Back to GetFilings.com



Table of Contents
 
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarter Ended
  
Commission File Number
September 30, 2002
  
0-23431
 
 
MILLER EXPLORATION COMPANY
(Exact Name of Registrant as Specified in Its Charter)
 
 
Delaware
  
38-3379776
(State or Other Jurisdiction of
  
(I.R.S. Employer
Incorporation or Organization)
  
Identification No.)
3104 Logan Valley Road
    
Traverse City, Michigan
  
49685-0348
(Address of Principal Executive Offices)
  
(Zip Code)
 
Registrant’s Telephone Number, Including Area Code:    (231) 941-0004
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes  x            No   ¨
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
  
Outstanding at November 14, 2002
Common stock, $.01 par value
  
1,992,159 shares
 

Table of Contents
 
MILLER EXPLORATION COMPANY
 
TABLE OF CONTENTS
 
          
Page No.
PART I.    FINANCIAL INFORMATION
       
Item 1.
       
3
          
   
Three Months and Nine Months Ended September 30, 2002 and 2001
     
3
          
   
September 30, 2002 and December 31, 2001
     
4
          
   
Nine Months Ended September 30, 2002
     
5
          
   
Nine Months Ended September 30, 2002 and 2001
     
6
        
7
Item 2.
       
17
Item 3.
       
25
Item 4.
         
PART II.    OTHER INFORMATION
       
Item 1.
       
26
Item 2.
       
27
Item 3.
       
27
Item 4.
       
27
Item 5.
       
28
Item 6.
       
28

2

Table of Contents
 
PART I.    FINANCIAL INFORMATION
 
Item 1.     Financial Statements
 
MILLER EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
 
   
For the Three Months Ended September 30,
     
For the Nine Months Ended September 30,
  
   
2002
     
2001
     
2002
     
2001
  
REVENUES:
                                   
Natural gas
  
$
1,501
 
   
 
2,695
 
   
$
5,299
 
   
$
12,072
 
Crude oil and condensate
  
 
548
 
   
 
795
 
   
 
2,330
 
   
 
2,621
 
Other operating revenues
  
 
37
 
   
 
65
 
   
 
142
 
   
 
234
 
   
  
  
  
Total operating revenues
  
 
2,086
 
   
 
3,555
 
   
 
7,771
 
   
 
14,927
 
   
  
  
  
OPERATING EXPENSES:
                                   
Lease operating expenses and production taxes
  
 
425
 
   
 
655
 
   
 
1,353
 
   
 
2,418
 
Depreciation, depletion and amortization
  
 
1,415
 
   
 
2,793
 
   
 
5,929
 
   
 
10,505
 
General and administrative
  
 
389
 
   
 
383
 
   
 
1,554
 
   
 
1,459
 
Cost ceiling writedown
  
 
—  
 
   
 
1,000
 
   
 
7,000
 
   
 
8,500
 
   
  
  
  
Total operating expenses
  
 
2,229
 
   
 
4,831
 
   
 
15,836
 
   
 
22,882
 
   
  
  
  
OPERATING INCOME (LOSS)
  
 
(143
)
   
 
(1,276
)
   
 
(8,065
)
   
 
(7,955
)
   
  
  
  
INTEREST EXPENSE
  
 
(145
)
   
 
(241
)
   
 
(547
)
   
 
(829
)
   
  
  
  
INCOME (LOSS) BEFORE INCOME TAXES
  
 
(288
)
   
 
(1,517
)
   
 
(8,612
)
   
 
(8,784
)
   
  
  
  
INCOME TAX PROVISION (CREDIT) (Note 2)
  
 
—  
 
   
 
(176
)
   
 
(5,743
)
   
 
(97
)
   
  
  
  
NET INCOME (LOSS)
  
$
(288
)
   
$
(1,341
)
   
$
(2,869
)
   
$
(8,687
)
   
  
  
  
EARNINGS (LOSS) PER SHARE (Note 3)
                                   
Basic
  
$
(0.01
)
   
$
(0.07
)
   
$
(0.15
)
   
$
(0.45
)
   
  
  
  
Diluted
  
$
(0.01
)
   
$
(0.07
)
   
$
(0.15
)
   
$
(0.45
)
   
  
  
  
 
The accompanying notes are an integral part of these consolidated financial statements.

3

Table of Contents
 
MILLER EXPLORATION COMPANY
 
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
 
    
As of September 30, 2002
     
As of December 31, 2001
  
    
(Unaudited)
         
ASSETS
                  
CURRENT ASSETS:
                  
Cash and cash equivalents
   
$
355
 
   
$
201
 
Accounts receivable
   
 
2,602
 
   
 
3,076
 
Inventories, prepaids and advances to other operators
   
 
621
 
   
 
523
 
    
  
Total current assets
   
 
3,578
 
   
 
3,800
 
    
  
OIL AND GAS PROPERTIES—at cost (full cost method):
                  
Proved oil and gas properties
   
 
151,916
 
   
 
146,649
 
Unproved oil and gas properties
   
 
4,532
 
   
 
11,244
 
Less-Accumulated depreciation, depletion and amortization
   
 
(137,363
)
   
 
(124,618
)
    
  
Net oil and gas properties
   
 
19,085
 
   
 
33,275
 
    
  
OTHER ASSETS
   
 
367
 
   
 
512
 
    
  
Total assets
   
$
23,030
 
   
$
37,587
 
    
  
LIABILITIES AND EQUITY
                  
CURRENT LIABILITIES:
                  
Notes payable
   
$
2,684
 
   
$
—  
 
Current maturities of long-term debt
   
 
1,800
 
   
 
—  
 
Accounts payable
   
 
534
 
   
 
2,767
 
Accrued expenses and other current liabilities
   
 
3,446
 
   
 
4,974
 
    
  
Total current liabilities
   
 
8,464
 
   
 
7,741
 
    
  
LONG-TERM DEBT
   
 
—  
 
   
 
6,696
 
DEFERRED INCOME TAXES (Note 2)
   
 
—  
 
   
 
5,743
 
COMMITMENTS AND CONTINGENCIES (Note 8)
                  
EQUITY:
                  
Common stock warrants, 13,350,498 outstanding at September 30, 2002 and December 31, 2001
   
 
860
 
   
 
860
 
Preferred stock, $0.01 par value; 2,000,000 shares authorized; none outstanding
            
 
—  
 
Common stock, $0.01 par value; 40,000,000 shares authorized; 19,921,590 shares and 19,478,853 shares outstanding at September 30, 2002 and December 31, 2001, respectively
   
 
199
 
   
 
195
 
Accumulated other comprehensive income (loss)
   
 
(83
)
   
 
89
 
Additional paid in capital
   
 
77,447
 
   
 
77,251
 
Retained deficit
   
 
(63,857
)
   
 
(60,988
)
    
  
Total equity
   
 
14,566
 
   
 
17,407
 
    
  
Total liabilities and equity
   
$
23,030
 
   
$
37,587
 
    
  
 
The accompanying notes are an integral part of these consolidated financial statements.

4

Table of Contents
 
MILLER EXPLORATION COMPANY
 
CONSOLIDATED STATEMENT OF EQUITY
(In thousands)
(Unaudited)
 
    
Common Stock Warrants
   
Preferred Stock
   
Common Stock
     
Accumulated Other Comprehensive Income (Loss)
     
Additional Paid In Capital
   
Retained Deficit
  
BALANCE-December 31, 2001
   
$
860
   
$
—  
   
$
195
     
$
89
 
   
$
77,251
   
$
(60,988
)
Issuance of benefit plan shares
   
 
—  
   
 
 —  
   
 
2
     
 
—  
 
   
 
74
   
 
—  
 
Issuance of non-employee directors’ shares
   
 
—  
   
 
—  
   
 
2
     
 
—  
 
   
 
122
   
 
—  
 
Change in unrealized (losses)
   
 
—  
   
 
—  
   
 
—  
     
 
(172
)
   
 
—  
   
 
—  
 
Net (loss)
   
 
—  
   
 
—  
   
 
—  
     
 
—  
 
   
 
—  
   
 
(2,869
)
    
  
  
    
  
  
BALANCE-September 30, 2002
   
$
860
   
$
—  
   
$
199
     
$
(83
)
   
$
77,447
   
$
(63,857
)
    
  
  
    
  
  
 
 
Disclosure of Comprehensive Income:
 
    
For the nine months ended September 30,
  
    
2002
     
2001
  
Net income (loss)
   
$
(2,869
)
   
$
(8,687
)
Other comprehensive income (loss)
   
 
(172
)
   
 
425
 
    
  
Total comprehensive income (loss)
   
$
(3,041
)
   
$
(8,262
)
    
  
 
The accompanying notes are an integral part of these consolidated financial statements.

5

Table of Contents
 
MILLER EXPLORATION COMPANY
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
    
For the Nine Months Ended September 30,
  
    
2002
     
2001
  
CASH FLOWS FROM OPERATING ACTIVITIES:
                  
Net income (loss)
   
$
(2,869
)
   
$
(8,687
)
Adjustments to reconcile net income (loss) to net cash from operating activities—
                  
Cost ceiling writedown
   
 
7,000
 
   
 
8,500
 
Depreciation, depletion and amortization
   
 
5,929
 
   
 
10,505
 
Deferred income taxes
   
 
(5,743
)
   
 
(96
)
Warrants and stock compensation
   
 
199
 
   
 
16
 
Deferred revenue
   
 
—  
 
   
 
(20
)
Changes in assets and liabilities—
                  
Restricted cash
   
 
—  
 
   
 
69
 
Accounts receivable
   
 
474
 
   
 
1,111
 
Other assets
   
 
(220
)
   
 
(306
)
Accounts payable
   
 
(2,233
)
   
 
(1,401
)
Accrued expenses and other current liabilities
   
 
(1,611
)
   
 
274
 
    
  
Net cash flows provided by operating activities
   
 
926
 
   
 
9,965
 
    
  
CASH FLOWS FROM INVESTING ACTIVITIES:
                  
Exploration and development expenditures
   
 
(2,303
)
   
 
(8,029
)
Proceeds from sale of oil and gas properties and purchases of equipment, net
   
 
3,743
 
   
 
52
 
    
  
Net cash flows provided by (used in) investing activities
   
 
1,440
 
   
 
(7,977
)
    
  
CASH FLOWS FROM FINANCING ACTIVITIES:
                  
Payments of principal
   
 
(19,284
)
   
 
(16,682
)
Borrowing on notes payable and long-term debt
   
 
17,072
 
   
 
12,664
 
    
  
Net cash flows used in financing activities
   
 
(2,212
)
   
 
(4,018
)
    
  
NET CHANGE IN CASH AND CASH EQUIVALENTS
   
 
154
 
   
 
(2,030
)
    
  
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD
   
 
201
 
   
 
2,292
 
    
  
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD
   
$
355
 
   
$
262
 
    
  
SUPPLEMENTAL CASH FLOW INFORMATION:
                  
Cash paid during the period for interest
   
$
782
 
   
$
712
 
    
  
 
The accompanying notes are an integral part of these consolidated financial statements.

6

Table of Contents
 
MILLER EXPLORATION COMPANY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(1)    Organization and Nature of Operations
 
The consolidated financial statements of Miller Exploration Company (the “Company”) and its subsidiary, Miller Oil Corporation, included herein have been prepared by management without audit pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, they reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial results for the interim periods presented. Certain information and notes normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, management believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001. The statements of operations for the three and nine month periods ended September 30, 2002, cannot necessarily be used to project results for the full year.
 
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Principles of Consolidation
 
The consolidated financial statements of the Company include the accounts of the Company and its subsidiary after elimination of all intercompany accounts and transactions.
 
Nature of Operations
 
The Company is a domestic, independent energy company engaged in the exploration, development and production of crude oil and natural gas. The Company has established exploration efforts concentrated primarily in the Mississippi Salt Basin of central Mississippi and on the Blackfeet Indian Reservation in Montana.
 
Oil and Gas Properties
 
SEC Regulation S-X, Rule 4-10 requires companies reporting on a full cost basis to apply a ceiling test wherein the capitalized costs, net of deferred income taxes, within the full cost pool may not exceed the net present value of the Company’s proven oil and gas reserves plus the lower of the cost or market value of unproved properties. Any such excess costs should be charged against earnings. Using unescalated period-end prices at September 30, 2002, of $4.14 per Mcf of natural gas and $30.45 per barrel of oil, no cost ceiling writedown was required for the quarter then ended. Using unescalated period-end prices at September 30, 2001, of $2.24 per Mcf of natural gas and $23.43 per barrel of oil, the Company would have recognized a $3.9 million non-cash cost ceiling writedown during the third quarter of 2001. However, based upon improvements in oil and gas prices experienced subsequent to period end, but prior to the respective report date, the non-cash cost ceiling writedown was reduced to $1.0 million.

7

Table of Contents
 
MILLER EXPLORATION COMPANY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Reclassifications
 
Certain reclassifications have been made to prior period statements to conform with the September 30, 2002 presentation.
 
Reverse Stock Split
 
All disclosures regarding amounts or per-share amounts for shares, options, and warrants are presented before adjustments for the one-for-ten reverse stock split that was effective October 11, 2002 (as more fully described in Note 11).
 
(2)    Income Taxes
 
In 1998, upon consummation of the Company’s initial public offering, the Company recorded a one-time non-cash accounting charge of $5.4 million to record net deferred tax liabilities, due to the use of different methods for tax and financial reporting purposes in accounting for various transactions and the resultant temporary differences between tax basis and financial reporting basis.
 
Based on estimates prepared as of June 30, 2002, of future anticipated taxable income and also taking into consideration the Company’s current net operating loss and depletion deduction carryforwards of approximately $38.6 million, it has been determined that there should be no accrual of future tax liability. Accordingly, at June 30, 2002, the Company recorded a $5.5 million income tax credit to reverse the entire deferred income tax liability balance.
 
(3)    Earnings Per Share
 
The computation of earnings (loss) per share for the three-month and nine-month periods ended September 30, 2002 and 2001 are as follows (in thousands, except per share data):
 
    
Three Months
     
Nine Months
  
    
Ended September 30,
     
Ended September 30,
  
    
2002
     
2001
     
2002
     
2001
  
Net income (loss) attributable to basic and diluted EPS
   
$
(288
)
   
$
(1,341
)
   
$
(2,869
)
   
$
(8,687
)
Average common shares outstanding applicable to basic EPS
   
 
19,898
 
   
 
19,479
 
   
 
19,781
 
   
 
19,430
 
Add: stock options, treasury shares and restricted stock
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
    
  
  
  
Average common shares outstanding applicable to diluted EPS
   
 
19,898
 
   
 
19,479
 
   
 
19,781
 
   
 
19,430
 
Earnings (loss) per share:
                                    
Basic
   
$
(0.01
)
   
$
(0.07
)
   
$
(0.15
)
   
$
(0.45
)
Diluted
   
$
(0.01
)
   
$
(0.07
)
   
$
(0.15
)
   
$
(0.45
)
 
Options and restricted stock were not included in the computation of diluted earnings per share because their effect was antidilutive.

8

Table of Contents
 
MILLER EXPLORATION COMPANY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(4)    Capital Resources and Liquidity
 
The Company’s primary ongoing sources of liquidity are from cash generated from operations and from the Company’s use of available borrowing capacity under its credit facility. The Company’s cash flow for the nine months ended September 30, 2002 decreased to $4.3 million from $10.2 million for the same period of the prior year, due to declining oil and gas production volumes and lower average commodity prices. The Company cannot predict future oil and natural gas price movements with certainty. Although commodity prices have rebounded in 2002, a return to the prices experienced during the fourth quarter of 2001 and first quarter of 2002, would likely have a material adverse effect on the Company’s liquidity, financial condition and results of operations.
 
The Company’s note payable to Veritas DGC Land, Inc. (as more fully discussed in Note 5) expires December 31, 2002 and the Company’s credit facility with Bank One, Texas, N.A. (“Bank One”) expires on August 1, 2003; therefore, both are classified as current liabilities in the Consolidated Balance Sheets and represents $4.4 million of the Company’s $4.9 million working capital deficit at September 30, 2002.
 
(5)    Notes Payable and Long-Term Debt
 
Notes Payable
 
In the past few years the Company has financed various insurance policy premiums. In January 2002, concurrent with the policy renewals, the Company entered into a $71,893 note payable agreement to finance general liability and workers’ compensation insurance premiums. Terms of such note call for nine monthly installment payments of $8,157, bearing interest at 5.05%. In February 2002, the Company entered into a $131,827 note payable agreement to finance control of well, boiler and machinery and personal property insurance premiums. Terms of such note call for nine monthly installment payments of $14,949, bearing interest at 4.91%. The outstanding balance of these notes payable was approximately $38,000 at September 30, 2002.
 
Bank Debt
 
On July 19, 2000, the Company entered into a senior credit facility with Bank One, which replaced the then existing credit facility with Bank of Montreal, Houston Agency. The new credit facility has a 30-month term with an interest rate of either the Bank One prime rate plus 2% or LIBOR plus 4% at the Company’s option. The Company’s new borrowing base determined by Bank One as of July 1, 2002, was $5.8 million. On September 30, 2002, the Company completed the sale of certain proved and unproved oil and gas properties (as more fully described in Note 9). In connection therewith, the Company’s borrowing base was reduced to $4.0 million until the next redetermination scheduled for February 1, 2003. Bank One also notified the Company that the maturity date of the credit facility has been extended to August 1, 2003 from January 18, 2003. At September 30, 2002, the outstanding balance under the Company’s credit facility with Bank One was $1.8 million. The weighted average interest rate for the credit facility at September 30, 2002, was 5.98%.
 
The Bank One credit facility includes certain covenants that impose restrictions on the Company with respect to, among other things, incurrence of additional indebtedness, limitations on financial ratios, making investments and mergers and consolidation. At September 30, 2002, the Company requested and obtained a waiver from Bank One for non-compliance with the covenant that requires maintenance of specified levels of commodity hedge contracts. The obligations under the credit facility are secured by a lien on all of the Company’s real and personal property.

9

Table of Contents
 
MILLER EXPLORATION COMPANY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Other
 
On April 14, 1999, the Company issued a $4.7 million note payable (the “Veritas Note”) to one of its suppliers, Veritas DGC Land, Inc. (“Veritas”), for the outstanding balance due to Veritas for past services provided in 1998 and 1999. The principal obligation under the Veritas Note was originally due on April 15, 2001.
 
On April 14, 1999, the Company also entered into an agreement (the “Warrant Agreement”) to issue warrants to Veritas that entitle Veritas to purchase shares of common stock in lieu of receiving cash payments for the accrued interest obligations under the Veritas Note. The Warrant Agreement required the Company to issue warrants to Veritas in conjunction with the signing of the Warrant Agreement, as well as on the six and, at the Company’s option, 12 and 18 month anniversaries of the Warrant Agreement. The warrants issued equal 9% of the then current outstanding principal balance of the Veritas Note. The number of shares issued upon exercise of the warrants on April 14, 1999, and on the six-month anniversary was determined based upon a five-day weighted average closing price of the Company’s Common Stock at April 14, 1999. The exercise price of each warrant is $0.01 per share. On April 14, 1999, warrants exercisable for 322,752 shares of common stock were issued to Veritas in connection with execution of the Veritas Note. On October 14, 1999 and April 14, 2000, warrants exercisable for another 322,752 and 454,994 shares, respectively, of Common Stock were issued to Veritas. The Company ratably recognized the prepaid interest into expense over the period to which it related.
 
On July 18, 2000, the Company entered into the First Amendment to Promissory Note, Warrant and Registration Rights Agreement (“First Amendment Agreement”). Under the terms of the First Amendment Agreement, the maturity of the Veritas Note was extended to July 21, 2003 from April 15, 2001 and the expiration date for all warrants issued was extended until June 21, 2004. The annual interest rate was reduced to 9 ¾% from 18%, provided the entire Note balance was paid in full by December 31, 2001. The Veritas note was not paid in full by December 31, 2001, and the interest rate was increased to 13 ¾% annually. Interest was payable on each October 15 and April 15 until the note is paid in full. The Company has paid additional interest of approximately $225,000 at the incremental 4% rate for the period of October 15, 2000 through April 14, 2002. Interest was required to be paid in warrants under the terms of the First Amendment Agreement until the Company was in compliance with the net borrowing base formula as defined in the Bank One credit facility, at which time interest would only be paid in cash. Since October 15, 2000, all interest payments have been made in cash.
 
On June 28, 2002, the Company entered into the Second Amendment to Promissory Note, Warrant and Registration Rights Agreement (“Second Amendment Agreement”). Concurrently with the execution of the Second Amendment Agreement, the Company made a $600,000 principal payment. Under terms of the Second Amendment Agreement, the Veritas Note was amended as follows: (1) The maturity of the Veritas Note has been changed to December 31, 2002 from July 21, 2003; (2) the note bears interest at the stated rate of 9 ¾%; (3) the past due annual interest rate was changed to 12% from 13 ¾%; and (4) six principal payments of $150,000, totaling $900,000 are required, and are payable on or before the last day of each month commencing on July 31, 2002. In the event that all six principal payments mentioned above are made timely, an interest payment will not be due on October 15, 2002, and Veritas shall forgive the remaining principal balance of $2.2 million and any accrued interest outstanding under the Veritas Note and the Company will recognize a gain of approximately $2.4 million. In the event that these six principal payments are not timely made, the entire principal balance outstanding under the Veritas Note shall be accelerated and become due and payable upon demand and shall accrue interest at the past due rate from the date of the Second Amendment Agreement until the Veritas Note is paid in full. The outstanding Veritas Note balance at September 30, 2002, was $2.6 million, and since the

10

Table of Contents
 
MILLER EXPLORATION COMPANY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
maturity date has been changed to December 31, 2002, the entire balance has been classified as a current liability in the Consolidated Balance Sheets.
 
As an inducement for Veritas to enter into the Second Amendment Agreement: (1) the Company has granted Veritas an overriding royalty interest on the Company’s entire leasehold that is not held by production and leases acquired through July 31, 2003 (excluding leases within the boundaries of the Blackfeet Indian Reservation); (2) the Company transferred its proprietary rights in approximately 140 square miles of 3-D seismic data with respect to certain areas within the Mississippi Salt Basin to Veritas in exchange for a 25-year license allowing the Company the use of same data. The Company has also agreed to an optional transfer fee on its currently licensed data, which in the aggregate totals approximately $3.1 million in the event of a change in control of the Company; and (3) certain Company Directors who own or control shares of Common Stock of the Company and are considered major stockholders have agreed to provide certain tag-along rights in the event one of these major stockholders negotiates a sale of Company Common Stock with a private party.
 
The Second Amendment Agreement also extended the expiration date of the warrants to July 31, 2004 from June 21, 2004. Also, any additional proceeds derived by the Company from the exercise of warrants issued (see Note 6) or from other debt or equity transactions must be used to pay interest and principal on the amended Veritas Note until paid in full.
 
(6)    Capital Transactions and Common Stock Warrants
 
On July 11, 2000, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with Guardian Energy Management Corp. (“Guardian”). Pursuant to the Securities Purchase Agreement, the Company issued to Guardian a convertible promissory note in the amount of $5.0 million, and three warrants exercisable for 1,562,500, 2,500,000 and 9,000,000 shares of the Company’s Common Stock, respectively. The issuance of the shares of Common Stock on the conversion of the note and exercise of the warrants was approved by the Company’s stockholders at a meeting on December 7, 2000. Until the stockholders approved the conversion of the note, the Company accrued interest at an amount equal to the prime rate plus 10% per annum (or 19.5%). The accrual of interest was required under Emerging Issues Task Force (“EITF”) 85-17 even though no interest was owed on this note since the stockholders approved the conversion of the note. Accordingly, the Company incurred approximately $0.4 million of interest expense on this convertible note during the year ended December 31, 2000.
 
Under accounting pronouncements in effect at the time of the transaction, in determining the beneficial conversion feature of the Guardian convertible note, the Company was required to assume that the fair value of the Guardian transaction was the closing price of the Company’s common stock on the commitment date (July 11, 2000) which was the date the agreements were signed ($1.56 per share) versus the value agreed to by both parties of $1.35 per share using various valuation methodologies. The difference between these values of $.21 per share resulted in a non-cash charge to interest expense of $0.8 million on the date of stockholder approval of the note conversion. Also, the Company was required to use a value of $1.56 per share of Company Common Stock to allocate value to the warrants issued to Guardian. This resulted in a non-cash charge to interest expense of $0.5 million, making an aggregate $1.3 million charge to interest expense related to valuation of the Guardian Transaction. These charges to interest expense are the result of using a prescribed fair value for the Company’s Common Stock in accounting for these transactions which may not represent the actual value of the Guardian Transaction.

11

Table of Contents
 
MILLER EXPLORATION COMPANY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
On July 11, 2000, the Company also signed a letter agreement to acquire an interest in certain undeveloped oil and gas properties and $0.5 million in cash from Eagle Investments, Inc. (“Eagle”) an affiliated entity controlled by C.E. Miller, the Chairman of the Company, in exchange for a total of 1,851,851 shares of common stock. In addition, Eagle was issued warrants exercisable for a total of 2,031,250 shares of Common Stock. This transaction with Eagle was approved by the Company’s stockholders at a meeting on December 7, 2000.
 
Common Stock Warrants
 
As of September 30, 2002, the Company has the following Common Stock warrants outstanding:
 
Warrants
     
Exercise Price
   
Expiration Date
    3,750,000 shares
     
$2.50
   
December 7, 2002
    600,498 shares
     
  0.01
   
July 31, 2004
    9,000,000 shares
     
  3.00
   
December 7, 2004
 
(7)    Risk Management Activities and Derivative Transactions
 
The Company uses a variety of financial derivative instruments (“derivatives”) to manage exposure to fluctuations in commodity prices. To qualify for hedge accounting, derivatives must meet the following criteria: (i) the item to be hedged exposes the Company to price risk; and (ii) the derivative reduces that exposure and is designated as a hedge. The Company periodically enters into certain derivatives for a portion of its oil and natural gas production to achieve a more predictable cash flow, as well as to reduce the exposure to price fluctuations. The Company’s hedging arrangements apply only to a portion of its production, provide only partial price protection against declines in oil and natural gas prices and limit potential gains from future increases in prices. Such hedging arrangements may expose the Company to risk of financial loss in certain circumstances, including instances where production is less than expected, the Company’s customers fail to purchase contracted quantities of oil or natural gas or a sudden unexpected event materially impacts oil or natural gas prices. For financial reporting purposes, gains and losses related to hedging are recognized as oil and gas revenues during the period the hedge transaction occurs. The Company expects that the amount of hedge contracts that it has in place will vary from time to time. For the nine months ended September 30, 2002 and 2001, the Company realized approximately $(0.2) million and $(2.2) million, respectively, of hedging (losses) which are included in oil and natural gas revenues in the consolidated statements of operations. The fair value of remaining derivative contracts at September 30, 2002, is approximately $(0.1) million. This amount is reflected in other current liabilities in the Consolidated Balance Sheet with a corresponding amount in comprehensive income (loss). For the nine months ended September 30, 2002 and 2001, the Company had hedged 60% and 53%, respectively, of its oil and natural gas production, and as of September 30, 2002, the Company had 0.4 Bcfe of open natural gas contracts for the months of October 2002 through May 2003. If all these open contracts had been settled as of September 30, 2002, the Company would have paid approximately $0.1 million.
 
(8)    Commitments and Contingencies
 
Stock-Based Compensation
 
During 1997, the Company adopted the Stock Option and Restricted Stock Plan of 1997 (the “1997 Plan”). The Board of Directors contemplates that the 1997 Plan primarily will be used to grant stock options.

12

Table of Contents
 
MILLER EXPLORATION COMPANY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
However, the 1997 Plan permits grants of restricted stock and tax benefit rights if determined to be desirable to advance the purposes of the 1997 Plan. These stock options, restricted stock and tax benefit rights are collectively referred to as “Incentive Awards.” Persons eligible to receive Incentive Awards under the 1997 Plan are directors, corporate officers and full-time employees of the Company and its subsidiary. A maximum of 2.4 million shares of Common Stock (subject to certain antidilution adjustments) are available for Incentive Awards under the 1997 Plan.
 
On January 1, 2000, the Company granted 191,500 stock options to certain employees with an exercise price of $0.01 per share. The right to exercise the options vests and the options become exercisable only when the average trading price of the Common Stock on the market remains above the designated target prices for a period of five consecutive trading days as follows:
 
Five-Day Daily Average Target
   
Percentage Vested
$2.00
   
40%
$2.75
   
additional 30%
$3.50
   
final 30%
 
When it is probable that the five-day stock price target will be attained (the “measurement date”), the Company will recognize compensation expense for the difference between the quoted market price of the Common Stock at this measurement date less the $0.01 per share grant price times the number of options that will vest. Management does not currently believe it is probable that any of these targets will be attained during 2002; therefore, no compensation expense has been recorded for these options.
 
On October 31, 2000, the Company granted 250,000 stock options to employees with an exercise price of $1.625 per share (the closing market price on the date of grant). The right to exercise the options vests at a rate of one-fifth per year beginning on the first anniversary of the grant date.
 
On April 6, 2001, the Company granted 190,000 stock options to the Chief Executive Officer of the Company. Of these options, 100,000 were issued under the same terms as those issued to certain employees on January 1, 2000, and the remaining 90,000 stock options were issued under the same terms as those issued to certain employees on October 31, 2000.
 
On November 12, 2001, the Company granted 337,000 stock options to employees with an exercise price of $1.25 per share. The right to exercise the options vests at a rate of one-fifth per year beginning on the first anniversary of the grant date.
 
The Company accounts for all stock options issued under the provisions and related interpretation of Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock-Based Compensation. The Company intends to continue to apply APB No. 25 for purposes of determining net income.
 
Litigation
 
On May 1, 2000, the Company filed a lawsuit in the Federal District Court for the District of Montana against K2 America Corporation and K2 Energy Corporation (collectively referred to in this section as “K2”). The Company’s lawsuit includes certain claims of relief and allegations by the Company against K2, including breach of contract arising from failure by K2 to agree to escrow, repudiation, and rescission; specific performance; declaratory relief; partition of K2 lands that are subject to the K2 Agreement; negligence; and

13

Table of Contents
 
MILLER EXPLORATION COMPANY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
tortuous interference with contract. The lawsuit is on file with the Federal District Court for the District of Montana, Great Falls Division and is not subject to a protective order. In an order dated September 4, 2001, the Federal District Court dismissed without prejudice the lawsuit against K2 and deferred the case to the Blackfeet Tribal Court for determination of whether it has jurisdiction over the claims made by the Company. The Company has filed a complaint in the Blackfeet Tribal Court in Montana against K2 substantially similar to the action previously filed in Federal District Court, while arguing to the Blackfeet Tribal Court that proper jurisdiction is with the Federal District Court. K2 has since filed a counterclaim against the Company to the effect that alleged actions by the Company damaged K2 by denying K2 the ability to participate in the Miller/Blackfeet IMDA and damaged K2’s goodwill with Tribal officials so as to impede other development initiatives on the Reservation. The Company answered K2’s counterclaim by asserting that any damages K2 may have incurred were caused in whole or in part by its own negligence, conduct, bad faith or fault. The Company believes K2’s counterclaim is without merit and will continue to vigorously contest it. The Blackfeet Tribal Business Council unanimously voted on May 1, 2002, to over-turn a previous Tribal Business Council decision which action reaffirms the Company’s 50% interest in the K2 Energy Exploration Agreement (K2/Blackfeet IMDA) covering 150,000 net Tribal mineral acres.
 
On May 1, 2000, the Company gave notice to the Blackfeet Tribal Business Council demanding arbitration of all disputes as provided for under the Miller/Blackfeet IMDA dated February 19, 1999, and pursuant to the K2/Blackfeet IMDA dated May 30, 1997. The disputes for which the Company demands arbitration include, but are not limited to the unreasonable withholding of a consent to a drilling extension as provided in the Miller/Blackfeet IMDA, as well as a determination by the Blackfeet Tribal Council dated March 16, 2000, that certain wells which the Company proposed to drill “would not satisfy the mandatory drilling obligations” under the K2/Blackfeet IMDA. The Rocky Mountain Regional Director of the Bureau of Indian Affairs (“BIA”) responded to the Company’s request for arbitration by stating that it was the BIA’s position that the Miller/Blackfeet IMDA was terminated. The Company also filed an appeal brief with the United States Department of Interior Appeals Division.
 
On January 25, 2002, the Interior Department Appeals Division vacated the BIA’s purported termination of the Miller/Blackfeet IMDA to allow arbitration to proceed. The outcome of the arbitration process is a new amended Exploration Agreement. The Company and the Blackfeet Tribal Business Council entered into an amended Exploration Agreement on June 3, 2002, covering 100,000 net Tribal mineral acres, and the Company deposited $525,000 with the BIA in anticipation of the BIA’s future approval of the Exploration Agreement. The Company received formal notice that the amended Miller/Blackfeet IMDA was approved by the BIA on July 26, 2002. The Company plans to make the optional final $525,000 payment under the amended IMDA by November 23, 2002. If the final payment is not made, the Company will forfeit its interest in the Miller/Blackfeet IMDA.
 
The Company was a defendant in a lawsuit filed June 1, 1999 by Energy Drilling Company (“Energy Drilling”), in the Parish of Catahoula, Louisiana arising from a blowout of the Victor P. Vegas #1 well that was drilled and operated by the Company. Energy Drilling, the drilling rig contractor on the well, was claiming damages related to the destruction of their drilling rig and related costs amounting to approximately $1.2 million, plus interest, attorneys’ fees and costs. In January 2001, the Federal District Court judge ruled against the Company on two of the three claims filed in this case with interest and day-rate charges left undetermined. This ruling was appealed by the Company to the U.S. Fifth Circuit Court of Appeals with the lower court ruling being upheld.

14

Table of Contents
 
MILLER EXPLORATION COMPANY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
This ruling is significant for oil and gas operators in the industry using the Independent Association of Drilling Contractors’ (“IADC”) standard drilling contracts. The Circuit Court of Appeals interpreted the IADC contract to assign responsibility for loss of the drilling contractor’s equipment to the operator under a catastrophic event not the fault of the operator and without determining whether there was an unsound location. In September 2002, the Company paid the judgment amount totaling approximately $780,000, which was covered by insurance.
 
In August 2002, the Court of Appeals ruled in favor of the Company on disputed interest and day-rate charges. Energy Drilling has filed an appeal of the Court of Appeals’ decision, which remains unresolved. The Company believes any remaining costs will be covered by insurance.
 
The Company was named in a lawsuit brought by Victor P. Vegas, the landowner of the surface location of the blowout well referenced above. The suit was filed July 20, 1999 in the Parish of Orleans, Louisiana, claiming unspecified damages related to environmental and other matters. Under a Department of Environmental Quality (“DEQ”) approved plan, site remediation has been completed and periodic testing is being performed. On December 11, 2001, the plaintiff submitted a remediation plan for more extensive clean-up and a settlement demand. In February 2002, the Company filed a remediation plan with the Louisiana DEQ for approval. In July 2002, the Civil District Court ruled that the DEQ would not have primary jurisdiction and that a jury trial would be held.
 
In the initial stages of this litigation, Plaintiffs only sought damages from remediation of the soil at the blowout site. Plaintiffs have recently designated additional experts in the litigation who have opined that underground aquifers below the site require remediation as well. As a result, Plaintiffs appear to be seeking significant additional damages related to remediation of underground water sources. If all the damages the Plaintiffs’ experts have opined may exist were to be awarded by a jury, the possibility exists that the Company would not have sufficient insurance or other resources available to cover the judgment. Notwithstanding this, the Company continues to vigorously defend the claims of the Plaintiffs, and believes that the actual probable damages at the site to be well within the Company’s insurance coverage. Moreover, the Company continues to work with the Louisiana Department of Natural Resources and Plaintiffs’ counsel to resolve, without a trial, all remediation issues as between the landowner and the Company.
 
The Company believes it has meritorious defenses to the unresolved claims discussed above and intends to vigorously contest them. The Company does not believe that the final outcome of these matters will have a material adverse effect on the Company’s operating results, financial condition or liquidity. Due to the uncertainties inherent in litigation, however, no assurances can be given regarding the final outcome of each action.
 
(9)    Sale of Oil and Gas Properties
 
On September 30, 2002, the Company completed the sale of its interest in the proved and unproved Pine Grove Field oil and gas properties, located in Jones County, Mississippi, to Bean Industries, Inc. for $3.75 million. The book value of these assets represents less than 10% of the Company’s total assets. The transaction had an August 1, 2002 effective date. In connection with the sale, Bank One reduced the Company’s borrowing base to $4.0 million from $5.8 million. Under full cost accounting, the sale proceeds are recorded as a reduction to the full cost pool and the proved oil and gas properties as reported in the Consolidated Balance Sheet at September 30, 2002.

15

Table of Contents
 
MILLER EXPLORATION COMPANY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(10)    Non-Cash Activities
 
The Company issued 243,493 and 125,599 shares of the Company’s Common Stock to its non-employee directors during the nine months ended September 30, 2002 and 2001, respectively, as compensation, as provided for under the Equity Compensation Plan for Non-Employee Directors. During the nine months ended September 30, 2002 and 2001, the Company issued 225,960 and 70,207 shares, respectively, of the Company’s Common Stock to the Company’s 401(K) Savings Plan as an employer matching contribution. For the nine months ended September 30, 2002 and 2001, the Company recognized $(0.1) million and $0.4 million, respectively, of other comprehensive income (loss) under the provisions of SFAS No. 133. These non-cash activities have been excluded from the Consolidated Statements of Cash Flows.
 
(11)    Reverse Stock Split
 
At the October 9, 2002, Special Meeting of the Common Shareholders, the shareholders approved an amendment of the Company’s Certificate of Incorporation to effect a reverse stock split of all of the outstanding shares of Common Stock, at the ratio of one for ten, effective October 11, 2002. The reverse stock split had the effect of converting the then current numbers of shares outstanding of 19,921,590 to 1,992,159 shares. The stock is currently traded on the NASDAQ Small Cap Market and the letter “D” was appended to the Company’s stock symbol (MEXPD) for a period of 20 business days following the effective date of the reverse split.

16

Table of Contents
 
Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Overview
 
The Company is an independent oil and gas exploration, development and production company that has developed a base of producing properties and inventory of prospects primarily in Mississippi.
 
The Company uses the full cost method of accounting for its oil and natural gas properties. Under this method, all acquisition, exploration and development costs, including any general and administrative costs that are directly attributable to the Company’s acquisition, exploration and development activities, are capitalized in a “full cost pool” as incurred. Additionally, proceeds from the sale of oil and gas properties are applied to reduce the costs in the full cost pool. The Company records depletion of its full cost pool using the unit-of-production method.
 
Securities and Exchange Commission (“SEC”) Regulation S-X, Rule 4-10 requires companies reporting on a full cost basis to apply a ceiling test wherein the capitalized costs, net of deferred income taxes, within the full cost pool may not exceed the net present value of the Company’s proven oil and gas reserves plus the lower of the cost or market value of unproved properties. Any such excess costs should be charged against earnings.
 
Results of Operations
 
The following table summarizes production volumes, average sales prices and average costs for the Company’s oil and natural gas operations for the periods presented (in thousands, except per unit amounts):
 
    
Three Months Ended Sept. 30
     
Nine Months Ended Sept. 30,
  
    
2002
     
2001
     
2002
     
2001
  
Production volumes:
                                    
Crude oil and condensate (MBbls)
   
 
25
 
   
 
35
 
   
 
115
 
   
 
110
 
Natural gas (MMcf)
   
 
471
 
   
 
764
 
   
 
1,743
 
   
 
2,718
 
Natural gas equivalent (MMcfe)
   
 
621
 
   
 
974
 
   
 
2,433
 
   
 
3,378
 
Revenues:
                                    
Crude oil and condensate
   
$
548
 
   
$
795
 
   
$
2,330
 
   
$
2,621
 
Natural gas
   
 
1,501
 
   
 
2,695
 
   
 
5,299
 
   
 
12,072
 
Operating expenses:
                                    
Lease operating expenses and production taxes
   
$
425
 
   
$
655
 
   
$
1,353
 
   
$
2,418
 
Depletion, depreciation and amortization
   
 
1,415
 
   
 
2,793
 
   
 
5,929
 
   
 
10,505
 
General and administrative
   
 
389
 
   
 
383
 
   
 
1,554
 
   
 
1,459
 
Cost ceiling writedown
   
 
—  
 
   
 
1,000
 
   
 
7,000
 
   
 
8,500
 
Interest expense
   
$
145
 
   
$
241
 
   
$
547
 
   
$
829
 
Net income (loss)
   
$
(288
)
   
$
(1,341
)
   
$
(2,869
)
   
$
(8,687
)
Average sales prices:
                                    
Crude oil and condensate ($ per Bbl)
   
$
21.92
 
   
$
22.71
 
   
$
20.26
 
   
$
23.83
 
Natural gas ($ per Mcf)
   
 
3.19
 
   
 
3.53
 
   
 
3.04
 
   
 
4.44
 
Natural gas equivalent ($ per Mcfe)
   
 
3.30
 
   
 
3.58
 
   
 
3.14
 
   
 
4.35
 
Average Costs ($ per Mcfe):
                                    
Lease operating expenses and production taxes
   
$
0.68
 
   
$
0.67
 
   
$
0.56
 
   
$
0.72
 
Depletion, depreciation and amortization
   
 
2.28
 
   
 
2.87
 
   
 
2.44
 
   
 
3.11
 
General and administrative
   
 
0.63
 
   
 
0.39
 
   
 
0.64
 
   
 
0.43
 

17

Table of Contents
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
 
Quarter Ended September 30, 2002 compared to Quarter Ended September 30, 2001
 
Oil and natural gas revenues for the quarter ended September 30, 2002 decreased 41% to $2.0 million from $3.5 million for the comparable period in the prior year. The revenues for the quarter ended September 30, 2002 and 2001 include approximately $(0.1) million and $0.5 million of hedging gains (losses), respectively (see “Risk Management Activities and Derivative Transactions” below). Production volumes for the quarter ended September 30, 2002, decreased 36% to 621 MMcfe from 974 MMcfe for the comparable period in the prior year. Oil and natural gas production from the Mississippi Salt Basin properties continued a downward trend since reserve discoveries made in 2002 have not been sufficient to offset normal depletion. The Company’s sale of its interest in the Pine Grove Field assets (as more fully described in Note 9) with an August 1, 2002, effective date, also contributed to a reduction in production volumes and associated revenues. For the remainder of 2002 into 2003, the Company plans to pursue asset purchases and/or sales, corporate mergers/combinations and/or joint ventures that will strategically position the Company to, among other things, diversify its asset base and develop new core areas for exploration and development to increase shareholder value. The Company expects financing of these acquisitions and/or mergers to come from a combination of proceeds from sales of producing properties, cash flows and, possibly, additional debt. Average realized oil prices for the quarter ended September 30, 2002, decreased 3% to $21.92 per barrel from $22.71 per barrel experienced during the comparable period of 2001. Realized natural gas prices for the quarter ended September 30, 2002, decreased 10% to $3.19 per Mcf from $3.53 per Mcf for the comparable period of the prior year.
 
Lease operating expenses (“LOE”) and production taxes for the quarter ended September 30, 2002 decreased 35% to $0.4 million from $0.7 million for the comparable period in the prior year. The LOE component for the quarter ended September 30, 2002, decreased 33% to $0.3 million from $0.5 million for the comparable period in the prior year, due primarily to more well workover expenses incurred in 2001. Production taxes for the quarter ended September 30, 2002, decreased 41% to $0.1 million from $0.2 million for the comparable period in the prior year due to declining production and revenues.
 
Depreciation, depletion and amortization (“DD&A”) expense for the quarter ended September 30, 2002, decreased 49% to $1.4 million from $2.8 million for the comparable period in the prior year, due to decreased production volumes and a reduced property cost basis after the $15.5 million cost ceiling writedown recognized in 2001 and the $7.0 million writedown at June 30, 2002.
 
General and administrative expenses have been virtually flat at $0.4 million for the quarters ended September 30, 2002 and 2001. It is anticipated that general and administrative expenses for the fourth quarter of 2002 and into 2003 will be noticeably lower due to staff reductions implemented in the third quarter of 2002 and closure of the Company’s Houston, Texas, office.
 
Using unescalated period-end prices at September 30, 2002, of $4.14 per Mcf of natural gas and $30.45 per barrel of oil, no cost ceiling writedown was required by the Company for the quarter ended September 30, 2002. The Company recognized a $1.0 million cost ceiling writedown for the quarter ended September 30, 2001.
 
Interest expense for the quarter ended September 30, 2002, decreased 40% to $0.1 million from $0.2 million for the comparable period in the prior year. This decrease is attributable to: (1) a decrease in the average outstanding credit facility balance during the third quarter of 2002 compared to the same quarter of the prior year; (2) full payment of the amount owed pursuant to the note held by Amerada Hess Corporation in August 2001; and (3) lower interest rates associated with the new Bank One credit facility which are prime rate sensitive.

18

Table of Contents
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
 
Net income (loss) for the quarter ended September 30, 2002, was $(0.3) million compared to $(1.3) million for the same period in the prior year, as a result of the factors described above.
 
Nine Months Ended September 30, 2002 compared to Nine Months Ended September 30, 2001
 
Oil and gas revenues for the nine months ended September 30, 2002, decreased 48% to $7.6 million from $14.7 million for the comparable period in the prior year. The revenues for the nine months ended September 30, 2002 and 2001, include approximately $(0.2) million and $(2.2) million of hedging (losses), respectively (see “Risk Management Activities and Derivative Transactions” below). Production volumes for the nine months ended September 30, 2002, decreased 28% to 2,433 MMcfe from 3,378 MMcfe for the comparable period in the prior year. The downward trend in production is attributable to the fact that the Company’s Mississippi Salt Basin properties are continuing to naturally deplete, while the results of curtailed drilling activities, due to decreased cash flows, have failed to reverse the declining production curve. Average realized oil prices for the nine months ended September 30, 2002 decreased 15% to $20.26 per barrel from $23.83 per barrel for the comparable period in the prior year. Realized prices for natural gas decreased 32% to $3.04 per Mcf from $4.44 per Mcf for the comparable period in the prior year. The volatile commodity prices and declining production volumes have had a material adverse effect on the Company’s cash flow and capital expenditures for 2002, and budgeted amounts for 2003.
 
Lease operating expenses (“LOE”) and production taxes for the nine months ended September 30, 2002, decreased 44% to $1.4 million from $2.4 million for the comparable period in the prior year. The LOE component for the nine months ended September 30, 2002, decreased 27% to $1.1 million from $1.4 million for the same period of 2001, due primarily to more rework projects on Mississippi Salt Basin wells in 2001 compared to 2002. Production taxes for the nine months ended September 30, 2002, decreased 69% to $0.3 million from $1.0 million for the same period in the prior year, due to declining production, declining revenues and applicable exemption from the 6% State of Mississippi production tax that was in place during the first quarter of 2002, compared to the first half of 2001 when the exemption did not apply due to higher average commodity prices during that time.
 
DD&A expense for the nine months ended September 30, 2002, decreased 44% to $5.9 million from $10.5 million for the comparable period of the prior year, due to decreased production volumes and reduced property cost basis after the $15.5 million cost ceiling writedown recognized in 2001 and the $7.0 million writedown at June 30, 2002.
 
General and administrative expenses for the nine months ended September 30, 2002, increased 7% to $1.6 million from $1.5 million for the same period of the prior year, primarily as a result of professional fees associated with a potential asset acquisition transaction that was terminated in March 2002, and increased health, general liability and director and officer insurance premiums. It is anticipated that general and administrative expenses for the fourth quarter of 2002 and into 2003 will be noticeably lower due to staff reductions implemented in the third quarter of 2002 and closure of the Company’s Houston, Texas, office.
 
A non-cash cost ceiling writedown of $7.0 million was recognized by the Company during the nine months ended September 30, 2002, compared to $8.5 million for the same period of the prior years, as previously discussed.
 
Interest expense for the nine months ended September 30, 2002, decreased 34% to $0.5 million from $0.8 million for the same period of the prior year. This decrease is attributable to: (1) a decrease in the average outstanding credit facility balance during the nine months ended September 30, 2002, compared to the same

19

Table of Contents
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
 
period of the prior year; (2) full payment of the Amerada Hess Corporation note in August 2001; and (3) lower interest rates associated with the Bank One credit facility which are prime rate sensitive.
 
Net income (loss) for the nine months ended September 30, 2002, was $(2.9) million compared to $(8.7) million for the same period of the prior year, as a result of the factors described above.
 
Capital Resources and Liquidity
 
Operating, Investing, and Financing Activities
 
The Company’s primary source of liquidity is cash generated from operations and from the Company’s use of available borrowing capacity under its credit facility. There was $0.9 million cash provided by operating activities for the nine months ended September 30, 2002, compared to $10.0 million for the same period of the prior year. The decrease in cash provided in 2002 compared to 2001 was the primary result of a decrease in operating income caused by declining production and much lower realized commodity prices. Cash was also used to further reduce payables and other current liabilities by approximately $3.8 million in 2002.
 
The Company’s primary use of cash is traditionally for its exploration and development activities. Net cash provided by (used in) investing activities was $1.4 million and $(8.0) million for the nine months ended September 30, 2002 and 2001, respectively. The increase in cash provided by investing activities during 2002 compared to 2001 was attributable to the planned reduction in 2002 exploration and development expenditures, and proceeds from the sale of the Pine Grove Field properties in September 2002 (as more fully described in Note 9).
 
The Company’s primary uses of capital have been to pay down the Company’s bank credit facility. Net cash used in financing activities was $2.2 million and $4.0 million in 2002 and 2001, respectively. The decrease in cash used in 2002 compared to 2001 is attributable to additional net principal payments made in 2001 compared to 2002 in connection with the Company’s “debt reduction initiative”.
 
Financing Arrangements
 
In the past few years the Company has financed various insurance policy premiums. In January 2002, concurrent with the policy renewals, the Company entered into a $71,893 note payable agreement to finance general liability and workers’ compensation insurance premiums. Terms of such note call for nine monthly installment payments of $8,157, bearing interest at 5.05%. In February 2002, the Company entered into a $131,827 note payable agreement to finance control of well, boiler and machinery and personal property insurance premiums. Terms of such note call for nine monthly installment payments of $14,949, bearing interest at 4.91%. The outstanding balance of these notes payable was approximately $38,000 at September 30, 2002.
 
On July 18, 2000, the Company entered into a new senior credit facility with Bank One, which replaced the then existing credit facility with Bank of Montreal. The new credit facility has a 30-month term with an interest rate of either Bank One prime plus 2% or LIBOR plus 4%, at the Company’s option. The Company’s obligations under the credit facility are secured by a lien on all of its real and personal property. The Company’s new borrowing base determined by Bank One as of July 1, 2002, was $5.8 million. On September 30, 2002, the Company completed the sale of certain proved and unproved oil and gas properties (as more fully described in Note 9). In connection therewith, the Company’s borrowing base was reduced to $4.0 million until the next redetermination date scheduled for February 1, 2003. Bank One also notified the Company that the maturity date

20

Table of Contents
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
 
of the credit facility has been extended to August 1, 2003 from January 18, 2003. At September 30, 2002, the outstanding balance under the Company’s credit facility with Bank One was $1.8 million.
 
The Bank One credit facility includes certain negative covenants that impose restrictions on the Company with respect to, among other things, incurrence of additional indebtedness, limitations on financial ratios, making investments and mergers and consolidation. At September 30, 2002, the Company requested and obtained a waiver from Bank One for the non-compliance with the covenant that requires specified levels of commodity hedge contracts. The obligations under the new credit facility are secured by a lien on all of the Company’s real and personal property.
 
On April 14, 1999, the Company issued a $4.7 million note payable (the “Veritas Note”) to one of its suppliers, Veritas DGC Land, Inc. (“Veritas”), for the outstanding balance due to Veritas for past services provided in 1998 and 1999. The principal obligation under the Veritas Note was originally due on April 15, 2001.
 
On April 14, 1999, the Company also entered into an agreement (the “Warrant Agreement”) to issue warrants to Veritas that entitle Veritas to purchase shares of common stock in lieu of receiving cash payments for the accrued interest obligations under the Veritas Note. The Warrant Agreement required the Company to issue warrants to Veritas in conjunction with the signing of the Warrant Agreement, as well as on the six and, at the Company’s option, 12 and 18 month anniversaries of the Warrant Agreement. The warrants issued equal 9% of the then current outstanding principal balance of the Veritas Note. The number of shares issued upon exercise of the warrants on April 14, 1999, and on the six-month anniversary was determined based upon a five-day weighted average closing price of the Company’s Common Stock at April 14, 1999. The exercise price of each warrant is $0.01 per share. On April 14, 1999, warrants exercisable for 322,752 shares of Common Stock were issued to Veritas in connection with execution of the Veritas Note. On October 14, 1999 and April 14, 2000, warrants exercisable for another 322,752 and 454,994 shares, respectively, of Common Stock were issued to Veritas. The Company ratably recognizes the prepaid interest into expense over the period to which it relates. For the years ended December 31, 2000 and 1999, the Company recognized non-cash interest expense of approximately $752,000 and $600,000, respectively, related to the Veritas Note Payable. Effective November 1, 2000, Veritas exercised 500,000 warrants to receive 496,923 shares (net of exercise price) of Company common stock.
 
On July 18, 2000, the Company entered into the First Amendment to Promissory Note, Warrant and Registration Rights Agreement (“First Amendment Agreement”). Under the terms of the First Amendment Agreement, the maturity of the Veritas Note was extended to July 21, 2003 from April 15, 2001, and the expiration date for all warrants issued was extended until June 21, 2004. The annual interest rate was reduced from 18% to 9 ¾%, provided the entire note balance was paid in full by December 31, 2001. The Veritas Note was not paid in full by December 31, 2001, and the interest rate was increased to 13 ¾% annually. Interest is payable on each October 15 and April 15 until the note is paid in full. The Company has paid additional interest of approximately $225,000 at the incremental 4% rate for the period of October 15, 2000 through April 14, 2002. Interest was required to be paid in warrants under the terms of the First Amendment Agreement until the Company was in compliance with the net borrowing base formula as defined in the Bank One credit facility, at which time interest would only be paid in cash. Since October 15, 2000, all interest payments have been made in cash.
 
On June 28, 2002, the Company entered into the Second Amendment to Promissory Note, Warrant and Registration Rights Agreement (“Second Amendment Agreement”). Concurrently with the execution of the Second Amendment Agreement, the Company made a $600,000 principal payment. Under terms of the Second Amendment Agreement, the Veritas Note was amended as follows: (1) The maturity of the Veritas Note has been changed to December 31, 2002 from July 21, 2003; (2) the note bears interest at the stated rate of 9 ¾%; (3) the past due annual interest rate was changed to 12% from 13 ¾%; and (4) six (6) principal payments of $150,000, totaling $900,000 are required, and are payable on or before the last day of each month commencing on

21

Table of Contents
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
 
July 31, 2002. In the event that all six principal payments mentioned above are made timely, an interest payment will not be due on October 15, 2002, and Veritas shall forgive the remaining principal balance of $2.2 million and any accrued interest outstanding under the Veritas Note and the Company will recognize a gain of approximately $2.4 million. In the event that these six principal payments are not timely made, the entire principal balance outstanding under the Veritas Note shall be accelerated and become due and payable upon demand and shall accrue interest at the past due rate from the date of the Second Amendment Agreement until the Veritas Note is paid in full. The outstanding Veritas Note balance at September 30, 2002, was $2.6 million, and since the maturity date has been changed to December 31, 2002, the entire balance has been classified as a current liability in the Consolidated Balance Sheets.
 
As an inducement for Veritas to enter into the Second Amendment Agreement: (1) the Company has granted Veritas an overriding royalty interest on the Company’s entire leasehold that is not held by production and leases acquired through July 31, 2003 (excluding leases within the boundaries of the Blackfeet Indian Reservation); (2) the Company transferred its proprietary rights in approximately 140 square miles of 3-D seismic data with respect to certain areas within the Mississippi Salt Basin to Veritas in exchange for a 25-year license allowing the Company the use of same data. The Company has also agreed to an optional transfer fee on its currently licensed data, which in the aggregate totals approximately $3.1 million in the event of a change in control of the Company; and (3) certain Company Directors who own or control shares of Common Stock of the Company and are considered major stockholders have agreed to provide certain tag-along rights in the event one of these major stockholders negotiates a sale of Company Common Stock with a private party.
 
The Second Amendment Agreement also extended the expiration date of the warrants to July 31, 2004, from June 21, 2004.
 
Any additional proceeds derived by the Company from the exercise of warrants issued (see Note 6 to the Consolidated Financial Statements in “Item 1. Financial Statements”) or from other debt or equity transactions must be used to pay interest and principal on the amended Veritas Note until paid in full.
 
Liquidity
 
The Company’s primary ongoing source of liquidity is from cash generated from operations and from the Company’s use of available borrowing capacity under its credit facility. During the course of the year, the amount outstanding under the credit facility will vary, as the Company’s approach is to borrow under the facility as needed to fund capital expenditures and pay-down the balance when cash is available in order to reduce interest charges.
 
As of September 30, 2002, the Company had a working capital deficit of $4.9 million, primarily due to decreased cash flow attributable to decreased production volumes, lower commodity prices, and reclassification of the outstanding credit facility balance and Veritas Note to current liabilities (as more fully described in Note 5 to the Consolidated Financial Statements in “Item 1. Financial Statements”). Approximately $2.2 million of the Veritas note balance will be forgiven on December 31, 2002, provided the remaining principal payments totalling $450,000 are timely made before that date. The Company expects that it will utilize its operational cash flows for 2002 to meet its working capital requirements and fund its capital expenditures through a mix of operational funds and additional borrowings under the credit facility.
 
The Company anticipates 2002 capital expenditures will be approximately $3.2 million, net of savings associated with promoted and carried interests in wells to be drilled in 2002. Cash flows will be used to fund drilling and development activities, processing of additional seismic data and leasehold acquisitions and

22

Table of Contents
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
 
extensions in the Company’s project areas. The actual amounts of capital expenditures and number of wells drilled may differ significantly from such estimates. Actual capital expenditures for the nine months ended September 30, 2002, were approximately $2.3 million. The significant decrease in expenditures anticipated for 2002 is due to the above-mentioned carries and promotes and lower working interests retained, and because the drilling activities for 2002 are in shallower, less expensive, lower risk wells.
 
The Company’s revenues, profitability, future growth and ability to borrow funds or obtain additional capital are highly dependent on prevailing prices of oil and natural gas. The Company cannot predict future oil and natural gas price movements with certainty. Although commodity prices in the second and third quarters of 2002 have rebounded, a return to significantly lower oil and gas prices experienced by the Company in the fourth quarter of 2001 and into the first quarter of 2002, would likely have an adverse effect on the Company’s liquidity, financial condition and results of operations. Lower oil and natural gas prices also may reduce the amount of reserves that can be produced economically by the Company.
 
The Company has experienced and expects to continue to experience substantial working capital requirements due to the Company’s current plans to reverse its declining production trend. For the remainder of 2002 and into 2003, the Company will focus more of its efforts toward drilling lower risk development wells, pursuing strategic reserve acquisitions, reducing general and administrative costs and evaluating potential corporate transactions that improve shareholder value. The Company believes that cash flow from operations, proceeds from asset sales, and draws on the credit facility should allow the Company to implement its present business strategy. However, additional debt or equity financing may be required in the future to fund reserve acquisitions, the exploration and development program, and to satisfy existing obligations. The failure to obtain and exploit such capital resources or consummate strategic asset sales could have a material adverse effect on the Company, including further curtailment of its exploration and other activities.
 
Future Financing Obligations
 
The Company has amended the Veritas Note (as more fully discussed in Note 5 to the Consolidated Financial Statements in “Item 1. Financial Statements”). In the event the Company is unable to comply with the terms of the amended Veritas Note, the Company believes it would be able to fulfill such obligations through the use of available cash flows, the identification of additional sources for debt or equity financings, or strategic asset sales. However, these expectations are dependent on several internal and external factors. If these factors differ from management’s expectations, they could have a material adverse effect on the Company’s ability to meet future financing obligations and cause the Company to further curtail its exploration and development activities.
 
Significant Accounting Policies
 
The results of operations, as presented above, are based on the application of accounting principles generally accepted in the United States. The application of these principles often requires management to make certain judgments, assumptions, and estimates that may result in different financial presentations. The Company believes that certain accounting principles are critical in understanding its financial statements.
 
Full Cost Method of Accounting
 
The Company uses the full cost method of accounting for its oil and natural gas properties. Under this method, all acquisition, exploration and development costs, including any general and administrative costs that are directly attributable to the Company’s acquisition, exploration and development activities, are capitalized in a “full cost pool” as incurred. The Company records depletion of its full cost pool using the unit-of-production

23

Table of Contents
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
 
method. SEC Regulation S-X, Rule 4-10 requires companies reporting on a full cost basis to apply a ceiling test wherein the capitalized costs within the full cost pool, net of deferred income taxes, may not exceed the net present value of the Company’s proved oil and gas reserves plus the lower of cost or market of unproved properties. Any such excess costs should be charged against earnings.
 
Use of Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting periods. Accordingly, actual results could differ from these estimates. Significant estimates include depreciation, depletion and amortization of proved oil and natural gas properties. Oil and natural gas reserve estimates, which are the basis for unit-of-production depletion and the cost ceiling test, are inherently imprecise and are expected to change as future information becomes available.
 
Effects of Inflation and Changes in Price
 
Crude oil and natural gas commodity prices have been volatile and unpredictable during 2002 and 2001. The wide fluctuations that have occurred during these periods have had a significant impact on the Company’s results of operations, cash flow and liquidity. Recent rates of inflation have had a minimal effect on the Company.
 
Environmental and Other Regulatory Matters
 
The Company’s business is subject to certain federal, state and local laws and regulations relating to the exploration for, and the development, production and transportation of, oil and natural gas, as well as environmental and safety matters. Many of these laws and regulations have become more stringent in recent years, often imposing greater liability on a larger number of potentially responsible parties. Although the Company believes it is in substantial compliance with all applicable laws and regulations, the requirements imposed by laws and regulations frequently are changed and subject to interpretation, and the Company is unable to predict the ultimate cost of compliance with these requirements or their effect on its operations. Any suspensions, terminations or inability to meet applicable bonding requirements could materially adversely affect the Company’s business, financial condition and results of operations. Although significant expenditures may be required to comply with governmental laws and regulations applicable to the Company, compliance has not had a material adverse effect on the earnings or competitive position of the Company. Future regulations may add to the cost of, or significantly limit, drilling activity.

24

Table of Contents
 
Item 3.     Quantitative and Qualitative Disclosures About Market Risk
 
The Company uses a variety of financial derivative instruments (“derivatives”) to manage exposure to fluctuations in commodity prices. To qualify for hedge accounting, derivatives must meet the following criteria: (i) the item to be hedged exposes the Company to price risk; and (ii) the derivative reduces that exposure and is designated as a hedge. The Company periodically enters into certain derivatives for a portion of its oil and natural gas production to achieve a more predictable cash flow, as well as to reduce the exposure to price fluctuations. The Company’s hedging arrangements apply only to a portion of its production, provide only partial price protection against declines in oil and natural gas prices and limit potential gains from future increases in prices. Such hedging arrangements may expose the Company to risk of financial loss in certain circumstances, including instances where production is less than expected, the Company’s customers fail to purchase contracted quantities of oil or natural gas or a sudden unexpected event materially impacts oil or natural gas prices. For financial reporting purposes, gains and losses related to hedging are recognized as oil and gas revenues during the period the hedge transaction occurs. The Company expects that the amount of hedge contracts that it has in place will vary from time to time. For the nine months ended September 30, 2002 and 2001, the Company realized approximately $(0.2) million and $(2.2) million, respectively, of hedging (losses) which are included in oil and natural gas revenues in the consolidated statements of operations. The fair value of remaining derivative contracts at September 30, 2002, is approximately $(0.1) million. This amount is reflected in other current liabilities in the Consolidated Balance Sheet with a corresponding amount in comprehensive income (loss). For the nine months ended September 30, 2002 and 2001, the Company had hedged 60% and 53%, respectively, of its oil and natural gas production, and as of September 30, 2002, the Company had 1.0 Bcfe of open natural gas contracts for the months of October 2002 through May 2003. If all these open contracts had been settled as of September 30, 2002, the Company would have paid approximately $0.1 million.
 
Market Risk Information
 
The market risk inherent in the Company’s derivatives is the potential loss arising from adverse changes in commodity prices. The prices of natural gas are subject to fluctuations resulting from changes in supply and demand. To reduce the price risk caused by market fluctuations, the Company’s policy is to hedge (through the use of derivatives) future production. Because commodities covered by these derivatives are substantially the same commodities that the Company sells in the physical market, no special correlation studies other than monitoring the degree of convergence between the derivative and cash markets are deemed necessary. The changes in market value of these derivatives have a high correlation to the price changes of natural gas.
 
Item 4.     Controls and Procedures
 
The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s “disclosure controls and procedures”, as such terms are defined in Rule 13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934, as amended, within 90 days of the filing date of this quarterly report. Based upon their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

25

Table of Contents
 
PART II.    OTHER INFORMATION
 
Item 1.     Legal Proceedings
 
On May 1, 2000, the Company filed a lawsuit in the Federal District Court for the District of Montana against K2 America Corporation and K2 Energy Corporation (collectively referred to in this section as “K2”). The Company’s lawsuit includes certain claims of relief and allegations by the Company against K2, including breach of contract arising from failure by K2 to agree to escrow, repudiation, and rescission; specific performance; declaratory relief; partition of K2 lands that are subject to the K2 Agreement; negligence; and tortuous interference with contract. The lawsuit is on file with the Federal District Court for the District of Montana, Great Falls Division and is not subject to a protective order. In an order dated September 4, 2001, the Federal District Court dismissed without prejudice the lawsuit against K2 and deferred the case to the Blackfeet Tribal Court for determination of whether it has jurisdiction over the claims made by the Company. The Company has filed a complaint in the Blackfeet Tribal Court in Montana against K2 substantially similar to the action previously filed in Federal District Court, while arguing to the Blackfeet Tribal Court that proper jurisdiction is with the Federal District Court. K2 has since filed a counterclaim against the Company to the effect that alleged actions by the Company damaged K2 by denying K2 the ability to participate in the Miller/Blackfeet IMDA and damaged K2’s goodwill with Blackfeet Tribal officials so as to impede other development initiatives on the Blackfeet Reservation. The Company answered K2’s counterclaim by asserting that any damages K2 may have incurred were caused in whole or in part by its own negligence, conduct, bad faith or fault. The Company believes K2’s counterclaim is without merit and will continue to vigorously contest it. The Blackfeet Tribal Business Council unanimously voted on May 1, 2002, to over-turn a previous Blackfeet Tribal Business Council decision which action reaffirms the Company’s 50% interest in the K2/Blackfeet IMDA covering 150,000 net Tribal mineral acres.
 
On May 1, 2000, the Company gave notice to the Blackfeet Tribal Business Council demanding arbitration of all disputes as provided for under the Miller/Blackfeet IMDA dated February 19, 1999, and pursuant to the K2/Blackfeet IMDA dated May 30, 1997. The disputes for which the Company demands arbitration include but are not limited to the unreasonable withholding of a consent to a drilling extension as provided in the Miller/Blackfeet IMDA, as well as a determination by the Blackfeet Tribal Council dated March 16, 2000, that certain wells which the Company proposed to drill “would not satisfy the mandatory drilling obligations” under the K2/Blackfeet IMDA. The Rocky Mountain Regional Director of the Bureau of Indian Affairs (“BIA”) responded to the Company’s request for arbitration by stating that it was the BIA’s position that the Miller/Blackfeet IMDA was terminated. The Company has filed an appeal brief with the United States Department of Interior Appeals Division.
 
On January 25, 2002, the Interior Department Appeals Division vacated the BIA’s purported termination of the Miller/Blackfeet IMDA to allow arbitration to proceed. On June 3, 2002, the Company entered into an amended IMDA with the Blackfeet Tribe. The Company and the Blackfeet Tribal Business Council entered into an amended Exploration Agreement on June 3, 2002, covering 100,000 net Tribal mineral acres, and the Company deposited $525,000 with the BIA in anticipation of the BIA’s future approval of the Exploration Agreement. The Company has received formal notice that the amended Miller/Blackfeet IMDA was approved by the BIA on July 26, 2002. The Company plans to make the optional final $525,000 payment under the amended IMDA by November 23, 2002. If the final payment is not made, the Company will forfeit its interest in the Miller/Blackfeet IMDA.
 
The Company was a defendant in a lawsuit filed June 1, 1999 by Energy Drilling Company (“Energy Drilling”), in the Parish of Catahoula, Louisiana arising from a blowout of the Victor P. Vegas #1 well that was drilled and operated by the Company. Energy Drilling, the drilling rig contractor on the well, is claiming damages related to the destruction of their drilling rig and related costs amounting to approximately $1.2 million, plus interest, attorneys’ fees and costs. In January 2001, the Federal District Court judge ruled against the

26

Table of Contents
Company on two of the three claims filed in this case with damages left undetermined. This ruling was appealed to the U.S. Fifth Circuit Court of Appeals with the lower court ruling being upheld.
 
This ruling is significant for oil and gas operators in the industry using the Independent Association of Drilling Contractors’ (“IADC”) standard drilling contracts. The Circuit Court of Appeals interpreted the IADC contract to assign responsibility for loss of the drilling contractor’s equipment to the operator under a catastrophic event not the fault of the operator and without determining whether there was an unsound location. In September 2002, the Company paid the judgment amount totaling approximately $780,000, which was covered by insurance.
 
In August 2002, the Court of Appeals ruled in favor of the Company on disputed interest and day-rate charges. Energy Drilling has filed an appeal of the Court of Appeals’ decision, which remains unresolved. The Company believes the judgment plus any associated costs will be covered by insurance.
 
The Company was named in a lawsuit brought by Victor P. Vegas, the landowner of the surface location of the blowout well referenced above. The suit was filed July 20, 1999 in the Parish of Orleans, Louisiana, claiming unspecified damages related to environmental and other matters. Under a Department of Environmental Quality (“DEQ”) approved plan, site remediation has been completed and periodic testing is being performed. On December 11, 2001, the plaintiff submitted a remediation plan for more extensive clean-up and a settlement demand. In February 2002, the Company filed a remediation plan with the Louisiana DEQ for approval. In July 2002, Civil District Court ruled that the DEQ would not have primary jurisdiction and that a jury trial would be held.
 
In the initial stages of this litigation, Plaintiffs only sought damages from remediation of the soil at the blowout site. Plaintiffs have recently designated additional experts in the litigation who have opined that underground aquifers below the site require remediation as well. As a result, Plaintiffs appear to be seeking significant additional damages related to remediation of underground water sources. If all the damages the Plaintiffs’ experts have opined may exist were to be awarded by a jury, the possibility exists that the Company would not have sufficient insurance or other resources available to cover the judgment. Notwithstanding this, the Company continues to vigorously defend the claims of the Plaintiffs, and believes that the actual probable damages at the site to be well within the Company’s insurance coverage. Moreover, the Company continues to work with the Louisiana DEQ and Plaintiffs’ counsel to resolve, without a trial, all remediation issues as between the landowner and the Company.
 
The Company believes it has meritorious defenses to the unresolved claims discussed above and intends to vigorously contest them. As indicated above, if all the damages the Plaintiff’s experts in the Victor P. Vegas lawsuit have opined may exist were to be awarded by a jury, the possibility exists that the Company would not have sufficient insurance or other resources available to cover the judgment. The Company does not believe that the final outcome of these matters will have a material adverse effect on the Company’s operating results, financial condition or liquidity. Due to the uncertainties inherent in litigation, however, no assurances can be given regarding the final outcome of each action.
 
Item 2.     Changes in Securities and Use of Proceeds
 
None
 
Item 3.     Defaults Upon Senior Securities
 
None
 
Item 4.     Submission of Matters to a Vote of Security Holders

27

Table of Contents
 
At the October 9, 2002, Special Meeting of the Common Stockholders, a proposal to amend the Company’s Certificate of Incorporation to effect a reverse stock split of all of the outstanding shares of Common Stock of the Company, at the ratio of one for ten was approved. The vote approving this proposal was as follows:
 
For
  
Against
  
Abstain
   
Votes Withheld
17,179,330
  
1,062,000
  
6,250
   
—  
 
Item 5.     Other Information
 
None
 
Item 6.     Exhibits and Reports on Form 8-K
 
(a)    Exhibits.  The following documents are filed as exhibits to this report on Form 10-Q:
 
Exhibit No.
   
Description
2.1(a)
   
Agreement for Purchase and Sale dated November 25, 1997 between Amerada Hess Corporation and Miller Oil Corporation. (Incorporated by reference to Exhibit 2.3 to the Company’s Amendment No. 1 to Registration Statement on Form S-1 filed on December 5, 1997 (File No. 333-40383).)
2.1(b)
   
First Amendment to Agreement for Purchase and Sale dated January 7, 1998. (Incorporated by reference to Exhibit 2.3(b) to the Company’s Amendment No. 3 to Registration Statement on Form S-1 filed on January 9, 1998 (File No. 333-40383).)
3.1
   
Certificate of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 filed on November 17, 1997 (File No. 333-40383).)
3.2*
   
Certificate of Amendment to the Certificate of Incorporation of the Registrant.
3.3
   
Bylaws of the Registrant. (Incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 000-23431).)
 
*
 
Filed herewith
 
 
(b)
 
Reports on Form 8-K.    The Company filed a report on Form 8-K on October 8, 2002. In the report, the Company reported that on September 30, 2002, it had completed the sale of its 35% working interest in the Pine Grove Field oil and gas assets located in Jones County, Mississippi, to Bean Industries, Inc., for $3.75 million.
 
SIGNATURES
 
Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
         
MILLER EXPLORATION COMPANY
Date: November 14, 2002
   
By:
   
/s/    Deanna L. Cannon
         
Deanna L. Cannon
Chief Financial Officer and Secretary

28

Table of Contents
 
CERTIFICATION
 
I, Kelly E. Miller, certify that:
 
 
1.
 
I have reviewed this quarterly report on Form 10-Q of Miller Exploration Company (the “registrant”);
 
 
2.
 
Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarter report;
 
 
3.
 
Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
 
4.
 
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
 
 
a)
 
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
 
b)
 
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
 
c)
 
presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
 
 
5.
 
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:
 
 
a)
 
all significant deficiencies in the design or operation of the internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
 
b)
 
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 
 
6.
 
The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
 
Dated:  November 14, 2002
 
By:
  
/s/    Kelly E. Miller        
   
Kelly E. Miller, President and Chief Executive Officer

29

Table of Contents
 
CERTIFICATION
 
I, Deanna L. Cannon, certify that:
 
 
1.
 
I have reviewed this quarterly report on Form 10-Q of Miller Exploration Company (the “registrant”);
 
 
2.
 
Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarter report;
 
 
3.
 
Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
 
4.
 
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
 
 
a)
 
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
 
b)
 
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
 
c)
 
presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
 
 
5.
 
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:
 
 
a)
 
all significant deficiencies in the design or operation of the internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
 
b)
 
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 
 
6.
 
The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
 
Dated:  November 14, 2002
 
By:
  
/s/    Deanna L. Cannon        
   
Deanna L. Cannon, Chief Financial Officer

30

Table of Contents
 
EXHIBIT INDEX
 
Exhibit No.
   
Description
2.1(a)
   
Agreement for Purchase and Sale dated November 25, 1997 between Amerada Hess Corporation and Miller Oil Corporation. (Incorporated by reference to Exhibit 2.3 to the Company’s Amendment No. 1 to Registration Statement on Form S-1 filed on December 5, 1997 (File No. 333-40383).)
2.1(b)
   
First Amendment to Agreement for Purchase and Sale dated January 7, 1998. (Incorporated by reference to Exhibit 2.3(b) to the Company’s Amendment No. 3 to Registration Statement on Form S-1 filed on January 9, 1998 (File No. 333-40383).)
3.1
   
Certificate of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 filed on November 17, 1997 (File No. 333-40383).)
3.2*
   
Certificate of Amendment to the Certificate of Incorporation of the Registrant.
3.3
   
Bylaws of the Registrant. (Incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 000-23431).)
 
 
 *
 
Filed herewith
 
 
(b)
 
Reports on Form 8-K.
 
The Company filed a report on Form 8-K on October 8, 2002. In the report, the Company reported that on September 30, 2002, it had completed the sale of its 35% working interest in the Pine Grove Field oil and gas assets located in Jones County, Mississippi to Bean Industries, Inc., for $3.75 million.

31

Table of Contents
 
IN WITNESS THEREOF, Miller Exploration Company has caused this certificate to be signed by Kelly E. Miller, its Chief Executive Officer, and attested by Deanna L. Cannon, its Secretary, this 9th day of October, 2002.
 
MILLER EXPLORATION COMPANY
By:
  
    /s/    Kelly E. Miller
   
    Name: Kelly E. Miller
    Chief Executive Officer
 
Attest:
 
/s/    Deanna L. Cannon
Name:  Deanna L. Cannon
Secretary

32