a lawsuit against Tri-UnionDevelopment Corporation (“TDC”), Helton v. Tri-Union, in the 80th Judicial DistrictCourt of Harris County, Texas, alleging that TDC owed additional royalties onoil and natural gas produced beginning in February 1987 through theinitiation of the lawsuit with respect to 18 acres of property in Alvin, Texas.As to the Helton parties’ largest claim, TDC received a favorable decision fromthe Texas Railroad Commission, which has been upheld on appeal, including mostrecently by the 5th Circuit Court of Appeals in May 2007. The Heltonparties have indicated that no further appeals are planned. The Company expectsto receive the $1.1 million placed into escrow in connection with theaction. The Company had not received those funds as of June 30, 2007.

***Other***

In addition, the Company is subject from time to timeto other claims and legal actions that arise in the ordinary course ofbusiness. The Company believes that the ultimate liability, if any, withrespect to these other claims and legal actions will not have a materialadverse effect on its consolidated financial position, results of operations orliquidity.

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**9.      GUARANTOR FINANCIAL INFORMATION**

Company subsidiaries TexCal Energy (LP) LLC and its foursubsidiaries, BMC, Ltd., and Whittier Pipeline Corp. (“Guarantors”) have fullyand unconditionally guaranteed, on a joint and several basis, the Company’sobligations under the senior notes. The Company has one subsidiary, EllwoodPipeline, Inc., that is not a Guarantor (the “Non-Guarantor Subsidiary”).All Guarantors are 100% owned by the Company. Presented below are the Company’scondensed consolidating balance sheets, statements of operations and cash flowsas required by Rule 3-10 of Regulation S-X of the Securities Exchange Actof 1934.

**CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSTHREE MONTHS ENDED JUNE 30, 2006 (Unaudited)(in thousands)**

| ** **                                              | ** ** | ** **            | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------|------------|-----------------------|------------|------------------|------------|---------------------|------------|------------------|------------|------------------|------------|
| ** **                                              | ** ** | **Venoco, Inc.** | ** ** | **Subsidiaries** | ** ** | **Subsidiary**      | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **REVENUES:**                                           |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Oil and natural gas sales                               |       |                  | $          | 51,050           |       |                |       | $                | 25,053     |             |       |   | $ | — |   |   |   | $ | — |   |   |   | $ | 76,103 |   |   |
| Commodity derivative losses                             |       |                  | (12,196    | )                |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | (12,196 | ) |   |
| Other                                                   |       |                  | 1,426      |             |       |                | 129        |             |       |             | 1,203      |   |   |   | (1,092 | ) |   |   | 1,666 |   |   |
| Total revenues                                          |       |                  | 40,280     |             |       |                | 25,182     |             |       |             | 1,203      |   |   |   | (1,092 | ) |   |   | 65,573 |   |   |
| **EXPENSES:**                                           |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Oil and natural gas production                          |       |                  | 13,558     |             |       |                | 9,243      |             |       |             | 395        |   |   |   | — |   |   |   | 23,196 |   |   |
| Transportation expense                                  |       |                  | 1,771      |             |       |                | 60         |             |       |             | —     |   |   |   | (1,026 | ) |   |   | 805 |   |   |
| Depletion, depreciation and amortization                |       |                  | 11,301     |             |       |                | 5,481      |             |       |             | 21         |   |   |   | — |   |   |   | 16,803 |   |   |
| Accretion of abandonment liability                      |       |                  | 455        |             |       |                | 181        |             |       |             | 5          |   |   |   | — |   |   |   | 641 |   |   |
| General and administrative, net of amounts  capitalized |       |                  | 7,473      |             |       |                | 242        |             |       |             | 66         |   |   |   | (66 | ) |   |   | 7,715 |   |   |
| Amortization of deferred loan costs                     |       |                  | 1,133      |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 1,133 |   |   |
| Interest, net                                           |       |                  | 15,439     |             |       |                | (20        | )                |       |             | (563       | ) |   |   | — |   |   |   | 14,856 |   |   |
| Loss on extinguishment of debt                          |       |                  | —     |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |
| Total expenses                                          |       |                  | 51,130     |             |       |                | 15,187     |             |       |             | (76        | ) |   |   | (1,092 | ) |   |   | 65,149 |   |   |
| Equity in  subsidiary income                            |       |                  | 6,764      |             |       |                | —     |             |       |             | —     |   |   |   | (6,764 | ) |   |   | — |   |   |
| Income before  income taxes                             |       |                  | (4,086     | )                |       |                | 9,995      |             |       |             | 1,279      |   |   |   | (6,764 | ) |   |   | 424 |   |   |
| Income tax  provision                                   |       |                  | (4,410     | )                |       |                | 3,998      |             |       |             | 512        |   |   |   | — |   |   |   | 100 |   |   |
| Net income                                              |       |                  | $          | 324              |       |                |       | $                | 5,997      |             |       |   | $ | 767 |   |   |   | $ | (6,764 | ) |   |   | $ | 324 |   |   |

 

 

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**CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSTHREE MONTHS ENDED JUNE 30, 2007 (Unaudited)(in thousands)**

| ** **                                              | ** ** | ** **            | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------|------------|-----------------------|------------|------------------|------------|---------------------|------------|------------------|------------|------------------|------------|
| ** **                                              | ** ** | **Venoco, Inc.** | ** ** | **Subsidiaries** | ** ** | **Subsidiary**      | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **REVENUES:**                                           | ** ** |                  | ** ** | ** **       |       |                | ** ** | ** **       |       |             | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Oil and natural gas sales                               |       |                  | $          | 57,832           |       |                |       | $                | 32,675     |             |       |   | $ | — |   |   |   | $ | — |   |   |   | $ | 90,507 |   |   |
| Commodity derivative losses                             |       |                  | (8,431     | )                |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | (8,431 | ) |   |
| Other                                                   |       |                  | 617        |             |       |                | 35         |             |       |             | 1,232      |   |   |   | (1,132 | ) |   |   | 752 |   |   |
| Total revenues                                          |       |                  | 50,018     |             |       |                | 32,710     |             |       |             | 1,232      |   |   |   | (1,132 | ) |   |   | 82,828 |   |   |
| **EXPENSES:**                                           | ** ** |                  | ** ** | ** **       |       |                | ** ** | ** **       |       |             | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Oil and natural gas production                          |       |                  | 15,155     |             |       |                | 10,379     |             |       |             | 412        |   |   |   | — |   |   |   | 25,946 |   |   |
| Transportation expense                                  |       |                  | 2,558      |             |       |                | (89        | )                |       |             | —     |   |   |   | (1,062 | ) |   |   | 1,407 |   |   |
| Depletion, depreciation and amortization                |       |                  | 15,585     |             |       |                | 7,950      |             |       |             | 21         |   |   |   | — |   |   |   | 23,556 |   |   |
| Accretion of abandonment liability                      |       |                  | 594        |             |       |                | 247        |             |       |             | 3          |   |   |   | — |   |   |   | 844 |   |   |
| General and administrative, net of amounts  capitalized |       |                  | 6,714      |             |       |                | 524        |             |       |             | 70         |   |   |   | (70 | ) |   |   | 7,238 |   |   |
| Amortization of deferred loan costs                     |       |                  | 985        |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 985 |   |   |
| Interest, net                                           |       |                  | 16,699     |             |       |                | (26        | )                |       |             | (661       | ) |   |   | — |   |   |   | 16,012 |   |   |
| Loss on extinguishment of debt                          |       |                  | 12,063     |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 12,063 |   |   |
| Total expenses                                          |       |                  | 70,353     |             |       |                | 18,985     |             |       |             | (155       | ) |   |   | (1,132 | ) |   |   | 88,051 |   |   |
| Equity in  subsidiary income                            |       |                  | 9,218      |             |       |                | —     |             |       |             | —     |   |   |   | (9,218 | ) |   |   | — |   |   |
| Income (loss)  before income taxes                      |       |                  | (11,117    | )                |       |                | 13,725     |             |       |             | 1,387      |   |   |   | (9,218 | ) |   |   | (5,223 | ) |   |
| Income tax  provision (benefit)                         |       |                  | (7,994     | )                |       |                | 5,352      |             |       |             | 542        |   |   |   | — |   |   |   | (2,100 | ) |   |
| Net income (loss)                                       |       |                  | $          | (3,123           | )          |                |       | $                | 8,373      |             |       |   | $ | 845 |   |   |   | $ | (9,218 | ) |   |   | $ | (3,123 | ) |   |

 

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**CONDENSEDCONSOLIDATING STATEMENTS OF OPERATIONSSIX MONTHS ENDED JUNE 30, 2006 (Unaudited)(in thousands)**

| ** **                                              | ** ** | ** **            | ** ** | ** **       | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                              | ** ** | ** **            | ** ** | **Guarantor**    | ** ** | **Guarantor**  | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                              | ** ** | **Venoco, Inc.** | ** ** | **Subsidiaries** | ** ** | **Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **REVENUES:**                                           |       |                  |       |             |       |           |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Oil and natural gas sales                               |       |                  | $          | 100,931          |       |           |       | $                | 26,443     |             |       |   | $ | — |   |   |   | $ | — |   |   |   | $ | 127,374 |   |   |
| Commodity derivative losses                             |       |                  | (27,766    | )                |       |           | —     |             |       |             | —     |   |   |   | — |   |   |   | (27,766 | ) |   |
| Other                                                   |       |                  | 2,861      |             |       |           | 129        |             |       |             | 2,744      |   |   |   | (2,354 | ) |   |   | 3,380 |   |   |
| Total revenues                                          |       |                  | 76,026     |             |       |           | 26,572     |             |       |             | 2,744      |   |   |   | (2,354 | ) |   |   | 102,988 |   |   |
| **EXPENSES:**                                           |       |                  |       |             |       |           |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Oil and natural gas production                          |       |                  | 25,301     |             |       |           | 9,324      |             |       |             | 893        |   |   |   | — |   |   |   | 35,518 |   |   |
| Transportation expense                                  |       |                  | 3,411      |             |       |           | 60         |             |       |             | —     |   |   |   | (1,861 | ) |   |   | 1,610 |   |   |
| Depletion, depreciation and amortization                |       |                  | 17,902     |             |       |           | 5,500      |             |       |             | 95         |   |   |   | — |   |   |   | 23,497 |   |   |
| Accretion of abandonment liability                      |       |                  | 904        |             |       |           | 196        |             |       |             | 11         |   |   |   | — |   |   |   | 1,111 |   |   |
| General and administrative, net of amounts  capitalized |       |                  | 12,170     |             |       |           | 242        |             |       |             | 202        |   |   |   | (493 | ) |   |   | 12,121 |   |   |
| Amortization of deferred loan costs                     |       |                  | 1,471      |             |       |           | —     |             |       |             | —     |   |   |   | — |   |   |   | 1,471 |   |   |
| Interest, net                                           |       |                  | 19,653     |             |       |           | (20        | )                |       |             | (1,004     | ) |   |   | — |   |   |   | 18,629 |   |   |
| Loss on extinguishment of debt                          |       |                  | —     |             |       |           | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |
| Total expenses                                          |       |                  | 80,812     |             |       |           | 15,302     |             |       |             | 197        |   |   |   | (2,354 | ) |   |   | 93,957 |   |   |
| Equity in  subsidiary income                            |       |                  | 8,290      |             |       |           | —     |             |       |             | —     |   |   |   | (8,290 | ) |   |   | — |   |   |
| Income (loss)  before income taxes                      |       |                  | 3,504      |             |       |           | 11,270     |             |       |             | 2,547      |   |   |   | (8,290 | ) |   |   | 9,031 |   |   |
| Income tax  provision (benefit)                         |       |                  | (1,927     | )                |       |           | 4,508      |             |       |             | 1,019      |   |   |   | — |   |   |   | 3,600 |   |   |
| Net income (loss)                                       |       |                  | $          | 5,431            |       |           |       | $                | 6,762      |             |       |   | $ | 1,528 |   |   |   | $ | (8,290 | ) |   |   | $ | 5,431 |   |   |

 

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**CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS SIX MONTHS ENDED JUNE 30, 2007 (Unaudited) (in thousands)**

| ** **                                              | ** ** | ** **            | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------|------------|-----------------------|------------|------------------|------------|---------------------|------------|------------------|------------|------------------|------------|
| ** **                                              | ** ** | **Venoco, Inc.** | ** ** | **Subsidiaries** | ** ** | **Subsidiary**      | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **REVENUES:**                                           |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Oil and natural gas sales                               |       |                  | $          | 105,109          |       |                |       | $                | 59,037     |             |       |   | $ | — |   |   |   | $ | — |   |   |   | $ | 164,146 |   |   |
| Commodity derivative losses                             |       |                  | (27,145    | )                |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | (27,145 | ) |   |
| Other                                                   |       |                  | 1,299      |             |       |                | 37         |             |       |             | 2,415      |   |   |   | (2,186 | ) |   |   | 1,565 |   |   |
| Total revenues                                          |       |                  | 79,263     |             |       |                | 59,074     |             |       |             | 2,415      |   |   |   | (2,186 | ) |   |   | 138,566 |   |   |
| **EXPENSES:**                                           |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Oil and natural gas production                          |       |                  | 30,504     |             |       |                | 19,593     |             |       |             | 936        |   |   |   | — |   |   |   | 51,033 |   |   |
| Transportation expense                                  |       |                  | 5,328      |             |       |                | 2          |             |       |             | —     |   |   |   | (2,046 | ) |   |   | 3,284 |   |   |
| Depletion, depreciation and amortization                |       |                  | 29,765     |             |       |                | 14,355     |             |       |             | 35         |   |   |   | — |   |   |   | 44,155 |   |   |
| Accretion of abandonment liability                      |       |                  | 1,161      |             |       |                | 449        |             |       |             | 7          |   |   |   | — |   |   |   | 1,617 |   |   |
| General and administrative, net of amounts  capitalized |       |                  | 15,462     |             |       |                | 1,570      |             |       |             | 141        |   |   |   | (140 | ) |   |   | 17,033 |   |   |
| Amortization of deferred loan costs                     |       |                  | 2,230      |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 2,230 |   |   |
| Interest, net                                           |       |                  | 30,674     |             |       |                | (45        | )                |       |             | (1,290     | ) |   |   | — |   |   |   | 29,339 |   |   |
| Loss on extinguishment of debt                          |       |                  | 12,063     |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 12,063 |   |   |
| Total expenses                                          |       |                  | 127,187    |             |       |                | 35,924     |             |       |             | (171       | ) |   |   | (2,186 | ) |   |   | 160,754 |   |   |
| Equity in  subsidiary income                            |       |                  | 15,699     |             |       |                | —     |             |       |             | —     |   |   |   | (15,699 | ) |   |   | — |   |   |
| Income (loss)  before income taxes                      |       |                  | (32,225    | )                |       |                | 23,150     |             |       |             | 2,586      |   |   |   | (15,699 | ) |   |   | (22,188 | ) |   |
| Income tax  provision (benefit)                         |       |                  | (18,737    | )                |       |                | 9,028      |             |       |             | 1,009      |   |   |   | — |   |   |   | (8,700 | ) |   |
| Net income (loss)                                       |       |                  | $          | (13,488          | )          |                |       | $                | 14,122     |             |       |   | $ | 1,577 |   |   |   | $ | (15,699 | ) |   |   | $ | (13,488 | ) |   |

 

22

----

**CONDENSEDCONSOLIDATING BALANCE SHEETSAT DECEMBER 31, 2006(in thousands)**

| ** **                                         | ** ** | **Venoco, Inc.** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **ASSETS**                                         |       |                  |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| CURRENT ASSETS:                                    |       |                  |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                         |       | $                     | (12        | )                           |       | $                               | 8,358      |             |       |             | $          | 18 |   |   |   | $ | — |   |   |   | $ | 8,364 |   |   |
| Accounts  receivable                               |       | 24,894                |       |                        | 23,026     |                            |       |             | 122        |             |       |   | — |   |   |   | 48,042 |   |   |
| Inventories                                        |       | 3,150                 |       |                        | 61         |                            |       |             | —     |             |       |   | — |   |   |   | 3,211 |   |   |
| Prepaid expenses  and other current assets         |       | 5,753                 |       |                        | 1,473      |                            |       |             | —     |             |       |   | — |   |   |   | 7,226 |   |   |
| Income taxes  receivable                           |       | 8,098                 |       |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | 8,098 |   |   |
| Deferred income  taxes                             |       | 879                   |       |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | 879 |   |   |
| Commodity  derivatives                             |       | 10,348                |       |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | 10,348 |   |   |
| TOTAL CURRENT  ASSETS                              |       | 53,110                |       |                        | 32,918     |                            |       |             | 140        |             |       |   | — |   |   |   | 86,168 |   |   |
| PROPERTY,  PLANT & EQUIPMENT, NET         |       | 363,947               |       |                        | 431,198    |                            |       |             | 772        |             |       |   | (21,664 | ) |   |   | 774,253 |   |   |
| COMMODITY  DERIVATIVES                             |       | 8,591                 |       |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | 8,591 |   |   |
| INVESTMENTS IN  AFFILIATES                         |       | 562,104               |       |                        | —     |                            |       |             | —     |             |       |   | (562,104 | ) |   |   | — |   |   |
| OTHER                                              |       | 18,413                |       |                        | 5,768      |                            |       |             | —     |             |       |   | — |   |   |   | 24,181 |   |   |
| TOTAL ASSETS                                       |       | $                     | 1,006,165  |                        |       | $                               | 469,884    |             |       |             | $          | 912 |   |   |   | $ | (583,768 | ) |   |   | $ | 893,193 |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY** |       |                  |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| CURRENT LIABILITIES:                               |       |                  |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Accounts payable  and accrued  liabilities         |       | $                     | 48,319     |                        |       | $                               | 5,581      |             |       |             | $          | — |   |   |   | $ | — |   |   |   | $ | 53,900 |   |   |
| Undistributed revenue  payable                     |       | 7,831                 |       |                        | 7,765      |                            |       |             | —     |             |       |   | — |   |   |   | 15,596 |   |   |
| Interest payable                                   |       | 5,300                 |       |                        | (5         | )                               |       |             | —     |             |       |   | — |   |   |   | 5,295 |   |   |
| Current  maturities of long-term   debt            |       | 3,557                 |       |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | 3,557 |   |   |
| Commodity  derivatives                             |       | 8,574                 |       |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | 8,574 |   |   |
| TOTAL CURRENT   LIABILITIES:                       |       | 73,581                |       |                        | 13,341     |                            |       |             | —     |             |       |   | — |   |   |   | 86,922 |   |   |
| LONG-TERM  DEBT                                    |       | 529,616               |       |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | 529,616 |   |   |
| DEFERRED INCOME  TAXES                             |       | 40,424                |       |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | 40,424 |   |   |
| COMMODITY  DERIVATIVES                             |       | 6,931                 |       |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | 6,931 |   |   |
| ASSET RETIREMENT  OBLIGATIONS                      |       | 29,296                |       |                        | 9,408      |                            |       |             | 280        |             |       |   | — |   |   |   | 38,984 |   |   |
| INTERCOMPANY  PAYABLES (RECEIVABLES)               |       | 136,001               |       |                        | (104,837   | )                               |       |             | (31,164    | )                |       |   | — |   |   |   | — |   |   |
| TOTAL LIABILITIES                                  |       | 815,849               |       |                        | (82,088    | )                               |       |             | (30,884    | )                |       |   | — |   |   |   | 702,877 |   |   |
| TOTAL  STOCKHOLDERS’  EQUITY                  |       | 190,316               |       |                        | 551,972    |                            |       |             | 31,796     |             |       |   | (583,768 | ) |   |   | 190,316 |   |   |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY   |       | $                     | 1,006,165  |                        |       | $                               | 469,884    |             |       |             | $          | 912 |   |   |   | $ | (583,768 | ) |   |   | $ | 893,193 |   |   |

 

23

----

**CONDENSED CONSOLIDATING BALANCE SHEETSAT JUNE 30, 2007 (Unaudited)(in thousands)**

| ** **                                       | ** ** | ** **            | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | ** **       | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|------------------|------------|---------------------|------------|------------------|------------|------------------|------------|
| ** **                                       | ** ** | **Venoco, Inc.** | ** ** | **Subsidiaries** | ** ** | **Subsidiary**      | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **ASSETS:**                                      | ** ** | ** **            | ** ** |             | ** ** | ** **          |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| CURRENT ASSETS:                                  |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   | ** ** |   |
| Cash and cash equivalents                        |       | $                     | 9,440      |             |       | $                   | 5,143      |             |       |             | $          | — |   |   |   | $ | — |   |   |   | $ | 14,583 | ** ** |   |
| Accounts receivable                              |       | 33,020                |       |             | 21,548     |                |       |             | 122        |             |       |   | — |   |   |   | 54,690 | ** ** |   |
| Inventories                                      |       | 2,577                 |       |             | 60         |                |       |             | —     |             |       |   | — |   |   |   | 2,637 | ** ** |   |
| Prepaid expenses and other current  assets       |       | 2,976                 |       |             | 1,202      |                |       |             | —     |             |       |   | — |   |   |   | 4,178 | ** ** |   |
| Income taxes receivable                          |       | 3,275                 |       |             | 1          |                |       |             | —     |             |       |   | — |   |   |   | 3,276 | ** ** |   |
| Deferred income taxes                            |       | 4,042                 |       |             | —     |                |       |             | —     |             |       |   | — |   |   |   | 4,042 | ** ** |   |
| Commodity derivatives                            |       | 7,133                 |       |             | —     |                |       |             | —     |             |       |   | — |   |   |   | 7,133 | ** ** |   |
| TOTAL CURRENT  ASSETS                            |       | 62,463                |       |             | 27,954     |                |       |             | 122        |             |       |   | — |   |   |   | 90,539 | ** ** |   |
| PROPERTY, PLANT &  EQUIPMENT, NET       |       | 478,349               |       |             | 549,614    |                |       |             | 737        |             |       |   | (21,664 | ) |   |   | 1,007,036 | ** ** |   |
| COMMODITY DERIVATIVES                            |       | 4,451                 |       |             | —     |                |       |             | —     |             |       |   | — |   |   |   | 4,451 | ** ** |   |
| INVESTMENTS IN AFFILIATES                        |       | 587,841               |       |             | —     |                |       |             | —     |             |       |   | (587,841 | ) |   |   | — | ** ** |   |
| OTHER                                            |       | 13,662                |       |             | 5,728      |                |       |             | —     |             |       |   | — |   |   |   | 19,390 | ** ** |   |
| TOTAL ASSETS                                     |       | $                     | 1,146,766  |             |       | $                   | 583,296    |             |       |             | $          | 859 |   |   |   | $ | (609,505 | ) |   |   | $ | 1,121,416 | ** ** |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**   | ** ** | ** **            | ** ** |             | ** ** | ** **          |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| CURRENT LIABILITIES:                             |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   | ** ** |   |
| Accounts payable and accrued  liabilities        |       | $                     | 63,341     |             |       | $                   | 5,330      |             |       |             | $          | — |   |   |   | $ | — |   |   |   | $ | 68,671 | ** ** |   |
| Undistributed revenue payable                    |       | 5,917                 |       |             | 7,906      |                |       |             | —     |             |       |   | — |   |   |   | 13,823 | ** ** |   |
| Interest payable                                 |       | 4,389                 |       |             | —     |                |       |             | —     |             |       |   | — |   |   |   | 4,389 | ** ** |   |
| Current maturities of long-term debt             |       | 2,885                 |       |             | —     |                |       |             | —     |             |       |   | — |   |   |   | 2,885 | ** ** |   |
| Commodity derivatives                            |       | 13,768                |       |             | —     |                |       |             | —     |             |       |   | — |   |   |   | 13,768 | ** ** |   |
| TOTAL CURRENT  LIABILITIES                       |       | 90,300                |       |             | 13,236     |                |       |             | —     |             |       |   | — |   |   |   | 103,536 | ** ** |   |
| LONG-TERM DEBT                                   |       | 745,514               |       |             | —     |                |       |             | —     |             |       |   | — |   |   |   | 745,514 | ** ** |   |
| DEFERRED INCOME  TAXES                           |       | 27,866                |       |             | —     |                |       |             | —     |             |       |   | — |   |   |   | 27,866 | ** ** |   |
| COMMODITY  DERIVATIVES                           |       | 23,145                |       |             | —     |                |       |             | —     |             |       |   | — |   |   |   | 23,145 | ** ** |   |
| ASSET RETIREMENT  OBLIGATIONS                    |       | 30,050                |       |             | 12,584     |                |       |             | 287        |             |       |   | — |   |   |   | 42,921 | ** ** |   |
| INTERCOMPANY  PAYABLES (RECEIVABLES)             |       | 51,457                |       |             | (17,646    | )                   |       |             | (33,811    | )                |       |   | — |   |   |   | — | ** ** |   |
| OTHER LONG-TERM  LIABILITIES                     |       | —                |       |             | —     |                |       |             | —     |             |       |   | — |   |   |   | — | ** ** |   |
| TOTAL LIABILITIES                                |       | 968,332               |       |             | 8,174      |                |       |             | (33,524    | )                |       |   | — |   |   |   | 942,982 | ** ** |   |
| TOTAL  STOCKHOLDERS’ EQUITY                 |       | 178,434               |       |             | 575,122    |                |       |             | 34,383     |             |       |   | (609,505 | ) |   |   | 178,434 | ** ** |   |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY |       | $                     | 1,146,766  |             |       | $                   | 583,296    |             |       |             | $          | 859 |   |   |   | $ | (609,505 | ) |   |   | $ | 1,121,416 | ** ** |   |

 

24

----

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSSIX MONTHS ENDED JUNE, 2006 (Unaudited)(in thousands)**

| ** **                                                 | ** ** | ** **            | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|-----------------------|------------|------------------|------------|---------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Venoco, Inc.** | ** ** | **Subsidiaries** | ** ** | **Subsidiary**      | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                     |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Net cash provided by (used in) operating activities        |       |                  | $          | 51,334           |       |                |       | $                | 7,296      |             |       |   | $ | (2,163 | ) |   |   | $ | — |   |   |   | $ | 56,467 |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                     |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Expenditures for oil and natural gas properties            |       |                  | (69,434    | )                |       |                | (14,040    | )                |       |             | —     |   |   |   | — |   |   |   | (83,474 | ) |   |
| Acquisitions of oil and natural gas properties             |       |                  | —     |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |
| Expenditures for property  and equipment and other         |       |                  | (3,259     | )                |       |                | (41        | )                |       |             | —     |   |   |   | — |   |   |   | (3,300 | ) |   |
| Proceeds from sale of oil and natural gas properties       |       |                  | —     |             |       |                | 3,031      |             |       |             | —     |   |   |   | — |   |   |   | 3,031 |   |   |
| Investment in Texcal, net of cash received                 |       |                  | (456,810   | )                |       |                | 9,291      |             |       |             | —     |   |   |   | — |   |   |   | (447,519 | ) |   |
| Net cash provided by (used in) investing activities        |       |                  | (529,503   | )                |       |                | (1,759     | )                |       |             | —     |   |   |   | — |   |   |   | (531,262 | ) |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                     |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Net proceeds from (repayments of) intercompany  borrowings |       |                  | (9,615     | )                |       |                | 7,721      |             |       |             | 1,894      |   |   |   | — |   |   |   | — |   |   |
| Proceeds from long-term debt                               |       |                  | 504,529    |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 504,529 |   |   |
| Principal payments on long-term  debt                      |       |                  | (15,000    | )                |       |                | —     |             |       |             | (33        | ) |   |   | — |   |   |   | (15,033 | ) |   |
| Deferred loan costs                                        |       |                  | (14,180    | )                |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | (14,180 | ) |   |
| Premium to retire debt                                     |       |                  | —     |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |
| Proceeds from derivative premium financing                 |       |                  | 3,903      |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 3,903 |   |   |
| Proceeds from exercise of stock options                    |       |                  | —     |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |
| Payments of dividends                                      |       |                  | (426       | )                |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | (426 | ) |   |
| Net cash provided by (used in) financing activities        |       |                  | 469,211    |             |       |                | 7,721      |             |       |             | 1,861      |   |   |   | — |   |   |   | 478,793 |   |   |
| Net increase (decrease) in cash and cash equivalents       |       |                  | (8,958     | )                |       |                | 13,258     |             |       |             | (302       | ) |   |   | — |   |   |   | 3,998 |   |   |
| Cash and cash equivalents, beginning of period             |       |                  | 9,041      |             |       |                | —     |             |       |             | 348        |   |   |   | — |   |   |   | 9,389 |   |   |
| Cash and cash  equivalents, end of period                  |       |                  | $          | 83               |       |                |       | $                | 13,258     |             |       |   | $ | 46 |   |   |   | $ | — |   |   |   | $ | 13,387 |   |   |

 

25

----

**CONDENSEDCONSOLIDATING STATEMENT OF CASH FLOWSSIX MONTHS ENDED JUNE 30, 2007 (Unaudited)(in thousands)**

| ** **                                                      | ** ** | ** **            | ** ** | **Guarantor**    | ** ** | **Non-  Guarantor** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------------------------------------------|------------|-----------------------|------------|------------------|------------|---------------------|------------|------------------|------------|------------------|------------|
| ** **                                                      | ** ** | **Venoco, Inc.** | ** ** | **Subsidiaries** | ** ** | **Subsidiary**      | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                          |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Net cash provided by (used in) operating activities             |       |                  | $          | 35,150           |       |                |       | $                | 30,350     |             |       |   | $ | 1,607 |   |   |   | $ | — |   |   |   | $ | 67,107 |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                     |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Expenditures for oil and natural gas properties                 |       |                  | (69,064    | )                |       |                | (79,960    | )                |       |             | —     |   |   |   | — |   |   |   | (149,024 | ) |   |
| Acquisitions of oil and natural gas properties                  |       |                  | (66,776    | )                |       |                | (49,654    | )                |       |             | —     |   |   |   | — |   |   |   | (116,430 | ) |   |
| Expenditures for property and equipment and other               |       |                  | (2,945     | )                |       |                | (265       | )                |       |             | —     |   |   |   | — |   |   |   | (3,210 | ) |   |
| Proceeds from sale of oil and natural gas properties            |       |                  | —     |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |
| Net cash provided by (used in) investing activities             |       |                  | (138,785   | )                |       |                | (129,879   | )                |       |             | —     |   |   |   | — |   |   |   | (268,664 | ) |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                     |       |                  |       |             |       |                |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Net proceeds from (repayments of) intercompany  borrowings |       |                  | (94,689    | )                |       |                | 96,314     |             |       |             | (1,625     | ) |   |   | — |   |   |   | — |   |   |
| Proceeds from long-term debt                                    |       |                  | 705,421    |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 705,421 |   |   |
| Principal payments on long-term debt                            |       |                  | (492,303   | )                |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | (492,303 | ) |   |
| Deferred loan costs                                             |       |                  | (4,790     | )                |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | (4,790 | ) |   |
| Premium to retire debt                                          |       |                  | (3,489     | )                |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | (3,489 | ) |   |
| Proceeds from derivative premium financing                      |       |                  | 1,676      |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 1,676 |   |   |
| Proceeds from exercise of stock options                         |       |                  | 208        |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 208 |   |   |
| Excess income tax benefits from share-based  compensation       |       |                  | 1,053      |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | 1,053 |   |   |
| Payments of dividends                                           |       |                  | —     |             |       |                | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |
| Net cash used in financing activities                           |       |                  | 113,087    |             |       |                | 96,314     |             |       |             | (1,625     | ) |   |   | — |   |   |   | 207,776 |   |   |
| Net increase (decrease) in cash and cash  equivalents      |       |                  | 9,452      |             |       |                | (3,215     | )                |       |             | (18        | ) |   |   | — |   |   |   | 6,219 |   |   |
| Cash and cash equivalents, beginning of period                  |       |                  | (12        | )                |       |                | 8,358      |             |       |             | 18         |   |   |   | — |   |   |   | 8,364 |   |   |
| Cash and cash  equivalents, end of period                       |       |                  | $          | 9,440            |       |                |       | $                | 5,143      |             |       |   | $ | — |   |   |   | $ | — |   |   |   | $ | 14,583 |   |   |

 

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**Item 2.**                        MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATION

The following discussionand analysis should be read in conjunction with “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” contained in ourAnnual Report on Form 10-K for the year ended December 31, 2006as well as with the financial statements and related notes and the otherinformation appearing elsewhere in this report. As used in this report, unlessthe context otherwise indicates, references to “we,” “our,” “ours,” and “us”refer to Venoco, Inc. and its subsidiaries collectively.

**Overview**

We are an independentenergy company primarily engaged in the acquisition, exploration, exploitationand development of oil and natural gas properties. Our strategy is to growthrough exploration, exploitation and development projects we believe to berelatively low risk and through selective acquisitions of underdevelopedproperties. Our average net production was 19,628 BOE/d in the second quarterof 2007, compared to 17,670 BOE/d in the first quarter of 2007 and 17,114 BOE/din the second quarter of 2006. We expect further increases in our productionthrough the remainder of 2007. See “—Trends Affecting Our Results ofOperations.”

***Recent Developments***

*PublicEquity Offering.**  *InJuly 2007, we completed a public offering in which we sold 6,565,000shares of our common stock (including shares sold pursuant to the underwriters’over-allotment option) and received net proceeds of $116.1 million. We used aportion of the proceeds of the offering to repay all amounts outstanding underour revolving credit facility and will use the remainder to fund our 2007capital expenditure program.

*SouthEllwood Sales Agreement.**  *In June 2007, we entered into an agreementpursuant to which we sell oil production from our South Ellwood field to theoperator of a refinery in Long Beach, California. The production is deliveredto Long Beach by the barge that services the field. The agreement has a term ofone year and provides for a price based on a fixed differential to the NYMEXprice for light sweet crude. Pursuant to the agreement, we expect to haveaccess to a second barge to make deliveries of oil production from the fieldwhen the barge we currently use is unavailable. Use of the second barge will besubject to receipt of necessary permits and approvals, and we cannot assure youthat those permits and approvals will be obtained.

*Newand Amended Credit Facilities.**  *In May 2007, we entered into (i) anew second lien term loan agreement to refinance and replace our existingsecond lien term loan facility and (ii) a fifth amendment to the secondamended and restated credit agreement governing our revolving credit facility. See“Liquidity and Capital Resources—Capital Resources and Requirements.”

*Asset Acquisitions.**  *In April and May of 2007,we consummated two acquisitions of properties in Texas and Southern California.As of December 31, 2006, the acquired properties had aggregate provedreserves of approximately 9.7 MMBOE. See “—Acquisitions.”

***Capital Expenditures***

We have developed anactive capital expenditure program to systematically exploit our extensiveinventory of drilling prospects and other projects. We expect that ourexploration, exploitation and development capital expenditures will be approximately$270.0 million in 2007, of which $150.1 million was spent in the firsthalf of the year. During 2007, we anticipate drilling between 140 and 165 grosswells, up from 70 gross wells drilled in 2006. We currently estimate ourinventory of drilling locations to be in excess 

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of 650.The following summarizes certain significant aspects of our capital spendingprogram to date in 2007:

*Coastal California—Exploitationand Development*

In the Coastal Californiaarea, we are focusing on the commencement of development activities in therecently-acquired West Montalvo field and have initiated a workover andrecompletion program on existing wells in the field. On platform Grace in theSanta Clara field, facilities construction is nearing completion and we expectto begin drilling operations in the third quarter. In the Sockeye field, we arecontinuing to implement our waterflood program from platform Gail and areworking on the evaluation and design of a possible expansion of the program. Weare also continuing to evaluate a possible expansion of our horizontal-welldrilling activities to the Monterey formation in the Sockeye field. In theSouth Ellwood field, the permitting process for a full-field developmentproject, including a lease extension, is continuing. We currently expect toreceive the draft environmental impact report for the project during the thirdquarter of 2007 and are anticipating final project approval in late 2008.However, we cannot assure you that the project approval will be obtained on theschedule we anticipate or at all.

*Sacramento Basin—Exploitationand Development*

In the Sacramento Basin,we continue to pursue our infill drilling program in the greater Grimes andWillows fields. We spudded 69 wells in the basin in the first six months of2007 and are on course to drill more than 120 wells for the year, as planned.In addition, we expect to achieve our target of 100 workovers and/orrecompletions performed in the basin during the year. We continue to test andevaluate potential downspacing opportunities as well as new methods ofimproving productivity and reducing drilling costs. As of June 30, 2007,our acreage position in the basin had grown to approximately 168,000 net acres(195,000 gross).

*Texas—Exploitationand Development*

In Texas, we havecontinued our workover and recompletion program in the Hastings complex,focusing primarily on increasing lift capacity through electrical submersiblepump conversions and improving water handling/injection capability. Inaddition, we spudded three infill replacement wells in the Hastings complex inthe first half of 2007. Two additional replacement wells are planned withpotential for an additional 15 to 20 wells depending on the success of theinitial program. Also, we initiated a workover and recompletion program in therecently-acquired Manvel field that is similar to the ongoing program in theHastings complex.

*Higher ImpactExploration Activities*

We expect to drill approximately nine higher impactexploration wells in 2007, including six in the Sacramento Basin, two inCoastal California and one in Texas. We drilled one well in this category inthe first half of the year, a successful well in the Sacramento Basin. Fivehigher impact exploration wells are expected to spud in the third quarter,including two in Coastal California and three in the Sacramento Basin.

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Theaggregate levels of capital expenditures for 2007, and the allocation of thoseexpenditures, are dependent on a variety of factors, including the availabilityof capital resources to fund the expenditures, the availability of servicecontractors and equipment, permitting issues, weather, limits on the number ofactivities that can be conducted at any one time on our offshore platforms andchanges in our business assessments as to where our capital can be mostprofitably employed. Accordingly, the actual levels of capital expenditures andthe allocation of those expenditures may vary materially from the estimatesdescribed above.

***Acquisitions***

*TexCalTransaction.**  *Weacquired TexCal Energy on March 31, 2006 for $456.8 million in cash.The acquisition is consistent with our strategy of acquiring large, maturefields with established reserves and significant exploitation and developmentpotential, and provided us with substantial additions to our multi-yeardrilling inventory.

*WestMontalvo and Manvel Acquisitions.**  *We acquired the West Montalvo fieldin Ventura County, California in May 2007 for approximately $61.3 million.The field includes an offshore portion that is reachable from onshorelocations. We acquired the Manvel field in Brazoria County, Texas, and certainrelated fields, in April 2007 for $46.1 million. We believe that theManvel field provides us with exploitation and development opportunities thatare similar to those in the Hastings complex, which is nearby and geologicallysimilar. We believe that both the West Montalvo and Manvel fields may besuitable for CO2 flooding.

*Other.**  *We have an active acreageacquisition program and we regularly engage in acquisitions (and, to a lesserextent, dispositions) of oil and natural gas properties in and around ourexisting core areas of operations.

***Trends Affecting our Results of Operations***

*Expected2007 Production.**  *Weexpect that execution of our capital expenditure program in 2007 and theacquisitions we completed in the second quarter will result in a significantincrease in our average net production for 2007 relative to 2006. We intend tofocus our efforts on the execution of development and workover/recompletionprograms in the Sacramento Basin, Texas and the fields we acquired in thesecond quarter, and maintenance of production from the majority of our otherproperties at rates consistent with year-end 2006 levels. We are pursuing amulti-year drilling program in the Sacramento Basin and plan to drill more than120 wells there in 2007. In the Hastings complex, we are continuing our activeworkover and recompletion program and expect to do so throughout 2007. Inaddition, we initiated a five-well replacement well pilot program in theHastings complex in the second quarter and expect to be in a position to assessthe results of the program in the third quarter. If the pilot program issuccessful, we plan to drill up to 15 additional replacement wells in thesecond half of 2007. We have also implemented development and workover programson our recently acquired assets. These programs are expected to show productiongains by the end of the year. Our expectations with respect to futureproduction rates are subject to a number of uncertainties, including thoseassociated with the availability and cost of rigs and third party services, oiland natural gas prices, the potential for mechanical problems or other eventsresulting in unexpected downtime, permitting issues, drilling success rates,pipeline capacity, the accuracy of our assumptions regarding the sustainabilityof historical growth rates and the performance of existing wells, weather andother factors, including those referenced in “Risk Factors.”

*ProductionExpenses.**  *Productionexpenses decreased to $14.53 per BOE in the second quarter of 2007 from $15.78per BOE in the first quarter 2007, due primarily to a reduction in remedialwork conducted in the Hastings complex and lower production in the firstquarter from the South Ellwood field that resulted from a temporary disruptionin barge deliveries and additional maintenance work that was 

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performed during theshut-in period. We expect that the amount of remedial work conducted in theHastings complex during the second half of 2007 will be substantially less thanin the first half. Also, we continue to add production from our lower operatingcost gas wells in the Sacramento Basin. These factors are expected to result inour 2007 production expenses continuing to trend downward on a per BOE basis.Our expectations with respect to future per-unit expenses are based in part onthe projected increases in our production described in the preceding paragraphand are subject to numerous risks and uncertainties, including those describedand referenced therein.

*Generaland Administrative Expenses.**  *General and administrative expenses decreased to $4.05per BOE in the second quarter of 2007 from $6.16 per BOE in the first quarterof 2007, due primarily to the increase in production quarter over quarter andan increase in the proportion of  generaland administrative expenses capitalized in connection with our 2007 development, exploitation, exploration andacquisition activities. In order to manage and maximize our growth, we havebeen increasing our professional staff and related infrastructure, which hasresulted in increased general and administrative costs. Many of our employeesare involved directly in our development, exploitation, exploration andacquisition activities and, therefore, a portion of the overhead related tothese employees is capitalized. While we expect our overall general andadministrative costs to be higher in 2007 than 2006, on a per BOE basis, weexpect that those expenses will decline in 2007 relative to 2006. As withproduction expenses, our expectations in this regard are based in part on ourprojected increases in production, which are subject to numerous risks anduncertainties. In addition, we have not to date fully quantified the expenseswe expect to incur with respect to Sarbanes-Oxley Act compliance, and thoseexpenses may be significant.

*Unrealized CommodityDerivative Gains and Losses.**  *Rising oil and natural gas prices created substantialunrealized commodity derivative losses in the first half of 2007, whilefluctuating oil prices and lower natural gas prices led to unrealized commodityderivative gains in 2006. These unrealized gains and losses resulted frommark-to-market valuations for non-highly effective or ineffective portions ofour derivative positions and are reflected as unrealized commodity derivativegains or losses in our income statement. Payments actually due to or fromcounterparties in the future on these derivatives will typically be offset bycorresponding changes in prices ultimately received from the sale of ourproduction. We may incur significant gains or losses of this type for theremainder of 2007 and in subsequent years. As described in Note 4 to thecondensed consolidated financial statements included in this report, wediscontinued hedge accounting as of April 1, 2007. This may increasevolatility in gains and losses of this type in subsequent periods.

***Internal Control Over Financial Reporting***

In November 2005, werestated the financial statements included in our Quarterly Reports on Form 10-Qfor the first two quarters of 2005. In addition, historically we operated witha relatively small number of employees in the accounting and financialreporting area. If we had previously conducted an assessment of our internalcontrols under the standards set forth in Section 404 of the Sarbanes-OxleyAct and related rules, either or both of these factors likely would have led usto conclude that we had one or more material weaknesses in our internalcontrols. In addition, our outside auditors, in the performance of their 2005and 2006 audits, concluded that material weaknesses in our internal controlsexisted in 2005 and 2006. We have taken a variety of actions to address theseissues, including the adoption of more extensive accounting controls andfinancial review procedures and the hiring of additional accounting staff. Asubstantial part of our efforts in this regard in 2006 focused on the design ofa more comprehensive system of internal controls. We are focusing on theimplementation and testing of this system in 2007.

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***Results of Operations***

Thefollowing table reflects the components of our oil and natural gas productionand sales prices and sets forth our operating revenues, costs and expenses on aBOE basis for the three and six months ended June 30, 2006 and 2007.

| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                        | ** ** | **2007**                                      | ** ** | **2006** | ** ** | **2007** | ** ** |
| **Production Volume:**                        | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Oil (MBbls)                                   |       | 907                                             |       | 1,006                                         |       | 1,606 |   | 1,889 |   |
| Natural gas (MMcf)                            |       | 3,902                                           |       | 4,681                                         |       | 5,764 |   | 8,925 |   |
| MBOE                                          |       | 1,557                                           |       | 1,786                                         |       | 2,567 |   | 3,377 |   |
| **Daily Average Production  Volume:**         | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Oil (Bbls/d)                                  |       | 9,967                                           |       | 11,055                                        |       | 9,982 |   | 10,436 |   |
| Natural gas  (Mcf/d)                          |       | 42,880                                          |       | 51,440                                        |       | 42,031 |   | 49,309 |   |
| BOE/d                                         |       | 17,114                                          |       | 19,628                                        |       | 16,987 |   | 18,654 |   |
| **Oil Price per Bbl Produced (in  dollars):** | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Realized price  before hedging gain (loss)    |       | $                                               | 61.50      |                                          | $          | 56.37 |   | $ | 57.31 |   | $ | 53.04 |   |
| Realized hedging  gain (loss)                 |       | (9.38                                           | )          | (0.10                                         | )          | (8.83 | ) | 0.11 |   |
| Net realized                                  |       | $                                               | 52.12      |                                          | $          | 56.27 |   | $ | 48.48 |   | $ | 53.15 |   |
| **Natural Gas Price per Mcf (in  dollars):**  | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Realized price  before hedging gain (loss)    |       | $                                               | 5.76       |                                          | $          | 6.96 |   | $ | 6.36 |   | $ | 7.04 |   |
| Realized hedging  gain (loss)                 |       | 0.46                                            |       | (0.01                                         | )          | 0.24 |   | (0.02 | ) |
| Net realized                                  |       | $                                               | 6.22       |                                          | $          | 6.95 |   | $ | 6.60 |   | $ | 7.02 |   |
| **Average Sale Price per BOE**                |       | $                                               | 43.12      |                                          | $          | 48.42 |   | $ | 44.15 |   | $ | 47.09 |   |
| **Expense  per BOE:**                         | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Production  expenses(1)                       |       | $                                               | 14.90      |                                          | $          | 14.53 |   | $ | 13.84 |   | $ | 15.11 |   |
| Transportation  expenses                      |       | 0.52                                            |       | 0.79                                          |       | 0.63 |   | 0.97 |   |
| Depreciation,  depletion and amortization     |       | 10.79                                           |       | 13.19                                         |       | 9.15 |   | 13.08 |   |
| General and  administrative expense(2)        |       | 4.96                                            |       | 4.05                                          |       | 4.72 |   | 5.04 |   |
| Interest expense, net                         |       | 9.54                                            |       | 8.97                                          |       | 7.26 |   | 8.69 |   |

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(1)          Production expenses arecomprised of oil and natural gas production expenses and production taxes.

(2)          Netof amounts capitalized.

***Comparison of Quarter Ended June 30, 2006 toQuarter Ended June 30, 2007***

*Oiland Natural Gas Revenues.**  *Oil and natural gas revenues increased $14.4 million(19%) to $90.5 million for the quarter ended June 30, 2007 from $76.1million for the same period in 2006. The increase was primarily due to a 15%increase in production and a 12% increase in our average realized sale priceper BOE.

Oil revenues increased by $4.3 million (8%) in thesecond quarter of 2007 to $57.9 million, compared to $53.6 million in thesecond quarter of 2006. Oil production rose 11%, with production of 1,006 MBblin the second quarter of 2007 compared to 907 MBbl in the second quarter of2006. The increase was attributable to our successful workover program in theHastings complex and production from the West Montalvo and Manvel fields. Ouraverage realized price for oil decreased $5.13 (8%), to $56.37 per Bbl for theperiod.

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Natural gas revenues increased $10.1 million in thesecond quarter of 2007 (45%) to $32.6 million compared to $22.5 million in thesecond quarter of 2006. Natural gas production increased 20%, with production of4,681 MMcf compared to 3,902 MMcf in the second quarter of 2006. The majorityof the increase was due to our drilling program in the Sacramento Basin. Ouraverage realized price for natural gas increased $1.20 (21%) to $6.96 per Mcffor the period.

*Commodity Derivatives andOther Revenues.**  *Thefollowing table sets forth the components of commodity derivative losses, netin our condensed consolidated statements of operations for the periodsindicated (in thousands):

| ** **                                                        | ** ** | **Three Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                        | ** ** | **2006**                                        | ** ** | **2007** | ** ** |
| Realized  commodity derivative losses                             |       | $                                               | (5,422     | ) | $ | (151 | ) |
| Unrealized  commodity derivative losses                           |       | (5,469                                          | )          | (5,861 | ) |
| Amortization of  derivative premiums and other comprehensive loss |       | (1,305                                          | )          | (2,419 | ) |
| Total                                                             |       | $                                               | (12,196    | ) | $ | (8,431 | ) |

 

Realized commodity derivative gains or losses representthe difference between the strike price in the contracts settled during theperiod and the ultimate settlement prices. The decrease in commodity derivativelosses in the 2007 period reflects the settlement of contracts at prices closerto the strike price than the contracts settled in 2006. Unrealized commodityderivative gains or losses represent the change in the fair value of our openderivative contracts from period to period. The increase in unrealizedcommodity derivative losses in the 2007 period reflects an increase in thenumber of derivative contracts outstanding as well as an increase in thefutures prices used to estimate the fair value of those contracts at the end ofthe period. Derivative premiums are amortized over the term of the underlyingderivative contracts. The increase in amortization of derivative premiums andother comprehensive losses in the 2007 period reflects additional premiums paidin connection with the additional contracts outstanding in the 2007 period andamortization of other comprehensive loss in the 2007 period.

Other revenue decreased 55%, from $1.7 million in thesecond quarter of 2006 to $0.8 million in the second quarter of 2007. Thedecrease was primarily due to lower transportation income received from purchasersof oil production from the South Ellwood field.

As a result of the foregoing factors, total revenuesincreased $17.2 million (26%) to $82.8 million in the second quarter of 2007,compared to $65.6 million in the second quarter of 2006.

*ProductionExpenses.**  *Productionexpenses increased $2.7 million (12%) to $25.9 million in the second quarter of2007 from $23.2 million in the second quarter of 2006. The increase wasprimarily due to costs associated with new wells drilled in the SacramentoBasin in the first and second quarters of 2007 and workovers in the Hastingscomplex. On a per unit basis, production expenses declined to $14.53 per BOE inthe second quarter of 2007 compared to $14.90 per BOE in the same period in2006. This decrease was attributable to increased production from lower costwells in the Sacramento Basin and additional production resulting from ourworkover programs.

*TransportationExpenses.**  *Transportationexpenses increased 75%, from $0.8 million in the second quarter of 2006 to $1.4million in the second quarter of 2007. This was primarily attributable toincreased transportation costs for barge deliveries. On a per BOE basis,transportation expenses increased $0.27 per BOE, from $0.52 per BOE in thesecond quarter of 2006 to $0.79 per BOE in the second quarter of 2007.

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*Depletion,Depreciation and Amortization (DD&A).**  *DD&A expense increased $6.8million (40%) to $23.6 million in the second quarter of 2007 from $16.8 millionin the second quarter of 2006. DD&A expense rose $2.40 per BOE, from $10.79per BOE in the second quarter of 2006 to $13.19 per BOE in the second quarterof 2007. The increase was primarily due to the increase in oil and natural gasproperty costs during the quarter resulting from our capital expenditureprogram and properties acquired in the 2007 period.

*Accretionof Abandonment Liability.**  *Accretion expense was $0.8 million in the secondquarter of 2007 compared to $0.6 million in the second quarter of 2006. Theincrease was due to accretion from new liabilities incurred in connection withthe Sacramento Basin drilling program and the addition of new propertiesacquired in the second quarter.

*Generaland Administrative (G&A).**  *G&A expense decreased $0.5million to $7.2 million in the second quarter of 2007 from $7.7 million in thesecond quarter of 2006. Increases in our professional staff and relatedinfrastructure costs were offset by an increase in general and administrativecosts that were capitalized for payroll and related overhead for activitiesthat are involved directly in our development, exploitation, exploration andacquisition efforts. Non-cash SFAS 123R share-based compensation expense increasedfrom $0.7 million in the second quarter of 2006 to $1.4 million in the secondquarter of 2007.

*InterestExpense and Amortization of Deferred Loan Costs.**  *Interest expense, net of interestincome, increased $1.1 million (8%), to $16.0 million in the second quarter of2007 from $14.9 million in the second quarter of 2006. The changes wereprimarily due to an increase in average debt outstanding during the 2007period.

*Losson Extinguishment of Debt.**   We incurred a loss on extinguishmentof debt of $12.1 million in the second quarter of 2007 when we prepaid theprior second lien term loan facility and replaced it with the new term loanfacility. We paid a premium of $3.5 million and wrote off related deferredloan costs of $8.6 million in connection with the prepayment of the priorterm loan facility.*

*Incometax expense.**  *Thenet loss in the second quarter of 2007 resulted in an income tax benefit of $2.1million compared to income tax expense of $0.1 million for the second quarterof 2006.

*Net Income (Loss).**  *The net loss for the second quarterof 2007 was $3.1 million compared to net income of $0.3 million for the sameperiod in 2006. The change between periods is the result of the items discussedabove.

***Comparison of Six Months Ended June 30, 2006 toSix Months Ended June 30, 2007***

*Oiland Natural Gas Revenues.**  *Oil and natural gas revenues increased $36.8 million (29%)to $164.2 million for the six months ended June 30, 2007 from $127.4million for the same period in 2006. The increase was primarily due to a 32%increase in production, which is largely attributable to the TexCal acquisitioncompleted on March 31, 2006 and increased natural gas production from ourlegacy properties.

Oil revenues increased by $10.6 million (12%) in thefirst half of 2007 to $101.3 million from $90.7 million in the first half of2006. Oil production rose 18%, with production of 1,889 MBbl in the first halfof 2007 compared to 1,606 MBbl in the first half of 2006. The productionincrease was attributable to the acquisition of the TexCal properties,partially offset by a 3% decline in production volumes from other Venocoproperties. The production decline for the other Venoco properties primarilyresulted from a temporary shut-in of production at the South Ellwood field inthe first quarter of 2007 due to a disruption in barge deliveries from thefield. Our average realized price for oil decreased $4.27 (7%) to $53.04 perBbl for the period.

Natural gas revenues increased $26.2 million (71%) inthe first half of 2007 to $62.8 million compared to $36.6 million in the firsthalf of 2006. Natural gas production increased 55%, with production of 8,925 

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MMcf compared to 5,764MMcf in the first half of 2006. The increase was due primarily to productionattributable to the TexCal acquisition and increased production resulting fromdrilling and recompletion activities at our legacy properties in the SacramentoBasin. Our average realized price for natural gas increased $0.68 (11%) to$7.04 per Mcf for the period.

*Commodity Derivatives andOther Revenues.**  *Thefollowing table sets forth the components of commodity derivative losses, netin our condensed consolidated statements of operations for the periodsindicated (in thousands):

| ** **                                                         | ** ** | **Six Months Ended June 30,**                                | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **      2006      ** | ** ** | **      2007      ** | ** ** |
| Realized commodity  derivative gains (losses)                      |       |                                                                             | $          | (9,696 | ) |   |   | $ | 23 |   |   |
| Unrealized commodity  derivative losses                            |       |                                                                             | (14,977    | ) |   |   | (22,851 | ) |   |
| Amortization of  derivative premiums and other comprehensive  loss |       |                                                                             | (3,093     | ) |   |   | (4,317 | ) |   |
| Total                                                              |       |                                                                             | $          | (27,766 | ) |   |   | $ | (27,145 | ) |   |

 

Realized commodity derivative gains or lossesrepresent the difference between the strike price in the contracts settledduring the period and the ultimate settlement prices. The realized commodityderivative gain in the 2007 period reflects the settlement of contracts atprices below the strike price, whereas the realized commodity derivative lossesin the 2006 period reflects the settlement of contracts at prices above thestrike price. Unrealized commodity derivative gains or losses represent thechange in the fair value of our open derivative contracts from period to period.The increase in unrealized commodity derivative losses in the 2007 periodreflects an increase in the number of derivative contracts outstanding as wellas an increase in the futures prices used to estimate the fair value of thosecontracts at the end of the period. Derivative premiums are amortized over theterm of the underlying derivative contracts. The increase in amortization ofderivative premiums and other comprehensive losses in the 2007 period reflectsadditional premiums paid in connection with the additional contractsoutstanding in the 2007 period and amortization of other comprehensive lossesbeginning in the second quarter of 2007.

Other revenue decreased 54%, from $3.4 million in thefirst half of 2006 to $1.6 million in the first half of 2007. The decrease wasprimarily due to lower transportation income received from purchasers of oilproduction from the South Ellwood field.

As a result of the foregoing factors, total revenuesincreased $35.6 million (35%) to $138.6 million in the first half of 2007,compared to $103.0 million in the first half of 2006.

*ProductionExpenses.**  *Productionexpenses increased $15.5 million (44%) to $51.0 million in the first half of2007 from $35.5 million in the first half of 2006. The increase was primarilydue to production expenses attributable to the TexCal acquisition and a 20%increase in production expenses related to other Venoco properties. Theincrease in production expenses for other Venoco properties relates to anincrease in the number of producing wells, normal variances of timing ofproduction expenses, including expenses relating to periodic maintenanceprojects which continued into the first half of 2007, and increased costs ofthird party services. On a per unit basis, production expenses rose to $15.11per BOE in the first half of 2007 compared to $13.84 per BOE in the same periodin 2006. A significant part of this increase was attributable to remedial workprojects performed in the Hastings complex that began in mid-2006. Inaddition, production expenses for other Venoco properties increased 9% on a perunit basis in the first half of 2007 primarily as a result of lower productionfrom the South Ellwood field due to a temporary disruption in barge deliveriesin the first quarter and additional maintenance work that was performed duringthe shut-in period.

*Transportation Expenses.**  *Transportation expenses increased104%, from $1.6 million in the first half of 2006 to $3.3 million in the firsthalf of 2007. This was primarily attributable to increased transportation 

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costs for bargedeliveries. On a per BOE basis, transportation expenses increased $0.34 perBOE, from $0.63 per BOE in the first half of 2006 to $0.97 per BOE in the firsthalf of 2007.

*Depletion, Depreciationand Amortization (DD&A).**  *DD&A expense increased $20.7 million (88%) to$44.2 million in the first half of 2007 from $23.5 million in the first half of2006. DD&A expense per BOE rose $3.93, from $9.15 per BOE in the first halfof 2006 to $13.08 per BOE in the first half of 2007. The increase was primarilydue to a higher depletion expense resulting from the increase in the oil andnatural gas properties obtained in the March 2006 TexCal acquisition, theproperties acquired in April and May of 2007 and the increase in oiland natural gas property costs during the period resulting from our capitalexpenditure program.

*Accretion of AbandonmentLiability.**  *Accretionexpense was $1.6 million in the first half of 2007 compared to $1.1 million inthe first half of 2006. The increase was due to accretion from the acquiredTexCal properties and from new wells drilled and completed in the second halfof 2006 and the first half of 2007.

*General and Administrative(G&A).  *G&A expense increased $4.9million (41%) to $17.0 million in the first half of 2007 from $12.1 million inthe first half of 2006. The increase resulted primarily from increases in ourprofessional staff and related infrastructure resulting from the March 31,2006 acquisition of TexCal and other growth. Other significant increases ingeneral and administrative expenses in the first half of 2007 relate to anon-recurring charge of $0.7 million attributable to a settlement of anemployment contract and an increase in non-cash SFAS 123R share-basedcompensation expense from $1.3 million in the first half of 2006 to $2.6million in the first half of 2007.

*Interest Expense andAmortization of Deferred Loan Costs.**  *Interest expense, net of interestincome, increased $10.7 million (57%) to $29.3 million in the first half of2007 from $18.6 million in the first half of 2006. The change was primarily dueto an increase in average debt outstanding during the 2007 period.

*Loss on Extinguishment ofDebt.**   We incurred a loss on extinguishment of debtof $12.1 million in the second quarter of 2007 when we prepaid the prior secondlien term loan facility and replaced it with the new term loan facility. Wepaid a premium of $3.5 million and wrote off related deferred loan costsof $8.6 million in connection with the prepayment of the prior term loanfacility.*

*Income tax expense.**  *The net loss in the first half of2007 resulted in an income tax benefit of $8.7 million compared to incometax expense of $3.6 million for the first half of 2006.

*Net Income.**  *The net loss for the first half of2007 was $13.5 million compared to net income of $5.4 million for the sameperiod in 2006. The change between periods is the result of the itemsdiscussed above.

**Liquidity and Capital Resources**

Our primary sources ofliquidity are cash generated from our operations and amounts available underour revolving credit facility.

***Cash Flows***

| ** **                             | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                          | ** ** | **2007** | ** ** |
| ** **                             | ** ** | **(in thousands)**                           | ** ** |
| Cash provided by  operating activities |       | $                                                 | 56,467     |   | $ | 67,107 |   |
| Cash used in investing  activities     |       | (531,262                                          | )          | (268,664 | ) |
| Cash provided by financing activities  |       | 478,793                                           |       | 207,776 |   |
|                                        |            |                                                   |            |  |  |  |  |

 

Netcash provided by operating activities was $67.1 million in the first half of2007 compared with $56.5 million in the first half of 2006. Cash flows fromoperating activities in the first half of 2007 were favorably impacted byproduction attributable to the March 2006 TexCal acquisition.

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Net cash used in investingactivities was $268.7 million in the first half of 2007 compared with$531.3 million in the first half of 2006. The primary investing activitiesin the first half of 2007 include $149.0 million in expenditures for oiland gas properties and $116.4 million paid to acquire the West Montalvoand Manvel fields and other minor property acquisitions. The primary investingactivities in the first half of 2006 include $445.5 million paid in cash toacquire TexCal (net of TexCal cash) and $83.5 million in expenditures foroil and gas properties.

Net cash provided byfinancing activities was $207.8 million in the first half of 2007 compared to$478.8 million in the first half of 2006. The primary financing activities inthe first half of 2007 were $151.1 million in net borrowings under thesecond lien term loan facility to fund capital expenditures and working capitalneeds, in addition to $64.4 million in net borrowings under the revolvingcredit facility. Proceeds from long-term debt in the first half of 2006included $350.0 million borrowed under the term loan facility and $139.5million in net borrowings under the revolving credit facility.

***Capital Resourcesand Requirements***

We plan to makesubstantial capital expenditures in the future for the acquisition,exploration, exploitation and development of oil and natural gas properties. Weexpect that our exploration, exploitation and development capital expendituresin 2007 will be approximately $270.0 million, of which we spent $150.1 millionin the first half of the year (excluding the effects of changes in accruedcapital expenditures). In addition, we completed two acquisitions in the secondquarter of 2007 for an aggregate purchase price of approximately $107.4 millionand will continue to pursue acquisitions on an opportunistic basis. We intendto finance our remaining 2007 capital expenditures primarily with cash flowfrom operations and cash on hand, supplemented with additional borrowings underour revolving credit facility. As of August 10, 2007, there was no amountdrawn under the revolving credit facility, which had a borrowing base of $125.0million as of that date.

*Equity Offerings.**  *We received $116.1 million in netproceeds from a public offering of common stock completed in July 2007,and used the majority of those proceeds to repay all amounts then outstandingunder our revolving credit facility. In addition, we expect to form a masterlimited partnership, or MLP, and offer common units representing limitedpartnership interests to the public. We expect to capitalize the MLP throughthe contribution of our interests in certain onshore fields in SouthernCalifornia and a portion of our interests in the South Ellwood field and in theHastings complex. We anticipate receiving a portion of the proceeds of theoffering of MLP interests as a distribution to us, but the amount of thedistribution, if any, has not been determined. Our plans with respect to theMLP may change, and we cannot assure you that we will form the MLP or that anyMLP offering will be completed.

*Second Lien Term Loan.**  *On May 7, 2007, we enteredinto a new second lien term loan agreement to refinance and replace our prior secondlien term loan facility. We entered into the new term loan agreement tofacilitate the financing of our second quarter acquisitions of the WestMontalvo and Manvel fields and to amend certain covenants included in theagreement governing the prior second lien term loan facility. We borrowed$500.0 million pursuant to the new term loan agreement on May 8, 2007. Ofthe total amount borrowed, $350.5 million was used to repay all amountsoutstanding under the prior second lien term loan facility plus accruedinterest, $3.5 million was used to pay a prepayment premium on those amountsand $4.6 million was used to pay transaction costs associated with the newfacility. The remaining borrowings were used to reduce amounts then outstandingunder our revolving credit facility.

The new term loanagreement contains customary representations, warranties, events of default andindemnities and certain customary covenants, including covenants that restrictour ability to incur additional indebtedness. The covenants and other terms ofthe agreement contain exceptions that are intended to permit us to form an MLPand certain related entities, to contribute assets to the MLP, to sell securitiesof the MLP and to cause the MLP to incur indebtedness and issue securities,subject in each case to the satisfaction of certain requirements. The agreementrequires us to maintain derivative contracts 

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coveringat least 70% of our projected oil and natural gas production attributable toproved developed producing reserves through May 8, 2010, and at least 50%of such production on an annual basis thereafter. We cannot, however, enterinto derivative contracts covering more than 80% of such oil and gas productionin any month. The agreement also prohibits us from paying dividends on ourcommon stock. The agreement will require us to make offers to prepay amountsoutstanding under the second lien term loan facility with the proceeds ofcertain transactions or events, including sales of assets, in certaincircumstances. Amounts prepaid under the facility may not be reborrowed. Thenew term loan facility is secured by a second priority lien on substantiallyall of our assets.

Loans made under the newterm loan agreement are designated, at our option, as either “Base Rate Loans”or “LIBO Rate Loans.” Base Rate Loans bear interest at a floating rate equal to(i) the greater of the overnight federal funds rate plus 0.50% and theadministrative agent’s announced base rate, plus (ii) 3.00%. LIBO RateLoans bear interest at LIBOR plus 4.00%. We have entered into interest rateswaps pursuant to which amounts borrowed under the new term loan agreement willeffectively bear interest at a fixed rate of approximately 9.3% until June 2010.See “—Quantitative and Qualitative Disclosures About Market Risk—Interest RateDerivative Transactions.”

*Amended Revolving CreditFacility.**  *Alsoon May 7, 2007, we entered into a fifth amendment to the second amendedand restated credit agreement governing our revolving credit facility. Theprincipal effects of the amendment were (i) to permit us to enter into thenew term loan agreement, (ii) to reduce the borrowing base under therevolving credit facility to $125.0 million and (iii) to change the rateat which amounts outstanding under the revolving credit agreement accrueinterest. Pursuant to the amendment, Base Rate Loans under the revolving creditfacility bear interest at a floating rate equal to (i) the greater of Bankof Montreal’s announced base rate and the overnight federal funds rate plus0.50% plus (ii) an applicable margin ranging from zero to 0.75%, basedupon utilization. LIBO Rate Loans under the revolving credit facility bearinterest at (i) LIBOR plus (ii) an applicable margin ranging from1.50% to 2.25%, based upon utilization. A commitment fee ranging from 0.375% to0.5% per annum is payable with respect to unused borrowing availability underthe facility.

Principal on the revolvingcredit facility is payable on March 30, 2009. The agreement governing thefacility contains customary representations, warranties, events of default,indemnities and covenants, including operational covenants that restrict ourability to incur indebtedness and financial covenants that require us tomaintain specified ratios of EBITDA (as defined in the agreement) to interestexpense, current assets to current liabilities, debt to EBITDA and PV-10 tototal debt. The ratios required to be met in order to remain in compliance withour financial covenants change at specified times over the duration of theloans. On March 31, 2007, the required ratio of EBITDA to interest expensechanged from 2.5:1 to 3:1 and the maximum permitted ratio of debt to EBITDAchanged from 4.5:1 to 4:1. These covenant levels will remain in effect until September 30,2007, at which time new EBITDA to interest expense and debt to EBITDA ratioscome into effect that will require higher levels of financial performanceand/or reduced indebtedness. The agreement governing the revolving creditfacility will require us to reduce amounts outstanding under the facility withthe proceeds of certain transactions or events, including sales of assets, incertain circumstances. The revolving credit facility is secured by a firstpriority lien on substantially all of our assets.

*Senior Notes.**  *We issued $150.0 million of oursenior notes in December 2004. The notes bear interest at 8.75% per yearand will mature on December 15, 2011. We may redeem the notes after December 15,2008, initially at a redemption price equal to 104.375% of the principalamount. In addition, before December 15, 2008, we may redeem all or partof the notes at a specified “make-whole” price, and before December 15,2007, we may redeem up to 35% of the notes with the net proceeds of certainpublic or private equity offerings at a redemption price of 108.75% of theprincipal amount of the notes. Upon the occurrence of a change of control ofour company, each holder of notes may require us to repurchase all or a portionof its notes for cash at a price equal to 101% of the aggregate principalamount of those 

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notes, plus anyaccrued and unpaid interest. The indenture governing the notes also containsoperational covenants that, among other things, limit our ability to makeinvestments, incur additional indebtedness or create liens on our assets. Thenotes are guaranteed by all of our subsidiaries other than Ellwood Pipeline, Inc.and are secured with the new second lien term loan on an equal and ratablebasis.

Because we must dedicate asubstantial portion of our cash flow from operations to the payment of intereston our debt, that portion of our cash flow is not available for other purposes.Our ability to make scheduled interest payments on our indebtedness and pursueour capital expenditure plan will depend to a significant extent on ourfinancial and operating performance, which is subject to prevailing economicconditions, commodity prices and a variety of other factors. If our cash flowand other capital resources are insufficient to fund our debt serviceobligations and our capital expenditure budget, we may be forced to reduce ordelay scheduled capital projects, sell material assets or operations and/orseek additional capital. Needed capital may not be available on acceptableterms or at all. Our ability to raise funds through the incurrence ofadditional indebtedness and certain other means is limited by covenants in ourdebt agreements. In addition, pursuant to the mandatory prepayment provisionsin our credit facilities described above, our ability to respond to a shortfallin our expected liquidity by selling assets or incurring additionalindebtedness would be limited by provisions in the facilities that require usto use some or all of the proceeds of such transactions to reduce amountsoutstanding under one or both of the facilities in some circumstances. If weare unable to obtain funds when needed and on acceptable terms, we may not beable to complete acquisitions that may be favorable to us, meet our debtobligations or finance the capital expenditures necessary to replace ourreserves.

**Item3.**                        Quantitativeand Qualitative Disclosures About Market Risk

This section providesinformation about derivative financial instruments we use to manage commodityprice volatility. Due to the historical volatility of crude oil and natural gasprices, we have implemented a hedging strategy aimed at reducing thevariability of the prices we receive for our production and providing a minimumrevenue stream. Currently, we purchase puts and enter into other derivativetransactions such as collars and fixed price swaps in order to hedge ourexposure to changes in commodity prices. All contracts are settled with cashand do not require the delivery of a physical quantity to satisfy settlement.While this hedging strategy may result in us having lower revenues than wewould have if we were unhedged in times of higher oil and natural gas prices,management believes that the stabilization of prices and protection afforded usby providing a revenue floor on a portion of our production is beneficial. Wehad hedging contracts in place for approximately 88% of our oil production andapproximately 64% of our natural gas production for the six months ended June 30,2007.

This section also providesinformation about derivative financial instruments we use to manage interestrate risk. See “—Interest Rate Derivative Transactions.”

**Cumulative Effect of DerivativeTransactions**

*Oil.*   Asof June 30, 2007, we had entered into option (including collar) agreementsto receive average minimum and maximum NYMEX West Texas Intermediate prices assummarized below. Location and quality differentials attributable to our propertiesare not reflected in those prices. The agreements provide for monthlysettlement based on the differential between the agreement price and the actualNYMEX crude oil price.

| ** **                                                   | ** ** | **Minimum**     | ** ** | **Maximum**          | ** ** |
|--------------------------------------------------------------|------------|-----------------|------------|----------------------|------------|
| ** **                                                   | ** ** | **Barrels/day** | ** ** | **Avg. Prices** | ** ** | **Barrels/day** | ** ** | **Avg. Prices** | ** ** |
| Crude oil derivatives at June 30, 2007 for  production: |       |            |       |                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| July 1—December 31,  2007                     |       |            | 9,880      |                 |       |   | $ | 51.98 |   |   |   | 8,915 |   |   |   | $ | 73.08 |   |   |
| January 1—December 31,  2008                  |       |            | 8,250      |                 |       |   | $ | 58.85 |   |   |   | 8,250 |   |   |   | $ | 73.63 |   |   |
| January 1—December 31,  2009                  |       |            | 7,330      |                 |       |   | $ | 58.18 |   |   |   | 7,330 |   |   |   | $ | 74.78 |   |   |
| January 1—December 31,  2010                  |       |            | 6,150      |                 |       |   | $ | 61.10 |   |   |   | 6,150 |   |   |   | $ | 72.88 |   |   |

 

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*Natural Gas.**  *As of June 30, 2007, we hadentered into option, swap and collar agreements to receive average minimum andmaximum PG&E Citygate prices as follows:

| ** **                                                     | ** ** | **Minimum**   | ** ** | **Maximum**          | ** ** |
|----------------------------------------------------------------|------------|---------------|------------|----------------------|------------|
| ** **                                                     | ** ** | **MMBtu/Day** | ** ** | **Avg. Prices** | ** ** | **MMBtu/Day** | ** ** | **Avg. Prices** | ** ** |
| Natural gas derivatives  at June 30, 2007 for production: |       |          |       |                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| July 1—December 31,  2007                       |       |          | 34,375     |                 |       |   | $ | 6.74 |   |   |   | 28,685 |   |   |   | $ | 10.81 |   |   |
| January 1—December 31,  2008                    |       |          | 20,650     |                 |       |   | $ | 7.59 |   |   |   | 19,097 |   |   |   | $ | 11.27 |   |   |
| January 1—December 31,  2009                    |       |          | 14,625     |                 |       |   | $ | 7.65 |   |   |   | 14,625 |   |   |   | $ | 11.57 |   |   |
| January 1—December 31,  2010                    |       |          | 11,900     |                 |       |   | $ | 7.22 |   |   |   | 11,900 |   |   |   | $ | 10.57 |   |   |

 

**Portfolio ofDerivative Transactions**

Our portfolio of commodityderivative transactions as of June 30, 2007 is summarized below:

**Oil**

| **Type of   Contract** | ** ** | ** ** | ** ** | **Basis** | ** ** | **Quantity   (Bbl/d)** | ** ** | **Strike Price ($/Bbl)** | ** ** | **Term**     | ** ** |
|-----------------------------|------------|------------|------------|-----------|------------|------------------------|------------|------------------------------------|------------|--------------|------------|
| Collar                      |       | NYMEX      |       |      | 2,000      |                   |       |                               | $          | 40.00/$65.80 |       |   | Jan 1—Dec 31, 07 |   |
| Collar                      |       | NYMEX      |       |      | 1,000      |                   |       |                               | $          | 40.00/$67.50 |       |   | Jan 1—Dec 31, 07 |   |
| Collar                      |       | NYMEX      |       |      | 1,000      |                   |       |                               | $          | 58.00/$76.25 |       |   | Jan 1—Dec 31, 07 |   |
| Collar                      |       | NYMEX      |       |      | 1,600      |                   |       |                               | $          | 53.00/$75.00 |       |   | Jan 1—Jun 30, 07 |   |
| Collar                      |       | NYMEX      |       |      | 1,030      |                   |       |                               | $          | 53.00/$75.00 |       |   | Jul 1—Dec 31, 07 |   |
| Put                         |       | NYMEX      |       |      | 2,000      |                   |       |                               | $          | 58.00 Floor  |       |   | Jan 1—Dec 31, 07 |   |
| Call                        |       | NYMEX      |       |      | 566        |                   |       |                               | $          | 77.15 Cap    |       |   | Jan 1—Jun 30, 07 |   |
| Collar                      |       | NYMEX      |       |      | 2,000      |                   |       |                               | $          | 57.00/$73.55 |       |   | Apr 1—Dec 31, 07 |   |
| Call                        |       | NYMEX      |       |      | 1,035      |                   |       |                               | $          | 81.00 Cap    |       |   | Jul 1—Dec 31, 07 |   |
| Collar                      |       | NYMEX      |       |      | 850        |                   |       |                               | $          | 60.00/$80.00 |       |   | Jul 1—Dec 31, 07 |   |
| Collar                      |       | NYMEX      |       |      | 3,450      |                   |       |                               | $          | 52.00/$75.00 |       |   | Jan 1—Jun 30, 08 |   |
| Collar                      |       | NYMEX      |       |      | 2,450      |                   |       |                               | $          | 52.00/$75.00 |       |   | Jul 1—Dec 31, 08 |   |
| Collar                      |       | NYMEX      |       |      | 1,000      |                   |       |                               | $          | 58.00/$78.00 |       |   | Jul 1—Dec 31, 08 |   |
| Collar                      |       | NYMEX      |       |      | 1,500      |                   |       |                               | $          | 58.00/$75.25 |       |   | Jan 1—Dec 31, 08 |   |
| Swap                        |       | NYMEX      |       |      | 2,500      |                   |       |                               | $          | 67.25        |       |   | Jan 1—Dec 31, 08 |   |
| Collar                      |       | NYMEX      |       |      | 800        |                   |       |                               | $          | 60.00/$82.75 |       |   | Jan 1—Dec 31, 08 |   |
| Collar                      |       | NYMEX      |       |      | 2,170      |                   |       |                               | $          | 50.00/$75.00 |       |   | Jan 1—Jun 30, 09 |   |
| Collar                      |       | NYMEX      |       |      | 1,000      |                   |       |                               | $          | 56.00/$79.25 |       |   | Jul 1—Dec 31, 09 |   |
| Collar                      |       | NYMEX      |       |      | 3,000      |                   |       |                               | $          | 55.00/$77.00 |       |   | Jan 1—Dec 31, 09 |   |
| Swap                        |       | NYMEX      |       |      | 2,000      |                   |       |                               | $          | 67.22        |       |   | Jan 1—Dec 31, 09 |   |
| Collar                      |       | NYMEX      |       |      | 750        |                   |       |                               | $          | 60.00/$82.75 |       |   | Jan 1—Dec 31, 09 |   |
| Collar                      |       | NYMEX      |       |      | 1,000      |                   |       |                               | $          | 60.00/$72.80 |       |   | Jan 1—Dec 31, 10 |   |
| Collar                      |       | NYMEX      |       |      | 3,500      |                   |       |                               | $          | 60.00/$73.00 |       |   | Jan 1—Dec 31, 10 |   |
| Swap                        |       | NYMEX      |       |      | 1,000      |                   |       |                               | $          | 66.75        |       |   | Jan 1—Dec 31, 10 |   |
| Collar                      |       | NYMEX      |       |      | 650        |                   |       |                               | $          | 60.00/$81.75 |       |   | Jan 1—Dec 31, 10 |   |

 

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**NaturalGas**

| **Type of  Contract** | ** ** | ** **         | ** ** | **Basis** | ** ** | **Quantity  (MMBtu/d)** | ** ** | **Strike Price  ($/MMBtu)** | ** **  | **Term** | ** **            |
|----------------------------|------------|--------------------|------------|-----------|------------|-------------------------|------------|----------------------------------|-------------|----------|-----------------------|
| Collar                     |       | PG&E  Citygate |       |      | 6,000      |                    |       | $                                | 6.00/$8.40  |     | Jan 1—Dec 31, 07 |   |
| Collar                     |       | NYMEX              |       |      | 5,000      |                    |       | $                                | 8.00/$14.60 |     | Jan 1—Dec 31, 07 |   |
| Put                        |       | NYMEX              |       |      | 10,000     |                    |       | $                                | 7.985 Floor |     | Jan 1—Dec 31, 07 |   |
| Call                       |       | NYMEX              |       |      | 4,564      |                    |       | $                                | 12.15 Cap   |     | Jan 1—Jun 30, 07 |   |
| Call                       |       | NYMEX              |       |      | 4,310      |                    |       | $                                | 11.95 Cap   |     | Jul 1—Dec 31, 07 |   |
| Basis Swap                 |       | PG&E  Citygate |       |      | 10,000     |                    |       | $                                | (0.58       | )        | Jan 1—Dec 31, 07 |   |
| Basis Swap                 |       | PG&E  Citygate |       |      | 10,000     |                    |       | $                                | (0.46       | )        | Jan 1—Dec 31, 07 |   |
| Collar                     |       | NYMEX              |       |      | 11,500     |                    |       | $                                | 7.50/$10.35 |     | Apr 1—Dec 31, 07 |   |
| Collar                     |       | NYMEX              |       |      | 1,875      |                    |       | $                                | 7.50/$14.10 |     | Jul 1—Dec 31, 07 |   |
| Put                        |       | NYMEX              |       |      | 6,000      |                    |       | $                                | 8.00 Floor  |     | Jan 1—Dec 31, 08 |   |
| Call                       |       | NYMEX              |       |      | 4,513      |                    |       | $                                | 12.15 Cap   |     | Jan 1—Jun 30, 08 |   |
| Call                       |       | NYMEX              |       |      | 4,382      |                    |       | $                                | 10.60 Cap   |     | Jul 1—Dec 31, 08 |   |
| Collar                     |       | NYMEX              |       |      | 7,500      |                    |       | $                                | 8.00/$12.75 |     | Jan 1—Dec 31, 08 |   |
| Collar                     |       | NYMEX              |       |      | 5,700      |                    |       | $                                | 7.75/$10.05 |     | Jan 1—Dec 31, 08 |   |
| Basis Swap                 |       | PG&E  Citygate |       |      | 10,000     |                    |       | $                                | (0.32       | )        | Jan 1—Dec 31, 08 |   |
| Basis Swap                 |       | PG&E  Citygate |       |      | 10,000     |                    |       | $                                | (0.38       | )        | Jan 1—Dec 31, 08 |   |
| Collar                     |       | NYMEX              |       |      | 1,450      |                    |       | $                                | 8.00/$12.95 |     | Jan 1—Dec 31, 08 |   |
| Swap                       |       | NYMEX              |       |      | 1,250      |                    |       | $                                | 8.72 Fixed  |     | Jan 1—Jun 30, 09 |   |
| Collar                     |       | NYMEX              |       |      | 1,250      |                    |       | $                                | 7.75/$13.05 |     | Jan 1—Jun 30, 09 |   |
| Swap                       |       | NYMEX              |       |      | 1,250      |                    |       | $                                | 8.00 Fixed  |     | Jul 1—Dec 31, 09 |   |
| Collar                     |       | NYMEX              |       |      | 1,250      |                    |       | $                                | 7.25/$11.30 |     | Jul 1—Dec 31, 09 |   |
| Collar                     |       | NYMEX              |       |      | 7,000      |                    |       | $                                | 7.50/$12.75 |     | Jan 1—Dec 31, 09 |   |
| Basis Swap                 |       | PG&E  Citygate |       |      | 6,000      |                    |       | $                                | 0.10        |     | Jan 1—Dec 31, 09 |   |
| Basis Swap                 |       | PG&E  Citygate |       |      | 7,500      |                    |       | $                                | 0.11        |     | Jan 1—Dec 31, 09 |   |
| Collar                     |       | NYMEX              |       |      | 4,000      |                    |       | $                                | 7.30/$9.85  |     | Jan 1—Dec 31, 09 |   |
| Collar                     |       | NYMEX              |       |      | 1,125      |                    |       | $                                | 8.00/$12.00 |     | Jan 1—Dec 31, 09 |   |
| Collar                     |       | NYMEX              |       |      | 10,000     |                    |       | $                                | 7.00/$10.35 |     | Jan 1—Dec 31, 10 |   |
| Basis Swap                 |       | PG&E  Citygate |       |      | 10,000     |                    |       | $                                | 0.22        |     | Jan 1—Dec 31, 10 |   |
| Collar                     |       | NYMEX              |       |      | 1,000      |                    |       | $                                | 7.00/$9.10  |     | Jan 1—Dec 31, 10 |   |
| Collar                     |       | NYMEX              |       |      | 900        |                    |       | $                                | 7.50/$12.20 |     | Jan 1—Dec 31, 10 |   |

 

Because a large portion of our commodity derivativesdo not qualify for hedge accounting and to increase clarity in our financialstatements, effective April 1, 2007 we elected to discontinue hedgeaccounting. Consequently, from that date forward, we will recognizemark-to-market gains and losses in earnings currently, rather than deferringsuch amounts in accumulated other comprehensive income for those commodityderivatives that qualify as cash flow hedges.

All derivative instrumentsare recorded on the balance sheet at fair value. Fair value is generallydetermined based on the difference between the fixed contract price and theunderlying market price at the determination date, and/or confirmed by thecounterparty. Changes in the fair value of derivatives are recorded incommodity derivative income (loss) on the income statement.

**Interest RateDerivative Transactions**

We are subject to interest rate risk with respect toamounts borrowed under our credit facilities because those amounts bearinterest at variable rates. As of August 10, 2007, there was approximately$500.0 million outstanding under those facilities. We have entered into twointerest rate swap transactions 

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to limit our exposure tochanges in interest rates with respect to our second lien term loan facility. InMay 2006, we entered into a swap to lock in our interest cost on $200.0million of borrowings through May 2008. In June 2007, we entered intoa second swap to lock in our interest cost on $300.0 million of borrowingsthrough May 2008 and on $500.0 million of borrowings from May 2008through June 2010. As a result of these transactions, amounts borrowedunder the second lien term loan facility will effectively bear interest at afixed rate of approximately 9.3% until June 2010. Accordingly, we expectto be subject to interest rate risk until that time only with respect toamounts borrowed under the revolving credit facility. A 1.0% increase ininterest rates on unhedged variable rate borrowings of $95.0 million at June 30,2007 would result in additional annualized interest expense of $1.0 million.

See note 3 to ourcondensed consolidated financial statements for a discussion of our long-termdebt as of June 30, 2007.

**Changes in FairValue**

Thefair value of outstanding oil and natural gas commodity derivative instruments atJune 30, 2007 was a net liability of $25.3 million. We would expect a$5.00 per Bbl increase in the price of oil and a $1.00 per MMBtu increase inthe price of natural gas to increase the net liability at June 30, 2007 by$58.1 million.

The fair value of our swaps and option contracts areestimated based on quoted prices from independent reporting services comparedto the contract price of the agreement, and approximate the cash gain or lossthat would have been realized if the contracts had been closed out at periodend. All hedge positions offset physical positions exposed to the cash market.None of these offsetting physical positions are included in the above table.Price risk sensitivities were calculated by assuming across-the-board increasesin price of $5.00 per Bbl for oil and $1.00 per MMBtu for natural gasregardless of term or historical relationships between the contractual price ofthe instruments and the underlying commodity price. In the event of actualchanges in prompt month prices equal to the assumptions, the fair value of ourderivative portfolio would typically change by less than the amount shown inthe table due to lower volatility in out-month prices. In the event of actualchanges in all months equal to the assumptions, the fair value of ourderivative portfolio would typically change by less than the amount shown inthe table due to the fact that many of the changes would be within the range ofour derivative collars where the movement in fair value would typically be lessthan the changes in commodity prices.

With respect to oil, wehad, as of June 30, 2007, NYMEX put options with a weighted average strikeprice of $58.00 per Bbl on 2,000 Bbl/d for 2007 oil production. With respect tonatural gas, we had, as of June 30, 2007, put options with a weightedaverage strike price of $7.985 per MMBtu on 10,000 MMBtu/d for 2007 natural gasproduction. These put options cost an average of $4.23 per Bbl and $1.00 perMMBtu (a total of $6.7 million), which payment is deferred until the putoptions settle. The fair value of the put options is not included in the fairvalue of derivatives in the table above.

**Item 4.**                        Controlsand Procedures

**Disclosure Controlsand Procedures**

Timothy Marquez,our Chief Executive Officer, and Timothy Ficker, our Chief Financial Officer,evaluated the effectiveness of our disclosure controls and procedures as of June 30,2007. Based on the evaluation, they believe that:

·       ourdisclosure controls and procedures were effective to ensure that informationrequired to be disclosed by us in the reports we file or submit under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms; and

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·       ourdisclosure controls and procedures were effective to ensure that informationrequired to be disclosed by us in the reports we file or submit under theSecurities Exchange Act of 1934 was accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosure.

We are currently takingsteps intended to enhance our internal control over financial reporting. See “Management’sDiscussion and Analysis of Financial Condition and Results of Operation—Overview—InternalControl Over Financial Reporting.”

**Internal ControlOver Financial Reporting**

Other than in connection with the steps we are takingto enhance our internal control over financial reporting as described in “Management’sDiscussion and Analysis of Financial Condition and Results of Operation—Overview—InternalControl Over Financial Reporting,” there has not been any change in ourinternal control over financial reporting that occurred during the quarterlyperiod ended June 30, 2007 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

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**PART II—OTHERINFORMATION**

**Item 1.**                        LegalProceedings

In March 2006, acomplaint was filed in District Court in Madison County, Texas against one ofour subsidiaries by the widow of an individual who was fatally injured whileworking as a gauger/pumper at a well operated by the subsidiary. The case as itrelates to us and our subsidiary was settled in July 2007 for an amountthat was covered by our insurance.

**Item 1A.**                RiskFactors

In addition to the otherinformation set forth in this report, you should carefully consider the factorsdiscussed in “Risk Factors” in our Annual Report on Form 10-K forthe year ended December 31, 2006, which could materially affect ourbusiness, financial condition and/or future results. The risks described in ourAnnual Report on Form 10-K are not the only risks facing us.Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect ourbusiness, financial condition and/or operating results. The following setsforth additional and/or updated information with respect to certain of therisks described in our Annual Report on Form 10-K:

***The market price of our common stock could beadversely affected by sales of substantial amounts of our common stock in thepublic markets or the issuance of additional shares of common stock.***

Sales of a substantialnumber of shares of our common stock in the public market, or the perceptionthat these sales may occur, could cause the market price of our common stock todecline. In addition, the sale of these shares in the public market, or thepossibility of such sales, could impair our ability to raise capital throughthe sale of additional stock. We, our directors and certain of our employeesentered into agreements with the underwriters of the public offering of ourcommon stock completed in July 2007 pursuant to which we and each of thosepersons agreed not to sell or otherwise dispose of shares of our common stockfor a “lock-up” period of 90 days following the offering, subject to anextension of up to 34 days in certain circumstances. Two of ourstockholders, the Marquez Trust and the Marquez Foundation, entered intosimilar lock-up agreements in connection with the offering. Subject tocompliance with the Securities Act of 1933 and other applicable laws, each ofthe persons subject to the lock-up agreements will be able to sell shares ofour common stock when the lock-up period expires. Similarly, we will not beprohibited from issuing shares of common stock following the expiration of thelock-up period. The substantial number of shares potentially eligible for salefollowing the expiration of the lock-up by us, our directors, our officersand/or our significant stockholders, could cause the market price of our stock todecline.

***Our plans with respect to the proposed MLP are subjectto a wide variety of risks and uncertainties.***

We expect to form an MLP and to offer common unitsrepresenting limited partnership interests in the MLP to the public. Our planswith respect to the MLP may change and are subject to market conditions andnumerous other risks beyond our control. It is possible that the MLP will notbe formed, will not complete an offering of securities, will not raise theexpected amount of capital even if an offering of securities is completedand/or will not be able to complete its proposed activities on the currentlycontemplated schedule. In addition, the structure, nature, purpose and proposedassets and liabilities of the MLP may change materially from those currentlyanticipated. The MLP, and our retained investment in it, will be subject to awide variety of risks, including those risks normally associated withoperations in the oil and natural gas industry.

This report on Form 10-Qshall not constitute an offer to sell or the solicitation of an offer to buyany securities. Any offers, solicitations of offers to buy, or any sales ofsecurities will only be made in accordance with the registration requirementsof the Securities Act of 1933 or an exemption therefrom.

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**Item 2.**                        UnregisteredSales of Equity Securities and Use of Proceeds.

Not Applicable

**Item 3.**                        DefaultsUpon Senior Securities.

NotApplicable

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

The2007 annual meeting of our stockholders was held on May 23, 2007 inDenver, Colorado. The following table summarizes the proposals submitted to avote of the stockholders and the results of the voting:

| ** **                                                                                                 | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain or  Withhold** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------------------------|------------|
| Election of  directors                                                                                     |       |       |       |        |       |                          |       |   |   |
| Timothy Marquez                                                                                            |       | 41,590,312 |       | —      |       |                          | 781,242    |   |   |
| Mark Snell                                                                                                 |       | 41,819,183 |       | —      |       |                          | 552,371    |   |   |
| Approval of  amendment of the 2005 Stock Incentive  Plan                                                   |       | 31,424,756 |       | 9,596,292   |       |                          | 11,139     |   |   |
| Approval of  performance-based compensation criteria, including the 2007 Senior Executive  Bonus Plan      |       | 40,932,376 |       | 86,252      |       |                          | 13,559     |   |   |
| Ratification of  Deloitte & Touche LLP as independent registered public accounting  firm for 2007 |       | 42,363,736 |       | 3,468       |       |                          | 4,350      |   |   |

 

The terms of office ofdirectors J.C. McFarland, Joel Reed and J. Timothy Brittan continued after themeeting. Of the 43,005,182 shares of common stock issued and outstanding as ofthe record date for the meeting, 42,371,554 shares were present by proxy at themeeting.

**Item 5.**                        OtherInformation.

Not Applicable

**Item6.**                        Exhibits.
| Exhibit  Number | ** ** | ** **                                                                                                                                     | ** ** | **Exhibit** |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|
| 31.1            |       | Certification of the  Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                 |
| 31.2            |       | Certification of  the Chief Financial Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                 |
| 32              |       | Certification of  the Chief Executive Officer and the Chief Financial Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
| August 13, 2007 | VENOCO, INC.                                   |
|----------------------|------------------------------------------------|
|                 | By:                                            | /s/ Timothy M. Marquez |
|                 | Name: Timothy M. Marquez                       |
|                 | Title: *Chairman and Chief  Executive Officer* |
|                 | By:                                            | /s/ Timothy A. Ficker |
|                 | Name: Timothy A. Ficker                        |
|                 | Title: *Chief Financial Officer*               |

 

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