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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q (Mark One)[X]
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934For the quarterly period ended September 30, 2004or[   ]
    
    Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934For the Transition Period From  toCommission file number 0-9498
 MISSION RESOURCES CORPORATION  Delaware
    
    76-0437769(State or other jurisdiction of
    
    (IRS Employer Identification Number)incorporation or organization)1331 Lamar, Suite 1455, Houston, Texas
    
    77010-3039(Address of principal executive offices)
    
    (ZIP Code)
 (713) 495-3000
Registrants telephone number, including area code Not Applicable
(Former name, former address and former fiscal year, if changed since last report) 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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes  [   ]  NO [X] As of November 8, 2004,
40,967,937 shares of common stock of
Mission Resources Corporation were outstanding.




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MISSION RESOURCES CORPORATION INDEX Page #PART I. FINANCIAL INFORMATION
    
    
    1ITEM 1. Financial Statements
    
    
    1Consolidated Balance Sheets:September 30, 2004 (Unaudited) and December 31, 2003
    
    
    1Consolidated Statements of Operations (Unaudited):Three months and nine months ended September 30, 2004 and 2003
    
    
    3Consolidated Statements of Cash Flows (Unaudited):Nine months ended September 30, 2004 and 2003
    
    
    4Notes to Consolidated Financial Statements (Unaudited)
    
    
    6ITEM 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    23ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    38ITEM 4. Controls and Procedures
    
    
    40PART II. OTHER INFORMATION
    
    
    41ITEM 1. Legal Proceedings
    
    
    41ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    41ITEM 3. Defaults Upon Senior Securities
    
    
    41ITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    41ITEM 5. Other Information
    
    
    41ITEM 6. Exhibits
    
    
    42Form of Nonstatutory Stock Option Grant AgreementForm of Director Non-Qualified Stock OptionForm of Incentive Stock Option Grant AgreementFirst Amend.to Employment Agmt - Robert L. CavnarFirst Amend.to Employment Agmt - Richard W. PiacentiFirst Amend.to Employment Agmt - John L. EellsFirst Amend.to Employment Agmt - Joseph G. NicknishFirst Amend.to Employment Agmt - Marshall L. MunsellConsent of Netherland, Sewell & Associates, Inc.Certification of CEO Purusant to Rule 13a-14(a)Certification of CFO Purusant to Rule 13a-14(a)Certification of CEO Purusant to 18 U.S.C. Section 1350Certification of CFO Purusant to 18 U.S.C. Section 1350
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MISSION RESOURCES CORPORATION 
 PART I. FINANCIAL INFORMATION
 
 ITEM 1. Financial Statements MISSION RESOURCES CORPORATION 
 CONSOLIDATED BALANCE SHEETS (Amounts in thousands) September 30, 2004
    
    December 31,2003(Unaudited)ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    7,655
    
    
    $
    2,234Cash held for reinvestment
    
    
    
    
    
    
    24,877Accounts receivable
    
    
    4,555
    
    
    
    6,327Accrued revenues
    
    
    11,912
    
    
    
    8,417Current deferred income taxes
    
    
    6,173
    
    
    
    3,076Prepaid expenses and other
    
    
    3,257
    
    
    
    2,523Total current assets
    
    
    33,552
    
    
    
    47,454PROPERTY AND EQUIPMENT, at cost:Oil and gas properties (full cost), including
unproved properties of $8,873 and $6,123 excluded
from amortization as of September 30, 2004 and
December 31, 2003, respectively
    
    
    867,959
    
    
    
    805,900Asset retirement cost
    
    
    12,600
    
    
    
    10,987Accumulated depreciation, depletion and amortization
    
    
    (556,770
    )
    
    
    (514,759
    )Net property, plant and equipment
    
    
    323,789
    
    
    
    302,128Leasehold, furniture and equipment
    
    
    5,119
    
    
    
    4,405Accumulated depreciation
    
    
    (2,635
    )
    
    
    (2,065
    )Net leasehold, furniture and equipment
    
    
    2,484
    
    
    
    2,340OTHER ASSETS
    
    
    8,678
    
    
    
    5,404$
    368,503
    
    
    $
    357,326
 See accompanying notes to condensed consolidated financial statements 1




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MISSION RESOURCES CORPORATION CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share information) September 30,
    
    December 31,2004
    
    2003(Unaudited)LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    9,165
    
    
    $
    8,864Accrued liabilities
    
    
    13,757
    
    
    
    9,131Interest payable
    
    
    6,324
    
    
    
    3,425Commodity derivative liabilities
    
    
    18,212
    
    
    
    8,597Asset retirement obligation
    
    
    1,585
    
    
    
    1,160Total current liabilities
    
    
    49,043
    
    
    
    31,177LONG-TERM DEBT:Term loan facility
    
    
    25,000
    
    
    
    80,000Revolving credit facility
    
    
    10,000
    
    
    
    Senior 9 7/8% notes due 2011
    
    
    130,000
    
    
    
    Senior subordinated 10 7/8% notes due 2007
    
    
    
    
    
    
    117,426Unamortized premium on issuance of senior subordinated 10 7/8% notes due
2007
    
    
    
    
    
    
    1,070Total long-term debt
    
    
    165,000
    
    
    
    198,496LONG-TERM LIABILITIES:Commodity derivative liabilities, excluding current portion
    
    
    4,463
    
    
    
    80Deferred income taxes, excluding current portion
    
    
    18,092
    
    
    
    20,346Other liabilities
    
    
    
    
    
    
    130Asset retirement obligation, excluding current portion
    
    
    31,245
    
    
    
    32,157Total long-term liabilities
    
    
    53,800
    
    
    
    52,713STOCKHOLDERS EQUITY:Preferred stock, $0.01 par value, 5,000,000 shares authorized,
none issued or outstanding at September 30, 2004 and
December 31, 2003
    
    
    
    
    
    
    Common stock, $0.01 par value, 60,000,000 shares authorized, 40,911,304 and
28,017,636 shares issued at September 30, 2004
and December 31, 2003, respectively
    
    
    413
    
    
    
    284Additional paid-in capital
    
    
    207,033
    
    
    
    172,532Retained deficit
    
    
    (90,110
    )
    
    
    (90,232
    )Treasury stock, at cost, 389,323 shares at September 30, 2004
and December 31, 2003
    
    
    (1,937
    )
    
    
    (1,937
    )Other comprehensive income (loss), net of taxes
    
    
    (14,739
    )
    
    
    (5,707
    )Total stockholders equity
    
    
    100,660
    
    
    
    74,940$
    368,503
    
    
    $
    357,326
 See accompanying notes to condensed consolidated financial statements 2




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MISSION RESOURCES CORPORATION 
 CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
 (Amounts in thousands, except per share information) Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003REVENUES:Oil and gas revenues
    
    $
    34,470
    
    
    $
    24,071
    
    
    $
    94,901
    
    
    $
    74,246Gain (loss) on extinguishments of debt
    
    
    50
    
    
    
    
    
    
    
    (2,606
    )
    
    
    22,375Interest and other income (expense)
    
    
    508
    
    
    
    170
    
    
    
    (681
    )
    
    
    89235,028
    
    
    
    24,241
    
    
    
    91,614
    
    
    
    97,513COSTS AND EXPENSES:Lease operating expenses
    
    
    8,077
    
    
    
    8,309
    
    
    
    21,283
    
    
    
    25,563Transportation costs
    
    
    76
    
    
    
    130
    
    
    
    164
    
    
    
    322Taxes other than income
    
    
    2,657
    
    
    
    2,106
    
    
    
    6,834
    
    
    
    6,951Asset retirement obligation accretion expense
    
    
    274
    
    
    
    350
    
    
    
    816
    
    
    
    1,038Depreciation, depletion and amortization
    
    
    11,683
    
    
    
    10,037
    
    
    
    33,947
    
    
    
    27,963General and administrative expenses
    
    
    7,005
    
    
    
    2,581
    
    
    
    12,784
    
    
    
    8,013Interest and related expenses
    
    
    3,891
    
    
    
    6,569
    
    
    
    15,598
    
    
    
    19,02833,663
    
    
    
    30,082
    
    
    
    91,426
    
    
    
    88,878Income (loss) before cumulative effect of a
change in accounting method
    
    
    1,365
    
    
    
    (5,841
    )
    
    
    188
    
    
    
    8,635Provision (benefit) for income taxes
    
    
    497
    
    
    
    (2,038
    )
    
    
    66
    
    
    
    3,029Income (loss) before income taxes and cumulative
effect of a change in accounting method
    
    
    868
    
    
    
    (3,803
    )
    
    
    122
    
    
    
    5,606Cumulative effect of a change in accounting
method, net of deferred tax of $935 in 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,736
    )Net income (loss)
    
    $
    868
    
    
    $
    (3,803
    )
    
    $
    122
    
    
    $
    3,870Income (loss) before cumulative effect of a
change in accounting method per share
    
    $
    0.02
    
    
    $
    (0.16
    )
    
    $
    0.00
    
    
    $
    0.24Income (loss) before cumulative effect of a
change in accounting method per share-diluted
    
    $
    0.02
    
    
    $
    (0.16
    )
    
    $
    0.00
    
    
    $
    0.23Net income (loss) per share
    
    $
    0.02
    
    
    $
    (0.16
    )
    
    $
    0.00
    
    
    $
    0.16Net income (loss) per share-diluted
    
    $
    0.02
    
    
    $
    (0.16
    )
    
    $
    0.00
    
    
    $
    0.16Weighted average common shares outstanding
    
    
    40,746
    
    
    
    23,515
    
    
    
    37,661
    
    
    
    23,508Weighted average common shares outstanding-diluted
    
    
    42,985
    
    
    
    23,515
    
    
    
    39,454
    
    
    
    24,291
 See accompanying notes to condensed consolidated financial statements 3




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MISSION RESOURCES CORPORATION 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 (Amounts in thousands) Nine Months Ended September 30,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    122
    
    
    $
    3,870Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation, depletion and amortization
    
    
    33,947
    
    
    
    27,963(Gain) loss on commodity hedges
    
    
    132
    
    
    
    (603
    )(Gain) loss on interest rate swap
    
    
    
    
    
    
    (520
    )(Gain) loss on extinguishment of debt
    
    
    2,606
    
    
    
    (22,375
    )Cumulative effect of a change in accounting
method, net of deferred tax
    
    
    
    
    
    
    1,736Asset retirement obligation accretion expense
    
    
    816
    
    
    
    1,038Amortization of deferred financing costs and bond
premium
    
    
    1,288
    
    
    
    1,536Deferred income taxes
    
    
    (277
    )
    
    
    2,754Compensation expense-stock options
    
    
    4,120
    
    
    
    Other
    
    
    353
    
    
    
    (341
    )Change in assets and liabilities:Accounts receivable and accrued revenue
    
    
    (2,122
    )
    
    
    8,237Accounts payable and accrued liabilities
    
    
    7,909
    
    
    
    2,973Abandonment costs
    
    
    (1,780
    )
    
    
    (3,542
    )Other
    
    
    (664
    )
    
    
    (1,385
    )Net cash flows provided by operating activities
    
    
    46,450
    
    
    
    21,341Cash flows from investing activities:Acquisition of oil and gas properties
    
    
    (30,420
    )
    
    
    (953
    )Additions to oil and gas properties
    
    
    (32,952
    )
    
    
    (23,010
    )Additions to leasehold, furniture and equipment
    
    
    (714
    )
    
    
    (875
    )Proceeds on sale of oil and gas properties, net
    
    
    8,632
    
    
    
    2,983Distribution from equity investment
    
    
    178
    
    
    
    Net cash flows used in investing activities
    
    
    (55,276
    )
    
    
    (21,855
    )Cash flows from financing activities:Proceeds from borrowings
    
    
    182,500
    
    
    
    80,000Repayment of borrowings
    
    
    (186,511
    )
    
    
    (71,700
    )Stock issuance costs, net of proceeds
    
    
    679
    
    
    
    Cash held for reinvestment
    
    
    24,877
    
    
    
    Financing costs
    
    
    (7,298
    )
    
    
    (4,787
    )Net cash flows provided by financing activities
    
    
    14,247
    
    
    
    3,513Net increase in cash and cash equivalents
    
    
    5,421
    
    
    
    2,999Cash and cash equivalents at beginning of period
    
    
    2,234
    
    
    
    11,347Cash and cash equivalents at end of period
    
    $
    7,655
    
    
    $
    14,346
 See accompanying notes to condensed consolidated financial statements 4




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MISSION RESOURCES CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited) (Amounts in thousands) Nine Months EndedSeptember 30,2004
    
    2003Supplemental disclosures of cash flow information:Cash paid during the period for:Interest
    
    $
    11,076
    
    
    $
    16,495Income taxes paid (refunded)
    
    $
    269
    
    
    $
    (550
    )
 See accompanying notes to condensed consolidated financial statements 5




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MISSION RESOURCES CORPORATION 
 Notes to Consolidated Financial Statements
 1. Summary of Significant Accounting Policies The accompanying unaudited consolidated financial statements have
been prepared in accordance with instructions to Form 10-Q and,
therefore, do not include all disclosures required by accounting
principles generally accepted in the United States of America. However,
in the opinion of management, these statements include all adjustments,
which are of a normal recurring nature, necessary to present fairly
Mission Resources Corporations (the Company or Mission) financial
position at September 30, 2004, and the results of operations and changes
in cash flows for the periods ended September 30, 2004 and 2003. Interim
period results are not necessarily indicative of results of operations or
cash flows for a full year. These financial statements should be read in
conjunction with the consolidated financial statements and notes to the
consolidated financial statements in the Companys Annual Report on Form
10-K for the year ended December 31, 2003. Principles of Consolidation The consolidated financial statements include the accounts of
Mission Resources Corporation and its wholly owned subsidiaries. Mission
owns a 26.6% interest in the White Shoal Pipeline Corporation that is
accounted for using the equity method. Missions net investment of
approximately $229,550 at September 30, 2004 is included in the other
assets line of the Consolidated Balance Sheet. Oil and Gas Property Accounting The Company uses the full cost method of accounting for its

investment in oil and gas properties. Under this method of accounting,
all costs of acquisition, exploration and development of oil and gas
reserves (including such costs as leasehold acquisition costs, geological
expenditure, dry hole costs, tangible and intangible development costs
and direct internal costs) are capitalized as the cost of oil and gas
properties when incurred. To the extent that capitalized costs of oil and
gas properties, net of accumulated depreciation, depletion and
amortization, exceed the discounted future net revenues of proved oil and
gas reserves net of deferred taxes, such excess capitalized costs would
be charged to operations. No such charges to operations were required
during the three and nine month periods ending September 30, 2004 or
2003. Royalties Payable The accrued liabilities line of the Consolidated Balance Sheet
includes approximately $3.0 million of royalties that are awaiting
completion of title opinions. Upon receipt of the title opinions and
executed division orders, Mission will be required to make payment. Since
June 30, 2004, Mission has made payments and reduced the June 30, 2004
balance of $4.6 million to the $3.0 million balance at September 30,
2004. This liability may increase in size as the well produces or
decrease as title opinions are completed and royalties paid. Typically,
royalties are paid within one to two months after the production is sold. 6




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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements Receivables Joint interest receivables are recorded at the invoiced amount and
typically do not bear interest. The Company reviews collectibility of
such receivables monthly. Balances over ninety days past due and
exceeding $30,000 are reviewed individually for collectibility. Account
balances are charged against earnings when the Company determines the
potential for recovery is remote. During the three months ended September
30, 2004, no such receivables were charged against earnings; however,
during the nine months ended September 30, 2004, approximately $399,000
of such receivables were charged against earnings. The income charge is
included in the interest and other income line of the Consolidated
Statement of Operations. The Company does not have any off-balance sheet
credit exposure related to its customers. From time to time, certain other receivables are created and may be
significant. The Company had recorded a receivable of approximately $1.5
million from a private oil and gas company representing six months of
override revenue. On November 8, 2004 the Company received $1.5 million
as full payment of this receivable. Comprehensive Income Comprehensive income includes all changes in a companys equity
except those resulting from investments by owners and distributions to
owners. The Companys total comprehensive income for the three months and
nine months ended September 30, 2004 and 2003 was as follows (in
thousands): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    868
    
    
    $
    (3,803
    )
    
    $
    122
    
    
    $
    3,870Hedge accounting for
derivative instruments,
net of tax
    
    
    (4,357
    )
    
    
    3,245
    
    
    
    (9,032
    )
    
    
    399Comprehensive income (loss)
    
    $
    (3,489
    )
    
    $
    (558
    )
    
    $
    (8,910
    )
    
    $
    4,269
 The accumulated balance of other comprehensive loss related to hedge
accounting is as follows (in thousands): Nine Months Ended September 30,2004
    
    2003December 31 balance
    
    $
    (5,707
    )
    
    $
    (4,195
    )Net loss on cash flow hedges
    
    
    (12,791
    )
    
    
    (13,185
    )Reclassification adjustments
    
    
    (1,074
    )
    
    
    13,369Tax effect on hedging activity
    
    
    4,833
    
    
    
    215September 30 balance
    
    $
    (14,739
    )
    
    $
    (3,796
    )
 Stock-Based Employee Compensation Plans At September 30, 2004, the Company has two active stock-based
employee compensation plans: the 1996 Stock Incentive Plan and the 2004
Stock Incentive Plan. The 2004 Plan was
approved by the Board of Directors on March 4, 2004 and by the Companys
stockholders at the May 19, 2004 annual stockholders meeting. One
inactive plan, the 1994 Stock Incentive Plan, 7




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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements still has options
outstanding that have not expired or been exercised; however, no new
options can be granted under the plan. The Company accounts for the plans
under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No
stock-based employee compensation cost is reflected in net income for
options granted under those plans when the exercise price of the option
is equal to the market value of the underlying common stock on the date
of the grant. Net income would be affected; however, if the exercise
price of the option differed from the market price. SFAS No. 148, Accounting for Stock-Based Compensation  Transition
and Disclosure, amends SFAS No. 123 to provide alternative methods of
transition for an entity that voluntarily changes to the fair value based
method of accounting for stock-based employee compensation and to require
prominent disclosure about the effects on reported net income of an
entitys accounting policy decisions with respect to stock-based employee
compensation. SFAS No. 148 amends APB Opinion No. 28, Interim Financial
Reporting, to require disclosure about those effects in interim financial
information. Had compensation cost for the Companys stock option
compensation plans been determined based on the fair value at the grant
dates for awards under these plans consistent with the method of SFAS No.
123, the Companys pro forma net income (loss) and pro forma net income
(loss) per share of common stock would have been as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss) (in thousands)As reported
    
    $
    868
    
    
    $
    (3,803
    )
    
    $
    122
    
    
    $
    3,870Pro forma
    
    $
    868
    
    
    $
    (3,943
    )
    
    $
    (3,325
    )
    
    $
    2,587Earnings (loss) per shareAs reported
    
    $
    0.02
    
    
    $
    (0.16
    )
    
    $
    0.00
    
    
    $
    0.16Pro forma
    
    $
    0.02
    
    
    $
    (0.17
    )
    
    $
    (0.09
    )
    
    $
    0.11Diluted earnings (loss) per shareAs reported
    
    $
    0.02
    
    
    $
    (0.16
    )
    
    $
    0.00
    
    
    $
    0.16Pro forma
    
    $
    0.02
    
    
    $
    (0.17
    )
    
    $
    (0.09
    )
    
    $
    0.11
 Recently Adopted Pronouncements Staff Accounting Bulletin (SAB) No. 106, regarding the application
of FASB Statement No. 143, Accounting for Asset Retirement Obligations,
by oil and gas producing companies following the full cost accounting
method was issued in September 2004. SAB 106 provided an interpretation
of how a company, after adopting Statement 143, should compute the full
cost ceiling to avoid double-counting the expected future cash outflows
associated with asset retirement costs. The provisions of this
interpretation have been applied by the Company and have no financial
impact. The FASB issued Interpretation No. 46 (R ), Consolidation of
Variable Interest Entities, an interpretation of APB No. 51, in January
2003. This interpretation addresses the consolidation by business
enterprises of variable interest entities as defined in the
interpretation. The interpretation applies immediately to variable
interest entities created after January 31, 2003, and to variable
interests in variable interest entities obtained after January 31, 2003.
The Company does not own an interest in any variable interest entities; therefore,
this interpretation does not have any effect on its financial statements.
The provisions of this interpretation will be applied in the future
should Mission acquire or establish a variable interest entity. 8




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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements Asset Retirement Obligations In July 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, which provided accounting requirements for
retirement obligations associated with tangible long-lived assets. SFAS
No. 143 requires that the Company record a liability for the fair value
of its asset retirement obligation, primarily comprised of its plugging
and abandonment liabilities, in the period in which it is incurred if a
reasonable estimate of fair value can be made. The liability is accreted
at the end of each period through charges to operating expense. The
amount of the asset retirement obligation is added to the carrying amount
of the asset and this additional carrying amount is depreciated over the
life of the asset. If the obligation is settled for other than the
carrying amount of the liability, the Company will recognize a gain or
loss on settlement. The Company adopted the provisions of SFAS No. 143 with a
calculation effective January 1, 2003. The Companys assets are primarily
working interests in producing oil and gas properties and related support
facilities. The life of these assets is generally determined by the
estimation of the quantity of oil or gas reserves available for
production and the amount of time such production should require. The
cost of retiring such assets, the asset retirement obligation, is
typically referred to as abandonment costs. The Company hired independent
engineers to provide estimates of current abandonment costs on all its
properties, applied valuation techniques appropriate under SFAS No. 143,
and in 2003 recorded a net initial asset retirement obligation of $44.3
million on its Consolidated Balance Sheet. An asset retirement cost of
$14.4 million was simultaneously capitalized in the oil and gas
properties section of the Consolidated Balance Sheet. The adoption of
SFAS No. 143 was accounted for as a change in accounting principle in
2003, requiring that a $2.7 million charge, net of $935,000 in deferred
tax be recorded to income as a cumulative effect of the change in
accounting principle. The following table shows changes in the asset retirement obligation
that have occurred in 2004 (amounts in thousands): Nine Months EndedAsset Retirement Obligation
    
    September 30, 2004December 31, 2003 balance
    
    $
    33,317Liabilities incurred
    
    
    2,098Liabilities settled
    
    
    (1,603
    )Liabilities sold
    
    
    (1,798
    )Accretion expense
    
    
    816Ending balance
    
    
    32,830Less: current portion
    
    
    1,585Long-term portion
    
    
    31,245
 Reclassifications Certain reclassifications of prior period statements have been made
to conform with current reporting practices. 9




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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements Use of Estimates In order to prepare these financial statements in conformity with
accounting principles generally accepted in the United States, management
of the Company has made a number of estimates and assumptions relating to
the reporting of assets and liabilities, the disclosure of contingent
assets and liabilities, and reserve information. Actual results could
differ from those estimates. 2. Stockholders Equity On February 25, 2004, the Company acquired $15 million of its 10
7/8% senior subordinated notes due 2007 from Stellar Funding, Ltd. in
exchange for 6.25 million shares of the Companys common stock. On March
15, 2004, the Company acquired an additional $15 million of its 10 7/8%
senior subordinated notes due 2007 from Harbert Distressed Investment
Master Fund, Ltd. in exchange for 6.0 million shares of the Companys
common stock. On April 8, 2004, Mission issued 312,000 shares of its common stock
in lieu of cash to its financial advisors as a fee for services rendered
during the debt refinancing discussed below in Note 3. The $1.2 million
fair value of this consideration was recorded as deferred financing costs
in the other assets line of the Consolidated Balance Sheet. On August 4, 2004, the Compensation Committee of the Board of
Directors of the Company granted to Robert L. Cavnar, Chairman, President
and CEO of the Company, a nonqualified option to acquire 800,000 shares
of the Companys common stock. This option was granted to replace the
grant of 800,000 share appreciation rights made to Mr. Cavnar in November
2003. The option was granted under the 2004 Incentive Plan, has a term of
10 years, is fully vested and has a strike price of $0.55 per share,
which is the same exercise price as the surrendered share appreciation
rights. As a result of this option having an exercise price below the
market value for the Companys common stock at the time of issuance, the
Company recognized a non-cash compensation expense of approximately $4.1
million ($2.6 million, net of tax) in the third quarter of 2004. The following represents a reconciliation of the numerator and
denominator of the basic earnings per share computation to the numerator
and denominator of the diluted earnings per share computation for the
three and nine months ended September 30, 2004 and 2003, respectively.
Additionally, potentially dilutive options and warrants that are not in
the money are excluded from the computation of diluted earnings per
share. For the three months ended September 30, 2004 and 2003, the
potentially dilutive options and warrants excluded represented 0.4
million and 1.0 million shares, respectively. For the nine months ended
September 30, 2004 and 2003, the potentially dilutive options and
warrants excluded represented 2.1 million and 1.1 million shares,
respectively. 10




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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements SFAS No. 128 reconciliation (amounts in thousands except per share
amounts): For the Three Months Ended
    
    For the Three Months EndedSeptember 30, 2004
    
    September 30, 2003Income
    
    Shares
    
    Per Share
    
    Income
    
    Shares
    
    Per Share(Numerator)
    
    (Denominator)
    
    Amount
    
    (Numerator)
    
    (Denominator)
    
    AmountIncome (loss) per common
share:Income (loss) available to
common stockholders
    
    $
    868
    
    
    
    40,746
    
    
    $
    0.02
    
    
    $
    (3,803
    )
    
    
    23,515
    
    
    $
    (0.16
    )Effect of dilutive
securities:Options and warrants
    
    
    
    
    
    
    2,239
    
    
    
    
    
    
    
    
    
    
    
    
    *Income (loss) per common
share-diluted:Income (loss) available to
common stockholders
and assumed conversions
    
    $
    868
    
    
    
    42,985
    
    
    $
    0.02
    
    
    $
    (3,803
    )
    
    
    23,515
    
    
    $
    (0.16
    )
 * 2,132 shares were excluded from this calculation because to include
would have been antidilutive. For the Nine Months Ended
    
    For the Nine Months EndedSeptember 30,
2004
    
    September 30, 2003Income
    
    Shares
    
    Per Share
    
    Income
    
    Shares
    
    Per Share(Numerator)
    
    (Denominator)
    
    Amount
    
    (Numerator)
    
    (Denominator)
    
    AmountIncome (loss) per common
share:Income (loss) available to
common stockholders
    
    $
    122
    
    
    
    37,661
    
    
    $
    0.00
    
    
    $
    3,870
    
    
    
    23,508
    
    
    $
    0.16Effect of dilutive securities:Options and warrants
    
    
    
    
    
    
    1,793
    
    
    
    
    
    
    
    
    
    
    
    783Income (loss) per common
share-diluted:Income (loss) available to
common stockholders
and assumed conversions
    
    $
    122
    
    
    
    39,454
    
    
    $
    0.00
    
    
    $
    3,870
    
    
    
    24,291
    
    
    $
    0.16
 As of September 30, 2004 and 2003, Mission held in treasury 389,323
shares of its common stock that had been acquired at an aggregate price
of $1.9 million. These treasury shares are reported at cost as a
reduction to Stockholders Equity on the Consolidated Balance Sheet. 3. Long Term Debt Refinancing On April 8, 2004, Mission issued new senior notes, announced the
redemption of its 10 7/8% senior subordinated notes due 2007 (the 10
7/8% Notes), and replaced both its revolving credit facility and its
term loan. Those transactions and the details of the resulting debt are
discussed below. 11




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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements 9 7/8% Notes On April 8, 2004, Mission issued $130.0 million of its 9 7/8% senior
notes due 2011 (the 9 7/8% Notes) which are guaranteed on an
unsubordinated, unsecured basis by all of its current subsidiaries.
Interest on the notes is payable semi-annually, on each April 1 and
October 1, commencing on October 1, 2004. A portion of the net proceeds from the offering of the 9 7/8% Notes
was set aside to redeem, on May 10, 2004, the $87.4 million aggregate
principal amount of the 10 7/8% Notes that remained outstanding. On April
8, 2004, the remainder of the net proceeds from the offering of the 9
7/8% Notes, together with $21.5 million that was advanced under the new
senior secured revolving credit facility (as described below) and $25.0
million that was borrowed under the new second lien term loan (as
described below), was used to completely discharge all of the Companys
outstanding indebtedness under its prior revolving credit facility and
term loan. At any time on or after April 9, 2005 and prior to April 9, 2008,
the Company may redeem up to 35% of the aggregate original principal
amount of the 9 7/8% Notes, using the net proceeds of equity offerings,
at a redemption price equal to 109.875% of the principal amount of the 9
7/8% Notes, plus accrued and unpaid interest. On or after April 9, 2008,
the Company may redeem all or a portion of the 9 7/8% Notes at the
redemption prices (expressed as percentages of principal amount) set
forth below plus accrued and unpaid interest, if redeemed during the
twelve-month period beginning on April 9 of the years indicated below: Year
    
    Percentage2008
    
    
    104.93750
    %2009
    
    
    102.46875
    %2010
    
    
    100.00000
    %
 If the Company experiences specific kinds of change of control, it
may be required to purchase all or part of the 9 7/8% Notes at a price
equal to 101% of the principal amount together with accrued and unpaid
interest. The 9 7/8% Notes contain covenants that, subject to certain
exceptions and qualifications, limit the Companys ability and the
ability of certain of its subsidiaries to:  
    
    incur additional indebtedness or issue certain
types of preferred stock or redeemable stock;
    
    transfer or sell assets;
    
    enter into sale and leaseback transactions;
    
    pay dividends or make other distributions on
stock, redeem stock or redeem subordinated debt;
    
    enter into transactions with affiliates;
    
    create liens on its assets;
    
    guarantee other indebtedness;
    
    enter into agreements that restrict dividends from subsidiaries;
    
    make investments; 12




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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements  
    
    sell capital stock of subsidiaries; and
    
    merge or consolidate. Standard and Poors and Moodys currently publish debt ratings for
the 9 7/8% Notes. Their ratings consider a number of items including the
Companys debt levels, planned asset sales, near-term and long-term
production growth opportunities, capital allocation challenges and
commodity price levels. Standard & Poors rating on the 9 7/8% Notes is
CCC and Moodys rating is Caa2. A decline in credit ratings will not
create a default or other unfavorable change in the 9 7/8% Notes. Senior Secured Revolving Credit Facility On April 8, 2004, the Company entered into a new senior secured
revolving credit facility led by Wells Fargo Bank, N.A. The facility,
which matures on April 8, 2007, is secured by a first priority mortgage
and security interest in at least 85% of the Companys oil and gas
properties, all of the ownership interests of all of the Companys
subsidiaries, and the Companys equipment, accounts receivable,
inventory, contract rights, general intangibles and other assets. The
facility is also guaranteed by all of the Companys subsidiaries. Availability under the facility, which includes a $3 million
subfacility for standby letters of credit, is subject to a borrowing base
that is determined at the sole discretion of the facility lenders. The
initial borrowing base of the facility was $50 million, of which $30
million was available for general corporate purposes and $20 million was
available for the acquisition of oil and gas properties approved by the
lenders. The borrowing base is redetermined on each April 1 and October
1. Mission and the lenders each have the option to request one
unscheduled interim redetermination between scheduled redetermination
dates. On October 1, 2004, it was determined that there will be no change
in the borrowing base. On April 8, 2004, the Company was advanced $21.5 million under the
facility, which amount, together with a portion of the net proceeds from
the offering of the 9 7/8% Notes and $25 million that was borrowed under
the new second lien term loan (as described below), was used to
completely discharge all of the Companys outstanding indebtedness under
its prior revolving credit facility and term loan. At September 30, 2004,
$10.0 million in borrowings were outstanding and $39.9 million was
available for borrowing ($20 million of which is restricted to the
acquisition of oil and gas properties approved by the lenders). Advances under the facility bear interest, at the Companys option,
at either (i) a margin (which varies from 25.0 basis points to 125.0
basis points based upon utilization of the borrowing base) over the base
rate, which is the higher of (a) Wells Fargos prime rate in effect on
that day,
and (b) the federal funds rate in effect on that day as announced by
the Federal Reserve Bank of New York, plus 0.5%; or (ii) a margin (which
varies from 175.0 basis points to 275.0 basis points based upon
utilization of the borrowing base) over LIBOR. The Company is allowed to
prepay any base rate or LIBOR loan without penalty, provided that each
prepayment is at least $500,000 and multiples of $100,000 in excess
thereof, plus accrued and unpaid interest. 13




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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements Standby letters of credit may be issued under the $3 million letter
of credit subfacility. Mission is required to pay, to the issuer of the
letter of credit, with respect to each issued letter of credit, (i) a per
annum letter of credit fee equal to the LIBOR margin then in effect
multiplied by the face amount of such letter of credit plus (ii) an
issuing fee of the greater of $500 or 12.5 basis points. The facility requires the Company to hedge forward, on a rolling
12-month basis, 50% of proved producing volumes projected to be produced
over the following 12 months. The Company is also required to hedge
forward, on a rolling 12-month basis, 25% of proved producing volumes
projected to be produced over the succeeding 12-month period. Any time
that Mission has borrowings under the facility in excess of 70% of the
borrowing base available for general corporate purposes, the agent under
the facility may require Mission to hedge a percentage of projected
production volumes on terms acceptable to the agent. The facility also contains the following restrictions on hedging
arrangements and interest rate agreements: (i) the hedge provider must be
a lender under the facility or an unsecured counterparty acceptable to
the agent under the facility; and (ii) total notional volume must be not
more than 75% of scheduled proved producing net production quantities in
any period or, with respect to interest rate agreements, notional
principal amount must not exceed 75% of outstanding loans, including
future reductions in the borrowing base. The facility contains the following covenants which are considered
important to Missions operations. At September 30, 2004, Mission was in
compliance with each of the following covenants:  
    
    The Company is required to maintain a current
ratio of consolidated current assets (as defined in the
facility) to consolidated current liabilities (as defined in
the facility) of not less than 1.0 to 1.0;
    
    The Company is required to maintain (on an
annualized basis until the passing of four fiscal quarters and
thereafter on a rolling four quarter basis) an interest
coverage ratio (as defined in the facility) of no less than
(i) 2.50 for June 30, 2004 through December 31, 2004, (ii)
2.75 for March 31, 2005 through June 30, 2005, and (iii) 3.0
for September 30, 2005 and thereafter;
    
    The Company is required to maintain (on an
annualized basis until the passing of four fiscal quarters and
thereafter on a rolling four quarter basis) a leverage ratio
(as defined in the facility) of no more than (i) 3.75 for June
30, 2004 through September 30, 2004, and (ii) 3.5 for December
31, 2004 and thereafter; and
    
    The Company is required to maintain a tangible
net worth (as defined in the facility) of not less than 85% of
tangible net worth at March 31, 2004, plus 50% of positive
net income after tax distributions, plus 100% of equity
offerings after March 31, 2004, excluding any asset impairment
charges. The facility also includes restrictions with respect to changes in
the nature of the Companys business; sale of all or a substantial or
material part of its assets; mergers, acquisitions, reorganizations and
recapitalizations; liens; guarantees; debt; leases; dividends and other
distributions; investments; debt prepayments; sale-leasebacks; capital
expenditures; lease expenditures; and transactions with affiliates. 14




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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements Second Lien Term Loan On April 8, 2004, Mission entered into a second lien term loan with
a syndicate of lenders arranged by Guggenheim Corporate Funding, LLC. The
loan, which matures on April 8, 2008, is secured by a second priority
security interest in the assets securing the senior secured revolving
credit facility. The facility is also guaranteed by all of Missions
subsidiaries. On April 8, 2004, the Company borrowed the $25.0 million
under the loan, which amount, together with a portion of the net proceeds
from the offering of the 9 7/8% Notes and $21.5 million borrowed under
the senior secured revolving credit facility (as described above), was
used to completely discharge all of the outstanding indebtedness under
the prior revolving credit facility and term loan. The loan accrues interest in each monthly interest period at the
rate of 30-day LIBOR plus 525 basis points per annum, payable monthly in
cash. The Company may prepay the loan at any time after the date six
months and one day after April 8, 2004 in whole or in part in multiples
of $1 million at the prices (expressed as percentages of principal
amount) set forth below, plus accrued and unpaid interest, if prepaid
during each successive 12-month period beginning on April 9th of each
year indicated below: Year
    
    Premium2004
    
    
    102
    %2005
    
    
    101
    %2006 to maturity
    
    
    100
    %
 provided, however, that no prepayment shall be made prior to the date six
months and one day after April 8, 2004. The loan contains covenants that are no more restrictive than those
contained in the senior secured revolving credit facility. Redeemed 10 7/8% Notes In April 1997, the Company issued $100 million of 10 7/8% Notes due
2007. On May 29, 2001, the Company issued an additional $125 million of
10 7/8% Notes with identical terms to the notes issued in April 1997 at a
premium of $1.9 million. The premium, shown separately on the
Consolidated Balance Sheet, was amortized as a reduction of interest
expense over the life of the 10 7/8% Notes so that the effective interest
rate on the additional 10 7/8% Notes was 10.5%. Interest on the 10 7/8%
Notes was payable semi-annually on April 1 and October 1. On March 28, 2003, the Company acquired, in a private transaction
with various funds affiliated with Farallon Capital Management, LLC,
approximately $97.6 million in principal
amount of the 10 7/8% Notes for approximately $71.7 million, plus
accrued interest. Including costs of the transaction and the removal of
$2.2 million of previously deferred financing costs related to the
acquired 10 7/8% Notes, the Company recognized a $22.4 million gain on
the extinguishment of the 10 7/8% Notes. In December 2003, February 2004 and March 2004, the Company, in
three private transactions, acquired $40.0 million aggregate principal
amount of the 10 7/8% Notes in exchange for an aggregate of 16.75 million
shares of its common stock as summarized below. 15




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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements Net Gain onExtinguishmentPrincipal
    
    Common
    
    of 10 7/8%Date
    
    Note Holder
    
    Value
    
    Shares
    
    NotesDecember 2003
    
    FTVIPT  Franklin
Income Securities
Fund and Franklin
Custodian Funds 
Income Series
    
    $10 million
    
    4.50 million
    
    $1.1 millionFebruary 2004
    
    Stellar Funding, Ltd.
    
    $15 million
    
    6.25 million
    
    $0.5 millionMarch 2004
    
    Harbert Distressed
Investment Master
 Fund, Ltd.
    
    $15 million
    
    6.00 million
    
    $0.9 million
 On May 10, 2004, the remaining $87.4 million of 10 7/8% Notes were
redeemed at a premium of approximately $1.6 million. This premium is
included in the $4.1 million ($2.6 million, net of tax) net loss on
extinguishment of debt reported in the three month period ended June 30,
2004. Former Credit Facilities The Company was party to a $150.0 million credit facility with a
syndicate of lenders. The credit facility was a revolving facility,
expiring May 16, 2004, which allowed Mission to borrow, repay and
re-borrow under the facility from time to time. The total amount which
might be borrowed under the facility was limited by the borrowing base
periodically set by the lenders based on Missions oil and gas reserves
and other factors deemed relevant by the lenders. The facility was
re-paid in full and cancelled on March 28, 2003. On March 28, 2003, simultaneously with the acquisition of $97.6
million in principal amount of the 10 7/8% Notes, the Company amended and
restated the credit facility with new lenders, led by Farallon Energy
Lending, LLC. Deferred financing costs of $947,000 relating to the
previously existing facility were charged to earnings as a reduction in
the gain on extinguishment of debt. Under the amended and restated
facility, the Company borrowed $80.0 million, the proceeds of which were
used to acquire approximately $97.6 million face amount of 10 7/8% Notes,
to pay accrued interest on the 10 7/8% Notes purchased, and to pay
closing costs. The amended and restated facility was cancelled in April
2004 and was replaced by the Senior Secured Revolving Credit Facility
discussed above. 4. Derivative Instruments and Hedging Activities The Company produces and sells crude oil, natural gas and natural
gas liquids. As a result, its operating results can be significantly
affected by fluctuations in commodity prices caused by changing market
forces. The Company periodically seeks to reduce its exposure to price
volatility by hedging a portion of its production through swaps, options
and other commodity derivative instruments. A combination of options,
structured as a costless collar, is the Companys preferred hedge
instrument because there are no up-front costs and protection is given
against low prices. Such hedges assure that Mission receives NYMEX prices
no lower than 16




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##### Table of Contents



MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements the price floor and no higher than the price ceiling for
hedged production. The Company has also entered into some commodity swaps
that fix the NYMEX price to be received. Hedging activities decreased
revenues by $5.7 million and $3.5 million for the three month periods
ended September 30, 2004 and 2003, respectively, and by $12.8 million and
$13.2 million for the nine month periods ended September 30, 2004 and
2003, respectively. The Companys 12-month average realized price, excluding hedges, for
natural gas was $0.03 per MCF less than the NYMEX MMBTU price. The
Companys 12-month average realized price, excluding hedges, for oil was
$1.29 per BBL less than the NYMEX price. Realized prices differ from
NYMEX as a result of factors such as the location of the property, the
heating content of natural gas and the quality of oil. The gas
differential stated above excludes the impact of the Mist field gas
production that is sold at an annually fixed price. The Company has elected to designate all hedges by applying the
interpretations from the FASBs Derivative Implementation Group issue
G-20 (DIG G-20). By using the DIG G-20 approach, because the Companys
collars and swaps meet specific criteria, the time value component is
included in the hedge relationship and is recorded to other comprehensive
income (OCI) rather than to income, which reduces earnings variability. Should ineffectiveness occur for reasons other than time, that
ineffectiveness is recognized currently and is reported in the interest
and other income line of the Consolidated Statement of Operations. The
Company has acquired a license for software specifically designed to make
the complex calculations required by SFAS No. 133, including calculating
ineffectiveness. The Company recognized a net gain related to the
ineffectiveness of its cash flow hedges in the three month period ended
September 30, 2004 of approximately $433,000 and a net loss related to
the ineffectiveness of its cash flow hedges for the nine month period
ended September 30, 2004 of approximately $132,000. As the existing
hedges settle over the next two years, gains or losses in OCI will be
reclassified to earnings. Using September 30, 2004 strip prices, the
amount expected to be reclassified over the next twelve months will be an
$11.5 million loss, net of taxes. The following tables detail the cash flow commodity hedges that were
in place at September 30, 2004: Oil Hedges NYMEX
    
    NYMEXPrice
    
    PriceBBLS
    
    
    
    
    
    
    
    
    
    Floor/Swap
    
    CeilingPeriod
    
    Per Day
    
    Total BBLS
    
    Type
    
    Avg.
    
    Avg.Fourth Qtr. 2004
    
    
    2,500
    
    
    
    230,000
    
    
    Swap
    
    $
    23.97
    
    
    
    N/AFourth Qtr. 2004
    
    
    500
    
    
    
    46,000
    
    
    Collar
    
    $
    35.00
    
    
    $
    46.15First Qtr. 2005
    
    
    2,500
    
    
    
    225,000
    
    
    Collar
    
    $
    28.71
    
    
    $
    32.78Second Qtr. 2005
    
    
    2,000
    
    
    
    182,000
    
    
    Collar
    
    $
    28.50
    
    
    $
    31.82Third Qtr. 2005
    
    
    2,000
    
    
    
    184,000
    
    
    Collar
    
    $
    28.13
    
    
    $
    31.04Fourth Qtr. 2005
    
    
    2,000
    
    
    
    184,000
    
    
    Collar
    
    $
    27.75
    
    
    $
    30.65First Qtr. 2006
    
    
    750
    
    
    
    67,500
    
    
    Collar
    
    $
    30.15
    
    
    $
    37.07Second Qtr. 2006
    
    
    750
    
    
    
    68,250
    
    
    Collar
    
    $
    30.10
    
    
    $
    36.35Third Qtr. 2006
    
    
    750
    
    
    
    69,000
    
    
    Collar
    
    $
    29.41
    
    
    $
    36.40Fourth Qtr. 2006
    
    
    750
    
    
    
    69,000
    
    
    Collar
    
    $
    29.34
    
    
    $
    35.92
 17




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##### Table of Contents



MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements Gas Hedges NYMEX
    
    NYMEXMMBTU
    
    Total
    
    
    
    
    
    Price Floor
    
    Price CeilingPeriod
    
    Per Day
    
    MMBTU
    
    Type
    
    Avg.
    
    Avg.Fourth Qtr. 2004
    
    
    16,500
    
    
    
    1,518,000
    
    
    Collar
    
    $
    4.64
    
    
    $
    5.73First Qtr. 2005
    
    
    12,000
    
    
    
    1,080,000
    
    
    Collar
    
    $
    4.85
    
    
    $
    8.85Second Qtr. 2005
    
    
    8,000
    
    
    
    728,000
    
    
    Collar
    
    $
    4.66
    
    
    $
    5.83Third Qtr. 2005
    
    
    8,000
    
    
    
    736,000
    
    
    Collar
    
    $
    4.66
    
    
    $
    5.80Fourth Qtr. 2005
    
    
    8,000
    
    
    
    736,000
    
    
    Collar
    
    $
    4.66
    
    
    $
    6.28First Qtr. 2006
    
    
    2,000
    
    
    
    180,000
    
    
    Collar
    
    $
    5.00
    
    
    $
    8.00
 The Company may also enter into financial instruments such as
interest rate swaps to manage the impact of interest rates. The Company
paid $1.3 million in February 2003 to cancel an interest rate swap under
which Mission received a fixed interest rate and paid a floating interest
rate. The swap originated in 1998 and had a notional value of $80
million. 5. Income Taxes The provision for federal and state income taxes for the three
months and nine months ended September 30, 2004 was based upon a 36% and
35% effective tax rate, respectively. In assessing the realizability of
the deferred tax assets, management considers whether it is more likely
than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets is dependent
upon the recognition of future taxable income during the periods in which
those temporary differences are available. Based upon projections for
future state taxable income, management believes it is more likely than
not that the Company will not realize its entire deferred tax asset
related to state income taxes. In addition, management believes it is
more likely than not that the Company will not realize its deferred tax
asset related to the impairment of the interest in Carpatsky. A valuation
allowance of approximately $ 5.1 million has been recorded at September
30, 2004. On December 17, 2003, the Company issued 4.5 million shares of
common stock in exchange for the surrender of $10 million of the 10 7/8%
Notes. As a result of this transaction, management believes that the
Company has experienced an ownership change as defined in Section 382
of the Internal Revenue Code, which could result in the imposition of
significant limitations on the future use of the Companys existing net
operating loss (NOL) and tax credit carryforwards in the future. The
limitations imposed by Section 382 could have an affect upon the
Companys ability to fully utilize its net operating loss and tax credit
carryforwards to offset future taxable income and related tax
liabilities. Quarterly, we review the estimated impact that a 382
Limitation may have upon the future availability of our net operating
losses. Based on that review, as of September 30, 2004, no limitation has
been reflected because there is not one indicated. 18




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##### Table of Contents



MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements 6. Guarantees In 1993 and 1996 the Company entered into agreements with surety
companies and with Torch Energy Advisors Incorporated (Torch) and Nuevo
Energy Company (Nuevo) whereby the surety companies agreed to issue
such bonds to the Company, Torch and/or Nuevo. However, Torch, Nuevo and
the Company agreed to be jointly and severally liable to the surety
company for any liabilities arising under any bonds issued to the
Company, Torch and/or Nuevo. Torch currently has no bonds outstanding
pursuant to these agreements and Nuevo has issued approximately $34.3
million of bonds. The Company has notified the sureties that it will not
be responsible for any new bonds issued to Torch or Nuevo. However, the
sureties are permitted under these agreements to seek reimbursement from
the Company, as well and from Torch and Nuevo, if the surety makes any
payments under the bonds issued to Torch and Nuevo. On May 17, 2004,
Plains Exploration and Production Company announced it had completed the
acquisition of Nuevo Energy Company effective May 14, 2004. The Companys subsidiaries, Mission E&P Limited Partnership, Mission
Holdings LLC and Black Hawk Oil Company are guarantors under the Senior
Secured Revolving Credit Facility, the Second Lien Term Loan and the
indenture for the 9 7/8% Notes. 7. Supplemental Guarantor Information  UNAUDITED Mission E&P Limited Partnership, Mission Holdings LLC and Black Hawk
Oil Company, all subsidiaries of Mission Resources Corporation
(collectively, the Guarantor Subsidiaries) are guarantors under the
Senior Secured Revolving Credit Facility, the Second Lien Term Loan and
the indenture for the 9 7/8% Notes. The Company does not believe that
separate financial statements and other disclosures concerning the
Guarantor Subsidiaries would provide any additional information that
would be material to investors in making an investment decision. 19




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##### Table of Contents



MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements CONDENSED CONSOLIDATING BALANCE SHEETS  UNAUDITED
As of September 30, 2004
(In thousands) Mission
    
    GuarantorResources
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedTotal current assets
    
    $
    27,676
    
    
    $
    5,876
    
    
    $
    
    
    
    $
    33,552Net property, plant and equipment
    
    
    184,120
    
    
    
    139,669
    
    
    
    
    
    
    
    323,789Net leasehold, furniture and equipment
    
    
    2,455
    
    
    
    29
    
    
    
    
    
    
    
    2,484Investment in subsidiaries
    
    
    147,107
    
    
    
    143,970
    
    
    
    (291,077
    )
    
    
    Total other assets
    
    
    8,678
    
    
    
    
    
    
    
    
    
    
    
    8,678Total assets
    
    $
    370,036
    
    
    $
    289,544
    
    
    $
    (291,077
    )
    
    $
    368,503Total current liabilities
    
    $
    46,623
    
    
    $
    2,420
    
    
    $
    
    
    
    $
    49,043Long-term debt
    
    
    165,000
    
    
    
    
    
    
    
    
    
    
    
    165,000Deferred taxes
    
    
    (43,276
    )
    
    
    61,368
    
    
    
    
    
    
    
    18,092Other long-term liabilities
    
    
    4,463
    
    
    
    
    
    
    
    
    
    
    
    4,463Intercompany
    
    
    56,433
    
    
    
    (56,433
    )
    
    
    
    
    
    
    Asset retirement obligation,
excluding current portion
    
    
    20,609
    
    
    
    10,636
    
    
    
    
    
    
    
    31,245Total stockholders equity
    
    
    120,184
    
    
    
    271,553
    
    
    
    (291,077
    )
    
    
    100,660Total liabilities and stockholders equity
    
    $
    370,036
    
    
    $
    289,544
    
    
    $
    (291,077
    )
    
    $
    368,503
 CONDENSED CONSOLIDATING INCOME STATEMENTS  UNAUDITED
For the Nine Months Ended September 30, 2004
(In thousands) Mission
    
    GuarantorResources
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues
    
    $
    61,936
    
    
    $
    29,678
    
    
    $
    
    
    
    $
    91,614Equity in earnings from subsidiaries
    
    
    1,010
    
    
    
    
    
    
    
    (1,010
    )
    
    
    Expenses
    
    
    (66,960
    )
    
    
    (24,466
    )
    
    
    
    
    
    
    (91,426
    )Net earnings (loss) before income taxes
    
    
    (4,014
    )
    
    
    5,212
    
    
    
    (1,010
    )
    
    
    188Income taxes
    
    
    (4,136
    )
    
    
    4,202
    
    
    
    
    
    
    
    66Net earnings (loss)
    
    $
    122
    
    
    $
    1,010
    
    
    $
    (1,010
    )
    
    $
    122
 20




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##### Table of Contents



MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS  UNAUDITED
For the Nine Months Ended September 30, 2004
(In thousands) Mission
    
    GuarantorResources
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedCash flows from operating activities:Net income (loss)
    
    $
    122
    
    
    $
    1,010
    
    
    $
    (1,010
    )
    
    $
    122Non-cash adjustments
    
    
    30,455
    
    
    
    11,520
    
    
    
    1,010
    
    
    
    42,985Changes in assets and liabilities
    
    
    (22,202
    )
    
    
    25,545
    
    
    
    
    
    
    
    3,343Net cash provided by operating activities
    
    
    8,375
    
    
    
    38,075
    
    
    
    
    
    
    
    46,450Cash flows from investing activities:Net property, plant and equipment
    
    
    (16,715
    )
    
    
    (38,025
    )
    
    
    
    
    
    
    (54,740
    )Leasehold, furniture and equipment
    
    
    (664
    )
    
    
    (50
    )
    
    
    
    
    
    
    (714
    )Other
    
    
    178
    
    
    
    
    
    
    
    
    
    
    
    178Net cash used in investing activities
    
    
    (17,201
    )
    
    
    (38,075
    )
    
    
    
    
    
    
    (55,276
    )Cash flows from financing activities:Proceeds from borrowings
    
    
    182,500
    
    
    
    
    
    
    
    
    
    
    
    182,500Repayment borrowings
    
    
    (186,511
    )
    
    
    
    
    
    
    
    
    
    
    (186,511
    )Stock issuance costs, net of proceeds
    
    
    679
    
    
    
    
    
    
    
    
    
    
    
    679Financing costs
    
    
    (7,298
    )
    
    
    
    
    
    
    
    
    
    
    (7,298
    )Restricted cash held for investments
    
    
    24,877
    
    
    
    
    
    
    
    
    
    
    
    24,877Net cash provided by financing activities
    
    
    14,247
    
    
    
    
    
    
    
    
    
    
    
    14,247Net increase (decrease) in cash and cash
equivalents
    
    
    5,421
    
    
    
    
    
    
    
    
    
    
    
    5,421Cash and cash equivalents at beginning of period
    
    
    2,224
    
    
    
    10
    
    
    
    
    
    
    
    2,234Cash and cash equivalents at end of period
    
    $
    7,645
    
    
    $
    10
    
    
    $
    
    
    
    $
    7,655
 CONDENSED CONSOLIDATING BALANCE SHEETS  UNAUDITED
As of December 31, 2003
(In thousands) Mission
    
    GuarantorResources
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedTotal current assets
    
    $
    40,557
    
    
    $
    6,897
    
    
    $
    
    
    
    $
    47,454Net property, plant and equipment
    
    
    188,964
    
    
    
    113,164
    
    
    
    
    
    
    
    302,128Net leasehold, furniture and equipment
    
    
    2,361
    
    
    
    (21
    )
    
    
    
    
    
    
    2,340Investment in subsidiaries
    
    
    146,097
    
    
    
    143,970
    
    
    
    (290,067
    )
    
    
    Total other assets
    
    
    5,404
    
    
    
    
    
    
    
    
    
    
    
    5,404Total assets
    
    $
    383,383
    
    
    $
    264,010
    
    
    $
    (290,067
    )
    
    $
    357,326Total current liabilities
    
    $
    30,185
    
    
    $
    992
    
    
    $
    
    
    
    $
    31,177Long-term debt
    
    
    198,496
    
    
    
    
    
    
    
    
    
    
    
    198,496Deferred taxes
    
    
    (37,034
    )
    
    
    57,380
    
    
    
    
    
    
    
    20,346Other long-term liabilities
    
    
    210
    
    
    
    
    
    
    
    
    
    
    
    210Intercompany
    
    
    73,969
    
    
    
    (73,969
    )
    
    
    
    
    
    
    Asset retirement obligation,
excluding current portion
    
    
    23,093
    
    
    
    9,064
    
    
    
    
    
    
    
    32,157Total stockholders equity
    
    
    94,464
    
    
    
    270,543
    
    
    
    (290,067
    )
    
    
    74,940Total liabilities and stockholders equity
    
    $
    383,383
    
    
    $
    264,010
    
    
    $
    (290,067
    )
    
    $
    357,326
 21




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##### Table of Contents



MISSION RESOURCES CORPORATION 8. Subsequent Events On November 9, 2004, the Compensation Committee of the Companys Board of
Directors approved an amendment to the Companys employment agreements with
Messrs. Cavnar, Piacenti, Eells, Munsell and Nicknish, making
consistent the gross-up
provisions relating to parachute payments under Section 280G of the Internal
Revenue Code to include payments made pursuant to agreements, plans,
instruments or obligations other than the employment agreements. 22




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##### Table of Contents



MISSION RESOURCES CORPORATION 
 ITEM 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations Mission is an independent oil and gas exploration and production company.
We drill for, acquire, develop and produce natural gas and crude oil. Our
property portfolio is comprised of long-lived, low-risk assets, like those in
the Permian Basin, and multi-reservoir, high-productivity assets found along
the Gulf Coast and in the Gulf of Mexico. Our operational focus remains on
efficient, well managed upstream natural gas and crude oil exploration and
production. We will continue to pursue complementary acquisitions when the
appropriate opportunities present themselves. Results of Operations The following table sets forth certain operating information for the Company
for the periods presented: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Production:Oil and condensate (MBBLs)
    
    
    430
    
    
    
    539
    
    
    
    1,235
    
    
    
    1,635Natural gas (MMCF)
    
    
    3,916
    
    
    
    2,540
    
    
    
    10,863
    
    
    
    7,293MMCFE
    
    
    6,496
    
    
    
    5,774
    
    
    
    18,273
    
    
    
    17,103Average sales price including the effect of hedges:Oil and condensate ($  per BBL)
    
    
    31.58
    
    
    
    25.33
    
    
    
    29.54
    
    
    
    25.29Natural gas ($  per MCF)
    
    
    5.34
    
    
    
    4.10
    
    
    
    5.38
    
    
    
    4.51Average sales price excluding the effect of hedges:Oil and condensate ($  per BBL)
    
    
    42.03
    
    
    
    29.08
    
    
    
    37.88
    
    
    
    29.52Natural gas ($  per MCF)
    
    
    5.63
    
    
    
    4.68
    
    
    
    5.61
    
    
    
    5.37Average costs per unit of production ($  per MCFE):Lease operating expenses
    
    
    1.24
    
    
    
    1.44
    
    
    
    1.16
    
    
    
    1.49General & administrative expense
    
    
    1.08
    
    
    
    0.45
    
    
    
    0.70
    
    
    
    0.47Depreciation, depletion and amortization
    
    
    1.77
    
    
    
    1.71
    
    
    
    1.83
    
    
    
    1.61
 Three Months Ended September 30, 2004 and 2003 Net Income (Loss) Net income for the three months ended September 30, 2004 was $868,000 or
$0.02 per share. Net loss for the three months ended September 30, 2003 was
$3.8 million or $0.16 per share. Higher gas volumes, higher commodity prices
and lower interest expense were the primary reasons for the improvement in the
current quarter of 2004. This was partially offset by lower oil volumes
resulting from property sales in 2003. In addition, net income was negatively
impacted in the three month period ended September 30, 2004 by the recognition
of $4.1 million in non-cash compensation expense ($2.6 million, net of taxes)
as a result of the issuance to our Chairman and CEO of stock options to replace
stock appreciation rights. 23




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##### Table of Contents



MISSION RESOURCES CORPORATION Oil and Gas Revenues Oil revenues for the three months ended September 30, 2004 were $13.6
million, as compared to $13.7 million for the respective period in 2003. Oil
production decreased 20% from 539,000 barrels in the three month period ended
September 30, 2003 to 430,000 barrels for the same period of 2004. The sale of
the Raccoon Bend and East Texas fields in the last half of 2003 accounted for
the production decrease. Realized oil prices averaged $31.58 per barrel in the
three month period ended September 30, 2004, as compared to $25.33 per barrel
in the three month period ended September 30, 2003. Gas revenues increased 101% from $10.4 million reported for the three
month period ended September 30, 2003 to $20.9 million for the three month
period ended September 30, 2004. This increase was driven by both production
and price increases. Gas production was up 54% compared to the same quarter of
2003 with 3,916 MMCF and 2,540 MMCF produced for the three month periods ended
September 30, 2004 and 2003, respectively. The January and April 2004
acquisitions of the Jalmat field in Lea County, New Mexico and new production
from the LeBlanc #1 well in Vermilion Parish, Louisiana, the South Marsh Island
A-11 and C-5 wells, offshore Louisiana, and the High Island 553 A-7
recompletion, offshore Texas, accounted for most of the production increase.
Realized gas prices averaged $5.34 per MCF, or 30% higher, in the three month
period ended September 30, 2004 as compared to $4.10 per MCF in the comparable
period of 2003. The realized prices discussed above include the impact of oil and gas
hedges. Decreases of
$3.5 million and $5.7 million related to hedging activity were reflected in oil
and gas revenues for the three months ended September 30, 2003 and September
30, 2004, respectively. Interest and Other Income (Loss) Interest and other income was a net gain of $508,000 for the three months
ended September 30, 2004 and was a net gain of $170,000 for the three months
ended September 30, 2003. Activity for 2003 included a gain of $187,000 from
the amortization of Other Comprehensive Income (OCI) related to cancelled
hedges. In the third quarter of 2004, a $433,000 gain on hedge ineffectiveness
was the most significant item. Lease Operating Expenses Lease operating expenses decreased from $8.3 million in the three months
ended September 30, 2003 to $8.1 million for the same period of 2004 or from
$1.44 per MCFE to $1.24 per MCFE on a per unit basis. This decline is primarily
related to the 2003 sales of high cost oil properties and the subsequent
redeployment of proceeds into lower cost gas properties.
In the fourth quarter, we expect to be on the high side of our
lease operating expense guidance for two reasons. First, workovers
are being performed in today's pricing environment that probably
would not have been done in the past, and second, there has been an
increase in the cost of basic oil field services. We expect these
increased costs to continue into 2005. Taxes Other Than Income The table below details the components of taxes other than income and
their respective changes between the periods (dollars in thousands). Three Months Ended September 30,
    
    Change2004
    
    2003
    
    Amount
    
    PercentProduction taxes
    
    $
    2,074
    
    
    $
    1,254
    
    
    $
    820
    
    
    
    65
    %Property taxes
    
    
    479
    
    
    
    740
    
    
    
    (261
    )
    
    
    (35
    %)Other taxes
    
    
    104
    
    
    
    112
    
    
    
    (8
    )
    
    
    (7
    %)Taxes other than income
    
    $
    2,657
    
    
    $
    2,106
    
    
    $
    551
 24




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##### Table of Contents



MISSION RESOURCES CORPORATION Taxes other than income increased from $2.1 million in the three months
ended September 30, 2003 to $2.7 million for the same period of 2004. In
general, production taxes increase as revenue and production increases. In
2004, the increase in production taxes was disproportionately larger than our
revenue increases because Louisianas tax rate on natural gas increased by 40%
and a significant portion of our gas production increase is from Louisiana
properties. Offsetting this increase is a 35% reduction in our property taxes.
This is due to the sale of many Texas properties late in 2003, and their
replacement with properties in New Mexico, which has lower property tax rates
than Texas. Depreciation, Depletion and Amortization Depreciation, depletion and amortization (DD&A) was $11.7 million for
the three months ended September 30, 2004 and $10.0 million for the three
months ended September 30, 2003. The 12.5% increase in production, on an MCFE
basis, discussed under Oil and Gas Revenues above, accounts for the majority of
the variance. In addition, DD&A per MCFE has increased from $1.71 per MCFE in
the third quarter of 2003 to $1.77 per MCFE in the third quarter of 2004. The
increase in DD&A on a per MCFE basis reflects the impact of decreases in
reserves due to property sales in 2003. This was partially offset by reserve
additions described in our July 1, 2004 reserve report prepared by Netherland,
Sewell and Associates, Inc. General and Administrative Expenses General and administrative expenses (G&A) were $7.0 million in the three
month period ended September 30, 2004, and were $2.6 million in the three month
period ended September 30, 2003. This increase is primarily the result of the
recognition of a non-cash compensation expense of $4.1 million from the
issuance to our Chairman and CEO of stock options to replace stock appreciation
rights. The options were granted with a strike price of $0.55 per share, which
is the same exercise price as the surrendered stock appreciation rights. As a
result of these options having an exercise price below the market value for
Missions common stock, we were required to recognize this non-cash expense. In
the fourth quarter, we expect to incur additional accounting fees relating to
Sarbanes-Oxley Act compliance. Interest Expense Interest expense decreased 41% to $3.9 million for the three months ended
September 30, 2004 from $6.6 million in the same period in 2003. The following
table details the components of interest and their respective changes between
the periods (dollars in thousands). Three Months Ended September 30,
    
    Change2004
    
    2003
    
    Amount
    
    PercentInterest on senior notes, net of
amortized premium
    
    $
    2,964
    
    
    $
    3,389
    
    
    $
    (425
    )
    
    
    (13
    %)Interest on term loan
    
    
    430
    
    
    
    2,419
    
    
    
    (1,989
    )
    
    
    (82
    %)Interest on credit facility
    
    
    141
    
    
    
    
    
    
    
    141
    
    
    
    100
    %Amortization of financing costs
    
    
    352
    
    
    
    695
    
    
    
    (343
    )
    
    
    (49
    %)Other
    
    
    4
    
    
    
    66
    
    
    
    (62
    )
    
    
    (94
    %)Interest expense
    
    $
    3,891
    
    
    $
    6,569
    
    
    $
    (2,678
    )
 Throughout 2003 and early 2004, interest expense on the term loan was
based on an $80 million principal balance at 12.0% interest. On April 8, 2004,
as part of the debt refinancing, the principal balance on the term loan was
repaid and replaced with a senior secured revolving credit facility and a
second lien term loan with a combined balance of $35 million and rates between
3.1% and 7.0%. This decrease in principal balance and interest rates resulted
in a significant reduction in interest paid in the 25




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MISSION RESOURCES CORPORATION three month period ending
September 30, 2004, as compared to the same period in 2003. Also, the 10 7/8%
senior notes were replaced with 9 7/8% notes resulting in a 13% reduction in
interest paid, net of amortized premiums. Income Taxes The provision for federal and state income taxes for the three months
ended September 30, 2004 was based upon a 36% effective tax rate. There is a
$5.1 million valuation allowance on deferred taxes applicable at September 30,
2004. In assessing the realizability of the deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Based upon
projections for future state taxable income, management believes it is more
likely than not that the Company will not realize its entire deferred tax asset
related to state income taxes. Nine Months Ended September 30, 2004 and 2003 Net Income (loss) Net income for the nine months ended September 30, 2004 was $122,000 or
$0.00 per share. Net income for the nine months ended September 30, 2003 was
$3.9 million or $0.16 per share. The nine months ended September 30, 2003
included a $22.4 million gain ($14.5 million, net of taxes) from the repurchase
and retirement of 10 7/8% Notes in March 2003. Absent the large gain in 2003,
the results for the nine month period ended September 30, 2003 would have been
a $10.6 million net loss. The improvement in the nine month period ended
September 30, 2004 resulted from increased gas production, higher oil and gas
prices and lower interest and lease operating expenses. This was partially
offset by an increase in G&A expense of $4.1 million ($2.6 million, net of
taxes) from the issuance to our Chairman and CEO of stock options to replace
stock appreciation rights. Oil and Gas Revenues Oil revenues for the nine months ended September 30, 2004 were $36.5
million, as compared to $41.3 million for the respective period in 2003. Oil
production decreased 24% from 1,635 MBBLs in the nine month period ended
September 30, 2003 to 1,235 MBBLs for the same period of 2004. The sale of the
Raccoon Bend and East Texas fields in the last half of 2003 accounts for the
production decrease. Higher realized oil prices that averaged $29.54 per barrel
in the nine month period ended September 30, 2004, as compared to $25.29 per
barrel in the nine month period ended September 30, 2003 partially offset the
oil production decline. Gas revenues increased 78% from $32.9 million reported for the nine months
ended September 30, 2003 to $58.4 million for the same period 2004. Gas
production was up 49% compared to the same period of 2003 with 10,863 MMCF and
7,293 MMCF for the nine month periods ended September 30, 2004 and 2003,
respectively. The January and April 2004 acquisitions of the Jalmat field in
Lea County, New Mexico along with production increases from the LeBlanc #1 well
in Vermilion Parish, Louisiana, the South Marsh Island A-11 and C-5 wells,
offshore Louisiana, and the High Island 553 A-7 recompletion, offshore Texas,
account for most of the production increase. Higher realized gas prices that
averaged $5.38 per MCF, or 19% higher, in the nine month period ended September
30, 2004 as compared to $4.51 per MCF in the comparable period of 2003. The realized prices discussed above include the impact of oil and gas
hedges. Decreases of
$12.8 million and $13.2 million related to hedging activity were reflected in
oil and gas revenues for the nine months ended September 30, 2004 and 2003,
respectively. 26




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##### Table of Contents



MISSION RESOURCES CORPORATION Extinguishment of Debt From March 2003 through April 2004, in several steps, we significantly
changed Missions debt structure. In March 2003, 43% of the 10 7/8% Notes were
acquired and retired at a net gain on extinguishment of debt of $22.4 million
($14.5 million net of taxes). In 2004, $30 million of the 10 7/8% Notes were
redeemed and our other credit facilities were cancelled and refinanced for a
net loss of $2.6 million ($1.7 million, net of taxes) Interest and Other Income (Loss) Interest and other income was a net loss of $681,000 for the nine months
ended September 30, 2004 and was a net gain of $892,000 for the nine months
ended September 30, 2003. Activity for 2003 includes a gain of $603,000 from
the amortization of OCI related to cancelled hedges and $341,000 of equity in
the earnings of White Shoal Pipeline Corporation. In the first nine months of
2004, bad debt expense of approximately $399,000 related to joint interest
receivables, hedge ineffectiveness loss of $132,000 and plugging and
abandonment costs of $293,000 on properties that we no longer own accounted for
most of the loss. Lease Operating Expenses Lease operating expense decreased from $25.6 million in the nine months
ended September 30, 2003 to $21.3 million for the same period of 2004. This
decline of approximately 17% is primarily related to our 2003 sales of high
cost properties and the subsequent redeployment of proceeds into lower cost gas
properties. Lease operating expenses decreased approximately 22% on a per MCFE
basis between the periods to $1.16 per MCFE. In the second quarter of 2004, we
recovered approximately $575,000 of previously paid Waddell Ranch field lease
operating expenses. Exclusive of this recovery, recurring lease operating
expense on an MCFE basis was $1.20 for the nine months ending September 30,
2004. In the fourth quarter, we expect to be on the high side of our
lease operating expense guidance for two reasons. First, workovers
are being performed in today's pricing environment that probably
would not have been done in the past, and second, there has been an
increase in the cost of basic oil field services. We expect these
increased costs to continue into 2005. Taxes Other Than Income The table below details the components of taxes other than income and
their respective changes between the periods (dollars in thousands). Nine Months Ended September 30,
    
    Change2004
    
    2003
    
    Amount
    
    PercentProduction taxes
    
    $
    5,027
    
    
    $
    3,831
    
    
    $
    1,196
    
    
    
    31
    %Property taxes
    
    
    1,479
    
    
    
    2,787
    
    
    
    (1,308
    )
    
    
    (47
    %)Other taxes
    
    
    328
    
    
    
    333
    
    
    
    (5
    )
    
    
    (2
    %)Taxes other than income
    
    $
    6,834
    
    
    $
    6,951
    
    
    $
    (117
    )
 Taxes other than income decreased from $7.0 million in the nine months
ended September 30, 2003 to $6.8 million for the same period of 2004. As a
result of the sale of Texas properties late in 2003, and their replacement with
properties in New Mexico, a state with lower property taxes than Texas, our
property taxes have been reduced by 47%. In general, production taxes increase
as revenue and production increases. In 2004, the increase in production taxes
was disporportionately larger than our revenue increases because Louisianas
tax rate on natural gas increased by 40%. 27




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MISSION RESOURCES CORPORATION Depreciation, Depletion and Amortization DD&A was $33.9 million for the nine months ended September 30, 2004 and
$28.0 million for the nine months ended September 30, 2003. DD&A per MCFE has
increased from $1.61 per MCFE in the nine months ended September 30, 2003 to
$1.83 per MCFE for the same period in 2004. The increase in DD&A on a per MCFE
basis reflects the impact of decreases in reserves due to property sales in
2003. This was partially offset by the Jalmat acquisition in January and April
2004 and reserve additions described in our July 1, 2004 reserve report
prepared by Netherland, Sewell and Associates, Inc. Also, approximately $1.9
million of the increase is the result of an overall volume increase of 6.8%. General and Administrative Expenses G&A expenses were $12.8 million in the nine month period ended September
30, 2004 and were $8.0 million in the nine month period ended September 30,
2003. This increase is primarily the result of the recognition of a non-cash
compensation expense of $4.1 million from the issuance of stock options to
replace stock appreciation rights. The options were granted with a strike price
of $0.55 per share, which is the same exercise price as the surrendered stock
appreciation rights. As a result of these options having an exercise price
below the market value for Missions common stock, we were required to
recognize this non-cash expense. Additional investor relations costs also
accounted for a portion of the increase. In the fourth quarter, we expect to
incur additional accounting fees relating to Sarbanes-Oxley Act compliance. Interest Expense Interest expense decreased 18% to $15.6 million for the nine months ended
September 30, 2004 from $19.0 million for the same period in 2003. The
following table details the components of interest and their respective changes
between the periods (dollars in thousands). Nine Months Ended September 30,
    
    Change2004
    
    2003
    
    Amount
    
    PercentInterest rate swap (gain) loss
    
    $
    
    
    
    $
    (520
    )
    
    $
    520
    
    
    
    100
    %Interest on senior notes, net of
amortized premium
    
    
    10,096
    
    
    
    12,757
    
    
    
    (2,661
    )
    
    
    (21
    %)Interest on term loan
    
    
    3,691
    
    
    
    4,918
    
    
    
    (1,227
    )
    
    
    (25
    %)Interest on credit facility
    
    
    373
    
    
    
    50
    
    
    
    323
    
    
    
    646
    %Amortization of financing costs
    
    
    1,384
    
    
    
    1,753
    
    
    
    (369
    )
    
    
    (21
    %)Other
    
    
    54
    
    
    
    70
    
    
    
    (16
    )
    
    
    (23
    %)Interest expense
    
    $
    15,598
    
    
    $
    19,028
    
    
    $
    (3,430
    )
 The interest rate swap was cancelled in February 2003 and was not
replaced. Throughout 2003 and early 2004, we repurchased approximately $137.6
million in 10 7/8% Notes. On May 10, 2004 the remaining $87.4 million of 10
7/8% Notes were redeemed. The redemption of all the 10 7/8% Notes and
subsequent issuance of the 9 7/8% Notes resulted in a significant reduction in
interest paid in the first nine months of 2004 as compared to the same period
in 2003. Also, throughout 2003 and early 2004 interest expense on the term loan
was based on an $80 million principal balance at 12% interest. On April 8,
2004, as part of the debt refinancing, the principal balance on the term loan
was repaid and replaced with a senior secured revolving credit facility and a
second lien term loan with a combined balance of $35 million and rates between
3.1% and 7.0%. This significant decrease in balance and interest rates resulted
in a reduction in interest paid in the nine month period ending September 30,
2004, as compared to the same period in 2003. 28




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MISSION RESOURCES CORPORATION Income Taxes The provision for federal and state income taxes for the nine months ended
September 30, 2004 was based upon a 35% effective tax rate. There was a $5.1
million valuation allowance on deferred taxes applicable at September 30, 2004.
In assessing the realizability of the deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Based upon projections for
future state taxable income, management believes it is more likely than not
that the Company will not realize its entire deferred tax asset related to
state income taxes. Financial Condition In 2002, management began evaluating various alternatives to improve
Missions financial position. In 2003 and the first half of 2004, the following
steps were taken to enhance our financial condition:  
    
    The March 2003 repurchase of approximately $97.6 million of
10 7/8% Notes financed with an $80.0 million term loan facility.
    
    The establishment of a new revolving credit facility in June
2003, making $12.5 million available for short-term borrowings.
    
    The issuance of 16.75 million shares of common stock in
exchange for $40 million of the 10 7/8% Notes in three transactions
in December 2003, February 2004 and March 2004.
    
    The issuance of $130 million of the 9 7/8% Notes, and the
simultaneous establishment of a new senior secured revolving credit
facility and a new second lien term loan.
    
    The redemption of the remaining $87.4 million aggregate
principal amount of the 10 7/8% Notes at a premium using a portion
of the proceeds from the issuance of the 9 7/8% Notes.
    
    The repayment in full of the prior term loan facility using
the remaining portion of the proceeds from the issuance of the 9
7/8% Notes, together with $21.5 million that was advanced under the
new senior secured revolving credit facility and $25 million that
was borrowed under the new second lien term loan. Our outstanding indebtedness totaled $165 million at September 30, 2004.
The nature of our indebtedness as of September 30, 2004 and December 31, 2003
is summarized on the table below (amounts in thousands). September 30,
    
    December 31,2004
    
    2003Term loan facility
    
    $
    
    
    
    $
    80,00010 7/8% Notes
    
    
    
    
    
    
    117,426Unamortized premium on 10 7/8% Notes
    
    
    
    
    
    
    1,0709 7/8% Notes
    
    
    130,000
    
    
    
    Second lien term loan facility
    
    
    25,000
    
    
    
    Senior
secured revolving credit facility(1)
    
    
    10,000
    
    
    
    Total debt
    
    $
    165,000
    
    
    $
    198,496
   (1) $39.9 million was available at September 30, 2004 for additional
borrowings under this facility. 29




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MISSION RESOURCES CORPORATION In July 2004, Mission announced that it had retained Petrie Parkman & Co.,
Inc. to assist in evaluating strategic alternatives and enhance stockholder
value. This process involved 1) a top-to-bottom review of the existing asset
base and opportunity set, 2) an assessment of the markets: commodities,
transactions, debt and equity, and 3) an evaluation of Missions strengths and
challenges in the current environment. The conclusions reached when this evaluation was completed in September
2004 are as follows:  
    
    Our existing asset base remains under-exploited.
    
    Mission has a strong menu of internal opportunities for value creation.
    
    Potential exists to acquire desirable assets in our core areas.
    
    Debt and equity capital is available to Mission, if needed, to
finance attractive growth opportunities.
    
    Missions team is highly qualified and deeply committed to creating
shareholder value in a disciplined fashion.Missions action plan as a result of these conclusions is as follows:
    
    Expand the exploration program in our core areas.
    
    Aggressively pursue acquisitions of producing properties.
    
    Hedge as appropriate to protect our investments.
    
    Continue to divest non-core properties for good value.
    
    Expand bank facilities as needed while maintaining discipline in our capital structure.
    
    Maintain an opportunistic posture. Liquidity and Capital Resources Missions principal sources of capital for the last three years have been
cash flow from operations, debt sources such as the issuance of bonds or credit
facility borrowings, issuances of common stock, and
the sale of oil and gas properties. Our primary uses of capital have been the
funding of exploration and development projects, property acquisitions and the
refinancing of long term debt. At September 30, 2004, we had negative working capital of $15.5 million
compared to a negative working capital, excluding $24.9 million in restricted
cash, of $8.6 million at December 31, 2003. The decrease in working capital can
primarily be attributed to increases in our commodity derivative liabilities
and accrued liabilities partially offset by increases in our accrued revenues
and current deferred income taxes. The size of our current liability related to commodity derivatives has
increased $9.6 million, as commodity prices increased, contributing to the
working capital reduction. The hedge liability as of September 30, 2004
represents the amount by which actual commodity prices exceed the price caps on
our hedges. Should commodity prices decrease, the liability will decline and
the premium over the hedge prices that we will realize on unhedged production
will also reduce. Since hedges are settled out of the receipts from the sale of
production, we anticipate having adequate cash inflows to settle any hedge
payments when they come due while maintaining revenue near the hedge price.
This working capital decrease was partially offset by an increase in current
deferred income taxes of $3.1 million. This current asset increase is directly
related to the increase in the commodity derivative liability. Royalties payable accounts for most of the increase in accrued
liabilities. The increase in royalties payable included approximately $3.0
million of royalties that are awaiting completion of title opinions. Upon
receipt of the title opinions and executed division orders, Mission will be
required to 30




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MISSION RESOURCES CORPORATION make payment. This payable may increase as the well produces or
decrease as title opinions are completed and royalties paid. Accrued revenues increased $3.5 million from December 31, 2003 to
September 30, 2004 mainly due to higher commodity prices. Higher production
volumes as a result of the Jalmat acquisition in the first half of 2004 also
had an impact on the increase in accrued revenues. Cash Flows Net cash flow provided by operating activities was $46.5 million and $21.3
million for the nine month periods ending September 30, 2004 and 2003,
respectively. The period-to-period increase in cash flow was primarily caused
by significantly higher gas revenues, reduced operating costs and reductions in
cash interest expense. Net cash used in investing activities for the nine month periods ending
September 30, 2004 and 2003 was $55.3 million and $21.9 million, respectively.
We spent $30.4 million to acquire oil and gas properties in the nine month
period ended September 30, 2004, compared to approximately $953,000 for the
same period of 2003. We invested $33.0 million in exploration and development
of oil and gas properties for the nine month period ended September 30, 2004
compared to $23.0 million for the same period of 2003. Proceeds from property
sales were $8.6 million and $3.0 million for the nine month periods ending
September 30, 2004 and 2003, respectively. Net cash provided by financing activities was $14.2 million and $3.5
million in the nine month periods ending September 30, 2004 and 2003,
respectively. The largest variance is $24.9 million of cash held for
reinvestment to acquire the Jalmat field in January 2004. A capital budget of $34.0 million was originally adopted for the year
2004, with approximately 60% for development, 20% for exploration and 20% for
seismic, land or corporate assets. The budget did not include an estimate for
costs of major acquisitions. As cash flows from operations in 2004 exceed
budgeted levels, we have allocated 50% of such excess cash flows, plus the $3.0
million proceeds from the
sale of our rights to Tranquillon Ridge, to capital projects with the remaining
portion to be used to reduce long-term debt. Using fourth quarter estimated
prices of $45.00 per BBL and $6.25 per MMBTU, we believe that we will spend
more than $50 million of cash flow on capital expenditures in 2004 without
incurring additional indebtedness. In addition, the proceeds from other
properties we may sell this year will be used to fund exploration and
development activities. We believe that cash flows from operating activities combined with our
ability to control the timing of substantially all of our future exploration
and development requirements will provide us with the flexibility and liquidity
to meet our planned capital requirements for 2004. Natural gas and oil prices,
the timing of our drilling program and drilling results have a significant
impact on the cash flows available for capital expenditures and our ability to
borrow and raise additional capital. Lower prices may also reduce the amount of
natural gas and oil that we can economically produce. Lower prices and/or lower
production may decrease revenues and cash flows, thus reducing the amount of
financial resources available to meet our capital requirements. In addition, as
of September 30, 2004, our revolving credit facility has $19.9 million
available for general corporate purposes, including exploratory and
developmental drilling, and $20.0 million available for acquisitions of oil and
gas properties. We also have an effective shelf registration statement relating
to the potential public offer and sale of any combination of common stock, debt
securities, preferred stock, depository shares, warrants, purchase contracts
and units from time to time as financing needs arise. The shelf registration
statement does not provide assurance that we will or could sell any such
securities. 31




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MISSION RESOURCES CORPORATION Contractual Obligations and Commercial Commitments Mission is required to make future payments under contractual obligations.
Mission has also made various commitments in the future should certain events
occur or conditions exist. As a result of the Jalmat field acquisition in
January 2004 and the debt for equity swaps in February and March 2004, our
contractual obligations and commercial commitments changed. Additionally, in
April and May of 2004, we substantially refinanced all Missions existing debt;
therefore, the following tables reflect future estimated payments related to
Missions obligations and commitments after such changes (amounts in
thousands): Contractual Cash Obligations: **
    
    Total
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    ThereafterLong Term Debt*
    
    $
    223,604
    
    
    $
    13,370
    
    
    $
    12,837
    
    
    $
    12,838
    
    
    $
    12,837
    
    
    $
    12,838
    
    
    $
    158,884Term Loan
    
    
    34,779
    
    
    
    4,060
    
    
    
    1,762
    
    
    
    1,761
    
    
    
    1,762
    
    
    
    25,434
    
    
    
    Operating Leases
    
    
    2,253
    
    
    
    866
    
    
    
    709
    
    
    
    677
    
    
    
    1
    
    
    
    
    
    
    
    Total Contractual Obligations
    
    $
    260,636
    
    
    $
    18,296
    
    
    $
    15,308
    
    
    $
    15,276
    
    
    $
    14,600
    
    
    $
    38,272
    
    
    $
    158,884
 Commercial Commitments: **
    
    Total
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    ThereafterCredit Facility
    
    $
    11,790
    
    
    $
    516
    
    
    $
    567
    
    
    $
    567
    
    
    $
    10,140
    
    
    $
    
    
    
    $
    Other Commercial Commitments
    
    
    6,445
    
    
    
    4,721
    
    
    
    1,193
    
    
    
    220
    
    
    
    173
    
    
    
    138
    
    
    
    Total Commercial Commitments
    
    $
    18,235
    
    
    $
    5,237
    
    
    $
    1,760
    
    
    $
    787
    
    
    $
    10,313
    
    
    $
    138
    
    
    $
    
   *
    
    Includes principal of $130 million on the 9 7/8% Notes due 2011 and
Note interest accrued monthly and payable April 1st and
October 1st of
each year.**
    
    Due to the completion of the debt refinancing in the second quarter of
2004, the Long Term Debt, Term Loan and Credit Facility activity was
recalculated to reflect current obligations and commitments. Subsequent Events On November 9, 2004, the Compensation Committee of the Companys Board of
Directors approved an amendment to the Companys employment agreements with
Messrs. Cavnar, Piacenti, Eells, Munsell and Nicknish, making
consistent the gross-up
provisions relating to parachute payments under Section 280G of the Internal
Revenue Code to include payments made pursuant to agreements, plans,
instruments or obligations other than the employment agreements. Critical Accounting Policies In response to SEC Release No. 33-8040, Cautionary Advice Regarding
Disclosure About Critical Accounting Policies, we identified those policies of
particular importance to the portrayal of our financial position and results of
operations and those policies that require our management to apply significant
judgment. We believe these critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements. 32




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##### Table of Contents



MISSION RESOURCES CORPORATION Full Cost Method of Accounting for Oil and Gas Assets We use the full cost method of accounting for investments in oil and gas
properties. Under the full cost method of accounting, all costs of acquisition,
exploration and development of oil and gas reserves are capitalized as incurred
into a full cost pool. Under the full cost method, a portion of
employee-related costs may be capitalized in the full cost pool if they are
directly identified with acquisition, exploration and development activities.
Generally, salaries and benefits are allocated based upon time spent on
projects. Amounts capitalized can be significant when exploration and major
development activities increase. We deplete the capitalized costs in the full cost pool, plus estimated
future expenditures to develop reserves, on a prospective basis using the units
of production method based upon the ratio of current production to total proved
reserves. Depreciation, depletion and amortization is a significant component
of our net income. Proportionally, it represented 36% and 38% of our total oil
and gas revenues for the nine month periods ended September 30, 2004 and 2003,
respectively. Any reduction in proved reserves without a corresponding
reduction in capitalized costs will increase the depletion rate. If, during
2004, our reserves increase by 10%, our depletion per MCFE would decrease
approximately $0.16 or 9%; however, a 10% decrease in reserves would have an
11% impact, increasing depletion per MCFE by approximately $0.20. Both the volume of proved reserves and the estimated future expenditures
used for the depletion calculation are obtained from the reserve estimates
prepared by independent reserve engineers. These reserve estimates rely upon
both the engineers quantitative and subjective analysis of various data, such
as engineering data, production trends and forecasts, estimated future spending
and the timing of spending. Finally, estimated production costs and commodity
prices are added to the assessment in order to determine whether the estimated
reserves have any value. Reserves that cannot be produced and sold at a profit
are not included in the estimated total proved reserves; therefore the quantity
of reserves can increase or
decrease as oil and gas prices change. See Risk Factors: Risks Related to
Our Business, Industry and Strategy in our Annual Report on Form 10-K filed
for the fiscal year ended December 31, 2003 for general cautions concerning the
reliability of reserve and future net revenue estimates by reserve engineers. The full cost method requires a quarterly calculation of a limitation on
capitalized costs, often referred to as a full cost ceiling calculation. The
ceiling is the discounted present value of our estimated total proved reserves
adjusted for taxes, using a 10% discount rate. To the extent that our
capitalized costs (net of depreciation, depletion, amortization, and deferred
taxes) exceed the ceiling, the excess must be written off to expense. Once
incurred, this impairment of oil and gas properties is not reversible at a
later date even if oil and gas prices increase. No such impairment was required
in the nine months ended September 30, 2004 and 2003. While the difficulty in estimating proved reserves could cause the
likelihood of a ceiling impairment to be difficult to predict, the impact of
changes in oil and gas prices is most significant. In general, the ceiling is
lower when prices are lower. Oil and gas prices at the end of the period are
applied to the estimated reserves, then costs are deducted to arrive at future
net revenues, which are then discounted at 10% to arrive at the discounted
present value of proved reserves. Additionally, we adjust the estimated future
revenues for the impact of our existing cash flow commodity hedges. The ceiling
calculation dictates that prices and costs in effect as of the last day of the
period are generally held constant indefinitely. Therefore, the future net
revenues associated with the estimated proved reserves are not based on
Missions assessment of future prices or costs, but rather are based on prices
and costs in effect as of the end the period. 33




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##### Table of Contents



MISSION RESOURCES CORPORATION Because the ceiling calculation dictates that prices in effect as of the
last day of the period be held constant, the resulting value is rarely
indicative of the true fair value of our reserves. Oil and natural gas prices
have historically been variable and, on any particular day at the end of a
period, can be either substantially higher or lower than our long-term price
forecast, which we feel is more indicative of our reserve value. You should not
view full cost ceiling impairments caused by fluctuating prices, as opposed to
reductions in reserve volumes, as an absolute indicator of a reduction in the
ultimate value of our reserves. Oil and gas prices used in the ceiling calculation at September 30, 2004
were $49.53 per barrel and $6.24 per MMBTU. A significant reduction in these
prices at a future measurement date could trigger a full cost ceiling
impairment. As an illustration, had oil and gas prices at September 30, 2004
been 10% lower, we would have been 42% closer to a ceiling impairment. Derivative Instruments Accounting All of our commodity derivative instruments represent hedges of the price
of future oil and natural gas production. We estimate the fair values of our
hedges at the end of each reporting period. The estimated fair values of our
commodity derivative instruments are recorded in the Consolidated Balance Sheet
as assets or liabilities as appropriate. For effective hedges, we record the change in the fair value of the hedge
instruments to other comprehensive income, a component of stockholders equity,
until the hedged oil or natural gas quantities are produced. Any
ineffectiveness in our hedges, which could represent either gains or losses, is
reported when calculated at the end of each accounting period as part of the
interest and other income line of the Statement of Operations. Estimating the fair values of commodity hedge derivatives requires complex
calculations, including the use of a discounted cash flow technique and our
subjective judgment in selecting an appropriate
discount rate. In addition, the calculation uses future NYMEX prices,
which although posted for trading purposes, are merely the market consensus of
forecast price trends. The results of our fair value calculation cannot be
expected to represent exactly the fair value of our commodity hedges. We
currently use a software product from an outside vendor to calculate the fair
value of our hedges. This vendor provides the necessary NYMEX futures prices
and the calculated volatility in those prices to us daily. The software is
programmed to apply a consistent discounted cash flow technique, using these
variables and a discount rate derived from prevailing interest rates. This
software is successfully used by several of our peers. Its methods are in
compliance with the requirements of SFAS No. 133 and have been reviewed by a
national accounting firm. In order to minimize the impact on managements
estimates on our ineffectiveness calculation, we began using this same software
to calculate any ineffectiveness in our hedge relationships. The software
facilitates the complex calculations and uses current prices downloaded to the
database, but the results are nevertheless estimates. The most significant
estimate used in the ineffectiveness calculation is our estimate of future
prices. We use the forward price curves posted for each of our contract prices. Revenue Recognition Mission records revenues from sales of crude oil and natural gas when
delivery to the customer has occurred and title has transferred. This occurs
when production has been delivered to a pipeline or a tanker lifting has
occurred. We may share ownership with other producers in certain properties. In
this case, we use the sales method to account for sales of production. It is
customary in the industry for various working interest partners to sell more or
less than their entitled share of natural gas production, creating gas
imbalances. Under the sales method, gas sales are recorded when revenue checks
are received or are receivable on the accrual basis. Typically no provision is
made on the balance sheet to 34




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##### Table of Contents



MISSION RESOURCES CORPORATION account for potential amounts due to or from
Mission related to gas imbalances. If the gas reserves attributable to a
property have depleted to the point that there are insufficient reserves to
satisfy existing imbalance positions, a liability or a receivable, as
appropriate, should be recorded equal to the net value of the imbalance. As of
September 30, 2004, the Company had recorded a net liability of approximately
$558,000, representing approximately 329,000 MCF at an average price of $1.69
per MCF, related to imbalances on properties at or nearing depletion. The net
liability accrued as of September 30, 2003, was $1.1 million representing
411,527 MCF at an average price of $2.69 per MCF. We value gas imbalances using the price at which the imbalance originated,
if required by the gas balancing agreement, or we use the current price where
there is no gas balancing agreement available. Reserve changes on any fields
that have imbalances could change this liability. We do not anticipate the
settlement of gas imbalances to adversely impact our financial condition in the
future. Settlements are typically negotiated, so the per MCF price for which
imbalances are settled could differ among wells and even among owners in one
well. Exclusive of the liability recorded for properties at or nearing
depletion (see discussion above), the Companys unrecorded imbalance, valued at
current prices would be a $1.4 million liability. Asset Retirement, Impairment or Disposal We adopted SFAS No. 143, Accounting for Asset Retirement Obligations
effective January 1, 2003. Previously our estimate of future plugging and
abandonment and dismantlement costs was charged to income by being included in
the capitalized costs that we depleted using the unit of production method.
SFAS No. 143 requires us to record a liability for the fair value of our
estimated asset retirement obligation, primarily comprised of our plugging and
abandonment liabilities, in the period in which it is incurred. Upon initial
implementation, we estimate asset retirement costs for all of our assets as of
such date, inflation adjust those costs to the forecast abandonment date,
discount that amount back to the date we acquired the asset and record an asset
retirement liability in that amount with a corresponding addition to our asset
value. Then we must compute all depletion previously taken on future plugging
and abandonment costs, and reverse that depletion. Finally, we must accrete the
liability to present day. Any
income effect of this initial implementation is reflected as a change in
accounting method on our Statement of Operations. After initial implementation, we reduce the liability as abandonment costs
are incurred. We will accrete the liability quarterly using the period and
effective interest rates determined at implementation. As new wells are drilled
or purchased their initial asset retirement cost and liability will be
calculated and recorded. Should either the estimated life or the estimated
abandonment costs of a property change upon our quarterly review, a new
calculation is performed using the same methodology of taking the abandonment
cost and inflating it forward to its abandonment date and then discounting it
back to the present using our risk-adjusted rate. The carrying value of the
asset retirement obligation is adjusted to the newly calculated value, with a
corresponding offsetting adjustment to the asset retirement cost; therefore,
abandonment costs will almost always approximate the estimate. We have
developed a process through which to track and monitor the obligations for each
asset following implementation of SFAS No. 143. When wells are sold the related liability and asset costs are removed from
the balance sheet. Any difference between the two remains in the full cost
pool. SFAS No. 143 does not specifically address the proper accounting to be
applied by a full cost method company when properties are sold. Should a
clarification be issued, there is a chance that Missions treatment will be
required to change and income would be impacted. As with previously discussed estimates, the estimation of our initial
liability and its subsequent remeasurements is dependent upon many variables.
We attempt to limit the impact of managements judgment on these variables by
using the input of qualified third parties when possible. We engaged an
independent engineering firm to evaluate our properties annually and to provide
us with estimates of 35




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MISSION RESOURCES CORPORATION abandonment costs. We used the remaining estimated useful
life from the yearend reserve reports by Netherland, Sewell & Associates, Inc.
in estimating when abandonment could be expected for each property. The
resulting estimate, after application of a discount factor and some significant
calculations, could differ from actual results, despite all our efforts to make
the most accurate estimation possible. Income Taxes Mission has accumulated substantial income tax deductions that have not
yet been used to reduce cash income taxes actually paid with the filing of our
income tax returns. These accumulated deductions are commonly referred to as
net operating loss carryforwards or NOLs. Our NOLs are, subject to a number of restrictions, available to reduce
cash taxes that may become owed in future years. In accordance with the
accounting for income taxes under SFAS No. 109, we record a deferred tax asset
and a reduction of our tax expense for our NOLs. If we estimate that some or
all of our NOLs are more likely than not going to expire or otherwise not be
utilized to reduce future tax, we record a valuation allowance to remove the
benefit of those NOLs from our financial statements. One of the restrictions on the future use of NOLs is contained in Section
382 of the Internal Revenue Code. In general, Section 382 provides that the
amount of existing NOLs that may be used to offset future taxable income after
the occurrence of an ownership change (as defined solely for Section 382
purposes) is limited to an amount that is determined, in part, by the fair
market value of the enterprise at the time the ownership change occurred. The
fair market value of the enterprises individual assets and the timing in which
the value of those assets are realized are also factors that impact the amount
of NOLs available under Section 382 (382 Limitation). As a result of our issuance of common stock in exchange for the retirement
of a portion of our 10 7/8% senior subordinated notes in December 2003, we
experienced an ownership change as defined under Section 382.
Consistent with previously described estimates, the initial estimation of
the future benefit of our NOLs is dependent upon many variables and is subject
to change. Managements judgment on these variables is based upon the input of
qualified third parties when possible. We have used information derived from
the public equity markets as well as data provided by an independent
engineering firm to assist us with determining fair market values. We have
engaged an international independent public accounting firm to assist us in
applying the numerous and complicated tax law requirements. However, despite
our attempt to make the most accurate estimates possible, the ultimate
utilization of our NOLs is highly dependent upon our actual production and the
realization of taxable income in future periods. As of September 30, 2004, no
limitation upon our existing NOLs is indicated. Forward-Looking Statements This quarterly report on Form 10-Q includes forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended
(the Securities Act), and Section 21E of the Securities Exchange Act of 1934,
as amended (Exchange Act). All statements other than statements of historical
fact are forward-looking statements. Forward-looking statements are subject to
certain risks, trends and uncertainties that could cause actual results to
differ materially from those projected. Among those risks, trends and
uncertainties are our estimate of the sufficiency of existing capital sources,
our highly leveraged capital structure, our ability to raise additional capital
to fund cash requirements for future operations, the uncertainties involved in
estimating quantities of proved oil and natural gas reserves, in prospect
development and property acquisitions and in projecting future rates of
production, the timing of development expenditures and drilling of wells, and
the operating hazards attendant to the oil and gas business. Although we
believe that in making such forward-looking statements our expectations are
based upon reasonable assumptions, such statements may be influenced by factors
that 36




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MISSION RESOURCES CORPORATION could cause actual outcomes and results to be materially different from
those projected. We cannot assure you that the assumptions upon which these
statements are based will prove to have been correct. When used in this Form 10-Q, the words expect, anticipate, intend,
plan, believe, seek, estimate and similar expressions are intended to
identify forward-looking statements, although not all forward-looking
statements contain these identifying words. Because these forward-looking
statements involve risks and uncertainties, actual results could differ
materially from those expressed or implied by these forward-looking statements
for a number of important reasons, including those discussed under
Managements Discussions and Analysis of Financial Condition and Results of
Operations, Risk Factors and elsewhere in this Form 10-Q. You should read these statements carefully because they discuss our
expectations about our future performance, contain projections of our future
operating results or our future financial condition, or state other
forward-looking information. Before you invest in our common stock, you
should be aware that the occurrence of any of the events described in
Managements Discussions and Analysis of Financial Condition and Results of
Operations, Risk Factors and elsewhere in this Form 10-Q could substantially
harm our business, results of operations and financial condition and that upon
the occurrence of any of these events, the trading price of our common stock
could decline, and you could lose all or part of your investment. We cannot guarantee any future results, levels of activity, performance or
achievements. Except as required by law, we undertake no obligation to update
any of the forward-looking statements in this Form 10-Q after the date of this
Form 10-Q. As used in this quarterly report, the words we, our, us, Mission
and the Company refer to Mission Resources Corporation, its predecessors and
subsidiaries, except as otherwise specified. Terms specific to the oil and gas industry may be used in this Form 10-Q. 37




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MISSION RESOURCES CORPORATION 
 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk Mission is exposed to market risk, including adverse changes in commodity
prices and interest rate. Commodity Price Risk Mission produces and sells crude oil, natural gas and natural gas liquids.
As a result, our operating results can be significantly affected by
fluctuations in commodity prices caused by changing market forces. We
periodically seek to reduce our exposure to price volatility by hedging a
portion of production through swaps, options and other commodity derivative
instruments. A combination of options, structured as a collar, is our preferred
hedge instrument because there are no up-front costs and protection is given
against low prices. These collars assure that the NYMEX prices we receive on
the hedged production will be no lower than the price floor and no higher than
the price ceiling. The oil hedges that are swaps fix the price to be received. Our 12-month average realized price, excluding hedges, for natural gas per
MCF was $0.03 per MCF less than the NYMEX MMBTU price. Our 12-month average
realized price, excluding hedges, for oil was $1.29 per BBL less than NYMEX.
Realized prices differ from NYMEX as a result of factors such as the location
of the property, the heating content of natural gas and the quality of oil. The
gas differential stated above excludes the impact of the Mist field gas
production that is sold at an annually fixed price. By removing the price volatility from hedged volumes of oil and natural
gas production, we have mitigated, but not eliminated, the potential negative
effect of declining prices on our operating cash flow. The potential for
increased operating cash flow due to increasing prices has also been reduced.
If all our
commodity hedges were to settle at September 30, 2004 prices, our cash flows
would decrease by $22.7 million; however the actual settlement of our
hedges will increase or decrease cash flows over the period of the hedges at
varying prices. As of November 9, 2004, Mission had the following hedges in
place: Oil Hedges NYMEX
    
    NYMEXPrice
    
    PriceBBLS
    
    
    
    
    
    
    
    
    
    Floor/Swap
    
    CeilingPeriod
    
    Per Day
    
    Total BBLS
    
    Type
    
    Avg.
    
    Avg.Fourth Qtr. 2004
    
    
    2,500
    
    
    
    230,000
    
    
    Swap
    
    $
    23.97
    
    
    
    N/AFourth Qtr. 2004
    
    
    500
    
    
    
    46,000
    
    
    Collar
    
    $
    35.00
    
    
    $
    46.15First Qtr. 2005
    
    
    2,500
    
    
    
    225,000
    
    
    Collar
    
    $
    28.71
    
    
    $
    32.78Second Qtr. 2005
    
    
    2,000
    
    
    
    182,000
    
    
    Collar
    
    $
    28.50
    
    
    $
    31.82Third Qtr. 2005
    
    
    2,000
    
    
    
    184,000
    
    
    Collar
    
    $
    28.13
    
    
    $
    31.04Fourth Qtr. 2005
    
    
    2,000
    
    
    
    184,000
    
    
    Collar
    
    $
    27.75
    
    
    $
    30.65First Qtr. 2006
    
    
    1,250
    
    
    
    112,500
    
    
    Collar
    
    $
    30.09
    
    
    $
    46.48Second Qtr. 2006
    
    
    1,250
    
    
    
    113,750
    
    
    Collar
    
    $
    30.06
    
    
    $
    45.13Third Qtr. 2006
    
    
    1,250
    
    
    
    115,000
    
    
    Collar
    
    $
    29.65
    
    
    $
    44.36Fourth Qtr. 2006
    
    
    1,250
    
    
    
    115,000
    
    
    Collar
    
    $
    29.61
    
    
    $
    43.41
 38




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MISSION RESOURCES CORPORATION Gas Hedges NYMEX
    
    NYMEXMMBTU
    
    Total
    
    
    
    
    
    Price Floor
    
    Price CeilingPeriod
    
    Per Day
    
    MMBTU
    
    Type
    
    Avg.
    
    Avg.Fourth Qtr. 2004
    
    
    16,500
    
    
    
    1,518,000
    
    
    Collar
    
    $
    4.64
    
    
    $
    5.73First Qtr. 2005
    
    
    15,500
    
    
    
    1,395,000
    
    
    Collar
    
    $
    5.00
    
    
    $
    9.75Second Qtr. 2005
    
    
    11,500
    
    
    
    1,046,500
    
    
    Collar
    
    $
    4.91
    
    
    $
    6.54Third Qtr. 2005
    
    
    11,500
    
    
    
    1,058,000
    
    
    Collar
    
    $
    4.91
    
    
    $
    6.49Fourth Qtr. 2005
    
    
    11,500
    
    
    
    1,058,000
    
    
    Collar
    
    $
    4.91
    
    
    $
    7.11First Qtr. 2006
    
    
    2,000
    
    
    
    180,000
    
    
    Collar
    
    $
    5.00
    
    
    $
    8.00
 These commodity derivative agreements expose Mission to counter party
credit risk to the extent the counter party is unable to met its monthly
settlement commitment to Mission. Mission believes it selects creditworthy
counter parties to its hedge transactions and has entered into all of its
derivative positions with only two different counter parties in order to
minimize this risk. Each of Missions counter parties have long term senior
unsecured debt ratings of at least A/A2 by Standard & Poors or Moodys. Interest Rate Risk Our new senior secured revolving credit facility and term loan have
floating interest rates and as such expose us to interest rate risk. If
interest rates were to increase 10% over their current levels, and at our
current level of borrowing, our annualized interest expense would increase
$215,000 or 1.4%. We have considered, but have not yet entered into, derivative
transactions designed to mitigate interest rate risk. The Company paid $1.3 million in February 2003 to cancel an interest rate
swap under which Mission received a fixed interest rate and paid a floating
interest rate. The swap originated in 1998 and had a notional value of $80
million. 39




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MISSION RESOURCES CORPORATION 
 ITEM 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures As of the end of the period covered by this report, Missions principal
executive officer (CEO) and principal financial officer (CFO) carried out
an evaluation of the effectiveness of Missions disclosure controls and
procedures pursuant to Rule 13a-15 of the Securities and Exchange Act of 1934.
Based on those evaluations, the CEO and CFO believe:  i.
    
    that Missions disclosure controls and procedures are
designed to ensure that information required to be disclosed by
Mission in the reports it files under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms, and that such
information is accumulated and communicated to Missions management,
including the CEO and CFO, as appropriate to allow timely decisions
regarding required disclosure; andii.
    
    that Missions disclosure controls and procedures are
effective. Changes in Internal Controls There have been no significant changes in Missions internal controls over
financial reporting during the period covered by this report that have
materially affected, or are reasonably likely to materially affect, Missions
control over financial reporting. 40




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##### Table of Contents



MISSION RESOURCES CORPORATION 
 PART II. OTHER INFORMATION 
 ITEM 1. Legal Proceedings The Company is involved in litigation relating to claims arising out of
its operations in the normal course of business, including workmens
compensation claims, tort claims and contractual disputes. Some of the existing
known claims against the Company are covered by insurance subject to the limits
of such policies and the payment of deductible amounts by the Company.
Management believes that the ultimate disposition of all uninsured or
unindemnified matters resulting from existing litigation will not have a
material adverse effect on the Companys business or financial position. 
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds None. 
 ITEM 3. Defaults Upon Senior Securities None. 
 ITEM 4. Submission of Matters to a Vote of Security Holders None. 
 ITEM 5. Other Information On July 29, 2004, the Company released a mid-year reserve update based
upon the review of Netherland, Sewell & Associates, Inc. The reserves were
priced at June 30, 2004 period end prices of $36.90 per BBL of oil and $6.02
per MMBTU of natural gas. Estimated net proved oil and gas reserves at June

30, 2004 were approximately 217 BCFE and the 10% present value of future cash
flows for such reserves is approximately $407 million. We more than replaced
production through reserve additions and extensions. The majority of the
extensions are proved undeveloped locations identified in the Jalmat field.
The Jalmat field acquisition in January and April 2004 is the majority of the
32.1 BCFE purchased reserves. Set forth below is a reconciliation of our year
end 2003 reserves to those reported as of June 30, 2004. BCFEProved reserves at beginning of year
    
    
    177.9Revisions of previous estimates
    
    
    (9.7
    )Extensions and discoveries
    
    
    31.9Production
    
    
    (11.8
    )Sales of reserves in-place
    
    
    (3.4
    )Purchase of reserves in-place
    
    
    32.1Proved reserves at June 30, 2004
    
    
    217.0
 - 41 -




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MISSION RESOURCES CORPORATION 
 ITEM 6. Exhibits 10.1*
    
    Form of Nonstatutory Stock Option Grant
Agreement under Mission Resources Corporation 2004
Incentive Plan.10.2*
    
    Form of Director Non-Qualified Stock
Option.10.3*
    
    Form of Incentive Stock Option Grant
Agreement under Mission Resources Corporation 2004
Incentive Plan.10.4*
    
    First Amendment to Employment
Agreement dated November 9, 2004 between Mission

Resources Corporation and Robert L. Cavnar.10.5*
    
    First Amendment to Employment
Agreement dated November 9, 2004 between Mission
Resources Corporation and Richard W. Piacenti.10.6*
    
    First Amendment to Employment
Agreement dated November 9, 2004 between Mission
Resources Corporation and John L. Eells.10.7*
    
    First Amendment to Employment
Agreement dated November 9, 2004 between Mission
Resources Corporation and Joseph G. Nicknish.10.8*
    
    First Amendment to Employment
Agreement dated November 9, 2004 between Mission
Resources Corporation and Marshall L. Munsell.10.9
    
    Nonstatutory Stock Option Grant
Agreement dated November 1, 2004 between Mission
Resources Corporation and Thomas C. Langford
(incorporated by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K filed on November
2, 2004).23.1*
    
    Consent of Netherland, Sewell and
Associates, Inc.31.1*
    
    Certification of Chief Executive
Officer pursuant to Rule 13a-14(a) / Rule 15d-14(a),
promulgated under the Securities Exchange Act of 1934,
as amended.31.2*
    
    Certification of Chief Financial
Officer pursuant to Rule 13a-14(a) / Rule 15d-14(a),
promulgated under the Securities Exchange Act of 1934,
as amended.32.1*
    
    Certification pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, of Chief Executive
Officer of the Company.32.2*
    
    Certification pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, of Chief Financial
Officer of the Company.
   *Filed herewith. - 42 -




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MISSION RESOURCES CORPORATION Pursuant to the requirements 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. MISSION RESOURCES CORPORATION(Registrant)Date: November 10, 2004
    
    By:
    
    /s/ Robert L. CavnarRobert L. Cavnar
Chairman and Chief Executive OfficerDate: November 10, 2004
    
    By:
    
    /s/ Richard W. PiacentiRichard W. PiacentiExecutive Vice President and Chief Financial Officer
 - 43 -




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EXHIBIT INDEX 10.1*
    
    Form of Nonstatutory Stock Option Grant
Agreement under Mission Resources Corporation 2004
Incentive Plan.10.2*
    
    Form of Director Non-Qualified Stock
Option.10.3*
    
    Form of Incentive Stock Option Grant
Agreement under Mission Resources Corporation 2004
Incentive Plan.10.4*
    
    First Amendment to Employment
Agreement dated November 9, 2004 between Mission
Resources Corporation and Robert L. Cavnar.10.5*
    
    First Amendment to Employment
Agreement dated November 9, 2004 between Mission
Resources Corporation and Richard W. Piacenti.10.6*
    
    First Amendment to Employment
Agreement dated November 9, 2004 between Mission
Resources Corporation and John L. Eells.10.7*
    
    First Amendment to Employment
Agreement dated November 9, 2004 between Mission
Resources Corporation and Joseph G. Nicknish.10.8*
    
    First Amendment to Employment
Agreement dated November 9, 2004 between Mission
Resources Corporation and Marshall L. Munsell.10.9
    
    Nonstatutory Stock Option Grant
Agreement dated November 1, 2004 between Mission
Resources Corporation and Thomas C. Langford
(incorporated by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K filed on November
2, 2004).23.1*
    
    Consent of Netherland, Sewell and
Associates, Inc.31.1*
    
    Certification of Chief Executive
Officer pursuant to Rule 13a-14(a) / Rule 15d-14(a),
promulgated under the Securities Exchange Act of 1934,
as amended.31.2*
    
    Certification of Chief Financial
Officer pursuant to Rule 13a-14(a) / Rule 15d-14(a),
promulgated under the Securities Exchange Act of 1934,
as amended.32.1*
    
    Certification pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, of Chief Executive
Officer of the Company.32.2*
    
    Certification pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, of Chief Financial
Officer of the Company.
   *Filed herewith.