##### Table of Contents

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SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





---




FORM 10-Q





QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF


THE SECURITIES EXCHANGE ACT OF 1934





For the Quarter Ended June 30,
2002

Commission File Number 0-23431





---




MILLER EXPLORATION COMPANY


(Exact Name of Registrant as Specified in Its Charter)





Delaware (State or Other
Jurisdiction of Incorporation or Organization)  3104 Logan Valley Road Traverse City, Michigan (Address of Principal Executive Offices)

38-3379776 (I.R.S.
Employer Identification No.)  49685-0348 (Zip Code)





Registrants Telephone Number, Including Area Code: (231)
941-0004





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





Yes X No





Indicate the number of shares
outstanding of each of the issuers classes of common stock, as of the latest practicable date.





Class Common stock, $.01 par
value

Outstanding at August 12,
2002 19,801,522 shares





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##### Table of Contents

MILLER EXPLORATION COMPANY





TABLE OF CONTENTS





Page No.PART I.    FINANCIAL INFORMATIONItem 1.

Financial Statements

3Consolidated Statements of OperationsThree Months and Six Months Ended June 30, 2002 and 2001

3Consolidated Balance SheetsJune 30, 2002 and December 31, 2001

4Consolidated Statement of EquitySix Months Ended June 30, 2002

5Consolidated Statements of Cash FlowsSix Months Ended June 30, 2002 and 2001

6Notes to Consolidated Financial Statements

7Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

16Item 3.

Quantitative and Qualitative Disclosures About Market Risk

24PART II.    OTHER INFORMATIONItem 1.

Legal Proceedings

25Item 2.

Changes in Securities and Use of Proceeds

26Item 3.

Defaults Upon Senior Securities

26Item 4.

Submission of Matters to a Vote of Security Holders

26Item 5.

Other Information

27Item 6.

Exhibits and Reports on Form 8-K

27




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##### Table of Contents

PART I.    FINANCIAL INFORMATION





Item 1.    
Financial Statements





MILLER EXPLORATION COMPANY


CONSOLIDATED STATEMENTS OF OPERATIONS


(In thousands, except per share amounts)


(Unaudited)





For the Three Months Ended June 30,


For the Six Months Ended June 30,2002


2001


2002


2001REVENUES:Natural gas

$
1,963


$
3,800


$
3,798


$
9,377Crude oil and condensate


931



910



1,782



1,825Other operating revenues


47



72



105



169Total operating revenues


2,941



4,782



5,685



11,371OPERATING EXPENSES:Lease operating expenses and production taxes


488



824



929



1,763Depreciation, depletion and amortization


2,422



3,525



4,514



7,712General and administrative


504



514



1,164



1,076Cost ceiling writedown


7,000



7,500



7,000



7,500Total operating expenses


10,414



12,363



13,607



18,051OPERATING INCOME (LOSS)


(7,473
)


(7,581
)


(7,922
)


(6,680
)INTEREST EXPENSE


(206
)


(331
)


(402
)


(588
)INCOME (LOSS) BEFORE INCOME TAXES


(7,679
)


(7,912
)


(8,324
)


(7,268
)INCOME TAX PROVISION (CREDIT) (Note 2)


(5,523
)


(169
)


(5,743
)


79NET INCOME (LOSS)

$
(2,156
)

$
(7,743
)

$
(2,581
)

$
(7,347
)EARNINGS (LOSS) PER SHARE (Note 3)Basic

$
(0.11
)

$
(0.40
)

$
(0.13
)

$
(0.38
)Diluted

$
(0.11
)

$
(0.40
)

$
(0.13
)

$
(0.38
)





The accompanying notes are an integral part of these consolidated financial
statements.




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MILLER EXPLORATION COMPANY


CONSOLIDATED BALANCE SHEETS


(In thousands, except share amounts)





As of June 30, 2002


As of December 31, 2001(Unaudited)ASSETSCURRENT ASSETS:Cash and cash equivalents

$
3


$
201Accounts receivable


2,419



3,076Inventories, prepaids and advances to other operators


599



523Total current assets


3,021



3,800OIL AND GAS PROPERTIESat cost (full cost method):Proved oil and gas properties


154,678



146,649Unproved oil and gas properties


5,090



11,244Less-Accumulated depreciation, depletion and amortization


(136,018
)


(124,618
)Net oil and gas properties


23,750



33,275OTHER ASSETS


402



512Total assets

$
27,173


$
37,587LIABILITIES AND EQUITYCURRENT LIABILITIES:Notes payable

$
3,202


$
Accounts payable


774



2,767Accrued expenses and other current liabilities


3,826



4,974Total current liabilities


12,402



7,741LONG-TERM DEBT


4,600



6,696DEFERRED INCOME TAXES (Note 2)






5,743COMMITMENTS AND CONTINGENCIES (Note 8)EQUITY:Common stock warrants, 13,350,498 outstanding atJune 30, 2002 and December 31, 2001


860



860Preferred stock, $0.01 par value; 2,000,000 shares authorized;none outstanding






Common stock, $0.01 par value; 40,000,000 shares authorized; 19,801,522 shares and 19,478,853 shares outstanding at June
30, 2002 and December 31, 2001, respectively


198



195Accumulated other comprehensive income (loss)


(131
)


89Additional paid in capital


77,413



77,251Retained deficit


(63,596
)


(60,988
)Total equity


14,771



17,407Total liabilities and equity

$
27,173


$
37,587





The accompanying notes are an integral part of these consolidated financial
statements.




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MILLER EXPLORATION COMPANY


CONSOLIDATED STATEMENT OF EQUITY


(In thousands)


(Unaudited)





Common Stock Warrants

Preferred Stock

Common Stock

Accumulated Other Comprehensive Income (Loss)


Additional Paid In Capital

Retained DeficitBALANCEDecember 31, 2001

$
860

$


$
195

$
89


$
77,251

$
(60,988
)Issuance of benefit plan shares








1






40


Issuance of non-employee directors shares








2






122


Change in unrealized (losses)











(220
)





Net (loss)


















(2,581
)BALANCEJune 30, 2002

$
860

$


$
198

$
(131
)

$
77,413

$
(63,569
)





Disclosure of Comprehensive Income:





For the six months ended June 30,2001


2002Net income (loss)

$
(2,581
)

$
(7,347
)Other comprehensive income (loss)


(220
)


346Total comprehensive income (loss)

$
(2,801
)

$
(7,001
)





The accompanying notes are an integral part of these consolidated financial
statements.




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MILLER EXPLORATION COMPANY


CONSOLIDATED STATEMENTS OF CASH FLOWS


(In thousands)


(Unaudited)





For the Six Months EndedJune 30,2002


2001CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)

$
(2,581
)

$
(7,347
)Adjustments to reconcile net income (loss) to net cash from operating activitiesCost ceiling writedown


7,000



7,500Depreciation, depletion and amortization


4,514



7,712Deferred income taxes


(5,743
)


79Warrants and stock compensation


164



16Deferred revenue






(17
)Changes in assets and liabilitiesRestricted cash






69Accounts receivable


657



1,851Other assets


(163
)


(879
)Accounts payable


(1,993
)


(137
)Accrued expenses and other current liabilities


(1,280
)


1,221Net cash flows provided by (used in) operating activities


575



10,068CASH FLOWS FROM INVESTING ACTIVITIES:Exploration and development expenditures


(1,879
)


(6,120
)Proceeds from sale of oil and gas properties and purchases of equipment, net






(5
)Net cash flows used in investing activities


(1,879
)


(6,125
)CASH FLOWS FROM FINANCING ACTIVITIES:Payments of principal


(11,516
)


(11,635
)Borrowing on notes payable and long-term debt


12,622



5,664Net cash flows provided by (used in) financing activities


1,106



(5,971
)NET CHANGE IN CASH AND CASH EQUIVALENTS


(198
)


(2,028
)CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD


201



2,292CASH AND CASH EQUIVALENTS AT END OF THE PERIOD

$
3


$
264SUPPLEMENTAL CASH FLOW INFORMATION:Cash paid during the period for interest

$
702


$
603





The accompanying notes are an integral part of these consolidated financial
statements.




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MILLER EXPLORATION COMPANY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





(1)    Organization and Nature of Operations





The consolidated financial statements of Miller Exploration Company (the Company) and its subsidiary included herein have been prepared by management without audit pursuant to the rules and regulations of the Securities
and Exchange Commission (the SEC). Accordingly, they reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial results for the interim periods presented. Certain information and
notes normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, management believes that the disclosures are
adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Companys Annual Report on Form 10-K for the
year ended December 31, 2001. The statements of operations for the three and six month periods ended June 30, 2002, cannot necessarily be used to project results for the full year.





The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates.





Principles of Consolidation





The consolidated financial statements of the Company include the accounts of the Company and its subsidiary after elimination of all intercompany accounts and transactions.





Nature of Operations





The Company is a domestic, independent energy company engaged in the exploration, development and production of crude oil and natural gas. The Company has established
exploration efforts concentrated primarily in the Mississippi Salt Basin of central Mississippi.





Oil and Gas
Properties





SEC Regulation S-X, Rule 4-10 requires companies reporting on a full cost basis to apply a ceiling
test wherein the capitalized costs, net of deferred income taxes, within the full cost pool may not exceed the net present value of the Companys proven oil and gas reserves plus the lower of the cost or market value of unproved properties. Any
such excess costs should be charged against earnings. Using unescalated period-end prices at June 30, 2002, of $3.24 per Mcf of natural gas and $26.86 per barrel of oil, the Company has recognized a non-cash cost ceiling writedown of $7.0 million.
The cost ceiling writedown is attributable to a decrease in the value of the Companys unproved properties as a result of the transfer of proprietary rights in 3-D seismic data to Veritas DGC Land, Inc. (as more fully discussed in Note 5) and
due to the fact that the Company has written off the $5.5 million balance at June 30, 2002, of deferred income taxes (as more fully discussed in Note 2) which are a component of the cost ceiling computation. Using unescalated period-end prices at
June 30, 2001, of $3.28 per Mcf of natural gas and $25.55 per barrel of oil, the Company recognized a $7.5 million cost ceiling writedown during the second quarter of 2001.




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MILLER EXPLORATION COMPANY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





Reclassifications





Certain
reclassifications have been made to prior period statements to conform with the June 30, 2002 presentation.





(2)    Income Taxes





In 1998, upon consummation of the Companys
initial public offering, the Company recorded a one-time non-cash accounting charge of $5.4 million to record net deferred tax liabilities, due to the use of different methods for tax and financial reporting purposes in accounting for various
transactions and the resultant temporary differences between tax basis and financial reporting basis.





Based on
estimates prepared as of June 30, 2002, of future anticipated taxable income and also taking into consideration the Companys current net operating loss and depletion deduction carryforwards of approximately $38.6 million, it has been
determined that there should be no future tax liability. Accordingly, at June 30, 2002, the Company has recorded a $5.5 million income tax credit to reverse the entire deferred income tax liability balance.





(3)    Earnings Per Share





The computation of earnings (loss) per share for the three-month and six-month periods ended June 30, 2002 and 2001 are as follows (in thousands, except per share data):





Three MonthsEnded June 30,


Six MonthsEnded June 30,2002


2001


2002


2001Net income (loss) attributable to basic and diluted EPS

$
(2,156
)

$
(7,743
)

$
(2,581
)

$
(7,347
)Average common shares outstanding applicable to basic EPS


19,802



19,446



19,721



19,405Add: stock options, treasury shares and restricted stock














Average common shares outstanding applicable to diluted EPS


19,802



19,446



19,721



19,405Earnings (loss) per share:Basic

$
(0.11
)

$
(0.40
)

$
(0.13
)

$
(0.38
)Diluted

$
(0.11
)

$
(0.40
)

$
(0.13
)

$
(0.38
)





Options and restricted stock were not included in the computation
of diluted earnings per share because their effect was antidilutive.





(4)    Capital Resources and Liquidity





The Companys primary ongoing sources of liquidity are from cash generated from operations and from the
Companys use of available borrowing capacity under its credit facility. The Companys cash flow for the six months ended June 30, 2002 decreased to $3.2 million from $7.9 million for the same period of the prior year, due to declining oil
and gas production volumes and lower average commodity prices. The Company cannot predict future oil and natural gas price movements with certainty. Although commodity prices have rebounded in 2002, a return to the prices experienced during the
fourth quarter of 2001, would likely have a material adverse effect on the Companys liquidity, financial condition and results of operations.




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MILLER EXPLORATION COMPANY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





The Companys note payable to Veritas DGC Land, Inc. (as more fully discussed in Note 5) expires December 31, 2002 and is classified as a current liability in the
Consolidated Balance Sheets representing $3.1 million of the Companys working capital deficit of $4.8 million at June 30, 2002.





(5)    Notes Payable and Long-Term Debt





Notes Payable





In the past few years the Company has financed various insurance policy premiums. In January 2002, concurrent
with the policy renewals, the Company entered into a $71,893 note payable agreement to finance general liability and workers compensation insurance premiums. Terms of such note call for nine monthly installment payments of $8,157, bearing
interest at 5.05%. In February 2002, the Company entered into a $131,827 note payable agreement to finance control of well, boiler and machinery and personal property insurance premiums. Terms of such note call for nine monthly installment payments
of $14,949, bearing interest at 4.91%. The outstanding balance of these notes payable was approximately $106,000 at June 30, 2002.





Bank Debt





On July 19, 2000, the Company entered into a senior credit facility
with Bank One, Texas, N.A. (Bank One), which replaced the then existing credit facility with Bank of Montreal, Houston Agency. The new credit facility has a 30-month term with an interest rate of either the Bank One prime rate plus 2% or
LIBOR plus 4% at the Companys option. The Companys new borrowing base determined by Bank One as of July 1, 2002, was $5.8 million. Commencing October 1, 2002, the borrowing base will be reduced $0.3 million each month until the next
redetermination scheduled for January 1, 2003. Bank One also notified the Company that the maturity date of the credit facility has been extended to August 1, 2003 from January 18, 2003. At June 30, 2002, the outstanding balance under the
Companys credit facility with Bank One was $4.6 million. The weighted average interest rate for the credit facility at June 30, 2002, was 6.06%.





The Bank One credit facility includes certain covenants that impose restrictions on the Company with respect to, among other things, incurrence of additional indebtedness, limitations on financial
ratios, making investments and mergers and consolidation. As a result of the $3.1 million note payable to Veritas DGC Land, Inc. being classified as a current liability (see further discussion below) at June 30, 2002, the Company is not in
compliance with the current ratio covenant and has obtained a waiver of this violation from Bank One. The obligations under the new credit facility are secured by a lien on all of the Companys real and personal property.





Other





On April 14, 1999, the Company issued a $4.7 million note payable (the Veritas Note) to one of its suppliers, Veritas DGC Land, Inc. (Veritas), for the outstanding balance due to Veritas for past
services provided in 1998 and 1999. The principal obligation under the Veritas Note was originally due on April 15, 2001.





On April 14, 1999, the Company also entered into an agreement (the Warrant Agreement) to issue warrants to Veritas that entitle Veritas to purchase shares of common stock in lieu of receiving cash payments for the accrued
interest obligations under the Veritas Note. The Warrant Agreement required the Company to issue warrants to Veritas in conjunction with the signing of the Warrant Agreement, as well as on the six and, at the Companys option, 12 and 18 month
anniversaries of the Warrant Agreement. The warrants issued equal 9% of the then current outstanding principal balance of the Veritas Note. The number of shares issued upon exercise of




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MILLER EXPLORATION COMPANY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





the warrants on April 14, 1999, and on the six-month anniversary was determined based upon a five-day weighted average closing price of the Companys Common Stock at April 14, 1999. The exercise
price of each warrant is $0.01 per share. On April 14, 1999, warrants exercisable for 322,752 shares of common stock were issued to Veritas in connection with execution of the Veritas Note. On October 14, 1999 and April 14, 2000, warrants
exercisable for another 322,752 and 454,994 shares, respectively, of Common Stock were issued to Veritas. The Company ratably recognized the prepaid interest into expense over the period to which it related.





On July 18, 2000, the Company entered into the First Amendment to Promissory Note, Warrant and Registration Rights Agreement (First
Amendment Agreement). Under the terms of the First Amendment Agreement, the maturity of the Veritas Note was extended to July 21, 2003 from April 15, 2001 and the expiration date for all warrants issued was extended until June 21, 2004. The
annual interest rate was reduced to 93⁄4% from 18%, provided the entire Note balance was paid in full by December 31, 2001. The Veritas note was not paid in full by December 31, 2001, and the interest rate was increased to 133/4% annually. Interest is payable on each October 15 and April 15 until the note is paid in full. The Company has
paid additional interest of approximately $225,000 at the incremental 4% rate for the period of October 15, 2000 through April 14, 2002. Interest was required to be paid in warrants under the terms of the First Amendment Agreement until the Company
was in compliance with the net borrowing base formula as defined in the Bank One credit facility, at which time interest would only be paid in cash. Since October 15, 2000, all interest payments have been made in cash.





On June 28, 2002, the Company entered into the Second Amendment to Promissory Note, Warrant and Registration Rights Agreement
(Second Amendment Agreement). Concurrently with the execution of the Second Amendment Agreement, the Company made a $600,000 principal payment. Under terms of the Second Amendment Agreement, the Veritas Note was amended as follows: (1)
The maturity of the Veritas Note has been changed to December 31, 2002 from July 21, 2003; (2) the note bears interest at the stated rate of 93/4%; (3) the past due annual interest rate was changed to 12% from 133/4%; and (4) six principal payments of $150,000, totaling $900,000 are required, and are payable on or before the last day of each month commencing on July 31, 2002. In the event that all six principal payments mentioned above are made
timely, an interest payment will not be due on October 15, 2002, and Veritas shall forgive the remaining principal balance of $2.2 million and any accrued interest outstanding under the Veritas Note and the Company will recognize a gain of
approximately $2.2 million. As an inducement for Veritas to enter into the Second Amendment Agreement: (1) the Company has agreed to grant Veritas an overriding royalty interest on the Companys entire leasehold that is not held by production
and leases acquired through July 31, 2003 (excluding leases within the boundaries of the Blackfeet Indian Reservation); (2) the Company will transfer its proprietary rights in approximately 140 square miles of 3-D seismic data with respect to
certain areas within the Mississippi Salt Basin to Veritas in exchange for a 25-year license allowing the Company the use of same data. The Company has also agreed to an optional transfer fee on its currently licensed data, which in the aggregate
totals approximately $3.1 million in the event of a change in control of the Company; and (3) certain Company Directors who own or control shares of Common Stock of the Company and are considered major stockholders have agreed to provide certain
tag-along rights in the event one of these major stockholders negotiates a sale of Company Common Stock with a private party. In the event that these six principal payments are not timely made, the entire principal balance outstanding under the
Veritas Note shall be accelerated and become due and payable upon demand and shall accrue interest at the past due rate from the date of the Second Amendment Agreement until the Veritas Note is paid in full. The outstanding Veritas Note balance at
June 30, 2002, was $3.1 million, and since the maturity date has been changed to December 31, 2002, the entire balance has been classified as a current liability in the Consolidated Balance Sheets.





The Second Amendment Agreement also extended the expiration date of the warrants to July 31, 2004 from June 21, 2004.







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##### Table of Contents

MILLER EXPLORATION COMPANY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





Any additional proceeds derived by the Company from the exercise of warrants issued (see Note 6) or from other debt or equity transactions must be used to pay interest and
principal on the amended Veritas Note until paid in full. Effective November 1, 2000, Veritas exercised 500,000 warrants to receive 496,923 shares (net of exercise price) of Company Common Stock.





The Companys long-term debt as of June 30, 2002, consisted of the outstanding credit facility balance with Bank One of $4.6 million.





(6)    Capital Transactions and Common Stock Warrants





On July 11, 2000, the Company entered into a Securities Purchase Agreement (the Securities Purchase Agreement) with Guardian Energy Management Corp.
(Guardian). Pursuant to the Securities Purchase Agreement, the Company issued to Guardian a convertible promissory note in the amount of $5.0 million, and three warrants exercisable for 1,562,500, 2,500,000 and 9,000,000 shares of the
Companys Common Stock, respectively. The issuance of the shares of Common Stock on the conversion of the note and exercise of the warrants was approved by the Companys stockholders at a meeting on December 7, 2000. Until the stockholders
approved the conversion of the note, the Company accrued interest at an amount equal to the prime rate plus 10% per annum (or 19.5%). The accrual of interest was required under Emerging Issues Task Force (EITF) 85-17 even though no
interest was owed on this note since the stockholders approved the conversion of the note. Accordingly, the Company incurred approximately $0.4 million of interest expense on this convertible note during the year ended December 31, 2000.





Under accounting pronouncements in effect at the time of the transaction, in determining the beneficial
conversion feature of the Guardian convertible note, the Company was required to assume that the fair value of the Guardian transaction was the closing price of the Companys common stock on the commitment date (July 11, 2000) which was the
date the agreements were signed ($1.56 per share) versus the value agreed to by both parties of $1.35 per share using various valuation methodologies. The difference between these values of $.21 per share resulted in a non-cash charge to interest
expense of $0.8 million on the date of stockholder approval of the note conversion. Also, the Company was required to use a value of $1.56 per share of Company Common Stock to allocate value to the warrants issued to Guardian. This resulted in a
non-cash charge to interest expense of $0.5 million, making an aggregate $1.3 million charge to interest expense related to valuation of the Guardian Transaction. These charges to interest expense are the result of using a prescribed fair value for
the Companys Common Stock in accounting for these transactions which may not represent the actual value of the Guardian Transaction.





On July 11, 2000, the Company also signed a letter agreement to acquire an interest in certain undeveloped oil and gas properties and $0.5 million in cash from Eagle Investments, Inc. (Eagle) an affiliated entity
controlled by C.E. Miller, the Chairman of the Company, in exchange for a total of 1,851,851 shares of common stock. In addition, Eagle was issued warrants exercisable for a total of 2,031,250 shares of Common Stock. This transaction with Eagle was
approved by the Companys stockholders at meeting on December 7, 2000.




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##### Table of Contents

MILLER EXPLORATION COMPANY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





Common Stock Warrants





As of
June 30, 2002, the Company has the following Common Stock warrants outstanding:





Warrants

Exercise Price

Expiration Date3,750,000 shares

$
2.50

December 7, 2002600,498 shares


0.01

July 31, 20049,000,000 shares


3.00

December 7, 2004





(7)    Risk Management Activities and Derivative Transactions





The Company uses a variety of financial derivative instruments (derivatives) to manage exposure
to fluctuations in commodity prices. To qualify for hedge accounting, derivatives must meet the following criteria: (i) the item to be hedged exposes the Company to price risk; and (ii) the derivative reduces that exposure and is designated as a
hedge. The Company periodically enters into certain derivatives for a portion of its oil and natural gas production to achieve a more predictable cash flow, as well as to reduce the exposure to price fluctuations. The Companys hedging
arrangements apply only to a portion of its production, provide only partial price protection against declines in oil and natural gas prices and limit potential gains from future increases in prices. Such hedging arrangements may expose the Company
to risk of financial loss in certain circumstances, including instances where production is less than expected, the Companys customers fail to purchase contracted quantities of oil or natural gas or a sudden unexpected event materially impacts
oil or natural gas prices. For financial reporting purposes, gains and losses related to hedging are recognized as oil and gas revenues during the period the hedge transaction occurs. The Company expects that the amount of hedge contracts that it
has in place will vary from time to time. For the six months ended June 30, 2002 and 2001, the Company realized approximately $(0.1) million and $(2.7) million, respectively, of hedging (losses) which are included in oil and natural gas revenues in
the consolidated statements of operations. The fair value of remaining derivative contracts at June 30, 2002, is approximately $(0.1) million. This amount is reflected in other current liabilities in the Consolidated Balance Sheet with a
corresponding amount in comprehensive income (loss). For the six months ended June 30, 2002 and 2001, the Company had hedged 58% and 69%, respectively, of its oil and natural gas production, and as of June 30, 2002, the Company had 1.0 Bcfe of open
natural gas contracts for the months of July 2002 through May 2003. If all these open contracts had been settled as of June 30, 2002, the Company would have paid approximately $0.1 million.





(8)    Commitments and Contingencies





Stock-Based Compensation





During 1997, the Company adopted
the Stock Option and Restricted Stock Plan of 1997 (the 1997 Plan). The Board of Directors contemplates that the 1997 Plan primarily will be used to grant stock options. However, the 1997 Plan permits grants of restricted stock and tax
benefit rights if determined to be desirable to advance the purposes of the 1997 Plan. These stock options, restricted stock and tax benefit rights are collectively referred to as Incentive Awards. Persons eligible to receive Incentive
Awards under the 1997 Plan are directors, corporate officers and full-time employees of the Company and its subsidiary. A maximum of 2.4 million shares of Common Stock (subject to certain antidilution adjustments) are available for Incentive Awards
under the 1997 Plan.




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##### Table of Contents

MILLER EXPLORATION COMPANY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





On January 1, 2000, the Company granted 191,500 stock options to certain employees with an exercise price of $0.01 per share. The right to exercise the options vests and
the options become exercisable only when the average trading price of the Common Stock on the market remains above the designated target prices for a period of five consecutive trading days as follows:





Five-Day Daily Average Target

Percentage Vested$2.00

40%$2.75

30%$3.50

30%





When it is probable that the five-day stock price target will be
attained (the measurement date), the Company will recognize compensation expense for the difference between the quoted market price of the Common Stock at this measurement date less the $0.01 per share grant price times the number of
options that will vest. Management does not currently believe it is probable that any of these targets will be attained during 2002; therefore, no compensation expense has been recorded for these options.





On October 31, 2000, the Company granted 250,000 stock options to employees with an exercise price of $1.625 per share (the closing market
price on the date of grant). The right to exercise the options vests at a rate of one-fifth per year beginning on the first anniversary of the grant date.





On April 6, 2001, the Company granted 190,000 stock options to the Chief Executive Officer of the Company. Of these options, 100,000 were issued under the same terms as those issued to certain
employees on January 1, 2000, and the remaining 90,000 stock options were issued under the same terms as those issued to certain employees on October 31, 2000.





On November 12, 2001, the Company granted 337,000 stock options to employees with an exercise price of $1.25 per share. The right to exercise the options vests at a rate of one-fifth per year
beginning on the first anniversary of the grant date.





The Company accounts for all stock options issued under the
provisions and related interpretation of Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock-Based Compensation. The Company intends to continue to apply APB No. 25 for purposes of determining net income.





Litigation





On May 1, 2000, the Company filed a lawsuit in the Federal District Court for the District of Montana against K2 America Corporation and K2 Energy Corporation (collectively referred to in this section
as K2). The Companys lawsuit includes certain claims of relief and allegations by the Company against K2, including breach of contract arising from failure by K2 to agree to escrow, repudiation, and rescission; specific
performance; declaratory relief; partition of K2 lands that are subject to the K2 Agreement; negligence; and tortuous interference with contract. The lawsuit is on file with the Federal District Court for the District of Montana, Great Falls
Division and is not subject to a protective order. In an order dated September 4, 2001, the Federal District Court dismissed without prejudice the lawsuit against K2 and deferred the case to the Blackfeet Tribal Court for determination of whether it
has jurisdiction over the claims made by the Company. The Company has filed a complaint in the Blackfeet Tribal Court in Montana against K2 substantially similar to the action previously filed in Federal District Court, while arguing to the
Blackfeet Tribal Court that proper jurisdiction is with the Federal District Court. K2 has since filed a counterclaim against the Company to the




13




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##### Table of Contents

MILLER EXPLORATION COMPANY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





effect that alleged actions by the Company damaged K2 by denying K2 the ability to participate in the Miller/Blackfeet IMDA and damaged K2s goodwill with Tribal officials so as to impede other
development initiatives on the Reservation. The Company answered K2s counterclaim by asserting that any damages K2 may have incurred were caused in whole or in part by its own negligence, conduct, bad faith or fault. The Company believes
K2s counterclaim is without merit and will continue to vigorously contest it. The Blackfeet Tribal Business Council unanimously voted on May 1, 2002, to over-turn a previous Tribal Business Council decision which action reaffirms the
Companys 50% interest in the K2 Energy Exploration Agreement (K2/Blackfeet IMDA) covering 150,000 net Tribal mineral acres.





On May 1, 2000, the Company gave notice to the Blackfeet Tribal Business Council demanding arbitration of all disputes as provided for under the Miller/Blackfeet IMDA dated February 19, 1999, and pursuant to the K2/Blackfeet IMDA
dated May 30, 1997. The disputes for which the Company demands arbitration include, but are not limited to the unreasonable withholding of a consent to a drilling extension as provided in the Miller/Blackfeet IMDA, as well as a determination by the
Blackfeet Tribal Council dated March 16, 2000, that certain wells which the Company proposed to drill would not satisfy the mandatory drilling obligations under the K2/Blackfeet IMDA. The Rocky Mountain Regional Director of the Bureau of
Indian Affairs (BIA) responded to the Companys request for arbitration by stating that it was the BIAs position that the Miller/Blackfeet IMDA was terminated. The Company also filed an appeal brief with the United States
Department of Interior Appeals Division. On January 25, 2002, the Interior Department Appeals Division vacated the BIAs purported termination of the Miller/Blackfeet IMDA to allow arbitration to proceed.





The Company and the Blackfeet Tribal Business Council entered into an Amended Exploration Agreement on June 3, 2002, covering 100,000 net
Tribal mineral acres, and the Company deposited $525,000 with the BIA in anticipation of the BIAs future approval of the Exploration Agreement. Once BIA approval of the Amended Miller/Blackfeet IMDA is received, the Companys request for
arbitration will be dropped.





The Company was a defendant in a lawsuit filed June 1, 1999 by Energy Drilling
Company (Energy Drilling), in the Parish of Catahoula, Louisiana arising from a blowout of the Victor P. Vegas #1 well that was drilled and operated by the Company. Energy Drilling, the drilling rig contractor on the well, was claiming
damages related to the destruction of their drilling rig and related costs amounting to approximately $1.2 million, plus interest, attorneys fees and costs. In January 2001, the Federal District Court judge ruled against the Company on two of
the three claims filed in this case with damages left undetermined. This ruling was appealed to the U.S. Fifth Circuit Court of Appeals with the lower court ruling being upheld. In August 2002, the Court of Appeals ruled in favor of the Company on
disputed interest and dayrate charges. The Company believes the judgment plus any associated costs will be covered by insurance.





The Company was named in a lawsuit brought by Victor P. Vegas, the landowner of the surface location of the blowout well referenced above. The suit was filed July 20, 1999 in the Parish of Orleans, Louisiana, claiming unspecified
damages related to environmental and other matters. Under a Department of Environmental Quality (DEQ) approved plan, site remediation has been completed and periodic testing is being performed. On December 11, 2001, the plaintiff
submitted a remediation plan for more extensive clean-up and a settlement demand. In February 2002, the Company filed a remediation plan with the Louisiana DEQ for approval. In July 2002, the Civil District Court ruled that the DEQ would not have
primary jurisdiction and that a jury trial would be held. The Company plans to appeal this decision and believes any costs associated with this lawsuit will be covered by insurance.




14




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##### Table of Contents

MILLER EXPLORATION COMPANY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





The Company is a party to a lawsuit brought by Bill and Joyce Vasilion against Amerada Hess Corporation (AHC) (the Companys joint venture partner at the
site of the alleged incident). The claim alleges that AHC (the operator) was negligent in failing to inspect a crane at a well site that was the subject of an accident which occurred in September 1994. This claim was settled on March 8, 2002.
Substantially all of the settlement amount was covered by insurance.





The Company believes it has meritorious
defenses to the unresolved claims discussed above and intends to vigorously contest them. The Company does not believe that the final outcome of these matters will have a material adverse effect on the Companys operating results, financial
condition or liquidity. Due to the uncertainties inherent in litigation, however, no assurances can be given regarding the final outcome of each action.





(9)    Non-Cash Activities





The Company issued 243,493 and 125,599
shares of the Companys Common Stock to its non-employee directors for the six-months ended June 30, 2002 and 2001, respectively, as compensation, as provided for under the Equity Compensation Plan for Non-Employee Directors. During the six
months ended June 30, 2002 and 2001, the Company issued 79,176 and 70,207 shares, respectively, of the Companys Common Stock to the Companys 401(K) Savings Plan as an employer matching contribution. For the six months ended June 30, 2002
and 2001, the Company recognized $(0.2) million and $0.3 million, respectively, of other comprehensive income (loss) under the provisions of SFAS No. 133. These non-cash activities have been excluded from the Consolidated Statements of Cash Flows.




15




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##### Table of Contents




Item 2.    
Managements Discussion and Analysis of Financial Condition and Results of Operations





Overview





The Company is an independent oil and gas exploration, development and production company that has developed
a base of producing properties and inventory of prospects primarily in Mississippi.





The Company uses the full
cost method of accounting for its oil and natural gas properties. Under this method, all acquisition, exploration and development costs, including any general and administrative costs that are directly attributable to the Companys acquisition,
exploration and development activities, are capitalized in a full cost pool as incurred. Additionally, proceeds from the sale of oil and gas properties are applied to reduce the costs in the full cost pool. The Company records depletion
of its full cost pool using the unit-of-production method.





Securities and Exchange Commission (SEC)
Regulation S-X, Rule 4-10 requires companies reporting on a full cost basis to apply a ceiling test wherein the capitalized costs, net of deferred income taxes, within the full cost pool may not exceed the net present value of the Companys
proven oil and gas reserves plus the lower of the cost or market value of unproved properties. Any such excess costs should be charged against earnings.





Results of Operations





The following table summarizes production volumes, average sales
prices and average costs for the Companys oil and natural gas operations for the periods presented (in thousands, except per unit amounts):





Three Months Ended June 30,


Six Months Ended June 30,2002


2001


2002


2001Production volumes:Crude oil and condensate (MBbls)


43



38



89



75Natural gas (MMcf)


604



872



1,272



1,954Natural gas equivalent (MMcfe)


862



1,100



1,806



2,404Revenues:Crude oil and condensate

$
931


$
910


$
1,782


$
1,825Natural gas


1,963



3,800



3,798



9,377Operating expenses:Lease operating expenses and production taxes

$
488


$
824


$
929


$
1,763Depletion, depreciation and amortization


2,422



3,525



4,514



7,712General and administrative


504



514



1,164



1,076Cost ceiling writedown


7,000



7,500



7,000



7,500Interest expense

$
206


$
331


$
402


$
588Net income (loss)

$
(2,156
)

$
(7,743
)

$
(2,581
)

$
(7,347
)Average sales prices:Crude oil and condensate ($ per Bbl)

$
21.65


$
23.95


$
20.02


$
24.33Natural gas ($ per Mcf)


3.25



4.36



2.99



4.80Natural gas equivalent ($ per Mcfe)


3.36



4.28



3.09



4.66Average Costs ($ per Mcfe):Lease operating expenses and production taxes

$
0.57


$
0.75


$
0.51


$
0.73Depletion, depreciation and amortization


2.81



3.20



2.50



3.21General and administrative


0.58



0.47



0.64



0.45




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##### Table of Contents

Managements Discussion and Analysis of Financial Condition and Results of Operations


(Continued)





Quarter Ended June 30,
2002 compared to Quarter Ended June 30, 2001





Oil and natural gas revenues for the quarter ended June 30, 2002
decreased 39% to $2.9 million from $4.7 million for the comparable period in the prior year. The revenues for the quarter ended June 30, 2002 and 2001 include approximately $(0.2) million and $(0.4) million of hedging (losses), respectively (see
Risk Management Activities and Derivative Transactions below). Production volumes for the quarter ended June 30, 2002, decreased 22% to 862 MMcfe from 1,100 MMcfe for the comparable period in the prior year. Oil and natural gas
production from the Mississippi Salt Basin properties continued a downward trend since no impactual gas well discoveries have been made recently to offset normal depletion. In 2002, the Company plans to pursue asset purchases, corporate
mergers/combinations and/or joint ventures that will strategically position the Company to, among other things, diversify its asset base, develop new core areas for exploration and development and to increase shareholder value. The Company expects
financing of these acquisitions and/or mergers to come from a combination of proceeds from sales of producing properties, cash flows and, possibly, additional debt. Average realized oil prices for the quarter ended June 30, 2002, decreased 10% to
$21.65 per barrel from $23.95 per barrel experienced during the comparable period of 2001. Realized natural gas prices for the quarter ended June 30, 2002, decreased 25% to $3.25 per Mcf from $4.36 per Mcf for the comparable period of the prior
year. The wide price fluctuations have substantially affected oil and gas revenues. The resultant reduction in cash flow from operations due to volatile commodity prices and lower production volumes has significantly impacted the Companys
budgeted exploration and development expenditures for 2002.





Lease operating expenses (LOE) and
production taxes for the quarter ended June 30, 2002 decreased 41% to $0.5 million from $0.8 million for the comparable period in the prior year. The LOE component for the quarter ended June 30, 2002, decreased 20% to $0.4 million from $0.6 million
for the comparable period in the prior year, due primarily to rework expenses incurred on one well in 2001. Production taxes for the quarter ended June 30, 2002, decreased 33% to $0.1 million from $0.3 million for the comparable period in the prior
year due to declining production and revenues.





Depreciation, depletion and amortization (DD&A)
expense for the quarter ended June 30, 2002, decreased 31% to $2.4 million from $3.5 million for the comparable period in the prior year, due to decreased production volumes and a reduced property cost basis after the $15.5 million cost ceiling
writedown recognized in 2001.





General and administrative expenses have been virtually flat at $0.5 million for
the quarter ended June 30, 2002 and 2001, respectively.





Using unescalated period-end prices at June 30, 2002, of
$3.24 per Mcf of natural gas and $26.86 per barrel of oil, the Company has recognized a non-cash cost ceiling writedown of $7.0 million. The cost ceiling writedown is attributable to a decrease in the value of the Companys unproved properties
as a result of the transfer of proprietary rights in 3-D seismic data to Veritas (as more fully discussed in Note 5) and due to the fact that the Company has written off the $5.5 million balance at June 30, 2002, of deferred income taxes (as more
fully discussed in Note 2). Using unescalated period-end prices at June 30, 2001, of $3.28 per Mcf of natural gas and $25.55 per barrel of oil, the Company recognized a $7.5 million cost ceiling writedown for the quarter ended June 30, 2001.





Interest expense for the quarter ended June 30, 2002, decreased 38% to $0.2 million from $0.3 million for the
comparable period in the prior year. This decrease is attributable to: (1) a decrease in the average outstanding credit facility balance during the first quarter of 2002 compared to the same quarter of the prior year; (2) full payment of the amount
owed pursuant to the note held by Amerada Hess Corporation in August 2001; and (3) lower interest rates associated with the new Bank One credit facility which are prime rate sensitive.




17




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##### Table of Contents

Managements Discussion and Analysis of Financial Condition and Results of Operations


(Continued)





Net income (loss) for the
quarter ended June 30, 2002, was $(2.2) million compared to $(7.7) million for the same period in the prior year, as a result of the factors described above.





Six Months Ended June 30, 2002 compared to Six Months Ended June 30, 2001





Oil and gas revenues for the six months ended June 30, 2002, decreased 50% to $5.5 million from $11.2 million for the comparable period in the prior year. The revenues for the six months ended June 30, 2002 and 2001, include
approximately $(0.1) million and $(2.7) million of hedging (losses), respectively (see Risk Management Activities and Derivative Transactions below). Production volumes for the six months ended June 30, 2002, decreased 25% to 1,806 MMcfe
from 2,404 MMcfe for the comparable period in the prior year. The downward trend in production is attributable to the Companys Mississippi Salt Basin properties which are continuing their natural depletion. Average realized oil prices for the
six months ended June 30, 2002 decreased 18% to $20.02 per barrel from $24.33 per barrel for the comparable period in the prior year. Realized prices for natural gas decreased 38% to $2.99 per Mcf from $4.80 per Mcf for the comparable period in the
prior year. The volatile commodity prices and declining production volumes have had a material adverse effect on the Companys cash flow and capital expenditures for 2002.





Lease operating expenses (LOE) and production taxes for the six months ended June 30, 2002, decreased 47% to $0.9 million from $1.8 million for the comparable
period in the prior year. The LOE component for the six months ended June 30, 2002, decreased 30% to $0.7 million from $1.0 million for the same period of 2001, due primarily to rework projects on three Mississippi Salt Basin wells in 2001, two of
which were successful in returning the wells to productive status. Production taxes for the six months ended June 30, 2002, decreased 75% to $0.2 million from $0.8 million for the same period in the prior year, due to declining production, declining
revenues and applicable exemption from the 6% State of Mississippi production tax that was in place during the first quarter of 2002, compared to the first half of 2001 when the exemption did not apply due to higher average commodity prices during
that time.





DD&A expense for the six months ended June 30, 2002, decreased 41% to $4.5 million from $7.7
million for the comparable period of the prior year, due to decreased production volumes and reduced property cost basis after the $15.5 million cost ceiling writedown recognized in 2001.





General and administrative expenses for the six months ended June 30, 2002, increased 8% to $1.2 million from $1.1 million for the same period of the prior year, primarily
as a result of professional fees associated with a potential asset acquisition transaction that was terminated in March 2002.





A non-cash cost ceiling writedown of $7.0 million was recognized by the Company at June 30, 2002, compared to $7.5 million at June 30, 2001, as previously discussed.





Interest expense for the six months ended June 30, 2002, decreased 32% to $0.4 million from $0.6 million for the same period of the prior year. This decrease is
attributable to: (1) a decrease in the average outstanding credit facility balance during the six months ended June 30, 2002, compared to the same period of the prior year; (2) full payment of the Amerada Hess Corporation note in August 2001; and
(3) lower interest rates associated with the Bank One credit facility which are prime rate sensitive.





Net income
(loss) for the six months ended June 30, 2002, was $(0.6) million compared to $(7.3) million for the same period of the prior year, as a result of the factors described above.




18




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##### Table of Contents

Managements Discussion and Analysis of Financial Condition and Results of Operations


(Continued)





Capital Resources and Liquidity





Operating, Investing, and Financing Activities





The Companys primary ongoing source of liquidity is cash generated from operations. There was $0.6 million cash provided by
operating activities for the six months ended June 30, 2002, compared to $10.1 million for the same period of the prior year. The decrease in cash provided in 2002 compared to 2001 was the primary result of a decrease in operating income caused by
declining production and much lower commodity prices. Cash was also used to reduce payables and other current liabilities.





The Companys primary use of cash has been for its exploration and development activities. Net cash used in investing activities was $1.9 million and $6.1 million for the six months ended June 30, 2002 and 2001, respectively.
The decrease in cash used in 2002 compared to 2001 was attributable to the planned reduction in 2002 exploration and development expenditures due to decreased cash flow, as previously discussed.





The Companys primary sources (and uses) of capital have been from the Companys bank credit facility. Net cash provided by (used in) financing activities
was $1.1 million and $(6.0) million in 2002 and 2001, respectively. The increase in cash provided in 2002 compared to 2001 is attributable to net borrowings under the Companys credit facility to help fund Company operations.





Financing Arrangements





In the past few years the Company has financed various insurance policy premiums. In January 2002, concurrent with the policy renewals, the Company entered into a $71,893 note payable agreement to
finance general liability and workers compensation insurance premiums. Terms of such note call for nine monthly installment payments of $8,157, bearing interest at 5.05%. In February 2002, the Company entered into a $131,827 note payable
agreement to finance control of well, boiler and machinery and personal property insurance premiums. Terms of such note call for nine monthly installment payments of $14,949, bearing interest at 4.91%. The outstanding balance of these notes payable
was approximately $106,000 at June 30, 2002.





On July 18, 2000, the Company entered into a new senior credit
facility with Bank One, which replaced the then existing credit facility with Bank of Montreal. The new credit facility has a 30-month term with an interest rate of either Bank One prime plus 2% or LIBOR plus 4%, at the Companys option. The
Companys obligations under the credit facility are secured by a lien on all of its real and personal property. The Companys new borrowing base determined by Bank One as of July 1, 2002, was $5.8 million. Commencing October 1, 2002, the
borrowing base will be reduced by $0.3 million per month until the next redetermination date scheduled for January 1, 2003. Bank One also notified the Company that the maturity date of the credit facility has been extended to August 1, 2003 from
January 18, 2003. At June 30, 2002, the outstanding balance under the Companys credit facility with Bank One was $4.6 million.





The Bank One credit facility includes certain negative covenants that impose restrictions on the Company with respect to, among other things, incurrence of additional indebtedness, limitations on financial ratios, making
investments and mergers and consolidation. As a result of the $3.1 million note payable to Veritas DGC Land, Inc. being classified as a current liability (see further discussion below) at June 30, 2002, the Company is not in compliance with the
current ratio covenant and has obtained a waiver of this violation from Bank One. The obligations under the new credit facility are secured by a lien on all of the Companys real and personal property.





On April 14, 1999, the Company issued a $4.7 million note payable (the Veritas Note) to one of its suppliers, Veritas DGC
Land, Inc. (Veritas), for the outstanding balance due to Veritas for past services provided in 1998 and 1999. The principal obligation under the Veritas Note was originally due on April 15, 2001.




19




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##### Table of Contents

Managements Discussion and Analysis of Financial Condition and Results of Operations


(Continued)





On April 14, 1999, the
Company also entered into an agreement (the Warrant Agreement) to issue warrants to Veritas that entitle Veritas to purchase shares of common stock in lieu of receiving cash payments for the accrued interest obligations under the Veritas
Note. The Warrant Agreement required the Company to issue warrants to Veritas in conjunction with the signing of the Warrant Agreement, as well as on the six and, at the Companys option, 12 and 18 month anniversaries of the Warrant Agreement.
The warrants issued equal 9% of the then current outstanding principal balance of the Veritas Note. The number of shares issued upon exercise of the warrants on April 14, 1999, and on the six-month anniversary was determined based upon a five-day
weighted average closing price of the Companys Common Stock at April 14, 1999. The exercise price of each warrant is $0.01 per share. On April 14, 1999, warrants exercisable for 322,752 shares of Common Stock were issued to Veritas in
connection with execution of the Veritas Note. On October 14, 1999 and April 14, 2000, warrants exercisable for another 322,752 and 454,994 shares, respectively, of Common Stock were issued to Veritas. The Company ratably recognizes the prepaid
interest into expense over the period to which it relates. For the years ended December 31, 2000 and 1999, the Company recognized non-cash interest expense of approximately $752,000 and $600,000, respectively, related to the Veritas Note Payable.
Effective November 1, 2000, Veritas exercised 500,000 warrants to receive 496,923 shares (net of exercise price) of Company common stock.





On July 18, 2000, the Company entered into the First Amendment to Promissory Note, Warrant and Registration Rights Agreement (First Amendment Agreement). Under the terms of the First Amendment Agreement, the
maturity of the Veritas Note was extended to July 21, 2003 from April 15, 2001, and the expiration date for all warrants issued was extended until June 21, 2004. The annual interest rate was reduced from 18% to 93/4%, provided the entire note balance was paid in full by December 31, 2001. The Veritas Note was not paid in full by
December 31, 2001, and the interest rate was increased to 133⁄4% annually. Interest is payable on each October 15 and April 15 until the note is paid in full. The Company has paid additional interest of approximately $225,000 at the incremental
4% rate for the period of October 15, 2000 through April 14, 2002. Interest was required to be paid in warrants under the terms of the First Amendment Agreement until the Company was in compliance with the net borrowing base formula as defined in
the Bank One credit facility, at which time interest would only be paid in cash. Since October 15, 2000, all interest payments have been made in cash.





On June 28, 2002, the Company entered into the Second Amendment to Promissory Note, Warrant and Registration Rights Agreement (Second Amendment Agreement). Concurrently with the execution
of the Second Amendment Agreement, the Company made a $600,000 principal payment. Under terms of the Second Amendment Agreement, the Veritas Note was amended as follows: (1) The maturity of the Veritas Note has been changed to December 31, 2002 from
July 21, 2003; (2) the note bears interest at the stated rate of 93/4%; (3) the past due annual interest rate
was changed to 12% from 133/4%; and six (6) principal payments of $150,000, totaling $900,000 are required, and
are payable on or before the last day of each month commencing on July 31, 2002. In the event that all six principal payments mentioned above are made timely, an interest payment will not be due on October 15, 2002, and Veritas shall forgive the
remaining principal balance of $2.2 million and any accrued interest outstanding under the Veritas Note and the Company will recognize a gain of approximately $2.2 million. As an inducement for Veritas to enter into the Second Amendment Agreement:
(1) the Company has agreed to grant Veritas an overriding royalty interest on the Companys entire leasehold that is not held by production and leases acquired through July 31, 2003 (excluding leases within the boundaries of the Blackfeet
Indian Reservation); (2) the Company will transfer its proprietary rights in approximately 140 square miles of 3-D seismic data with respect to certain areas within the Mississippi Salt Basin to Veritas in exchange for a 25-year license allowing the
Company the use of same data. The Company has also agreed to an optional transfer fee on its currently licensed data, which in the aggregate totals approximately $3.1 million in the event of a change in control of the Company; and (3) certain
Company Directors who own or control shares of Common Stock of the Company and are considered major stockholders have agreed to provide certain tag-along rights in the event one of these major stockholders negotiates a sale of Company Common Stock
with a private party. In the event that these six principal payments are not timely made, the entire principal balance outstanding under the Veritas Note shall be accelerated and become due and payable upon demand and shall accrue interest at the
past due rate from the date of the Second Amendment Agreement until the Veritas Note is paid in full. The outstanding Veritas Note balance at June 30, 2002, was $3.1 million, and since the maturity date has been changed to December 31, 2002, the
entire balance has been classified as a current liability in the Consolidated Balance Sheets.





The
Second Amendment Agreement also extended the expiration date of the warrants to July 31, 2004, from June 21, 2004.




20




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##### Table of Contents

Managements Discussion and Analysis of Financial Condition and Results of Operations


(Continued)





Any additional proceeds
derived by the Company from the exercise of warrants issued (see Note 6) or from other debt or equity transactions must be used to pay interest and principal on the amended Veritas Note until paid in full.





Liquidity





The Companys primary ongoing source of liquidity is from cash generated from operations and from the Companys use of available borrowing capacity under its credit facility. During the course of the year, the amount
outstanding under the credit facility will vary, as the Companys approach is to borrow under the facility as needed to fund capital expenditures and pay-down the balance when cash is available in order to reduce interest charges.





As of June 30, 2002, the Company had a working capital deficit of $9.4 million, primarily due to decreased cash flow
attributable to decreased production volumes, low commodity prices, and reclassification of the outstanding credit facility balance and Veritas Note to current liabilities as more fully described in Note 5. The Company expects that it will utilize
its operational cash flows for 2002 to meet its working capital requirements and fund its capital expenditures through a mix of operational funds and additional borrowings under the credit facility.





The Company anticipates 2002 capital expenditures will be approximately $3.0 million, net of savings associated with promoted and carried
interests in wells to be drilled in 2002. Cash flows will be used to fund drilling and development activities, processing of additional seismic data and leasehold acquisitions and extensions in the Companys project areas. The actual amounts of
capital expenditures and number of wells drilled may differ significantly from such estimates. Actual capital expenditures for the six months ended June 30, 2002, were approximately $1.9 million. Despite the reduced capital expenditure budget, the
Company intends to drill the same number of gross wells as it did in 2001. The significant decrease in expenditures anticipated for 2002 is due to the above-mentioned carries and promotes, and because the planned drilling activities for 2002 are in
shallower, less expensive, lower risk wells.





The Companys revenues, profitability, future growth and
ability to borrow funds or obtain additional capital are highly dependent on prevailing prices of oil and natural gas. The Company cannot predict future oil and natural gas price movements with certainty. Although commodity prices in 2002 have
rebounded, a return to significantly lower oil and gas prices experienced by the Company in the fourth quarter of 2001, would likely have an adverse effect on the Companys liquidity, financial condition and results of operations. Lower oil and
natural gas prices also may reduce the amount of reserves that can be produced economically by the Company.




21




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##### Table of Contents

Managements Discussion and Analysis of Financial Condition and Results of Operations


(Continued)





The Company has
experienced and expects to continue to experience substantial working capital requirements due to the Companys current plans for asset growth. In 2002, the Company will focus more of its efforts toward drilling lower risk development wells and
strategic reserve acquisitions. The Company believes that cash flow from operations, proceeds from asset sales, and draws on the credit facility should allow the Company to implement its present business strategy through 2002. However, additional
debt or equity financing may be required in the future to fund reserve acquisitions, the exploration and development program, and to satisfy existing obligations. The failure to obtain and exploit such capital resources or consummate strategic asset
sales could have a material adverse effect on the Company, including further curtailment of its exploration and other activities.





Future Financing Obligations





The Company has amended the Veritas Note (as more fully
discussed in Note 5). In the event the Company is unable to comply with the terms of the amended Veritas Note, the Company believes it would be able to fulfill such obligations through the use of available cash flows; the identification of
additional sources for debt or equity financings; or strategic asset sales. However, these expectations are dependent on several internal and external factors. If these factors differ from managements expectations, they could have a material
adverse effect on the Companys ability to meet future financing obligations and cause the Company to further curtail its exploration and development activities.





Significant Accounting Policies





The results of operations,
as presented above, are based on the application of accounting principles generally accepted in the United States. The application of these principles often requires management to make certain judgments, assumptions, and estimates that may result in
different financial presentations. The Company believes that certain accounting principles are critical in understanding its financial statements.





Full Cost Method of Accounting





The Company uses the full
cost method of accounting for its oil and natural gas properties. Under this method, all acquisition, exploration and development costs, including any general and administrative costs that are directly attributable to the Companys acquisition,
exploration and development activities, are capitalized in a full cost pool as incurred. The Company records depletion of its full cost pool using the unit-of-production method. SEC Regulation S-X, Rule 4-10 requires companies reporting
on a full cost basis to apply a ceiling test wherein the capitalized costs within the full cost pool, net of deferred income taxes, may not exceed the net present value of the Companys proved oil and gas reserves plus the lower of cost or
market of unproved properties. Any such excess costs should be charged against earnings.





Use of Estimates





The preparation of financial statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of
revenue and expense during the reporting periods. Accordingly, actual results could differ from these estimates. Significant estimates include depreciation, depletion and amortization of proved oil and




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Managements Discussion and Analysis of Financial Condition and Results of Operations


(Continued)





natural gas properties. Oil and natural gas
reserve estimates, which are the basis for unit-of-production depletion and the cost ceiling test, are inherently imprecise and are expected to change as future information becomes available.





Effects of Inflation and Changes in Price





Crude
oil and natural gas commodity prices have been volatile and unpredictable during 2002 and 2001. The wide fluctuations that have occurred during these periods have had a significant impact on the Companys results of operations, cash flow and
liquidity. Recent rates of inflation have had a minimal effect on the Company.





Environmental and Other Regulatory Matters





The Companys business is subject to certain federal, state and local laws and regulations relating to
the exploration for, and the development, production and transportation of, oil and natural gas, as well as environmental and safety matters. Many of these laws and regulations have become more stringent in recent years, often imposing greater
liability on a larger number of potentially responsible parties. Although the Company believes it is in substantial compliance with all applicable laws and regulations, the requirements imposed by laws and regulations frequently are changed and
subject to interpretation, and the Company is unable to predict the ultimate cost of compliance with these requirements or their effect on its operations. Any suspensions, terminations or inability to meet applicable bonding requirements could
materially adversely affect the Companys business, financial condition and results of operations. Although significant expenditures may be required to comply with governmental laws and regulations applicable to the Company, compliance has not
had a material adverse effect on the earnings or competitive position of the Company. Future regulations may add to the cost of, or significantly limit, drilling activity.




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##### Table of Contents

Item 3.    
Quantitative and Qualitative Disclosures About Market Risk





The Company uses a variety of
financial derivative instruments (derivatives) to manage exposure to fluctuations in commodity prices. To qualify for hedge accounting, derivatives must meet the following criteria: (i) the item to be hedged exposes the Company to price
risk; and (ii) the derivative reduces that exposure and is designated as a hedge. The Company periodically enters into certain derivatives for a portion of its oil and natural gas production to achieve a more predictable cash flow, as well as to
reduce the exposure to price fluctuations. The Companys hedging arrangements apply only to a portion of its production, provide only partial price protection against declines in oil and natural gas prices and limit potential gains from future
increases in prices. Such hedging arrangements may expose the Company to risk of financial loss in certain circumstances, including instances where production is less than expected, the Companys customers fail to purchase contracted quantities
of oil or natural gas or a sudden unexpected event materially impacts oil or natural gas prices. For financial reporting purposes, gains and losses related to hedging are recognized as oil and gas revenues during the period the hedge transaction
occurs. The Company expects that the amount of hedge contracts that it has in place will vary from time to time. For the six months ended June 30, 2002 and 2001, the Company realized approximately $(0.1) million and $(2.7) million, respectively, of
hedging (losses) which are included in oil and natural gas revenues in the consolidated statements of operations. The fair value of remaining derivative contracts at June 30, 2002, is approximately $(0.1) million. This amount is reflected in other
current liabilities in the Consolidated Balance Sheet with a corresponding amount in comprehensive income (loss). For the six months ended June 30, 2002 and 2001, the Company had hedged 58% and 69%, respectively, of its oil and natural gas
production, and as of June 30, 2002, the Company had 1.0 Bcfe of open natural gas contracts for the months of July 2002 through May 2003. If all these open contracts had been settled as of June 30, 2002, the Company would have paid approximately
$0.1 million.





Market Risk Information





The market risk inherent in the Companys derivatives is the potential loss arising from adverse changes in commodity prices. The prices of natural gas are subject to
fluctuations resulting from changes in supply and demand. To reduce the price risk caused by market fluctuations, the Companys policy is to hedge (through the use of derivatives) future production. Because commodities covered by these
derivatives are substantially the same commodities that the Company sells in the physical market, no special correlation studies other than monitoring the degree of convergence between the derivative and cash markets are deemed necessary. The
changes in market value of these derivatives have a high correlation to the price changes of natural gas.




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##### Table of Contents

PART II.    OTHER INFORMATION





Item 1.    
Legal Proceedings





On May 1, 2000, the Company filed a lawsuit in the Federal District
Court for the District of Montana against K2 America Corporation and K2 Energy Corporation (collectively referred to in this section as K2). The Companys lawsuit includes certain claims of relief and allegations by the Company
against K2, including breach of contract arising from failure by K2 to agree to escrow, repudiation, and rescission; specific performance; declaratory relief; partition of K2 lands that are subject to the K2 Agreement; negligence; and tortuous
interference with contract. The lawsuit is on file with the Federal District Court for the District of Montana, Great Falls Division and is not subject to a protective order. In an order dated September 4, 2001, the Federal District Court dismissed
without prejudice the lawsuit against K2 and deferred the case to the Blackfeet Tribal Court for determination of whether it has jurisdiction over the claims made by the Company. The Company has filed a complaint in the Blackfeet Tribal Court in
Montana against K2 substantially similar to the action previously filed in Federal District Court, while arguing to the Blackfeet Tribal Court that proper jurisdiction is with the Federal District Court. K2 has since filed a counterclaim against the
Company to the effect that alleged actions by the Company damaged K2 by denying K2 the ability to participate in the Miller/Blackfeet IMDA and damaged K2s goodwill with Blackfeet Tribal officials so as to impede other development initiatives
on the Blackfeet Reservation. The Company answered K2s counterclaim by asserting that any damages K2 may have incurred were caused in whole or in part by its own negligence, conduct, bad faith or fault. The Company believes K2s
counterclaim is without merit and will continue to vigorously contest it. The Blackfeet Tribal Business Council unanimously voted on May 1, 2002, to over-turn a previous Blackfeet Tribal Business Council decision which action reaffirms the
Companys 50% interest in the K2/Blackfeet IMDA covering 150,000 net Tribal mineral acres.





On May 1, 2000,
the Company gave notice to the Blackfeet Tribal Business Council demanding arbitration of all disputes as provided for under the Miller/Blackfeet IMDA dated February 19, 1999, and pursuant to the K2/Blackfeet IMDA dated May 30, 1997. The disputes
for which the Company demands arbitration include but are not limited to the unreasonable withholding of a consent to a drilling extension as provided in the Miller/Blackfeet IMDA, as well as a determination by the Blackfeet Tribal Council dated
March 16, 2000, that certain wells which the Company proposed to drill would not satisfy the mandatory drilling obligations under the K2/Blackfeet IMDA. The Rocky Mountain Regional Director of the Bureau of Indian Affairs
(BIA) responded to the Companys request for arbitration by stating that it was the BIAs position that the Miller/Blackfeet IMDA was terminated. The Company has filed an appeal brief with the United States Department of
Interior Appeals Division. On January 25, 2002, the Interior Department Appeals Division vacated the BIAs purported termination of the Miller/Blackfeet IMDA to allow arbitration to proceed. On June 3, 2002, the Company entered into an amended
IMDA with the Blackfeet Tribe.





The Company and the Blackfeet Tribal Business Council entered into an amended
Exploration Agreement on June 3, 2002, covering 100,000 net Tribal mineral acres, and the Company deposited $525,000 with the BIA in anticipation of the BIAs future approval of the Exploration Agreement. Once BIA approval of the amended
Miller/Blackfeet IMDA is received, the Companys request for arbitration will be dropped.





The Company was a
defendant in a lawsuit filed June 1, 1999 by Energy Drilling Company (Energy Drilling), in the Parish of Catahoula, Louisiana arising from a blowout of the Victor P. Vegas #1 well that was drilled and operated by the Company. Energy
Drilling, the drilling rig contractor on the well, is claiming damages related to the destruction of their drilling rig and related costs amounting to approximately $1.2 million, plus interest, attorneys fees and costs. In January 2001, the
Federal District Court judge ruled against the Company on two of the three claims filed in this case with damages left undetermined. This ruling was appealed to the U.S. Fifth Circuit Court of Appeals with the lower court ruling being upheld. In
August 2002, the Court of




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##### Table of Contents

Appeals ruled in favor of the Company on disputed interest and dayrate charges. The Company believes the judgment plus any associated costs will be covered by insurance.





The Company was named in a lawsuit brought by Victor P. Vegas, the landowner of the surface location of the blowout well referenced above.
The suit was filed July 20, 1999 in the Parish of Orleans, Louisiana, claiming unspecified damages related to environmental and other matters. Under a Department of Environmental Quality (DEQ) approved plan, site remediation has been
completed and periodic testing is being performed. On December 11, 2001, the plaintiff submitted a remediation plan for more extensive clean-up and a settlement demand. In February 2002, the Company filed a remediation plan with the Louisiana DEQ
for approval. In July 2002, Civil District Court ruled that the DEQ would not have primary jurisdiction and that a jury trial would be held. The Company plans to appeal this decision and believes any costs associated with this lawsuit will be
covered by insurance.





The Company is a party to a lawsuit brought by Bill and Joyce Vasilion against Amerada Hess
Corporation (the Companys joint venture partner at the site of the alleged incident). The claim alleges that AHC (the operator) was negligent in failing to inspect a crane at a well site that was the subject of an accident which occurred in
September 1994. This claim was settled on March 8, 2002. The Company expects the settlement amount will be covered by insurance.





The Company believes it has meritorious defenses to the unresolved claims discussed above and intends to vigorously contest them. The Company does not believe that the final outcome of these matters will have a material adverse
effect on the Companys operating results, financial condition or liquidity. Due to the uncertainties inherent in litigation, however, no assurances can be given regarding the final outcome of each action.





Item 2.    
Changes in Securities and Use of Proceeds





None





Item 3.    
Defaults Upon Senior Securities





None





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





The Companys Board of
Directors is currently composed of five members. At the May 23, 2002 Annual Meeting of Common Stockholders, the following nominees were elected to the Companys Board of Directors for a term of three years:





Name

Votes For

Votes WithheldRobert M. Boeve

18,167,931

135,500C. E. Gene Miller

18,167,931

135,500





The remaining members of the Companys Board of Directors are
Kelly E. Miller (term expires in 2004), Richard J. Burgess (term expires in 2003), and Paul A. Halpern (term expires in 2003).





Also at the May 23, 2002 Annual Meeting of Common Stockholders, a proposal to amend the Companys Equity Compensation Plan for Non-Employee Directors to increase the number of authorized shares of Common Stock issuable under the
plan from 600,000 to 1,100,000 was approved. The vote approving this proposal was as follows:





For

Against

Abstain

Votes Withheld16,552,521

1,739,510

11,400






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##### Table of Contents

Item 5.    
Other Information





On May 13, 2002, the Company dismissed Arthur Andersen LLP
(Arthur Andersen), as the Companys independent accountant due to the lack of appropriate continuity of Arthur Andersen personnel working on the review of the Companys quarterly financial statements as of March 31, 2002 and
for the quarter then ended. As a consequence, the financial statements as of March 31, 2002, and for the three months then ended, contained in the Companys For 10-Q for the quarterly period ended March 31, 2002, and filed with the SEC on May
15, 2002, were not reviewed by an independent public accountant.





On June 27, 2002, the Company appointed Plante
& Moran, LLP, as its new independent auditors. These actions were approved by the Companys Board of Directors upon the recommendation of its Audit Committee and reported in the Companys Form 8-K filed July 3, 2002, with the SEC.
Plante & Moran, LLP, have reviewed the interim financial statements contained in the Companys Form 10-Q for the quarterly period ended March 31, 2002, filed with the SEC on May 15, 2002, and no changes have been made to such interim
financial statements.





Item 6.    
Exhibits and Reports on Form 8-K





(a)  Exhibits. The following
documents are filed as exhibits to this report on Form 10-Q:





Exhibit No.

Description2.1(a)

Agreement for Purchase and Sale dated November 25, 1997 between Amerada Hess Corporation and Miller Oil Corporation. (Incorporated by reference to Exhibit
2.3 to the Companys Amendment No. 1 to Registration Statement on Form S-1 filed on December 5, 1997 (File No. 333-40383).)2.1(b)

First Amendment to Agreement for Purchase and Sale dated January 7, 1998. (Incorporated by reference to Exhibit 2.3(b) to the Companys Amendment No. 3
to Registration Statement on Form S-1 filed on January 9, 1998 (File No. 333-40383).)3.1

Certificate of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the Companys Registration Statement on Form S-1 filed on
November 17, 1997 (File No. 333-40383).)3.2

Bylaws of the Registrant. (Incorporated by reference to Exhibit 3.2 to the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 1998
(File No. 000-23431).)10.1*

Second Amendment to Promissory Note, Warrant and Registration Rights Agreement dated June 28, 2002, between Veritas DGC Land, Inc., and Miller Exploration
Company.99.1*

Certification of Chief Executive Officer of Miller Exploration Company, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.99.2*

Certification of Chief Financial Officer of Miller Exploration Company, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.


---

* Filed herewith.





(b)  Reports on Form 8-K. The Company filed a report on Form 8-K on July 2, 2002. In the report, the Company reported,
under Item 4, that on June 27, 2002, it had appointed Plante & Moran, LLP, as the Companys new independent auditors and that this appointment was approved by the Companys Board of Directors upon the recommendation of the Audit
Committee.




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##### Table of Contents

SIGNATURES





Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





MILLER EXPLORATION COMPANYDate:    August 12, 2002



By:

/s/    DEANNA L.
CANNONDeanna L. Cannon Chief
Financial Officer and Secretary




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##### Table of Contents




EXHIBIT INDEX





Exhibit No.

Description2.1(a)

Agreement for Purchase and Sale dated November 25, 1997 between Amerada Hess Corporation and Miller Oil Corporation. (Incorporated by reference to Exhibit
2.3 to the Companys Amendment No. 1 to Registration Statement on Form S-1 filed on December 5, 1997 (File No. 333-40383).)2.1(b)

First Amendment to Agreement for Purchase and Sale dated January 7, 1998. (Incorporated by reference to Exhibit 2.3(b) to the Companys Amendment No. 3
to Registration Statement on Form S-1 filed on January 9, 1998 (File No. 333-40383).)3.1

Certificate of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the Companys Registration Statement on Form S-1 filed on
November 17, 1997 (File No. 333-40383).)3.2

Bylaws of the Registrant. (Incorporated by reference to Exhibit 3.2 to the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 1998
(File No. 000-23431).)10.1*

Second Amendment to Promissory Note, Warrant and Registration Rights Agreement dated June 28, 2002, between Veritas DGC Land, Inc., and Miller Exploration
Company.99.1*

Certification of Chief Executive Officer of Miller Exploration Company, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.99.2*

Certification of Chief Financial Officer of Miller Exploration Company, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.





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* Filed herewith.





(b)    Reports on Form 8-K. The Company
filed a report on Form 8-K on July 2, 2002. In the report, the Company reported, under Item 4, that on June 27, 2002, it had appointed Plante & Moran, LLP, as the Companys new independent auditors and that this appointment was approved by
the Companys Board of Directors upon the recommendation of the Audit Committee.




29