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(3)  ASSET RETIREMENT OBLIGATION

     Beginning in 2003, Statement of Financial Accounting Standards No. 143 “Asset Retirement Obligations” (“SFAS 143”) requires the Company to recognize an estimated liability for the plugging and abandonment of its oil and gas wells and associated pipelines and equipment. Previously, the Company had recognized a plugging and abandonment obligation primarily for its offshore properties. This liability was shown netted against oil and gas properties on the balance sheet. Under SFAS 143, the Company now recognizes a liability for asset retirement obligations in the period in which they are incurred, if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS 143 requires the Company to consider estimated salvage value in the calculation of DD&A. Consistent with industry practice, historically the Company had assumed the cost of plugging and abandonment on its onshore properties would be offset by salvage value received. The adoption of SFAS 143 resulted in (i) an increase of total liabilities because retirement obligations are required to be recognized, (ii) an increase in the recognized cost of assets because the retirement costs are added to the carrying amount of the long-lived asset, and (iii) an increase in DD&A expense, because of the accretion of the retirement obligation and increased basis. The majority of the asset retirement obligations recorded by the Company relate to the plugging and abandonment of oil and gas wells. The decline in the current portion of the asset retirement obligation in the current period is the result of a reassessment of the timing of certain oil and gas well abandonments.

     The estimated liability is based on historical experience in plugging and abandoning wells, estimated remaining lives of those wells based on reserves estimates, external estimates as to the cost to plug and abandon the wells in the future, and federal and state regulatory requirements. The liability is discounted using an assumed credit-adjusted risk-free interest rate of 9%. Revisions to the liability could occur due to changes in estimates of plugging and abandonment costs, changes in the risk-free interest rate or remaining lives of the wells, or if federal or state regulators enact new plugging and abandonment requirements. At the time of abandonment, the Company may be required to recognize a gain or loss on abandonment based on actual costs incurred.

     The adoption of SFAS 143 as of January 1, 2003 resulted in a cumulative effect gain of $4.5 million (net of income taxes of $2.4 million) or $0.08 per share which is included in income in the nine months ended September 30, 2003. The adoption resulted in a January 1, 2003 cumulative effect adjustment to record (i) a $37.3 million increase in the carrying values of proved properties, (ii) a $21.0 million decrease in accumulated depletion, (iii) a $2.3 million increase in current plugging and abandonment liabilities, (iv) a $49.1 million increase in non-current plugging and abandonment liabilities, and (v) a $2.4 million decrease in deferred tax assets. The pro forma effects of the application of SFAS 143, as if the statement had been adopted net-of-tax on January 1, 2002 (rather than January 1, 2003), including an associated proforma asset retirement obligation on that date of $48.3 million, are presented below (in thousands, except per share data):

     A reconciliation of the Company’s liability for plugging and abandonment costs for the nine months ended September 30, 2003 is as follows (in thousands):

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(4) ACQUISITIONS

     Acquisitions are accounted for under the purchase method. Purchase prices are assigned to acquired assets and assumed liabilities based on their estimated fair value at acquisition. The Company purchased various properties for $9.5 million and $12.4 million during the nine months ended September 30, 2002 and 2003, respectively. These purchases include $4.4 million and $8.0 million for proved oil and gas reserves, respectively, while the remainder represents unproved acreage.

(5) SUPPLEMENTAL CASH FLOW INFORMATION

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(6) INDEBTEDNESS

     The Company had the following debt and Trust Preferred Securities outstanding as of the dates shown below (in thousands) (interest rates at September 30, 2003, excluding the impact of interest rate swaps, are shown parenthetically):

     Interest paid in cash during the three months ended September 30, 2002 and 2003 totaled $7.7 million and $7.0 million, respectively. Interest paid in cash during the nine months ended September 30, 2002 and 2003 totaled $19.6 million and $17.6 million, respectively. No interest expense was capitalized during the three months or the nine months ended September 30, 2002 and 2003.

Senior Credit Facility

     In 2002, the Company entered into an amended and restated $225.0 million secured revolving bank facility (the “Senior Credit Facility”) which is secured by substantially all of the assets of the Company (excluding the Company’s interest in Great Lakes). The Senior Credit Facility provides for a borrowing base subject to redeterminations semi-annually each April and October and pursuant to certain unscheduled redeterminations. As of September 30, 2003, the outstanding balance under the Senior Credit Facility was $94.3 million and there was approximately $75.7 million of borrowing capacity available. Effective October 1, 2003, the borrowing base was increased from $170.0 million to $180.0 million and there was approximately $83.6 million of borrowing capacity available. The loan matures on January 1, 2007. Borrowings under the Senior Credit Facility can either be base rate loans or LIBOR loans. On all base rate loans, the rate per annum is equal to the lesser of (i) the maximum rate (the “weekly ceiling” as defined in Section 303 of the Texas Finance Code or other applicable laws if greater) (the “Maximum Rate”) or, (ii) the sum of (A) the higher of (1) the prime rate for such date, or (2) the sum of the federal funds effective rate for such date plus one-half of one percent (0.50%) per annum, plus a base rate margin of between 0.25% to 1.0% per annum depending on the total outstanding under the Senior Credit Facility relative to the borrowing base under the Senior Credit Facility. On all LIBOR loans, the Company pays a varying rate per annum equal to the lesser of (i) the Maximum Rate, or (ii) the sum of the quotient of (A) the LIBOR base rate, divided by (B) one minus the reserve requirement applicable to such interest period, plus a LIBOR margin of between 1.50% and 2.25% per annum depending on the total outstanding under the Senior Credit Facility relative to the borrowing base under the Senior Credit Facility. The Company may elect, from time to time, to convert all or any part of its

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LIBOR loans to base rate loans or to convert all or any part of its base rate loans to LIBOR loans. The weighted average interest rate (including applicable margin) was 3.8% and 2.8% for the three months ended September 30, 2002 and 2003, respectively, and 4.0% and 3.2% for the nine months ended September 30, 2002 and 2003, respectively. A commitment fee is paid on the undrawn balance based on an annual rate of 0.375% to 0.50%. At September 30, 2003, the commitment fee was 0.375% and the interest rate margin was 1.75%. At October 31, 2003, the interest rate (including applicable margin) was 2.9%.

Great Lakes Credit Facility

     The Company consolidates its proportionate share of borrowings on the Great Lakes’ $275.0 million secured revolving bank facility (the “Great Lakes Credit Facility”). The Great Lakes Credit Facility is non-recourse to the Company and provides for a borrowing base subject to redeterminations semi-annually each April and October and pursuant to certain unscheduled redeterminations. As of September 30, 2003, the Company’s portion of the outstanding balance owed under the Great Lakes Credit Facility was $71.5 million. The loan matures on January 1, 2007. Any advance under the commitment may be a base rate loan or a Eurodollar loan. On all base rate loans the Company pays a varying rate per annum equal to the lesser of (i) the maximum nonusurious rate of interest under applicable law, or (ii) the sum of the base rate plus a base rate margin of between 0.25% to 0.75% per annum depending on the amounts outstanding on the loan, plus all outstanding letters of credit, divided by the borrowing base under the Great Lakes Credit Facility. On all Eurodollar loans, the Company pays a varying rate per annum equal to the lesser of (i) the maximum nonusurious rate of interest under applicable law, or (ii) the Eurodollar rate plus a Eurodollar margin of between 1.50% to 2.0% per annum depending on the amounts outstanding on the loan, plus all outstanding letters of credit, divided by the borrowing base under the Great Lakes Credit Facility. Great Lakes may elect, from time to time, to convert all or any part of its Eurodollar loans to base rate loans or to convert all or any part of its base rate loans to Eurodollar loans. Cash distributions to members of the joint venture are limited by a covenant contained in the Great Lakes Credit Facility. A commitment fee is paid on the undrawn balance at an annual rate of 0.25% to 0.50%. At September 30, 2003, the commitment fee was 0.375% and the interest rate margin was 1.75%. The average interest rate on the Great Lakes Credit Facility, excluding hedges, was 3.9% and 2.8% for the three months ended September 30, 2002 and 2003, respectively, and 3.9% and 3.1% for the nine months then ended, respectively. After hedging (see Note 7), the rate was 7.0% and 4.9% for the three months ended September 30, 2002 and 2003, respectively, and 7.0% and 5.4% for the nine months ended September 30, 2002 and 2003, respectively. At October 31, 2003, the interest rate was 2.9% excluding hedges and 5.1% after hedging.

8-3/4% Senior Subordinated Notes due 2007

     In 1997, the Company sold $125 million in aggregate principal amount of its 8-3/4% Senior Subordinated Notes due 2007 (the “8-3/4% Notes”). Interest on the 8-3/4% Notes was payable semi-annually in arrears in January and July of each year. On August 20, 2003, the Company completed the redemption of its outstanding 8-3/4% Notes at approximately 102.9% of principal amount, plus accrued interest. Interest on the notes ceased to accrue on the redemption date. The aggregate redemption price, including the premium, was $70.8 million. The premium of $2.0 million is included in interest expense in the Company’s Statement of Operations in the third quarter of 2003. The redemption was financed by the issuance of the 7-3/8% Senior Subordinated Notes due 2013.

7-3/8% Senior Subordinated Notes due 2013

     On July 21, 2003, the Company issued $100.0 million aggregate principal amount of the Company’s 7-3/8% Senior Subordinated Notes due 2013. The offering of the 7-3/8% Senior Subordinated Notes due 2013, on July 21, 2003, was not registered under the Securities Act of 1933, as amended (the “Securities Act”) or under any state securities laws because the 7-3/8% Senior Subordinated Notes due 2013 were only offered to qualified institutional buyers and to non-U.S. persons outside the United States in compliance with Rule 144A and Regulation S under the Securities Act (the “Outstanding Notes”). On October 23, 2003, $100,000,000 aggregate principal amount of the Outstanding Notes were exchanged for $100,000,000 aggregate principal amount of the Company’s 7-3/8% Senior Subordinated Notes due 2013 issued in a registered exchange offer for which a registration statement on Form S-4 was filed under the Securities Act (the “Exchange Notes”) as required by the Registration Rights Agreement, by and among the Company and UBS Securities LLC, Banc One Capital Markets, Inc., Credit Lyonnais Securities (USA) Inc., and McDonald Investments (the “Registration Rights Agreement”). The Exchange Notes are

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identical to the Outstanding Notes except that the Exchange Notes are registered under the Securities Act and do not have restrictions on transfer, registration rights or provisions for additional interest. As used in this Form 10-Q, the term “7-3/8% Notes” refer to both the Outstanding Notes and the Exchange Notes. The Company will pay interest on the 7-3/8% Notes semi-annually in arrears in January and July of each year, starting in January 2004. The 7-3/8% Notes mature in July 2013. The 7-3/8% Notes are guaranteed by certain of the Company’s subsidiaries (the “Subsidiary Guarantors”). The 7-3/8% Notes were issued at a discount which will be amortized over the life of the 7-3/8% Notes in interest expense.

     The Company may redeem the 7-3/8% Notes, in whole or in part, at any time on or after July 15, 2008, at redemption prices from 103.7% of the principal amount as of July 15, 2008, and declining to 100.0% on July 15, 2011 and thereafter. Prior to July 15, 2006, the Company may redeem up to 35% of the original aggregate principal amount of the notes at a redemption price of 107.4% of the principal amount thereof plus accrued and unpaid interest, if any, with the proceeds of certain equity offerings. If the Company experiences a change of control, the Company may be required to repurchase all or a portion of the 7-3/8% Notes at 101% of the principal amount thereof plus accrued and unpaid interest, if any. The 7-3/8% Notes and the guarantees by the Subsidiary Guarantors are general, unsecured obligations and are subordinated to the Company’s and the Subsidiary Guarantors senior debt and will be subordinated to future senior debt that the Company and the Subsidiary Guarantors are permitted to incur under the senior credit facilities and the indenture governing the 7-3/8% Notes.

6% Convertible Subordinated Debentures due 2007

     In 1996, the Company sold $55.0 million aggregate principal amount of 6% Convertible Subordinated Debentures due 2007 (the “6% Debentures”). Interest on the 6% Debentures is payable semi-annually each February and August. The 6% Debentures are convertible into shares of the Company’s common stock at the option of the holder at any time prior to maturity, unless previously redeemed or repurchased, at a conversion price of $19.25 per share, subject to adjustment in certain events. The 6% Debentures will mature in 2007. The 6% Debentures are subject to redemption at the Company’s option, in whole or in part, at redemption prices from 102.5% of the principal amount as of September 30, 2003, and declining to 101.0% in 2006. Upon a change of control, the Company is required to offer to repurchase each holder’s 6% Debenture at a purchase price equal to 100% of the principal amount thereof, plus accrued and unpaid interest to the date of repurchase. The 6% Debentures are unsecured general obligations and are subordinated to all of the Company’s senior indebtedness.

     During the three months ended September 30, 2002, $800,000 face amount of the 6% Debentures were repurchased for cash at a discount. During the nine months ended September 30, 2002, $7.1 million of 6% Debentures were retired in exchange for 1,165,700 shares of the Company’s common stock and $815,000 were repurchased for cash at a discount. During the nine month period ended September 30, 2003, $880,000 was retired in exchange for 128,793 shares of the Company’s common stock. The Company recorded a $465,000 conversion expense related to this exchange (see discussion below). For both the three month and nine month periods ending September 30, 2003, $6.4 million of the 6% Debentures were repurchased for cash at a discount. On October 31, 2003, $11.6 million of the 6% Debentures was outstanding.

5-3/4%Trust Preferred Securities – manditorily redeemable securities of subsidiary

     In 1997, the Company issued $120.0 million of the Trust Preferred Securities through a newly-formed affiliate Lomak Financing Trust (the “Trust”). The Trust issued 2,400,000 shares of the Trust Preferred Securities at $50 per share. Each Trust Preferred Security is convertible at the holder’s option into shares of the Company’s common stock, at a conversion price of $23.50 per share. The Trust invested the $120 million of proceeds in the 5-3/4% convertible junior subordinated debentures (the “Junior Debentures”). The sole assets of the Trust are the Junior Debentures. The Junior Debentures and the related Trust Preferred Securities mature in November 2027. The Company and the Trust may redeem the Junior Debentures and the Trust Preferred Securities, respectively, in whole or in part. As of September 30, 2003, the price at which these redemptions could be made was approximately 102.9% of the principal amount. The premium declines proportionally every 12 months until November 2007, when the redemption price becomes fixed at 100% of the principal amount. If any Junior Debentures are redeemed prior to the scheduled maturity date, the Trust must redeem Trust Preferred Securities having an aggregate liquidation amount equal to the aggregate principal amount of the Junior Debentures the Company redeems. The Company has guaranteed the payments of distributions and other payments on the Trust Preferred Securities only if and to the extent that the Trust has funds available. The Company’s guarantee, when taken together with the Company’s

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obligation under the Junior Debentures and related indenture and declaration of trust, provides a full and unconditional guarantee on a subordinated basis of amounts due on the Trust Preferred Securities.

     The accounts of the Trust are included in the consolidated financial statements after eliminations. Distributions of the Trust are recorded as Interest expense in the Consolidated Statement of Operations, are tax deductible and are subject to limitations in the Senior Credit Facility as described below. During the nine months ended September 30, 2002, $2.4 million of Trust Preferred Securities were retired in exchange for 283,200 shares of common stock. In addition, during the three months ended September 30, 2002, $2.5 million of the Trust Preferred Securities were repurchased for cash at a discount. On September 23, 2003, the Company exchanged $10.2 million in cash and $50.0 million of a newly issued 5.9% cumulative convertible preferred stock (the “Convertible Preferred”) for $79.5 million of the Trust Preferred Securities held by the largest holder of the Trust Preferred Securities. The Convertible Preferred was exempt from registration under Section 3(a)(9) of the Securities Act because the Convertible Preferred was only exchanged by the Company with that holder and no commission or other remuneration was paid or given directly or indirectly for soliciting such exchange. The Company paid approximately $550,000 in consulting fees for financial advice regarding the restructuring of the Company's balance sheet. On October 31, 2003, $1.4 million of the Trust Preferred Securities was outstanding.

Debt Covenants

     The debt agreements contain covenants relating to net worth, working capital, dividends and financial ratios. The Company was in compliance with all covenants at September 30, 2003. Under the Senior Credit Facility, common and preferred dividends are permitted. The Senior Credit Facility provides for a restricted payment basket of $20.0 million plus 50% of net income (excluding Great Lakes) plus 66-2/3% of distributions, dividends or payments of debt from or proceeds from sales of equity interests of Great Lakes plus 66-2/3% of net cash proceeds from common stock issuances. Approximately $43.1 million was available under the Senior Credit Facility’s restricted payment basket on September 30, 2003.

Induced Conversions

     In September 2002, the Emerging Issues Task Force (“EITF”) issued EITF Issue No. 02-15, Determining Whether Certain Conversions of Convertible Debt to Equity Securities are Within the Scope of FASB Statement No. 84 “Induced Conversions of Convertible Debt” (“SFAS 84”). SFAS 84 was issued to amend APB Opinion No. 26, “Early Extinguishment of Debt” to exclude from its scope convertible debt that is converted to equity securities of the debtor pursuant to conversion privileges different from those included in the terms of the debt at issuance, and the change in conversion privileges is effective for a limited period of time, involves additional consideration, and is made to induce conversion. SFAS 84 applies only to conversions that both (a) occur pursuant to changed conversion privileges that are exercisable only for a limited period of time and (b) include the issuance of all of the equity securities issuable pursuant to conversion privileges included in the terms of the debt at issuance for each debt instrument that is converted. The Task Force reached a consensus that SFAS 84 applies to all conversions that both (a) occur pursuant to changed conversion privileges that are exercisable only for a limited period of time and (b) include the issuance of all of the equity securities issuable pursuant to conversion privileges included in the terms of the debt at issuance for each debt instrument that is converted, regardless of the party that initiates the offer. This consensus should be applied prospectively to debt conversions completed after September 11, 2002. Since 1999, the Company has retired certain of the 6% Debentures and the Trust Preferred Securities, each of which are convertible into the Company’s common stock, by either purchasing securities for cash or issuing common stock in exchange for such securities. Since the exchanges of common stock for these convertible debt securities were at relative market values, the convertible securities were retired at a discount to face value. Under the provisions of SFAS 84, when an inducement is issued to retire convertible debt, the face value of the convertible debt security shall be charged to Stockholders’ equity (common stock and paid in capital), the shares of common stock issued in excess of the shares that would have been issued under the terms of the debt instrument are expensed at the market value of such shares and an offsetting increase to paid in capital will also be recorded. Therefore, instead of recording gains on retirements of such securities acquired at discounts to face value, an expense will be recorded. There will be no difference in Stockholders’ equity from the change in methods of recording the transactions.

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(7) FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

     The Company’s financial instruments include cash and equivalents, receivables, payables, debt and commodity and interest rate derivatives. The book value of cash and equivalents, receivables and payables is considered representative of fair value because of their short maturity. The book value of bank borrowings is believed to approximate fair value because of their floating rate structure.

     The following table sets forth the book and estimated fair values of financial instruments as of December 31, 2002 and September 30, 2003 (in thousands):

(1)

Fair value based on quotes received from brokerage firms. Quotes for September 30, 2003 were 96% for the 7-3/8% Notes, 98% for the 6% Debentures and 76% for the Trust Preferred Securities.

     A portion of future oil and gas sales is periodically hedged through the use of swap and collar contracts. In the second quarter of 2003, the hedging program was modified to include collars, which assume a minimum floor price and a predetermined ceiling price. Realized gains and losses on these instruments are reflected in the contract month being hedged as an adjustment to oil and gas revenue. At times, the Company seeks to manage interest rate risk through the use of swaps. Gains and losses on interest rate swaps are included as an adjustment to interest expense in the relevant periods.

     At September 30, 2003, the Company had hedging swap contracts covering 60.0 Bcf of gas at prices averaging $4.10 per mcf and 1.5 million barrels of oil at prices averaging $24.92 per barrel. The Company also has collars covering 0.6 Bcf of gas at prices of $4.00-$6.75 and 0.6 million barrels of oil at prices of $24.00-$27.71. The fair value, represented by the estimated amount that would be realized upon termination, based on contract prices versus the New York Mercantile Exchange (“NYMEX”) price on September 30, 2003, was a net unrealized pre-tax loss of $46.3 million. The contracts expire monthly through December 2006. Gains or losses on open and closed contracts are determined as the difference between the contract price and the reference price, which are closing prices on the NYMEX. Transaction gains and losses on settled contracts are determined monthly and are included as increases or decreases to oil and gas revenues in the period the hedged production is sold. Oil and gas revenues were increased by $3.5 million and decreased by $12.3 million due to hedging in the three months ended September 30, 2002 and 2003, respectively. Oil and gas revenues were increased by $18.8 million and decreased by $53.5 million due to hedging in the nine months ended September 30, 2002 and 2003, respectively.

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          The following schedule shows the effect of closed oil and gas hedges since January 1, 2002 and the value of open contracts at September 30, 2003 (in thousands):