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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended September 30, 2004

For the transition period from                      to                     

Commission file number 1-10262

HARKEN ENERGY CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (817) 424-2424

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report: N/A

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 þ No ¨

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

Yes ¨ No þ

The number of shares of Common Stock, par value $0.01 per share, outstanding as of November 1, 2004 was 207,809,100.

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HARKEN ENERGY CORPORATION

INDEX TO QUARTERLY REPORT

September 30, 2004

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PART I – FINANCIAL INFORMATION

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ITEM 1. CONDENSED FINANCIAL STATEMENTS

HARKEN ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

The accompanying Notes to Consolidated Condensed Financial Statements

are an integral part of these Statements.

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HARKEN ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

The accompanying Notes to Consolidated Condensed Financial Statements

are an integral part of these Statements.

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HARKEN ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS’ EQUITY

(in thousands)

(Unaudited)

The accompanying Notes to Consolidated Condensed Financial Statements

are an integral part of these Statements.

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HARKEN ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying Notes to Consolidated Condensed Financial Statements

are an integral part of these Statements.

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HARKEN ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

September 30, 2003 and 2004

(Unaudited)

The accompanying consolidated condensed financial statements of Harken Energy Corporation (“Harken”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to these rules and regulations, although Harken believes that the disclosures made are adequate to make the information presented not misleading. In the opinion of Harken, these financial statements contain all adjustments necessary to present fairly its financial position as of December 31, 2003 and September 30, 2004 and the results of its operations and changes in its cash flows for all periods presented as of September 30, 2003 and 2004. See Note 10 - Stockholders’ Equity for discussion of reporting for the payment of the preferred stock dividends. All other adjustments represent normal recurring items. These condensed financial statements should be read in conjunction with the financial statements and the notes thereto included in Harken’s Annual Report on Form 10-K for the year ended December 31, 2003. Certain prior year amounts have been reclassified to conform with the 2004 presentation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 reported period. Actual results could differ from these estimates.

The results of operations for the three month and nine month periods ended September 30, 2004 are not necessarily indicative of the results to be expected for the full year.

Comprehensive Income (Loss) – Comprehensive income (loss) includes changes in stockholders’ equity during the periods that do not result from transactions with stockholders. Harken’s total comprehensive income (loss) is as follows:

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Recently Issued Accounting Pronouncements - In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus that mineral rights, as defined in EITF Issue No. 04-2, “Whether Mineral Rights Are Tangible or Intangible Assets,” are tangible assets and that they should be removed as examples of intangible assets in SFAS Nos. 141 and 142. The Financial Accounting Standards Board (“FASB”) has recently ratified this consensus and directed the FASB staff to amend SFAS Nos. 141 and 142 through the issuance of FASB Staff Positions FSP FAS 141-1 and FSP FAS 142-1. Historically, Harken has included the costs of such mineral rights as tangible assets, which is consistent with the EITF’s consensus.

In September 2004, the Securities and Exchange Commission (“SEC”) released Staff Accounting Bulletin No. 106 (SAB 106) which expresses the SEC’s views regarding the application of FASB Statement No. 143, Accounting for Asset Retirement Obligations (SFAS 143), by oil and gas producing companies following the full cost accounting method. SAB 106 addresses the calculation of ceiling tests for full-cost oil and gas companies, depreciation, depletion and amortization as affected by the adoption of SFAS 143, as well as the required related disclosures. SAB 106 had no impact on Harken’s financial position or results of operations.

In late 2003, Harken sold the majority of its oil and gas properties located in the Panhandle region of Texas for a gross sales price of approximately $7.0 million, subject to certain adjustments. No gain or loss was recognized on this transaction as the entire amount of the proceeds (including any subsequent purchase price adjustments), was recorded as a reduction to the domestic full cost pool. During the nine months ended September 30, 2004, Harken has paid approximately $119,000 in net purchase price adjustments related to the sale of certain Panhandle oil and gas properties.

In September 2004, Harken invested $12.5 million in a start-up energy company, International Business Associates, Ltd. (“IBA”) which was formed to focus primarily on opportunities created by the recent deregulation of the energy markets in Eastern Europe. It is anticipated that IBA will engage in trading gas futures contracts, principally in Hungary as well as in the United States. IBA’s trading operations are expected to begin in late 2004 or early 2005. In exchange for Harken’s $12.5 million cash investment, Harken received 12,500 shares of nonvoting preferred stock along with warrants to purchase 48% of IBA’s common stock for a nominal amount. No dividends will be paid on the preferred shares. Under the terms of the agreements, on or about February 15 of each year, as long as any of the preferred stock remains outstanding and if the annual net income of IBA equals or exceeds $2,000,000, the preferred shares will be redeemed by IBA in cash at the liquidation value at an amount equal to 50% of IBA’s available cash flow in the preceding calendar year. Until the preferred shares are redeemed in full, Harken has the right to nominate the majority of the Board of Directors of IBA. Harken currently holds three of the five IBA Board of Directors positions. Harken’s preferred stock investment represents almost 100% of IBA’s initial working capital as of September 30, 2004.

In accordance with Financial Accounting Standards Board Interpretations 46 (Revised December 2003) “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (FIN 46R), Harken’s investment in IBA is a variable interest. FIN 46R requires the consolidation of a variable interest entity, as defined, if a company will absorb a majority of the variable interest entity’s expected losses, receive a majority

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of the variable interest entity’s expected residual returns, or both. Harken has determined that the investment in IBA meets the requirements of FIN 46R, and Harken is the primary beneficiary, as defined. Therefore, Harken has consolidated the assets, liabilities and results of operations of IBA as of September 30, 2004 and for the period from September 10, the closing date of the transaction, through September 30, 2004. IBA’s results of operations were not significant for the period ended September 30, 2004.

A summary of property and equipment follows:

Effective January 1, 2003, Harken changed its method of accounting for asset retirement obligations in accordance with FASB Statement No. 143, “Accounting for Asset Retirement Obligations” (SFAS 143). Prior to the effective date of SFAS 143, Harken reflected asset retirement obligations for acquired assets net of related estimated salvage values to be realized at the time of retirement. Under SFAS 143, Harken recognizes the full amount of asset retirement obligations beginning in the period in which they are incurred if a reasonable estimate of a fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The net of tax cumulative effect of the change in accounting method on prior years resulted in a charge to income of $813,000 ($0.01 per share) in the first quarter of 2003.

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A summary of Harken’s assets with required asset retirement obligations as of September 30, 2004 is as follows:

Harken reflects no asset retirement obligation for Global’s Colombian facilities as upon the expiration of the related Association Contract, the ownership of such facilities reverts to Empresa Colombiana de Petroleos (“Ecopetrol”).

The following table describes all changes to Harken’s asset retirement obligation liability during the nine months ended September 30, 2004.

Accretion expense was $97,000 and $304,000 for the three and nine months ended September 30, 2004 in the Consolidated Condensed Statement of Operations.

Harken’s Middle American operations are conducted through its ownership in Global Energy Development PLC (“Global”). Global’s ordinary shares are listed for trading on the Alternative Investment Market of the London Stock Exchange. At September 30, 2004, Harken owns approximately 85% of Global’s common shares, which may be subject to reduction under certain circumstances, as further described in Note 7 – Global Warrants and Stock Options.

Colombian Operations – Global’s Colombian operations are conducted through Harken de Colombia, Ltd., a wholly owned subsidiary of Global, which held three exclusive Colombian Association Contracts with Ecopetrol and two Exploration and Production Contract with the newly formed National Hydrocarbons Agency of the Republic of Colombia. As of November 4, 2004, Global is in compliance with the requirements of each of its Association Contracts and Exploration and Production Contracts.

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In September 2004, Global signed an Exploration and Production Contract with the National Hydrocarbons Agency of the Republic of Colombia for the Rio Verde area, located in the central Llanos region. The contract assigns Global exclusive exploration and production rights to 75,000 acres located approximately 40 kilometers north of Global’s Palo Blanco complex.

Global currently owns a 100% working interest in the Rio Verde contract, and production, if any, is subject to a 10.5% percent royalty interest. The contract duration is approximately six years for the exploration phase and 24 years for the following exploitation phase. The time period for Phase 1 of the Rio Verde contract is 20 months. Terms of the contract require Global during Phase 1 to equip for production two existing wells located on the Rio Verde acreage, the Tilodiran #1 and the Macarenas #1. These wells, drilled in 1986 and 1993 respectively, tested productive. The estimated costs to equip for production the two existing wells is approximately $2 million. Also during Phase 1 of the contract, Global is required to reprocess 300 kilometers of existing seismic and acquire 50 kilometers of new 2D seismic. The estimated cost to reprocess and acquire the seismic is approximately $800,000.

If Global elects to enter Phase 2 of the Rio Verde contract, Global must drill one exploration well and acquire a further 25 kilometers of 2D seismic. Phases 3, 4 and 5, also optional, require one exploratory well to be drilled per phase. Phases 2, 3, 4 and 5 have a time period of 12 months each. In October 2004, Global commenced rig mobilization of the Tilodiran #1 well. Global expects that re-completion operations on this well will require 40 days to equip the well for continuous production.

In November 2004, Global signed a new exploration and production contract with the National Hydrocarbons Agency of the Republic of Colombia for the Los Hatos area, located in the central Llanos region. Global owns 100% of the contract, subject only to an initial 8% royalty payable to the Colombian Ministry of Energy. The final size of the royalty is to be determined by future production levels. The contract duration is approximately 6 years for the exploration phase and 24 years for the exploitation phase.

The contract grants Global exclusive exploration and production rights to 85,000 acres which are adjoined to the established Palo Blanco field. The terms of the contract require Global during phase 1 to drill one exploratory well. The time period for phase 1 is 16 months. If Global elects to enter phase 2 of the contract, Global must drill either one well or acquire 50 kilometers of 2D seismic data. Phases 3, 4 and 5, also optional, require one exploratory well to be drilled per phase. Phases 2,3,4 and 5 have a time period of 12 months each.

Peru Operations – In April 2001, Global, through a wholly owned subsidiary, signed a Technical Evaluation Agreement (“Peru TEA”) with Perupetro, the national oil company of Peru. The Peru TEA covered an area of approximately 6.8 million gross acres in northeastern Peru. All work requirements under the Peru TEA were satisfied prior to its expiration. Prior to expiration, Global exercised its option to convert a portion of the Peru TEA into a Production Sharing Contract. As of November 4, 2004, the negotiations with Perupetro for a Production Sharing Contract are still in progress and are expected to be completed during late 2004.

Panama Operations – In September 2001, Global, through a wholly owned subsidiary, signed a Technical Evaluation Agreement (“Panama TEA”) with the Ministry of Commerce and Industry for the Republic of Panama. The Panama TEA covered an area approximately 1.4 million gross acres divided into three blocks in and offshore Panama. Global completed all of its obligations under the Panama TEA and exercised its option to negotiate an Exploration and Exploitation Contract. As of November 4, 2004, the

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negotiations with the Panamanian government are still in progress and are expected to be completed in early 2005.

Global Warrants held by Lyford - In July and August 2002, Harken issued a 10% Term Loan Payable (the “Investor Term Loan”) in the total principal amount of $5,000,000 to Lyford Investments Enterprises Ltd. (“Lyford”), in exchange for cash in the principal amount of the Investor Term Loan. The principal of Lyford is Phyllis Quasha, whose son, Alan G. Quasha, is a member of Harken’s board of directors and the Chairman of Harken. Harken’s indebtedness to Lyford under the Investor Term Loan was repaid in full in March 2003.

As additional consideration for the Investor Term Loan, as amended, Harken issued to Lyford warrants (the “Lyford Warrants”) to purchase up to 7,000,000 shares held by Harken of Global at a price of 50 UK pence per share. The warrants will expire on October 13, 2005, 90 days after the originally scheduled maturity date of the Investor Term Loan. These warrants constitute approximately 29% of Harken’s holdings of Global shares.

Global Warrants held by Global’s Minority Interest Owners - In August 2002, Global issued to its minority shareholders warrants to purchase up to 505,407 shares of Global stock at UK 60 pence per share.

Harken is required to account for the Global Warrants held by Global’s minority stockholders and the Lyford Warrants (collectively referred to as “Global Warrants held by Outside Parties”) as derivatives in accordance with the Statement of Financial Accounting Standard No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). SFAS 133 requires Harken to record the estimated fair value of the warrants as a liability at issuance and to adjust the liability to estimated fair value each period with any changes in value reflected in earnings.

Following Global’s announcement of year-end 2003 results and successful drilling results in 2004, there was a 190% increase in Global’s common share price from approximately 50 UK pence at December 31, 2003 to 145 UK pence at June 30, 2004. As of September 30, 2004, Global’s common share price had decreased to 137 UK pence per share.

As a result of the changes in share price, Harken recorded a net loss of $11,361,000 for the nine-month period and a gain of $1,120,000 for the three-month period ended September 30, 2004 for the changes in the fair value of the Global Warrants held by Outside Parties. The fair value of the warrants was calculated by a third party firm based on the underlying market price of the Global common stock. As long as the Global Warrants held by Outside Parties remain outstanding, Harken could experience additional gains or losses associated with any changes in fair value of these Global Warrants held by Outside Parties. Given the nature of these derivatives, changes in the underlying market price of Global’s ordinary common shares and the resulting fair value of these warrants may create significant volatility in the Harken’s results of operations in future periods.

Global Warrants held by Harken - In August 2002, Global issued to Harken warrants to purchase 6,487,481 of Global’s ordinary common shares at UK 60 pence per share. Since Global is a consolidated subsidiary, this warrant issuance is not reflected in the consolidated condensed financial statements. The estimated fair market value of these warrants at September 30, 2004 was approximately $10.2 million, as calculated by a third-party firm.

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Global Stock Options - In addition to the warrants described above, certain employees and directors of Global hold options to purchase 3,375,000 of Global’s ordinary common shares at 50 pence per share.

If all Global warrants and share options were exercised, Harken’s ownership in Global could decrease from 85.62% to 61.11%. Harken’s ownership interest in Global may be further reduced by additional equity issuances of Global.

A summary of convertible notes payable is as follows:

7% European Notes — At December 31, 2003, Harken had outstanding a total of approximately $340,000 principal amount of its 7% European Notes, which were to mature on March 31, 2007. In February 2004, in accordance with the terms of the 7% European Notes, Harken converted the remaining outstanding principal amounts of $340,000, plus accrued and unpaid interest of its 7% European Notes into approximately 696,000 shares of Harken common stock. No gain or loss was recorded for the mandatory conversions of the 7% European Notes as this transaction did not qualify as debt extinguishment.

4.25% Convertible Notes — In December 2003, Harken issued to qualified investors a total of $5 million principal amount of its 4.25% Convertible Notes due 2006 (the “4.25% Convertible Notes”), which mature on December 14, 2006, in exchange for $5 million cash. The 4.25% Convertible Notes are unsecured and rank equal to all other present and future unsecured indebtedness of Harken. Both principal and accrued interest on the 4.25% Convertible Notes are payable semi-annually in six equal installments at Harken’s option in cash or with shares of Harken common stock equal to 110% of the principal amount to be redeemed divided by the 30-day average market price of Harken’s common stock immediately prior to the semi-annual redemption date. The first principal installment payment along with accrued interest was paid in cash as of June 30, 2004. At December 31, 2003 and September 30, 2004, respectively, based on the scheduled principal installments, approximately $1.7 million of the 4.25% Convertible Notes are classified as current debt in the Consolidated Condensed Balance Sheet.

Pursuant to the terms of the 4.25% Convertible Notes, Harken is required to maintain unencumbered assets such that the ratio of (a) the fair market value of the unencumbered assets to (b) the outstanding principal amount of the 4.25% Convertible Notes, is equal to or greater than 1.5 to 1.0. At September 30, 2004, Harken was in compliance with the asset coverage ratio under the 4.25% Convertible Notes.

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5% Senior Convertible Notes — In August 2004, Harken issued to qualified investors $5,245,000 aggregate principal amount of its 5% Senior Convertible Notes due June 30, 2009 (the “ 5% Notes”) in exchange for $5,245,000 in cash. The 5% Notes are convertible into shares of Harken’s common stock at a conversion price of $0.52 per share, subject to adjustments in certain circumstances. The 5% Notes bear interest at the rate of 5% per annum. Interest is payable semi-annually in arrears on December 31 and June 30, commencing December 31, 2004. Upon registration with the SEC of the shares of Harken’s common stock into which the 5% Notes are convertible, the holders of the 5% notes may exercise their rights to convert the 5% Notes. The Notes may be converted in whole or in part, at Harken’s option, after the effective date of the registration statement, if at any time following such effective date the average market price of Harken’s common stock over any 20 consecutive business day period equals or exceeds 125% of the conversion price ($0.65 per share). The outstanding principal balance of the Notes becomes due and payable in full on June 30, 2009 in cash or, at Harken’s option, in shares of Harken common stock equal to 110% of the principal amount of the 5% Notes divided by the 20-day average market price of Harken’s common shares immediately preceding the date of notice of redemption.

Issuance of Series J Convertible Preferred Stock and Warrants –

In March 2004, Harken’s Board of Directors approved the authorization and issuance of up to 65,000 shares of a new series of convertible preferred stock, the Series J Preferred. In April 2004, in exchange for $5.0 million in cash, Harken issued

The Series J Preferred has a liquidation value of $100 per share, is non-voting and is convertible at the holders’ option into common stock at a conversion price of $0.85 per share, subject to adjustments in certain circumstances. The Series J Preferred is also convertible by Harken, into freely tradable shares of Harken common stock at the conversion price, if for any period of thirty consecutive calendar days the average closing price of Harken common stock has equaled or exceeded 150% of the conversion price ($1.28 per share).

Dividends - The holders of the Series J Preferred are entitled to receive dividends at an annual rate equal to 5% per share. All dividends on the Series J Preferred stock are payable quarterly in arrears, beginning on September 30, 2004 in cash or, at Harken’s option, in shares of Harken common stock. The dividend payment in September 2004 was paid in cash. The Series J Preferred dividend and liquidation rights rank junior to all claims of creditors, including holders of outstanding debt securities, but senior to the holders of Harken common stock and pari passu to the holders of any other series of Harken preferred stock, unless otherwise provided.

Warrants – Warrants were issued in connection with the Series J Preferred to purchase 3,019,988 shares of Harken’s common stock. These warrants have a term of one year and an exercise price of $0.93. Harken may call the warrants if the closing price of Harken’s common stock over five consecutive days closes at or above 150% of the exercise price ($1.40 per share).

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Unit Purchase Warrants - The unit purchase warrants issued in connection with the Series J Preferred have an exercise price of $100 per unit. Each unit consists of one share of Series J Preferred and one warrant to purchase that number of shares of Harken’s common stock that equals 50% of the number of shares of Harken common stock into which one share of the Series J Preferred that is purchased, by exercise of the unit purchase warrant, may be converted. These unit purchase warrants expire in April 2005.

Additional Dividend Feature – If an additional dividend event occurs while the Series J Preferred is outstanding, the holders will have the right to an annual additional dividend calculated at a rate of 6.0% per annum of the issue price of any outstanding Series J Preferred, payable in cash, until such additional dividend event has been remedied. Additional dividend events include the failure of Harken common stock to be listed for trading on any principal market, Harken’s failure to declare or pay in full any dividend payable on the shares of Series J Preferred on the applicable dividend payment date, as well as other additional dividend events that are defined in the terms of the Series J Preferred.

Optional Redemption Event - If an optional redemption event occurs while the Series J Preferred is outstanding, each holder will have the right to require Harken to repurchase all or any portion of such holder’s Series J Preferred at the greater of (x) 115% of the stated value of the Series J Preferred, or (y) the market value of Harken common stock as if the Series J Preferred were converted at the then prevailing conversion price at the time of redemption. An optional redemption event includes the failure to declare and pay dividends on the Series J Preferred, voluntary liquidation, a fundamental change in the ownership of Harken, failure of Harken to generally pay its debts as they become due, as well as other events defined in the terms of the Series J Preferred.

Accounting for the Series J Preferred Stock and Warrants – In accordance with EITF Topic D-98 “Classification and Measurement of Redeemable Securities” (EITF D-98), the Series J Preferred contains certain provisions whereby redemption is deemed to be out of Harken’s control. Therefore the fair value of the Series J Preferred, of approximately $4.7 million is classified as temporary equity in the Consolidated Condensed Balance Sheet at September 30, 2004.

In accordance with EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (EITF 00-19), the common stock warrants were initially measured at fair value of $287,000 by an independent third party and are classified as permanent equity in the Consolidated Condensed Balance Sheet at September 30, 2004. The fair value allocated to the unit purchase warrants, approximately $38,000, is also classified as permanent equity in the Consolidated Condensed Balance Sheet at September 30, 2004.

After allocating the net proceeds between the Series J Preferred, the common stock warrants and the unit purchase warrants, Harken determined no beneficial conversion feature existed.

Adjustment of Series J Conversion Price and Warrant Exercise Price – In May 2004, as a result of Harken’s issuance of its Series L Convertible Preferred Stock (the “Series L Preferred”), the conversion price of the Series J Preferred was adjusted from $0.87 to $0.85. In accordance with EITF Issue 00-27, Issue 7, the number of the additional shares issuable upon conversion of the Series J Preferred multiplied by Harken’s stock price on the date of the original transaction is recorded as a Payment of Preferred Stock Dividends of approximately $135,000 which is included as a decrease to Net Income Attributed to Common Stock in the

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Consolidated Condensed Statement of Operations for the nine months ended September 30, 2004. In addition, the original exercise price of the common stock warrants issued with the Series J Preferred was adjusted from $0.98 to $0.95. In August 2004, as a result of Harken’s issuance of its 5% Notes, the exercise price of the common stock warrants issued with the Series J Preferred was adjusted from $0.95 to $0.93. In conjunction with SFAS 123 “Accounting for Stock Based Compensation” (SFAS 123), the incremental increase in the fair value of the warrant of approximately $8,000 and $19,000, respectively, is recorded as a Payment of Preferred Stock Dividends which is included as a decrease to Net Income Attributed to Common Stock in the Consolidated Condensed Statement of Operations for the three and nine months ended September 30, 2004. If Harken issues any additional shares of its common stock or any common stock equivalent at a price per share less than the conversion price of the Series J Preferred, the conversion price of the Series J Preferred is subject to additional adjustment.

Issuance of Series L Convertible Preferred Stock and Warrants –

In March 2004, Harken’s Board of Directors approved the authorization and issuance of up to 65,000 shares of convertible preferred stock, the Series L Preferred. In May 2004, Harken issued 50,000 shares of Series L Preferred stock and warrants to purchase shares of Harken common stock in exchange for $5 million in cash. Shares of the Series L Preferred have a liquidation value of $100 per share, are non-voting and were convertible at the holders’ option into Harken common stock at a conversion price of $0.71 per share, subject to adjustments in certain circumstances. See Subsequent Event – Series L Conversion / Redemption Agreement discussion below.

Dividends - The holders of the Series L Preferred are entitled to receive dividends at an increasing rate starting at 4% per share. All dividends on the Series L Preferred are payable semi-annually on June 30 and December 30. Dividends may be paid in cash or, at Harken’s option, in freely tradable shares of Harken common stock. The dividend rate may escalate to 12% under certain events of default, including failure to declare and pay dividends. The June 2004 dividend payment was paid in cash at Harken’s option.

The dividend and liquidation rights of the Series L Preferred shall rank junior to all claims of creditors, including holders of outstanding debt securities, but senior to holders of Harken common stock and pari passu to any other series of Harken preferred stock, unless otherwise provided.

Warrants - The warrants to purchase 3,712,049 shares of Harken’s common stock issued in connection with the Series L Preferred are exercisable for two years from issuance and have an exercise price of $0.67.

Accounting for the Series L Preferred Stock and Warrants – In accordance with EITF D-98, events of default for the Series L Preferred contain certain provisions whereby redemption is deemed to be out of Harken’s control. Therefore the fair value of the Series L Preferred of approximately $4.0 million is classified as temporary equity in the Consolidated Condensed Balance Sheet at September 30, 2004. In accordance with EITF 00-19, the fair value allocated to the common stock warrants of approximately $976,000 is classified as permanent equity in the Consolidated Condensed Balance Sheet at September 30, 2004.

The proceeds allocated to the Series L Preferred represented a discount to the market value of the underlying common stock. The discount of approximately $498,000 was treated as a beneficial conversion feature and was recognized as a Payment of Preferred Stock Dividends and presented as a decrease to Net Income Attributed to Common Stock in the third quarter of 2004, when the registration statement related to the shares of Series L Preferred became effective.

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Adjustment of Series L Conversion Price and Warrant Exercise Price – In August 2004, as a result of Harken’s issuance of its 5% Notes, the original conversion price of the Series L Preferred was adjusted from $0.72 to $0.71. In accordance with EITF Issue 00-27, Issue 7, the number of the additional shares issuable upon conversion of the Series L Preferred multiplied by Harken’s stock price on the date of the original transaction is recorded as a Payment of Preferred Stock Dividends of approximately $51,000 which is presented as a decrease to Net Income Attributed to Common Stock in the Consolidated Condensed Statement of Operations for the three and nine months ended September 30, 2004. In addition, the original exercise price of the common stock warrants issued with the Series L Preferred was adjusted from $0.68 to $0.67. The incremental increase in the fair value of the warrant of approximately $9,000 was recorded as a Payment of Preferred Stock Dividends which is presented as a decrease to Net Income Attributed to Common Stock in the Consolidated Condensed Statement of Operations for the three and nine months ended September 30, 2004. If Harken issues any additional shares of its common stock or any common stock equivalent at a price per share less than the conversion price of the Series L Preferred, the conversion price of the Series L Preferred is subject to additional adjustment.

Subsequent Event – Series L Conversion / Redemption Agreement and Issuance of Series M Cumulative Convertible Preferred Stock

In October 2004, Harken entered into a Conversion/Redemption Agreement (the “Agreement”) with the holders of the Series L Preferred, pursuant to which Harken has modified the conversion terms of the Series L Preferred as a part of the agreement to issue the Series M Cumulative Convertible Preferred Stock, as described below.

Pursuant to the Agreement, each holder of the Series L Preferred has agreed to convert at least 20% of its holdings of Series L Preferred on each of October 8, 2004, November 2, 2004, December 1, 2004, December 30, 2004 and February 1, 2005, provided Harken meets certain conditions. Harken has agreed that the conversion price will be the volume weighted average price of the Harken’s common stock for the twenty consecutive trading days immediately preceding the applicable conversion date. On October 8 and November 3, 2004, a total of $2 million, plus accrued dividends, of the Series L Preferred was converted into 3.6 million shares of Harken’s common stock.

Concurrent with the Agreement, in October 2004, Harken sold 50,000 shares of its Series M Cumulative Convertible Preferred Stock (the “Series M Preferred”) and issued warrants to purchase up to 4,385,965 shares of Harken’s common stock at an exercise price equal to $0.57 per share. The aggregate purchase price for the Series M Preferred and the related warrants was cash consideration of $5,000,000.

The Series M Preferred has a liquidation value of $100 per share, is non-voting and is convertible at the holders’ option into common stock at a conversion price of $0.60 per share, subject to adjustments in certain circumstances. If for any period of thirty consecutive days the average closing price of Harken common stock during such period trades above $0.75 per share for 30 consecutive days, up to 25,000 shares of the Series M Preferred is convertible by Harken into freely tradable shares of Harken common stock at $0.60 per share. If the average daily volume weighted average price of Harken’s common stock during a period of thirty trading days equals or exceeds $0.90, Harken may convert all the Series M Preferred into freely tradable shares of Harken common stock at $0.60 per share.

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Common Stock — At each of its stockholders meetings held in February and May 2004, Harken received stockholder approval to increase Harken’s authorized shares of common stock by 50 million shares at each meeting, increasing total authorized shares from 225 million shares at December 31, 2003 to 325 million shares of common stock as of September 30, 2004. At December 31, 2003 and September 30, 2004, 185,405,471 and 206,470,362 shares of Harken common stock, respectively, were issued.

Treasury Stock — At December 31, 2003 and September 30, 2004, Harken had 605,700 shares of treasury stock. During 2003 and the nine months ended September 30, 2004, Harken did not purchase any shares of its common stock.

Series G1 Convertible Preferred Stock - The Series G1 Convertible Preferred Stock (the “Series G1 Preferred”), which was issued in October 2000, has a liquidation value of $100 per share, is non-voting, and is convertible at the holder’s option into Harken common stock at a conversion price of $12.50 per share, subject to adjustment in certain circumstances.

The Series G1 Preferred holders are entitled to receive dividends at an annual rate equal to $8 per share when, as and if declared by Harken’s Board of Directors. All dividends on the Series G1 Preferred are cumulative and payable semi-annually in arrears, payable on June 30 and December 30. At Harken’s option, dividends may also be payable in Harken common stock valued at $12.50 per share.

During April 2004, Harken’s Board of Directors declared that a dividend be paid on all accrued and unpaid dividends as of June 30, 2004 payable to holders of Harken’s Series G1 and Series G2 Preferred. The dividend was paid with shares of common stock. As of the record date for such dividends, in May 2004, there were 295,372 shares of the Series G1 Preferred outstanding. In June 2004, Harken had accrued approximately $1.2 million of dividends in arrears related to the Series G1 Preferred, or approximately $4.00 per share of such preferred stock outstanding. In June 2004, a total of approximately 94,500 shares of Harken common stock were paid to holders of the Series G1 Preferred.

During the nine months ended September 30, 2004, holders of 28,940 shares of the Series G1 Preferred elected to exercise their conversion option, and such holders were issued 231,651 shares of Harken common stock.

Series G2 Convertible Preferred Stock — In July 2001, Harken’s Board of Directors approved the issuance of shares of the Series G2 Preferred, which has a liquidation value of $100 per share, is non-voting, and is convertible at the holder’s option into Harken common stock at a conversion price of $3.00 per share, subject to adjustment in certain circumstances. The Series G2 Preferred is also convertible by Harken into shares of Harken common stock if for any period of twenty consecutive calendar days, the average of the closing prices of Harken common stock during such period shall have equaled or exceeded $3.75 per share.

The Series G2 Preferred holders are entitled to receive dividends at an annual rate equal to $8 per share when, as and if declared by Harken’s Board of Directors. All dividends on the Series G2 Preferred are cumulative and payable semi-annually in arrears, payable on June 30 and December 30. At Harken’s option, dividends may also be payable in Harken common stock at $3.00 per share of Harken common stock.

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During April 2004, Harken’s Board of Directors declared that a dividend be paid as of June 30, 2004 to holders of the Series G1 Preferred and the Series G2 Preferred, such dividend to be paid with shares of common stock. As of the record date for such dividends, in May 2004, there were 27,150 shares of the Series G2 Preferred outstanding. In June 2004, Harken had accrued approximately $108,600 of dividends in arrears related to the Series G2 Preferred or approximately $4.00 per share of such preferred stock outstanding. In June 2004, a total of approximately 36,200 shares of Harken common stock were paid to holders of the Series G2 Preferred.

During the nine months ended September 30, 2004, holders of 14,500 shares of the Series G2 Preferred elected to exercise their conversion option, and such holders were issued 487,697 shares of Harken common stock.

Accounting for Payment of Series G1 and Series G2 Preferred Stock Dividends – Harken accounts for the payment of the Series G1 Preferred and the Series G2 Preferred stock dividends with shares of Harken common stock as a liability extinguishment in accordance with APB 26. Net Income Attributable to Common Stock, as previously reported in Harken’s Form 10-Q for the three and nine months ended September 30, 2003, has been changed since Harken determined it is necessary to account for the January 2003 payment of dividends on the Series G1 Preferred and the Series G2 Preferred with shares of Harken common stock to reflect, in accordance with APB 26, the difference between the carrying value of the preferred stock dividend liability of approximately $7.4 million and the fair market value of the shares of Harken common stock of approximately $227,000 issued by Harken in payment of the liability. The difference was recognized as a Payment of Preferred Stock Dividends of approximately $7.0 million in the Consolidated Condensed Statement of Operations for the period ended March 31, 2003 as an increase, net of income taxes paid on behalf of the preferred shareholders, to Net Income Attributed to Common Stock. Harken had previously accounted for the payment of dividends of the Series G1 Preferred and the Series G2 Preferred with shares of Harken common stock as a conversion transaction, pursuant to the terms of the respective preferred stock agreement, with the difference between the carrying amount of the preferred stock dividend liability and the par value of the common stock issued recorded to Additional Paid-in Capital. This accounting treatment had no effect on Harken’s revenues, net income, net working capital, or cash flow for the periods in question. Basic earnings per share increased from a loss per share of $(0.01) to earnings per share of $0.06, and diluted earnings per share increased from a loss per share of $(0.01) to earnings per share of $0.00 for the nine months ended September 30, 2003 as a result of the increase to Income Attributable to Common Stock. Additionally, none of Harken’s debt compliance covenants were affected by this accounting treatment.

In June 2004, Harken paid the dividends on the Series G1 Preferred and the Series G2 Preferred accrued at June 30, 2004 with approximately 130,700 shares of Harken common stock. The difference between the carrying value of the preferred stock dividend liability at June 30, 2004, approximately $1.3 million, and the fair market value of the shares of Harken common stock issued by Harken in payment of the liability in June 2004, approximately $69,000, is recognized as a Payment of Preferred Stock Dividends in the Consolidated Condensed Statement of Operations as of September 30, 2004 as a $1.2 million increase to Net Income Attributed to Common Stock.

Subsequent Event – Inducement to Voluntarily Convert Series G1 and Series G2 Preferred to Shares of Harken’s Common Stock – In October 2004, Harken entered into agreements with the holders of the Series G1 and Series G2 Preferred which provided a 20% increase in the number of shares of Harken’s common stock each Series G1 and Series G2 Preferred holder would receive upon voluntary conversion under the original terms of the Series G1 and G2 Preferred agreements. In November 2004, holders of 287,447 and 18,700 shares of

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Series G1 and G2 Preferred, respectively, elected to exercise their conversion option under the revised agreement, and such holders were issued a total of 3.6 million shares of Harken’s common stock.

Series G3 Convertible Preferred Stock — During the first nine months of 2004, holders of the remaining 76,700 shares of Harken’s Series G3 Preferred stock elected to exercise their conversion option, and these remaining holders were issued a total of approximately 15.5 million shares of Harken common stock. At September 30, 2004, the Series G3 Preferred is no longer outstanding.

Issuance of Series G4 Convertible Preferred Stock — In March 2004, Harken’s Board of Directors approved the authorization and issuance of up to 150,000 shares of a new series of convertible preferred stock, the Series G4 Preferred. In April 2004, Harken issued 77,517 shares of the Series G4 Preferred in exchange for approximately 1,000 shares of the Series G1 Preferred and 23,000 shares of the Series G2 Preferred and $2.4 million in cash. The Series G4 Preferred has a liquidation value of $100 per share, is non-voting and is convertible at the holders’ option into Harken common stock at a conversion price of $2.00 per share, subject to adjustments in certain circumstances. The Series G4 Preferred is also convertible by Harken into freely tradable shares of Harken common stock if for any period of twenty consecutive calendar days the average of the closing prices of Harken common stock has equaled or exceeded $2.20 per share, initially. This target price will be reduced by 10 percent of the immediately preceding target price in December of each year, commencing December 31, 2004.

The holders of the Series G4 Preferred are entitled to receive dividends, when as and if declared by the Board of Directors, at an annual rate equal to $8.00 per share. All dividends on the Series G4 Preferred are payable semi-annually in arrears in cash or, at Harken’s option, in shares of Harken’s common stock, payable on June 30 and December 31, commencing December 31, 2004. At Harken’s option, the dividends can be paid in shares of Harken’s common stock valued at $2.00 per share. The Series G4 Preferred dividend and liquidation rights rank junior to all claims of creditors, including holders of outstanding debt securities, but senior to Harken common stockholders and pari passu to any other series of Harken preferred stock, unless otherwise provided.

Harken may also redeem the Series G4 Preferred in whole or in part for cash at any time at $100 per share plus any accrued and unpaid dividends. In addition, on or after January 1, 2006, Harken may further elect, in any six month period, to redeem up to 50% of the outstanding Series G4 Preferred with shares of Harken common stock valued at an average market price, and using a redemption value of the Series G4 Preferred that includes a 5% premium based on Harken’s market capitalization at the time of redemption.

Accounting for the Series G4 Preferred Stock Issuance — Harken has reflected the difference between the face amount of the Series G1 Preferred and the Series G2 Preferred, plus the $2.4 million in cash, less transaction fees, and the fair value of the Series G4 Preferred shares issued as Exchange on Preferred Stock of approximately $337,000 in the Consolidated Condensed Statement of Operations for the nine months ended September 30, 2004, as an increase to Net Income Attributed to Common Stock. The valuation of the Series G4 Preferred stock is supported by an appraisal, performed by RP&C International Inc. (“RP&C”), and is based on the market value of the underlying conversion shares of Harken common stock as of the date of the exchange along with a discounted value associated with an assumed dividend yield.

Accumulated Other Comprehensive Income — During 2003, Harken recorded unrealized holding gains of $606,000 on its available for sale investment in NOIT in Other Comprehensive Income in stockholders’ equity in the Consolidated Condensed Balance Sheet at December 31, 2003. In February 2004, upon the sale

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of Harken’s investment in NOIT, the accumulated holding gain of $606,000 in Other Comprehensive Income was realized into earnings. Harken recorded a total gain on sale of the NOIT investment of approximately $1 million in the Consolidated Condensed Statement of Operations as of September 30, 2004.

Private Placement of Common Stock - In March 2004, Harken issued 3.6 million shares of Harken common stock in a private placement offering to two institutional investors for a total of $3.5 million in cash, less transaction costs. In connection with this private placement common stock offering, in March 2004, Harken issued to those investors, warrants to purchase 1.75 million shares of Harken’s common stock. The warrants are exercisable, at a price of $1.056 per share, at any time prior to March 8, 2005. The warrants also contain a call option whereby at any time during the exercise period, Harken has the right to call the warrants at $0.05 per warrant provided that Harken’s market price of its common stock is equal to or greater than 125% of the exercise price for at least 15 consecutive trading days.

In accordance with EITF 00-19, these warrants were initially measured at fair value and are classified as permanent equity in the Consolidated Condensed Balance Sheet at September 30, 2004.

Harken has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS 123 requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of Harken’s employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized.

Harken’s 1993 Stock Option and Restricted Plan authorized the grant of options to Harken employees and directors for up to 400,000 shares of Harken common stock. Harken’s 1996 Stock Option and Restricted Stock Plan authorized the grant of 1,852,500 shares of Harken common stock. All options granted had 10-year terms, vested and became fully exercisable at the end of 4 years of continued employment. At September 30, 2004, all of Harken’s previously issued and/or outstanding employee stock options had expired or were previously voluntarily surrendered, therefore no pro-forma information regarding net income and net income per share is required. As of September 2004 and after duly authorized action by Harken’s Board of Directors, all of Harken’s stock option plans have been terminated. See Note 7 – Global Warrants and Stock Options for discussion on Global stock options.

(12) RELATED PARTY TRANSACTIONS

In November 2001, Global elected to its Board of Directors a director who is also a director of RP&C. RP&C has historically provided financial and transaction consulting services to Harken. In addition, RP&C has served as a financial advisor in connection with Harken’s restructuring of its international assets, obligations and operations through its Global subsidiary. Also, RP&C currently serves as Global’s nominated advisor for the AIM Exchange in London. During the three months and the nine months ended September 30, 2004, Harken paid to RP&C approximately $282,000 and $632,000, respectively, for transaction costs associated with transaction consulting services. In connection with these services provided, RP&C may continue to earn such fees in the future.

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Harken holds certain commodity derivative instruments which are effective in mitigating commodity price risk associated with a portion of its future monthly natural gas production and related cash flows. Harken’s oil and gas operating revenues and cash flows are impacted by changes in commodity product prices, which are volatile and cannot be accurately predicted. Harken’s objective for holding these commodity derivatives is to protect the operating revenues and cash flows related to a portion of its future natural gas sales and crude oil from the risk of significant declines in commodity prices.

During 2004, Harken held a natural gas collar contract consisting of a fixed price floor option of $3.00 per MMBTU and a fixed price cap option of $4.95 per MMBTU covering 70,000 MMBTUs per month. Harken had not designated the above derivative as a hedge under SFAS No. 133, therefore the derivative was marked to market each period. The change in the fair value of the derivative of approximately $303,000 in 2004 is reflected as an increase to Other Income in the Consolidated Condensed Statement of Operations. Such natural gas collar contract was settled at fair value in June 2004.

In December 2003, Harken purchased a crude oil floor contract with a strike price of $27.00 per barrel for a notional amount of 6,000 barrels per month over a period of the contract from January 1, 2004 through December 31, 2004. In March 2004, Harken terminated this crude oil floor contract and replaced it with a crude oil floor contract with a strike price of $28.00 per barrel for a notional amount of 6,000 barrels per month over a period of the contract from April 1, 2004 through December 31, 2004. In June 2004, Harken terminated this crude oil floor contract and replaced it with a crude oil floor contract with a strike price of $30.00 per barrel for a notional amount of 6,000 barrels per month over a contract period from July through December 2004. During the three months and nine months ended September 30, 2004, approximately $19,000 and $104,000, respectively, is included as a decrease to Other Income in the Consolidated Condensed Statement of Operations to reflect the decrease in value of this crude oil floor contract associated with time value. Such crude oil floor contract is reflected in Prepaid Expenses and Other Assets in the Consolidated Condensed Balance Sheet at September 30, 2004 with a market value of approximately $14,000.

In January 2004, Harken purchased a natural gas floor contract with a strike price of $4.00 per MMBTU for a notional amount of 90,000 MMBTUs per month over the period of the contract from July 1, 2004 through December 31, 2004. This natural gas floor contract is reflected in Prepaid Expenses and Other Assets in the Consolidated Condensed Balance at September 30, 2004 with a market value of approximately $5,000. During the three months and nine months ended September 30, 2004, approximately $13,000 and $54,000, respectively, is included as a decrease to Other Income in the Consolidated Condensed Statement of Operations to reflect the decrease in value of this natural gas floor contract associated with time value.

In September 2004, Harken purchased a crude oil floor contract with a strike price of $30.00 per barrel for a notional amount of 6,000 barrels per month over a period of the contract from January 1, 2005 through December 31, 2005. This crude oil floor contract is reflected in Prepaid Expenses and Other Assets in the Consolidated Condensed Balance Sheet at September 30, 2004 with a market value of approximately $52,000.

Each of the above option floor contracts have been designated as cash flow hedges of the exposure from the variability of cash flows from future specified production from certain of Harken’s domestic property operations. Gains and losses from commodity derivative instruments are reclassified into earnings when the associated hedged production occurs. Harken holds no derivative instruments which are designated as either fair value hedges or foreign currency hedges. Settlements of oil and gas commodity derivatives are based on

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the difference between fixed option prices and the New York Mercantile Exchange closing prices for each month during the life of the contracts. Harken monitors its crude oil and natural gas production prices compared to New York Mercantile Exchange prices to assure its commodity derivatives are effective hedges in mitigating its commodity price risk.

Harken’s accounting policies for each of its operating segments are the same as those for its consolidated financial statements. There are no intersegment sales or transfers. Revenues and expenses not directly identifiable with either segment, such as certain general and administrative expenses, are allocated by Harken based on various internal and external criteria including an assessment of the relative benefit to each segment.

As of September 30, 2004, Harken has identified a new operating segment to reflect its investment in IBA. Harken’s financial information for each of its operating segments is as follows for the periods ended September 30, 2003 and 2004 (amounts in thousands):