UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

 

 

WASHINGTON, D.C.  20549

 

 

FORM 10-Q

 

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the Quarter Ended September 30, 2004
		or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the Transition Period From                 to

 

Commission File Number:  000-25717

 

 

PETROHAWK ENERGY CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware		86-0876964
(State of Incorporation)		(I.R.S. Employer Identification No.)
1100 Louisiana, Suite 4400, Houston, TX		77002
(Address of principal executive offices)		(Zip Code)

 

(832) 204-2700

(Registrant’s telephone number, including area code)

 

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 ý  No o

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes o  No ý

 

As of November 1, 2004, the Registrant had 13,892,167 shares of Common Stock, $.001 par value, outstanding.

 

 

INDEX

 

PART I - FINANCIAL INFORMATION
ITEM 1.  Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003 (unaudited)
	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and nine months ended September 30, 2004 and 2003 (unaudited)
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003 (unaudited)
	Notes to Condensed Consolidated Financial Statements (unaudited)
ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Disclosure Regarding Forward-Looking Statements
	PHAWK, LLC Transaction
	Related Party Transaction
	Overview
	Liquidity and Capital Resources
	Capital Expenditures
	Significant Accounting Policies
	Comparison of Results of Operations for the three and nine months ended September 30, 2004 and 2003
ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk
ITEM 4.  Controls and Procedures.
PART II. - OTHER INFORMATION
ITEM 2.  Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
ITEM 4.  Submission of Matters to a Vote of Security Holders
ITEM 6.  Exhibits
Signatures

 

2

 

PART I

ITEM 1.  FINANCIAL STATEMENTS

PETROHAWK ENERGY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

 

		SEPTEMBER 30, 2004			DECEMBER 31, 2003
CURRENT ASSETS
Cash		$	35,096,236		$	2,109,681
Accounts receivable
Oil and gas sales		4,168,686			1,898,746
Other		598,260			113,529
Prepaid expenses and other		1,112,885			564,980
Total current assets		40,976,067			4,686,936
OIL AND GAS PROPERTY, at cost (full cost method)
Evaluated properties		87,782,235			78,717,380
Unevaluated properties		740,519			1,294,212
Less – accumulated amortization of full cost pool		(43,121,687		)	(39,740,116		)
Net oil and gas properties		45,401,067			40,271,476
OTHER OPERATING PROPERTY AND EQUIPMENT, at cost
Gas gathering system and equipment		1,502,692			1,496,404
Support equipment		220,482			197,379
Other		760,990			276,498
Less – accumulated depreciation		(855,894		)	(813,450		)
Net other operating property and equipment		1,628,270			1,156,831
DEBT ISSUE COSTS, net of amortization of $90,287		1,335,299			—
OTHER ASSETS		377,232			—
TOTAL ASSETS		$	89,717,935		$	46,115,243
CURRENT LIABILITIES
Accounts payable, trade		$	593,308		$	1,646,559
Dividends payable		—			112,707
Asset retirement obligations – current portion		220,386			171,860
Liabilities from price risk management activities		592,500			—
Other accrued liabilities		1,976,408			566,990
Total current liabilities		3,382,602			2,498,116
LONG-TERM DEBT		—			13,284,652
SUBORDINATED CONVERTIBLE NOTE PAYABLE		35,000,000			—
ASSET RETIREMENT OBLIGATIONS, less current portion		1,524,886			1,062,860
STOCKHOLDERS’ EQUITY
Preferred stock, $.001 par value, 5,000,000 shares authorized: 598,271 and 604,271shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively. Liquidation value at September 30, 2004 of $5,533,890.		598			604
Common stock, $.001 par value: 50,000,000 shares authorized; 13,870,549 and 6,223,036 shares issued at September 30, 2004 and December 31, 2003, respectively; 13,862,167 and 6,214,654 shares outstanding at September 30, 2004 December 31, 2003, respectively.		13,871			6,223
Additional paid-in capital		73,778,685			51,930,449
Treasury stock, at cost; 8,382 shares at September 30, 2004 and December 31, 2003.		(36,428		)	(36,428		)
Accumulated deficit		(23,946,279		)	(22,631,233		)
Total stockholders’ equity		49,810,447			29,269,615
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	89,717,935		$	46,115,243

 

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

 

3

 

PETROHAWK ENERGY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(unaudited)

 

		FOR THE THREE MONTHS ENDED SEPTEMBER 30,						FOR THE NINE MONTHS ENDED SEPTEMBER 30,
		2004			2003			2004			2003
REVENUES:
Oil and gas		$	5,531,893		$	3,215,201		$	14,378,746		$	9,169,983
Field services		57,306			61,263			250,664			250,411
Total revenues		5,589,199			3,276,464			14,629,410			9,420,394
COSTS AND EXPENSES:
Production:
Lease operations		879,964			569,193			2,457,445			1,703,313
Production, severance and ad valorem taxes		290,717			205,820			780,374			654,296
Field services		42,826			50,621			131,099			143,889
General and administrative		1,597,039			658,390			4,017,117			1,907,505
Stock-based compensation		898,000			45,657			2,925,216			211,636
Depreciation, depletion and amortization		1,271,221			1,197,554			3,531,587			3,812,592
Accretion of asset retirement obligations		23,026			13,704			69,078			41,110
Total costs and expenses		5,002,793			2,740,939			13,911,916			8,474,341
INCOME FROM OPERATIONS		586,406			535,525			717,494			946,053
OTHER INCOME (EXPENSE):
Unrealized losses on mark-to-market commodity derivative contracts		(592,500		)	—			(592,500		)	—
Interest expense		(784,923		)	(123,065		)	(1,278,862		)	(367,400		)
Interest income and other		129,365			1,352			148,265			3,708
Total other income (expense)		(1,248,058		)	(121,713		)	(1,723,097		)	(363,692		)
INCOME (LOSS) BEFORE INCOME TAX BENEFIT		(661,652		)	413,812			(1,005,603		)	582,361
INCOME TAX BENEFIT		61,185			—			24,000			—
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE		(600,467		)	413,812			(981,603		)	582,361
CUMULATIVE EFFECT ON PRIOR YEARS FROM ADOPTION OF FASB STATEMENT NO. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATION, NET OF TAX		—			—			—			1,640
NET INCOME (LOSS)		(600,467		)	413,812			(981,603		)	584,001
PREFERRED DIVIDENDS		111,586			112,707			333,443			334,445
NET INCOME (LOSS) APPLICABLE TO COMMON STOCKHOLDERS		$	(712,053	)	$	301,105		$	(1,315,046	)	$	249,556
NET INCOME (LOSS) PER SHARE:
Basic		$	(0.05	)	$	0.05		$	(0.13	)	$	0.04
Fully Diluted		$	(0.05	)	$	0.05		$	(0.13	)	$	0.04
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic		13,817,614			6,214,654			9,762,828			6,216,141
Fully Diluted		13,817,614			6,258,165			9,762,828			6,239,901
COMPREHENSIVE INCOME (LOSS):
NET INCOME (LOSS)		$	(600,467	)	$	413,812		$	(981,603	)	$	584,001
OTHER COMPREHENSIVE INCOME (LOSS):
Realized loss on qualifying cash flow hedges		—			100,789			—			1,336,844
Unrealized loss on qualifying cash flow hedges		—			(5,172		)	—			(634,427		)
TOTAL COMPREHENSIVE INCOME (LOSS)		$	(600,467	)	$	509,429		$	(981,603	)	$	1,286,418

 

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

 

4

 

PETROHAWK ENERGY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

		FOR THE NINE MONTHS ENDED SEPTEMBER 30,
		2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) before cumulative effect of change in accounting principle		$	(981,603	)	$	582,361
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation, depletion and amortization		3,531,587			3,812,592
Amortization of debt issue costs		90,287			—
Accretion of asset retirement obligations		69,078			41,110
Stock-based compensation		2,925,216			211,636
Unrealized losses on mark-to-market commodity derivative contracts		592,500			—
Common stock issued in lieu of directors’ fees		34,980			—
Changes in operating assets and liabilities:
Accounts receivable		(2,754,671		)	(78,143		)
Prepaid expenses and other		(547,905		)	(264,169		)
Accounts payable, trade		(1,053,251		)	(1,168,467		)
Other accrued liabilities		1,409,418			31,771
Asset retirement obligations incurred		(2,526		)	(76,591		)
Net cash provided by operating activities		3,313,110			3,092,100
CASH FLOWS FROM INVESTING ACTIVITIES:
Oil and gas property expenditures		(6,253,068		)	(1,953,914		)
Acquisition of oil and gas properties from PHAWK, LLC		(2,636,003		)	—
Proceeds from sale of oil and gas properties		832,245			533,142
Gas gathering and other equipment expenditures		(631,790		)	(28,005		)
Change in other assets		(377,232		)	—
Net cash used in investing activities		(9,065,848		)	(1,448,777		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable		(13,284,652		)	(360,439		)
Proceeds from issuance of common stock and warrants		25,249,120			—
Proceeds from issuance of subordinated convertible note payable		35,000,000			—
Debt issue costs related to PHAWK, LLC Transaction		(1,425,586		)	—
Equity offering costs related to PHAWK, LLC Transaction		(722,315		)	—
Return of capital to PHAWK, LLC		(5,575,626		)	—
Preferred stock dividends paid		(446,148		)	(334,445		)
Acquisition of preferred and treasury stock		(55,500		)	(8,255		)
Net cash provided by (used in) financing activities		38,739,293			(703,139		)
NET INCREASE IN CASH AND CASH EQUIVALENTS		32,986,555			940,184
CASH AND CASH EQUIVALENTS:
Beginning of period		2,109,681			927,313
End of period		$	35,096,236		$	1,867,497
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for:
Interest		$	1,257,214		$	444,745
Income taxes		$	—		$	14,500

 

The accompanying notes are an integral part to these condensed consolidated financial statements

 

5

 

CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PETROHAWK ENERGY CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.                                       BASIS OF PRESENTATION

 

The accompanying condensed consolidated financial statements of Petrohawk Energy Corporation (formerly known as Beta Oil & Gas, Inc.) and subsidiaries (“Petrohawk” or “the Company”) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions of Form 10-Q and Rule 10-01 of Regulation S-X.  In the opinion of management, the accompanying unaudited financial statements contain all adjustments necessary to present fairly the Company’s financial position as of September 30, 2004 and the results of its operations for the three and nine months ended September 30, 2004 and 2003 and cash flows for the nine months ended September 30, 2004 and 2003.  Management believes all such adjustments are of a normal recurring nature.  The results of operations for interim periods are not necessarily indicative of results to be expected for a full year.  Although we believe that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information normally included in financial statements and related footnotes prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).  The December 31, 2003 consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States.  The accompanying financial statements should be read in conjunction with the audited financial statements as contained in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2003 that was filed April 20, 2004.

 

PHAWK, LLC Transaction

 

On December 12, 2003, the Company entered into a securities purchase agreement with PHAWK, LLC, formerly known as Petrohawk Energy, LLC (“PHAWK, LLC”), a privately-held independent exploration and production company headquartered in Houston, Texas, pursuant to which PHAWK, LLC agreed to a cash investment of $60,000,000 in the Company’s common stock, warrants and a convertible note.  On May 25, 2004, the Company’s stockholders approved the transaction with PHAWK, LLC (the “PHAWK, LLC Transaction”), whereby the Company received $25,000,000 for the issuance of 7,575,757 shares of its common stock and 5,000,000 five-year common stock purchase warrants exercisable at a price of $3.30 per share.  Additionally, the Company issued a $35,000,000 convertible note that is an unsecured five-year obligation that after two years will be convertible by the holder into the Company’s common stock at a conversion price of $4.00 per share.  Interest only will be payable under the note in quarterly installments at the rate of 8% per annum.  The full amount of the principal and accrued and unpaid interest will be payable on the fifth anniversary of the date of the note.

 

The Company incurred approximately $2.3 million in offering costs related to the PHAWK, LLC Transaction.  Approximately $1.4 million of the costs were allocated to debt issue costs based upon the face value of the subordinated note payable to the total proceeds received by the Company.  The debt issue costs are being amortized over a five-year period.  The remaining $0.9 million of costs, including $0.2 million incurred in 2003, are included as equity offering costs and are reflected as a reduction to Stockholders’ Equity.

 

Future use of these proceeds will include acquisitions of oil and gas properties, future development and exploitation of existing and acquired oil and gas properties and exploration activity.  Approximately $13.3 million of these proceeds were used to repay all of the Company’s existing long-term bank debt.

 

6

 

Reclassifications

 

Certain reclassifications of prior period amounts have been made to conform to current period presentation.

 

Oil and Gas Properties

 

The Company accounts for its oil and gas producing activities using the full cost method of accounting as prescribed by the SEC. Accordingly, all costs incurred in the acquisition, exploration, and development of proved oil and gas properties, including the costs of abandoned properties, dry holes, geophysical costs, and annual lease rentals are capitalized.  All general corporate costs are expensed as incurred.  In general, sales or other dispositions of oil and gas properties are accounted for as adjustments to capitalized costs, with no gain or loss recorded; unless the adjustments would significantly alter the relationship between capitalized costs and proved reserves.  Amortization of evaluated oil and gas properties is computed on the units of production method based on all proved reserves on a country-by-country basis.  Unevaluated oil and gas properties are assessed at least annually for impairment either individually or on an aggregate basis, if the properties have similar characteristics.  The net capitalized costs of evaluated oil and gas properties are subject to a full cost ceiling limitation in which the costs are not allowed to exceed their related estimated future net revenues discounted at 10%, net of tax considerations. Any impairments to unevaluated properties are recorded as transfers to the full cost pool.

 

With the volatility of commodity prices and the possibility of exploration expenditures resulting in no significant proved reserve additions, it is possible that future impairments of oil and gas properties could occur.  The price measurement date is on the last day of the quarter or year-end as required by SEC rules.

 

2.                                       ASSET RETIREMENT OBLIGATIONS

 

The Company adopted SFAS No. 143 effective January 1, 2003.  SFAS No. 143 requires that the fair value of an asset retirement cost, and corresponding liability, should be recorded as part of the cost of the related long-lived asset and subsequently allocated to expense using a systematic and rational method. Upon adoption, the Company recorded an asset retirement obligation of $913,560 to reflect the Company’s legal obligations related to future plugging and abandonment of its wells.  The Company estimated the expected cash flow associated with the obligation and discounted the amount using a credit-adjusted, risk-free interest rate of 8%.  The transition adjustment resulting from the adoption of SFAS No. 143, and reported as a cumulative effect of a change in accounting principle, was an increase to income of $1,640 in 2003. There was no comparable adjustment in 2004.

 

The Company recorded the following activity related to the liability for the nine months ended September 30, 2004 and 2003:

 

		FOR THE NINE MONTHS ENDED SEPTEMBER 30
		2004				2003
Beginning balance – liability for asset retirement obligations		$		1,234,720		$	—
Initial liability for asset retirement obligations as of January 1, 2003		—				913,560
Obligations fulfilled during the period		(2,526			)	(76,591			)
Additions		444,000				—
Accretion expense		69,078				41,110
Ending balance – liability for asset retirement obligations		$	1.745,272			$		878,079

 

At September 30, 2004, $220,386 of the liability for asset retirement obligations balance is classified as current and presented as a separate line item on the consolidated balance sheet.

 

7

 

3.                                       STOCKHOLDERS’ EQUITY

 

Stock Split

On May 18, 2004, the Company’s Board of Directors approved a one-for-two reverse stock split that was effective May 26, 2004. The reverse split was implemented to effect the conditional approval by The NASDAQ National Market of the Company’s listing application, which was later formally approved.

 

Share and per share data (except par value) for periods presented have been restated to reflect the reverse stock split.

 

Stock -Based Compensation

On January 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), as amended by Statement of Financial Accounting Standards No. 148 Accounting for Stock-Based Compensation – Transition and Disclosure (“SFAS No. 148”), in accounting for its employee and director stock options and applies the fair value based method of accounting to such options using the “prospective method” as defined by SFAS No. 148.  Under SFAS No. 123, the fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model.  Previous to the adoption, the Company elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”) and related interpretations in accounting for its employee stock options.  However, as required by SFAS No. 123, the Company disclosed on a pro forma basis the impact of the fair value accounting for employee stock options.  Transactions in equity instruments with non-employees for goods or services have been accounted for using the fair value method as prescribed by SFAS No. 123.

 

Since the Company adopted the fair value recognition provisions of SFAS No. 123 prospectively for all employee awards granted, modified or settled after January 1, 2003, the cost related to stock-based compensation included in the determination of income for the three and nine month periods ended  September 30, 2004 and 2003 is less than that which would have been recognized if the fair value method had been applied to all awards since the original effective date of SFAS No. 123.  Awards vest over periods ranging from one to three years.  The following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each period.

 

		FOR THE THREE MONTHS ENDED SEPTEMBER 30,							FOR THE NINE MONTHS ENDED SEPTEMBER 30,
		2004				2003			2004					2003
Net income (loss) applicable to common stockholders as reported		$	(712,053		)	$	301,105		$	(1,315,046			)	$		249,556
Add: Stock-based compensation expense included in reported net income (loss)		898,000				45,657			2,925,216					211,636
Deduct: Total stock-based compensation expense determined under fair value method for all awards		(898,000			)	(65,511		)	(3,132,637				)	(313,333			)
Pro forma net income (loss) applicable to common stockholders		$	(712,053		)	$	281,251		$		(1,522,467		)	$	147,859
Income (loss) per share:
Basic – as reported		$		(0.05	)	$	0.05		$			(0.13	)	$	0.04
Basic – pro forma		$		(0.05	)	$	0.05		$			(0.16	)	$	0.02
Diluted – as reported		$		(0.05	)	$	0.05		$			(0.13	)	$	0.04
Diluted – pro forma		$		(0.05	)	$	0.04		$			(0.16	)	$	0.02

 

8

 

The fair value of each grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average assumptions used for options granted in 2004 include expected volatility of approximately 73.9%, risk-free interest rates ranging from 2.84% to 2.96% and expected lives of three years.  The weighted average assumptions used for options granted in 2003 include expected volatility of approximately 61.3%, a risk-free interest rate of 3.15% and expected lives of 5.2 years.

 

During the third quarter of 2004, the Company recognized $898,000 of non-cash stock-based compensation expense related to stock options, as described below, that were granted to employees of the Company.

 

During the second quarter of 2004, and in connection with the PHAWK, LLC Transaction, the Company recorded $1,979,712 of non-cash stock-based compensation expense related to employee stock options as follows:

 

•                  $182,516 of stock-based compensation expense as a result of the accelerated vesting of certain stock options of employees who were employed on May 25, 2004 (closing of the PHAWK, LLC Transaction).

 

•                  $1,797,196 of stock-based compensation expense as a result of the modification of certain stock options of employees whereby the period for which the employee has to exercise was extended to the earlier of the option expiration date or five years from the date of the closing of PHAWK, LLC Transaction.

 

Additionally, $47,504 of stock-based compensation was recorded during the six month period ended June 30, 2004 under the amortization of the certain employee stock options granted after the Company’s adoption of FAS 123 effective January 1, 2003.

 

Stock Options Grants

On July 12, 2004, the Company granted stock options covering 687,500 shares of common stock to employees of the Company.  The options will vest over a two-year period with one-third vesting on the date of grant, one-third in one year from the date of the grant and the remaining one-third in two years from the date of the grant.  The options have an exercise price of $7.50 per share and will expire on July 12, 2014.

 

On September 27, 2004, the Company granted stock options covering 15,000 shares of common stock to an employee of the Company.  The options will vest over a two-year period with one–third vesting on the date of grant, one-third in one year from the date of the grant and the remaining one-third in two years from the date of the grant.  The options have an exercise price of $7.99 per share and will expire on September 27, 2014.

 

Common Stock Warrants

During the second quarter of 2004, and in connection with the PHAWK, LLC Transaction, the Company issued PHAWK, LLC 5,000,000 five-year common stock purchase warrants at a price of $3.30 per share. The warrants are exercisable at any time and expire on May 25, 2009.

 

Treasury Stock

Effective January 14, 2003, the Company’s Board of Directors authorized a stock repurchase program for up to an aggregate of 50,000 shares of the Company’s common stock.  Purchases may be made in the open market, at prevailing market prices, or in privately negotiated transactions from time to time, and will depend on market conditions, business opportunities and other factors. Any purchases are expected to be made in compliance with the safe harbor provisions of Rule 10b-18 promulgated by the SEC under the Securities and Exchange Act of 1934.

 

The Company did not purchase any shares of common stock during the nine months ended September 30, 2004.  In August 2004, the Company’s Board of Directors terminated the stock repurchase program.  During the nine-month period ended September 30, 2003, the Company purchased 5,375 shares for $8,255, or $1.54 per share.  At September 30, 2004, the Company held 8,382 treasury shares.

 

9

 

4.                                       NET INCOME (LOSS) PER COMMON SHARE

 

		FOR THE THREE MONTHS ENDED SEPTEMBER 30,								FOR THE NINE MONTHS ENDED SEPTEMBER 30,
		2004					2003			2004				2003
Basic:
Net income (loss)		$	(600,467			)	$	413,812		$	(981,603		)	$	584,001
Less: Preferred dividends		(111,586				)	(112,707		)	(333,443			)	(334,445		)
Net income (loss) applicable to common stockholders		$	(712,053			)	$	301,105		$	(1,315,046		)	$	249,556
Weighted average number of common shares		13,817,614					6,214,654			9,762,828				6,216,141
Basic earnings (loss) per share		$			(0.05	)	$	0.05		$	(0.13		)	$	0.04
Diluted:
Net income (loss) applicable to common stockholders		$	(712,053			)	$	301,105		$	(1,315,046		)	$	249,556
Add: Preferred dividends		—					—			—				—
Net income (loss) for diluted Earnings (loss) per share		$		(712,053		)	$	301,105		$		(1,315,046	)	$	249,556
Weighted average number of common shares		13,817,614					6,214,654			9,762,828				6,216,141
Common stock equivalent shares representing shares issuable upon exercise of stock options		Antidilutive					43,511			Antidilutive				23,760
Common stock equivalent shares representing shares issuable upon exercise of warrants		Antidilutive					Antidilutive			Antidilutive				Antidilutive
Common stock equivalent shares representing shares “as-if” conversion of subordinated note payable		Antidilutive					—			Antidilutive				—
Common stock equivalent shares representing shares “as-if” conversion of preferred shares		Antidilutive					Antidilutive			Antidilutive				Antidilutive
Weighted average number of shares used in calculation of diluted income (loss) per share		13,817,614					6,258,165			9,762,828				6,239,901
Diluted earnings (loss) per share		$			(0.05	)	$	0.05		$		(0.13	)	$	0.04

 

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The following common stock equivalents were not included in the computation for diluted earnings (loss) per share because their effects were antidilutive.

 

COMMON STOCK EQUIVALENTS		2004		2003
Incentive stock options		339,000		237,750
Non-qualified options		342,500		352,500
Warrants		5,832,046		919,500
“As-if” conversion of subordinated notes payable		8,750,000		—
“As-if” conversion of preferred stock		598,271		604,271
		15,861,817		2,114,021

 

5.               RELATED PARTY TRANSACTION

 

On August 11, 2004, the Company purchased working interests in certain oil and gas properties and various other assets from PHAWK, LLC for $8.5 million.  The effective date of the acquisition is June 1, 2004.  Since the Company and PHAWK, LLC are under common control, the assets were recorded by the Company at the net book value of PHAWK, LLC at the time of the sale.  The purchase price exceeded the net book value by approximately $5.6 million.  The excess is reflected as a return of capital to PHAWK, LLC in the financial statements.

 

A Special Committee of one disinterested director was formed by the Company’s board of directors to evaluate, negotiate and complete the purchase.  The Special Committee hired an independent reservoir engineering firm to provide a reserve evaluation and engaged an independent financial advisor to evaluate the fairness, from a financial point of view, to the Company.  The independent financial advisor has rendered a fairness opinion to the Special Committee.

 

6.               LONG-TERM DEBT

 

On May 25, 2004, and in connection with the PHAWK, LLC Transaction, the Company issued a $35,000,000, five-year unsecured subordinated note payable to PHAWK, LLC. The note payable bears interest at 8%, is payable quarterly until maturity and is convertible after two years to common stock of the Company at a conversion price of $4.00.  The full amount of the principal and accrued and unpaid interest will be payable on May 25, 2009.

 

During 2003, the Company’s revolving credit agreement with a commercial bank was re-determined and its maturity extended to April 1, 2005.  At September 30, 2004, the $25,000,000 credit facility had a borrowing base of $13,180,000, which is subject to an automatic monthly reduction of $88,000 that commenced July 31, 2003 and is collateralized by the Company’s oil and gas properties and gas gathering system and related assets.  At September 30, 2004, there were no outstanding borrowings under the credit agreement. The Company pays a commitment fee equal to 0.25% (1/4 of a percentage point) on the unused portion of the borrowing base, which was approximately $223,000 at September 30, 2004, due quarterly in arrears.  The next re-determination for the borrowing base will occur in November 2004.

 

At September 30, 2004, the Company had various outstanding letters of credit of $201,000, which reduces the amount available under the borrowing base.  The Company pays an annual renewal of 2.25% of the face amount of the letters of credit.

 

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7.               DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

Natural Gas - From time to time, the Company may hedge a portion of its natural gas production and use costless collars, swaps or a combination of those derivatives when hedging.  During the third quarter of 2004, the Company entered into natural gas derivative contracts to hedge a portion of Petrohawk’s natural gas production for calendar year 2005.  The derivative contracts are comprised of costless collars covering volumes of approximately 135,000 MMBTU per month in 2005.  The Company elected not to designate these derivative contracts as cash flow hedges for accounting purposes, and accordingly, records the changes in mark-to-market of these derivative contracts as gains or losses in the income statement.  During third quarter of 2004, the Company recognized an unrealized loss on mark-to-market of the natural gas derivative contracts of $0.6 million.

 

For the contracts settled during the three and nine months ended September 30, 2003, the Company had realized losses of $71,137 and $1,105,469, respectively.  The impact of the natural gas hedges reduced the Company’s average natural gas price received for the three and nine months ended September 30, 2003 by $0.16 per Mcf and $0.81 per Mcf, respectively.  Based on the actual average daily natural gas production for the nine months ended September 30, 2003, approximately 41% of the Company’s natural gas production was hedged for this period.  At September 30, 2003, there were no outstanding hedge contracts.

 

Crude Oil - During the nine months ended September 30, 2004, the Company had no outstanding commodity price hedging contracts related to crude oil production.  From time to time, the Company may hedge a portion of its crude oil production and use costless collars, swaps or a combination of those derivatives when hedging.

 

For the contracts settled during the three and nine months ended September 30, 2003, the Company had realized losses of $29,652 and $231,375, respectively.  The impact of the crude oil hedges reduced the Company’s average crude price received for the three and nine months ended September 30, 2003 by $0.82 per Bbl and $2.47 per Bbl, respectively.  Based on the actual average daily crude oil production for the nine months ended September 30, 2003, approximately 32% of the Company’s crude oil production was hedged for this period.  At September 30, 2003, there were no outstanding hedge contracts.

 

8.               COMMITMENTS AND CONTINGENCIES

 

From time to time, the Company is a party to ordinary routine litigation incidental to our business.  We are not currently a party to any pending litigation, and we are not aware of any threatened litigation that would in the opinion of our legal counsel, have a significant impact on the financial statements.  We have not been a party to any bankruptcy, receivership, reorganization, adjustment or similar proceeding.

 

9.               SUBSEQUENT EVENT

 

On October 13, 2004, the Company entered into an Agreement and Plan of Merger with privately-held Wynn-Crosby Energy, Inc. (“Wynn-Crosby”), and an Agreement and Plan of Mergers with various partnerships managed by Wynn-Crosby.  Pursuant to such agreements, the Company will acquire Wynn-Crosby and the partnerships for $425 million, subject to certain adjustments.  The transaction has been approved by the Company’s Board of Directors and is expected to close on or before November 30, 2004.  In accordance with the agreement, the Company paid $4.25 million to Wynn-Crosby on October 13, 2004 as a non-refundable deposit on the purchase price.  The agreements contain customary representations and warranties and closing conditions.  The Company intends to finance the acquisition using a combination of cash, bank debt and equity.

 

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

 

The following discussion is to inform you about our financial position, liquidity and capital resources as of September 30, 2004 and December 31, 2003 and the results of operations for the three and nine month periods ended September 30, 2004 and 2003.

 

Disclosure Regarding Forward-Looking Statements

Included in this report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  All statements, other than statements of historical facts, included in or incorporated by reference into this Form 10-Q that address activities, events or developments that the Company expects or anticipates will or may occur in the future are forward-looking statements.  The words “should,” “believe,” “intend,” “expect,” “anticipate,” “project,” “estimate,” “predict,” “plan” and similar expressions are also intended to identify forward-looking statements.

 

These forward-looking statements include, but are not limited to, statements regarding:

 

•                  estimates of proved reserve quantities and net present values of those reserves;

•                  estimates of probable and possible reserve quantities;

•                  reserve potential;

•                  business strategy;

•                  estimates of future commodity prices;

•                  amounts and types of capital expenditures and operating expenses;

•                  expansion and growth of our business and operations;

•                  expansion and development trends of the oil and natural gas industry;

•                  production of oil and natural gas reserves;

•                  exploration prospects;

•                  wells to be drilled, and drilling results;

•                  operating results and working capital; and

•                  future methods and types of financing.

 

Such forward-looking statements involve assumptions and are subject to known and unknown risks and uncertainties that could cause actual results or performance to differ materially from those expressed or implied by such forward-looking statements.  Although we believe that the assumptions reflected in such forward-looking statements are reasonable, we can give no assurance that such assumptions will prove to have been correct.  Forward-looking statements speak only as of the date they are made and we undertake no obligation to update them.  Reserve estimates of oil and gas properties are generally different from the quantities of oil and natural gas that are ultimately recovered or found. This is particularly true for estimates applied to exploratory prospects and new production. Additionally, any statements contained in this report regarding forward-looking statements are subject to various known and unknown risks, uncertainties and contingencies, many of which are beyond our control.

 

Numerous important factors, risks and uncertainties may affect the Company’s operating results, including:

 

•                  the risks associated with exploration;

•                  the ability to find, acquire, market, develop and produce new properties;

•                  natural gas and oil price volatility;

•                  uncertainties in the estimation of proved reserves and in the projection of production of proved reserves;

•                  future rates of production and timing of development expenditures;

 

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•                  operating hazards attendant to the natural gas and oil business;

•                  downhole drilling and completion risks that are generally not recoverable from third parties or insurance;

•                  potential mechanical failure or under-performance of significant wells;

•                  climatic conditions;

•                  availability and cost of material and equipment;

•                  delays in anticipated start-up dates;

•                  actions or inactions of third-party operators of the Company’s properties;

•                  the ability to find and retain skilled personnel;

•                  availability of capital;

•                  the strength and financial resources of competitors;

•                  regulatory developments;

•                  environmental risks; and

•                  general economic conditions, including wars and acts of terrorism.

 

These and other risks and uncertainties, which are more fully described in our Annual Report on Form 10-K/A filed with the SEC, could cause actual results and developments to be materially different from those expressed or implied by any of these forward-looking statements.  Such things may cause actual results, performance, achievements or expectations to differ materially from the anticipated results, performance, achievements or expectations.

 

PHAWK, LLC Transaction

 

On December 12, 2003, the Company entered into a securities purchase agreement with PHAWK, LLC pursuant to which we agreed to issue to PHAWK, LLC for an aggregate of $60,000,000 in cash:

 

•    7,575,757 shares of our common stock;

 

•      five year warrants to purchase up to an additional 5,000,000 shares of our common stock at an exercise price of $3.30 per share; and

 

•      a convertible promissory note in the face amount of $35,000,000 which will be convertible after two years into shares of our common stock at a conversion price of $4.00 per share.

 

On May 25, 2004, the PHAWK, LLC Transaction was approved by the stockholders of the Company. Because issuance of the shares of common stock to PHAWK, LLC in connection with this transaction resulted in a change of control of the Company as defined in the NASDAQ rules, we were required by the rules of The Nasdaq Stock Market to obtain stockholder approval of the issuance of the shares.

 

Related Party Transaction

As previously noted, on August 11, 2004 the Company purchased working interests in certain oil and gas properties and various other assets from PHAWK, LLC for $8.5 million.  The effective date of the acquisition is June 1, 2004.  Since the Company and PHAWK, LLC are under common control, the assets were recorded by the Company at the net book value of PHAWK, LLC at the time of the sale.  The purchase price exceeded the net book value by approximately $5.6 million.  The excess is reflected as a return of capital to PHAWK, LLC in the financial statements.

 

A Special Committee of one disinterested director was formed by the Company’s board of directors to evaluate, negotiate and complete the purchase.  The Special Committee hired an independent reservoir engineering firm to provide a reserve evaluation and engaged an independent financial advisor to evaluate the fairness, from a financial point of view, to the Company.  The independent financial advisor has rendered a fairness opinion to the Special Committee.

 

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Overview

During the first nine months of 2004, a sustained improvement in our financial condition was a result of higher cash flows from operations and financing activities.  A continuation of favorable commodity price environment and increasing production rates were the primary factors for the improving cash flow.  With the success of our exploration, exploitation and development activity in the last half of 2003 and first nine months of 2004, our current production rates have increased.  Our net daily average production rate for the nine months ended September 30, 2004 was approximately 8.6 MMcfe compared to 7.0 MMcfe for the same period ended in 2003, a 23% increase.  We continue to be optimistic about the long-term outlook for natural gas and crude oil pricing, but realize that the overall environment for commodity pricing is very volatile and can be materially affected, favorably or unfavorably, by such factors as global uncertainty, imports/exports, weather trends, power generation and industrial demands.

 

Liquidity and Capital Resources

A company’s liquidity is the amount of time expected to elapse until an asset can be converted to cash or conversely until a liability has to be paid.  Liquidity is one indication of a company’s ability to meet its obligations or commitments.  Historically, our major sources of liquidity have come from internally generated cash flow from operations and proceeds from public and private stock offerings.

 

The following table represents the sources and uses of cash for the periods indicated.

 

		FOR THE NINE MONTHS ENDED SEPTEMBER 30,
		2004				2003
Beginning cash balance		$	2,109,681			$	927,313
Sources of cash:
Cash provided by operations		3,313,110				3,092,100
Cash provided by sales of oil and gas properties		832,245				533,142
Cash provided by financing activities		60,249,120				—
Total sources of cash including cash on hand		66,504,156				4,552,555
Uses of cash:
Oil and gas expenditures		(8,889,071			)	(1,953,914		)
Gas gathering and other equipment expenditures		(1,009,022			)	(28,005		)
Cash used by financing activities		(21,509,827			)	(703,139		)
Total uses of cash		(31,407,920			)	(2,685,058		)
Ending cash balance		$		35,096,236		$	1,867,497

 

Working capital and liquidity

At September 30, 2004, the Company’s working capital was $37.6 million, compared to $2.2 million at December 31, 2003.  Our working capital and liquidity have shown continual improvement as a result of the PHAWK, LLC Transaction and due to higher cash flows from operations.

 

Our principal source of short-term liquidity is from internally-generated cash flow, cash on hand and up to approximately $13.0 million available under the credit facility.  Should natural gas and crude oil prices decrease materially, our current operating cash flow would decrease and our liquidity and working capital position would be negatively impacted and could adversely impact our growth capability.

 

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Long term liquidity and capital resources

We have no material long-term commitments associated with our capital expenditure plans or operating agreements. Consequently, we have a significant degree of flexibility to adjust the level of such expenditures as circumstances warrant.  The level of capital expenditures will vary in future periods depending on the success we have with our exploitation, developmental and exploration activities in future periods, gas and oil price conditions and other related economic factors. Currently no sources of liquidity or financing are provided by off-balance sheet arrangements or transactions with unconsolidated, limited-purpose entities.  The following tables show our contractual obligations and commitments:

 

		Payments Due by Period
Contractual Obligations		Total			Less than 1 year			1-3 years			4-5 years			After 5 years
Subordinated Debt		$	35,000,000		$	—		$	—		$	35,000,000		$	—
Operating Leases		1,659,143			345,646			990,085			323,412			—
Total Cash Obligations		$	36,659,143		$	345,646		$	990,085		$	35,323,412		$	—

 

		Amount of Commitment Expiration per Period
Other Commercial Commitments		Total			Less than 1 year			1-3 years		4-5 years		After 5 years
Standby letters of credit		$	201,000		$	201,000		—		—		—

 

We are obligated to pay dividends of approximately $111,000 per quarter on the 8% Convertible Preferred Stock.

 

The Company is contractually obligated to acquire Wynn-Crosby and related limited partnerships managed by Wynn-Crosby for $425 million.  The Company intends to finance this acquisition using a combination of cash, bank debt and equity.

 

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Current borrowing base

The current credit agreement, which was re-determined and extended during the quarter ended June 30, 2003, has a maturity date of April 1, 2005 and at September 30, 2004, had a borrowing capacity of $13,180,000 subject to an automatic monthly reduction of $88,000, which commenced on July 31, 2003.  At September 30, 2004, there were no borrowings outstanding.

 

At September 30, 2004, the Company had various outstanding letters of credit of $201,000, which reduces the amount available under the borrowing base.  The Company pays an annual renewal of 2.25% of the face amount of the letter of credit.

 

Capital Expenditures

For the nine months ended September 30, 2004, we had capital expenditures of approximately $9.7 million.   The Company’s available capital as a result of the PHAWK, LLC Transaction would allow for the additional capital deployment should drilling or other opportunities be presented to the Company for consideration.

 

Significant Accounting Policies

 

We rely on certain accounting policies in the preparation of our financial statements.  Certain judgments and uncertainties affect the application of such policies.  Certain accounting principles are employed in the adherence and implementation of these policies along with management judgments.  The following is a discussion of each policy and how certain judgments and/or uncertainties could materially impact these policies:

 

Use of Estimates - The preparation of our condensed consolidated financial statements in conformity with generally accepted accounting principles requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, if any, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  The estimates include oil and gas reserve quantities, which form the basis for the calculation of amortization and impairment of oil and gas properties.  We emphasize that reserve estimates are inherently imprecise and that estimates of more recent discoveries are more imprecise than those for properties with long production histories. Actual results could materially differ from these estimates. Volatility in commodity prices also impacts reserve estimates since future revenues from production may decline significantly if there is a material decrease in natural gas and/or crude oil prices from the previous reserve estimation date, which is at each quarter end.

 

Oil and gas properties - - We account for our oil and gas producing activities using the full cost method of accounting.  Accordingly, all costs incurred in the acquisition, exploration, and development of proved oil and gas properties, including the costs of abandoned properties, dry holes, geophysical costs, and annual lease rentals are capitalized.  All general corporate costs are expensed as incurred.  In general, sales or other dispositions of oil and gas properties are accounted for as adjustments to capitalized costs, with no gain or loss recorded, unless the adjustments would significantly alter the relationship between capitalized costs and proved reserves.  Amortization of evaluated oil and gas properties is computed on the units of production method based on all proved reserve quantities.  The net capitalized costs of evaluated oil and gas properties adjusted for deferred tax effects (full cost ceiling limitation) are not to exceed their related estimated future net revenues discounted at 10%, and the lower of cost or estimated fair value of unevaluated properties, net of tax considerations. Unevaluated oil and gas properties are assessed at least annually for impairment either individually or on an aggregate basis.  Unevaluated leasehold costs, including brokerage costs, are individually assessed quarterly based on the remaining primary term of the leasehold.  During the nine month period ended September 30, 2004, unevaluated seismic, geological and geophysical costs,  leasehold costs and related brokerage fees of $704,668 were transferred to U.S. evaluated costs, or the full cost pool.  For the remaining costs, which includes seismic and geological and geophysical primarily related to Jackson County, Texas, historically we have estimated reserve potential for the unevaluated properties using comparable producing areas or wells and risk that estimate by 50-75%.  As mentioned previously in Use of Estimates, reserve estimations are more imprecise for new or unevaluated areas. Consequently, should certain geological conditions or factors exist, such as reservoir depletion, reservoir faulting, reservoir quality etc., but unknown to us at the time of our assessment, a materially different result could occur.

 

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Recently Issued Accounting Standards

In September 2004, the SEC issued Staff Accounting Bulletin No. 106 (SAB 106) that provides guidance to oil and gas companies following the full cost accounting method regarding the application of SFAS 143.  SAB 106 requires companies calculating the full cost ceiling test to exclude future cash outflows associated with settling asset retirement obligations that have been accrued on the balance sheet as required by SFAS 143.  However, estimated dismantlement and abandonment costs related to future development activities, which are not required to be accrued under SFAS 143, should continue to be included in the full cost ceiling test.  The SEC staff has also recommended that companies discuss how the adoption of SFAS 143 has affected their accounting for oil and gas operations.  The accounting and disclosure requirements of SAB 106 are to be applied prospectively beginning with the first quarter of 2005.  The Company is currently evaluating the impact, if any, that SAB 106 may have on its calculations under the full cost ceiling test.

 

Derivative instruments and hedging activity – We use derivatives in a limited manner to protect against commodity price volatility.  Effectively, we sell a portion of our natural gas and crude oil based on a NYMEX based price with a set floor (bottom) and ceiling (top) price or a range.  Our derivatives are recorded on the balance sheet at fair value and changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, depending on the type of transaction.  Typically, our derivative contract will consist of a cash flow hedge transaction in which it hedges the variability of cash flow related to a forecasted transaction.  Changes in the fair value of these derivative instruments are recorded in other comprehensive income and reclassified as earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item.  The fair value of these contracts may vary materially with the fluctuations of natural gas and crude oil prices.  However, the fluctuation in fair value will be offset by the actual value received from the hedged volume.

 

Stock-based compensation - On January 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure (“SFAS No. 148”), in accounting for our employee and director stock options using the “prospective method” as defined by SFAS No. 148.  Under SFAS No. 123, the fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model.  Previous to the adoption, the Company elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”) and related interpretations in accounting for its employee stock options.  However, as required by SFAS No. 123, the Company disclosed on a pro forma basis the impact of the fair value accounting for employee stock options.  Transactions in equity instruments with non-employees for goods or services have been accounted for using the fair value method as prescribed by SFAS No. 123.

 

Comparison of Results of Operations

Quarter ended September 30, 2004 and compared to quarter ended September 30, 2003

The Company reported a net loss of $0.6 million for the three months ended September 30, 2004 compared to net income of $0.4 million for the same period in 2003.  Increased revenues resulting from higher natural gas and crude oil prices and increased sales volumes were more than offset by higher production expenses, general and administrative expenses, stock-based compensation expense, unrealized losses on derivative contracts and interest expense when compared to the same period for last year.

 

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The following table summarizes key items of comparison for the periods indicated.  Dollars, except for per unit data, and production data are in thousands.

 

		Three Months Ended September 30,
		2004			2003
Net Production Data:
Natural Gas (MMcf)		604.9			436.4
Crude Oil (MBbl)		44.6			36.1
Equivalent Production (Mmcfe)		872.8			653.1
Average Daily Production (Mmcfe)		9.5			7.1
Average Sales Price (1):
Natural Gas (per Mcf)		$	6.03		$	5.10
Crude Oil (per Bbl)		$	42.18		$	27.40
Equivalent price (per Mcfe)		$	6.34		$	4.92
Expenses ($ per Mcfe):
Lease Operations		$	1.01		$	0.87
Production, severance and ad valorem taxes		$	0.33		$	0.32
General and administrative (2)		$	1.83		$	1.01
Stock-based compensation		$	1.03		$	0.07
DD&A (3)		$	1.39		$	1.75
Unrealized losses on mark-to-market commodity derivative contracts		$	0.68		$	—
Interest		$	0.90		$	0.19

 

(1)          Includes impact of hedging

(2)          Excludes Stock-based compensation expense

(3)          Includes DD&A for oil and gas properties only

 

Oil and gas sales:

For the three months ended September 30, 2004, oil and gas sales increased $2.3 million or 72%, from the same period in 2003, to $5.5 million.  The increase for the three months was a result of higher natural gas and crude oil prices received and higher sales volumes during the quarter ended September 30, 2004.  Natural gas storage level concerns, crude oil supply uncertainty due to global events and a weaker U.S. dollar, which impacts the OPEC basket price, favorably impacted commodity prices during the period.  In turn, natural gas prices have remained stronger due to the higher crude oil prices and seasonal demand during the quarter.  The prices received for our natural gas and crude oil during the quarter ended September 30, 2003 were also unfavorably impacted by our commodity hedges, as discussed further below under Hedging.

 

The higher commodity prices resulted in an increase in oil and gas revenues. The increase in production was a result of our drilling activity in the Broussard, Louisiana and Brookshire Dome, Texas properties and the drilling and recompletion activity during the last half of 2003 and this quarter on the WEHLU, Oklahoma properties.  Our incremental increase in production from these areas was partially offset by the natural decline in the production rates from our offshore Louisiana and South Texas properties.

 

Hedging:

Generally, we sell our natural gas and crude oil to various purchasers on an indexed-based or spot price.  The indices for natural gas are generally affected by the NYMEX – Henry Hub spot prices while the posted prices for crude oil are generally affected by the NYMEX-Crude Oil West Texas Intermediate prices.  From time to time, we use financial derivative instruments on a limited basis to lessen the impact of price volatility.

 

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