CONTANGO OIL & GAS CO - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2004

Commission file number 001-16317

CONTANGO OIL & GAS COMPANY

(Exact name of registrant as specified in its charter)

Delaware

95-4079863

(State or other jurisdiction of

incorporation or organization)

(IRS Employer

Identification No.)

3700 Buffalo Speedway, Suite 960

Houston, Texas 77098

(Address of principal executive offices)

(713) 960-1901

(Issuer’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ¨ No x

Total number of shares of common stock, par value $0.04 per share, outstanding as of November 11, 2004 was 13,004,950.

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004

TABLE OF CONTENTS


		Page
PART I – FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Consolidated Balance Sheets as of September 30, 2004 and June 30, 2004		2

Consolidated Statements of Operations for the three months ended September 30, 2004 and 2003		4

Consolidated Statements of Cash Flows for the three months ended September 30, 2004 and 2003		5

Consolidated Statement of Stockholders’ Equity for the three months ended September 30, 2004 and 2003		6

Notes to the Consolidated Financial Statements		7-13

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		14

Item 3. Quantitative and Qualitative Disclosures about Market Risk		30

Item 4. Controls and Procedures		30

PART II – OTHER INFORMATION

Item 1. Legal Proceedings		30

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		30

Item 3. Defaults Upon Senior Securities		30

Item 4. Submission of Matters to a Vote of Security Holders		31

Item 5. Other Information		31

Item 6. Exhibits		31

All references in this Form 10-Q to the “Company”, “Contango”, “we”, “us” or “our” are to Contango Oil & Gas Company and its subsidiaries. Unless otherwise noted, all information in this Form 10-Q relating to natural gas and oil reserves and the estimated future net cash flows attributable to those reserves are based on estimates prepared by independent engineers and are net to our interest.

WEBSITE ACCESS TO REPORTS

General information about us can be found on our Website at www.contango.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments and exhibits to those reports, are available free of charge through our Website as soon as reasonably practicable after we file or furnish them to the Securities and Exchange Commission.

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS


	September 30, 2004			June 30, 2004
	(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents	$	132,611		$	396,753
Accounts receivable, net		4,445,962			4,715,748
Other		259,515			139,778

Total current assets		4,838,088			5,252,279

PROPERTY, PLANT AND EQUIPMENT:
Natural gas and oil properties, successful efforts method of accounting:
Proved properties		54,469,181			54,850,979
Unproved properties, not being amortized		5,483,952			7,540,678
Furniture and equipment		184,373			184,508
Accumulated depreciation, depletion and amortization		(28,386,229	)		(27,282,035	)

Total property, plant and equipment		31,751,277			35,294,130

OTHER ASSETS:
Cash held by affiliates		2,205,855			779,361
Investment in Freeport LNG project		2,333,333			2,333,333
Investment in Contango Venture Capital Corporation		489,012			500,000
Deferred income tax asset		1,412,640			1,188,407
Facility fee		157,376			157,579
Other		5,822			5,822

Total other assets		6,604,038			4,964,502

TOTAL ASSETS	$	43,193,403		$	45,510,911

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

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS’ EQUITY


	September 30, 2004			June 30, 2004
	(Unaudited)
CURRENT LIABILITIES:
Accounts payable	$	801,945		$	810,360
Accrued exploration and development		1,066,271			950,175
Income taxes payable		975,560			240,758
Other accrued liabilities		327,223			219,282

Total current liabilities		3,170,999			2,220,575

LONG-TERM DEBT		1,300,000			7,089,000

ASSET RETIREMENT OBLIGATION		88,677			84,805

STOCKHOLDERS’ EQUITY:
Convertible preferred stock, 6%, Series C, $0.04 par value, 4,000 shares authorized, 1,400 shares issued and outstanding at September 30, 2004 and 1,600 shares issued and outstanding at June 30, 2004, liquidation preference of $5,000 per share		56			64
Common stock, $0.04 par value, 50,000,000 shares authorized, 15,579,950 issued and 13,004,950 outstanding at September 30, 2004 and 14,885,700 issued and 12,310,700 outstanding at June 30, 2004		623,198			595,428
Additional paid-in capital		31,091,499			29,979,965
Treasury stock at cost (2,575,000 shares)		(6,180,000	)		(6,180,000	)
Retained earnings		13,098,974			11,721,074

Total stockholders’ equity		38,633,727			36,116,531

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	43,193,403		$	45,510,911

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

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three Months Ended September 30,
	2004			2003
REVENUES:
Natural gas and oil sales	$	6,672,242		$	8,252,504
Gain from hedging activities		—			82,242

Total revenues		6,672,242			8,334,746

EXPENSES:
Operating expenses		851,862			1,652,229
Exploration expenses		810,905			1,356,113
Depreciation, depletion and amortization		1,729,903			1,793,836
Impairment of natural gas and oil properties		112,000			—
General and administrative expense		812,473			377,107

Total expenses		4,317,143			5,179,285

INCOME FROM OPERATIONS		2,355,099			3,155,461

Interest expense		(48,976	)		(164,410	)
Interest income		17,853			14,416
Gain on sale of marketable securities		—			645,299
Gain (loss) on sale of assets and other		(40,506	)		1,054,605

INCOME BEFORE INCOME TAXES		2,283,470			4,705,371

Provision for income taxes		(800,570	)		(1,646,880	)

NET INCOME		1,482,900			3,058,491
Preferred stock dividends		105,000			150,000

NET INCOME ATTRIBUTABLE TO COMMON STOCK	$	1,377,900		$	2,908,491

NET INCOME PER SHARE:
Basic	$	0.11		$	0.31

Diluted	$	0.10		$	0.25

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic		12,867,906			9,298,650

Diluted		14,580,970			12,425,936

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

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	Three Months Ended September 30,
	2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	1,482,900		$	3,058,491
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, depletion and amortization		1,729,903			1,793,836
Impairment of natural gas and oil properties		112,000			—
Exploration expenditures		473,980			370,973
Benefit for deferred income taxes		(224,232	)		(635,935	)
(Gain) loss on sale of assets and other		40,506			(1,699,904	)
Unrealized gain on hedges		—			(82,242	)
Stock-based compensation		84,128			30,407
Changes in operating assets and liabilities:
Decrease in accounts receivable and others		322,061			1,853,911
Increase in prepaid insurance		(82,012	)		(132,961	)
Increase (decrease) in accounts payable		201,252			(359,461	)
Increase in other accrued liabilities		365,555			167,723
Increase in taxes payable		734,801			1,573,441
Other		228			15,381

Net cash provided by operating activities		5,241,070			5,953,660

CASH FLOWS FROM INVESTING ACTIVITIES:
Natural gas and oil exploration and development expenditures		(909,666	)		(166,751	)
Natural gas and oil exploration and development reimbursement		2,162,357			—
Increase in net investment in affiliates		(1,426,494	)		(800,762	)
Investment in Freeport LNG project		—			(300,000	)
Investment in Contango Venture Capital Corporation		(28,860	)		—
Purchase of marketable equity securities		—			(375,000	)
Proceeds from sales of marketable equity securities		—			834,474
Additions to furniture and equipment		(2,535	)		(4,136	)
Increase in advances to operators		(441,182	)		(1,827,447	)
Sales costs		—			(5,281	)
Proceeds from sale of assets		—			4,034,626

Net cash (used) provided in investing activities		(646,380	)		1,389,723

CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under credit facility		1,350,000			8,097,000
Repayments under credit facility		(7,139,000	)		(14,516,100	)
Repurchase/cancellation of stock options, warrants and others		—			(749,998	)
Preferred stock dividends		(105,000	)		(150,000	)
Proceeds from exercised options, warrants and others		1,055,168			—
Debt issue costs		(20,000	)		—

Net cash used by financing activities		(4,858,832	)		(7,319,098	)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(264,142	)		24,285
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		396,753			219,242

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	132,611		$	243,527

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for taxes	$	290,000		$	706,000

Cash paid for interest	$	58,460		$	151,946

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

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)


	For the Three Months Ended September 30, 2003
	Preferred Stock					Common Stock			Paid-in Capital			Treasury Stock			Retained Earnings			Total Shareholders’ Equity
	Shares		Amount			Shares	Amount		Paid-in Capital			Treasury Stock			Retained Earnings			Total Shareholders’ Equity
Balance at June 30, 2003	7,500		$	300		9,296,076	$	473,399	$	21,803,090		$	(6,180,000	)	$	4,640,725		$	20,737,514
Exercise of stock options	—			—		3,750		150		7,350			—			—			7,500
Cashless exercise of stock options	—			—		1,866		75		(75	)		—			—			—
Tax benefit from exercise of stock options	—			—		—		—		3,373			—			—			3,373
Expense of stock options	—			—		—		—		27,034			—			—			27,034
Repurchase/cancellation of stock options and warrants	—			—		—		—		(757,498	)		—			—			(757,498	)
Net income	—			—		—		—		—			—			3,058,491			3,058,491
Preferred stock dividends	—			—		—		—		—			—			(150,000	)		(150,000	)

Balance at September 30, 2003	7,500		$	300		9,301,692	$	473,624	$	21,083,274		$	(6,180,000	)	$	7,549,216		$	22,926,414


	For the Three Months Ended September 30, 2004
	Preferred Stock					Common Stock			Paid-in Capital			Treasury Stock			Retained Earnings			Total Shareholders’ Equity
	Shares		Amount			Shares	Amount		Paid-in Capital			Treasury Stock			Retained Earnings			Total Shareholders’ Equity
Balance at June 30, 2004	1,600		$	64		12,310,700	$	595,428	$	29,979,965		$	(6,180,000	)	$	11,721,074		$	36,116,531
Exercise of stock options and warrants	—			—		527,584		21,103		1,034,065			—			—			1,055,168
Expense of stock options	—			—		—		—		84,128			—			—			84,128
Partial conversion of Series C preferred stock	(200	)		(8	)	166,666		6,667		(6,659	)		—			—			—
Net income	—			—		—		—		—			—			1,482,900			1,482,900
Preferred stock dividends	—			—		—		—		—			—			(105,000	)		(105,000	)

Balance at September 30, 2004	1,400		$	56		13,004,950	$	623,198	$	31,091,499		$	(6,180,000	)	$	13,098,974		$	38,633,727

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

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete annual financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal recurring nature. Certain prior year amounts have been reclassified to conform to the current year presentation. The financial statements should be read in conjunction with the audited financial statements and notes included in Contango Oil & Gas Company’s (“Contango” or the “Company”) Form 10-K for the fiscal year ended June 30, 2004. The results of operations for the three months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2005.

1. Summary of Critical Accounting Policies

The application of generally accepted accounting principles involves certain assumptions, judgments, choices and estimates that affect reported amounts of assets, liabilities, revenues and expenses. Thus, the application of these principles can result in varying results from company to company. Contango’s critical accounting principles, which are described below, relate to the successful efforts method for costs related to natural gas and oil activities, consolidation principles and stock options.

Successful Efforts Method of Accounting. The Company follows the successful efforts method of accounting for its natural gas and oil activities. Under the successful efforts method, lease acquisition costs and all development costs are capitalized. Unproved properties are reviewed quarterly to determine if there has been impairment of the carrying value, and any such impairment is charged to expense in the period. Exploratory drilling costs are capitalized until the results are determined. If proved reserves are not discovered, the exploratory drilling costs are expensed. Other exploratory costs, such as seismic costs and other geological and geophysical expenses, are expensed as incurred. The provision for depreciation, depletion and amortization is based on the capitalized costs as determined above. Depreciation, depletion and amortization is on a cost center by cost center basis using the unit of production method, with lease acquisition costs amortized over total proved reserves and other costs amortized over proved developed reserves.

When circumstances indicate that proved properties may be impaired, the Company compares expected undiscounted future cash flows on a cost center basis to the unamortized capitalized cost of the asset. If the future undiscounted cash flows, based on the Company’s estimate of future natural gas and oil prices and operating costs and anticipated production from proved reserves, are lower than the unamortized capitalized cost, then the capitalized cost is reduced to fair market value.

On July 1, 2003, the Company changed its accounting policy for amortizing and impairing the Company’s natural gas and oil properties from a well-by-well cost center basis to a field-by-field cost center basis. Management believes the newly adopted policy is preferable in the circumstances to have greater comparability with other successful efforts natural gas and oil companies by conforming to predominant industry practice. In addition, the field level is consistent with the Company’s operational and strategic assessment of its natural gas and oil investments. The Company determined that the cumulative effect of the change in accordance with APB Opinion No. 20 was immaterial to the consolidated financial statements.

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

disproportionate allocations of their profits and losses among the owners. Accordingly, the Company determines its income or losses from the ventures based on a hypothetical liquidation determination of how increases or decreases in the book value of the ventures’ net assets will ultimately affect the cash payments to the Company in the event of dissolution.

By agreement, since the Company was the only owner that contributed cash to Republic Exploration and Magnolia Offshore Exploration, the Company consolidated 100% of the ventures’ net assets and results of operations until the ventures expended all of the Company’s initial cash contributions. Subsequent to that event, the owners’ share in the net assets of the ventures is based on their stated ownership percentages. By agreement, the owners in Contango Offshore Exploration immediately share in the net assets of Contango Offshore Exploration, including the initial Company cash contribution, based on their stated ownership percentages. The other owners of Republic Exploration, Magnolia Offshore Exploration and Contango Offshore Exploration contributed seismic data and related geological and geophysical services to the ventures.

Contango’s 10% limited partnership interest in Freeport LNG is accounted for at cost. As a 10% limited partner, the Company has no ability to direct or control the operations or management of the general partner.

Contango’s 32% ownership in Contango Capital Partnership Management, LLC and its 20% limited partnership interest in Trulite, L.P. are accounted for using the equity method. Under the equity method, only Contango’s investment in and amounts due to and from the equity investee are included in the consolidated balance sheet.

Recent Accounting Pronouncements. The Financial Accounting Standards Board (“FASB”) has issued several new pronouncements, including Interpretation No. 46 (revised December 2003) (“FIN 46R”), “Consolidation of Variable Interest Entities, an interpretation of ARB 51”, Statement of Financial Accounting Standards No. 149 (“SFAS 149”), “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” and Statement of Financial Accounting Standards No. 150 (“SFAS 150”), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”.

The primary objectives of FIN 46R are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (these entities are referred to as “variable interest entities” or “VIEs”) and how to determine if a business enterprise should consolidate the VIEs. This new model for consolidation applies to an entity for which either:

•

The equity investors (if any) do not have a controlling financial interest; or

•

The equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from other parties.

In addition, FIN 46R requires that all enterprises with a significant variable interest in a VIE make additional disclosures regarding their relationship with the VIE. The interpretation requires public entities to apply FIN 46R to all entities that are considered special purpose entities in practice and under the FASB literature that was applied before the issuance of FIN 46R by the end of the first reporting period that ends after December 15, 2003. Application of the accounting requirements of the interpretation to all other entities is required by the end of the first reporting period that ends after March 15, 2004. The adoption of FIN 46R had no effect on the Company’s financial statements.

SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and hedging activities under SFAS 133. The amendments set forth in SFAS 149 require that contracts with comparable characteristics be accounted for similarly. SFAS 149 is generally effective for contracts entered into or modified after June 20, 2003 (with limited exceptions) and for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively only. The adoption of SFAS 149 had no effect on the Company’s financial statements.

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of the first interim period beginning after June 15, 2003. It was to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of SFAS 150 and still existing at the beginning of the interim period of adoption. Restatement is not permitted. The adoption of SFAS 150 did not have an impact on the Company’s consolidated financial position or results of operations.

Stock-Based Compensation. Prior to the fiscal year-ended June 30, 2002, the Company accounted for employee stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”. Under the intrinsic method, compensation cost for stock options is measured as the excess, if any, of the fair value of the Company’s common stock at the date of the grant over the amount an employee must pay to acquire the common stock.

Effective July 1, 2001, the Company prospectively changed its method of accounting for employee stock-based compensation to the fair value based method prescribed in Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation”. Under the fair value based method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the award vesting period. The fair value of each award is estimated as of the date of grant using the Black-Scholes options-pricing model.

The Company has determined that the fair value method is preferable to the intrinsic value method previously applied. During the three months ended September 30, 2004 and 2003, the Company recorded a charge of $84,128 and $27,034 to general and administrative expense, respectively. Because compensation expense is recognized over a vesting period, the effect of applying the fair value method in the initial years of implementation may not be representative of the effects on net income (loss) that will be reported in future years.

2. Long-Term Debt

The Company’s credit facility is a secured, reducing revolving line of credit with Guaranty Bank, FSB, secured by natural gas and oil reserves. In September 2004, the borrowing base was redetermined to $21 million in two tranches. Tranche A provides for a borrowing base of $19 million and matures on June 29, 2006. This amount reduces by $595,000 per month the first day of each month beginning November 1, 2004. Borrowings under Tranche A bear interest, at the Company’s option, at either (i) LIBOR plus two percent (2%) or (ii) the bank’s base rate plus one-fourth percent (¹/4%) per annum. Additionally, the Company pays a quarterly commitment fee of three-eighths percent (³/8%) per annum on the average availability of Tranche A. Tranche B provides for a borrowing base of $2 million and matures on April 1, 2005. Borrowings under Tranche B will reduce by $595,000 per month the first day of each month following the month in which Tranche B is funded, with the final reduction on April 1, 2005. Further, any amounts borrowed and repaid under Tranche B cannot be reborrowed. Borrowings under Tranche B bear interest, at the Company’s option, at either (i) LIBOR plus three percent (3%) or (ii) the bank’s base rate plus three-quarters percent (³/4%) per annum. Additionally, the Company pays a quarterly commitment fee of one-half percent (¹/2%) per annum on the average availability under Tranche B.

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

related to working capital, funded debt to EBITDAX, and debt service coverage, as defined in the credit facility. Additionally, the credit facility contains certain negative covenants that, among other things, restrict or limit our ability to incur indebtedness, sell assets, pay dividends and reacquire or otherwise acquire or redeem capital stock. Failure to maintain required financial ratios or comply with the credit facility’s covenants can result in a default and acceleration of all indebtedness under the credit facility. The Company’s long-term debt as of the period indicated is as follows:


	September 30, 2004		June 30, 2004
Outstanding under line of credit	$	1,300,000	$	7,089,000
Current portion of long-term debt		—		—

Total long-term debt	$	1,300,000	$	7,089,000

As of September 30, 2004, the Company was in compliance with its financial covenants, ratios and other provisions of the credit facility.

3. Net Income per Common Share

The table below sets forth a reconciliation of the components of basic and diluted net income per common share for the periods indicated.


	Three Months Ended September 30, 2004
	Net Income		Shares	Per Share
Basic:
Net income attributable to common stock	$	1,377,900	12,867,906	$	0.11

Effect of potential dilutive securities:
Stock options and warrants		—	544,735
Series C preferred stock		105,000	1,168,329

Diluted:
Net income	$	1,482,900	14,580,970	$	0.10

Anti-dilutive securities:
Shares assumed not issued from options to purchase common shares as the exercise price was above the average market price for the period	$	—	21,000	$	7.37

	Three Months Ended September 30, 2003
	Net Income		Shares	Per Share
Basic:
Net income attributable to common stock	$	2,908,491	9,298,650	$	0.31

Effect of potential dilutive securities:
Stock options and warrants		—	990,923
Series A preferred stock		50,000	1,000,000
Series B preferred stock		100,000	1,136,363

Diluted:
Net income	$	3,058,491	12,425,936	$	0.25

Anti-dilutive securities:
Shares assumed not issued from options to purchase common shares as the exercise price was above the average market price for the period	$	—	225,000	$	4.45

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

4. Conversion of Series C Preferred Stock into Common Stock

On July 1, 2004, private institutional investors elected to convert 200 of the 1,600 outstanding shares of the Company’s Series C convertible cumulative preferred stock into 166,666 shares of Contango common stock.

5. Investment in Freeport LNG

In July 2004, Freeport LNG finalized its transaction with ConocoPhillips for the construction and use of the proposed liquefied LNG receiving terminal in Freeport, Texas. ConocoPhillips acquired 1 billion cubic feet per day of regasification capacity in the terminal, purchased a 50% interest in the general partner managing the Freeport LNG project and will provide substantial construction funding to the venture. This construction funding will be non-recourse to Contango. Freeport LNG and the ConocoPhillips team continue to negotiate the engineering, procurement and construction contract for the terminal. The current management of Freeport LNG will remain in place and will oversee the commercial activities of the partnership, while ConocoPhillips will manage the construction of the facility and oversee its operations.

6. Investment in Alternative Energy

In June 2004, our wholly owned subsidiary, Contango Venture Capital Corporation, acquired a 32% interest in Contango Capital Partnership Management, LLC. Contango Capital Partnership Management was formed by us and other investors to invest in the energy venture capital market with a focus on domestically sourced, environmentally preferred energy technologies and to expose us to leading edge technologies and opportunities in alternative energy markets. Our cash contribution of $0.5 million is being used to fund the initial overhead for the sourcing and management of energy venture capital investments. We hold two of six seats on the board of managers of Contango Capital Partnership Management, LLC.

In July 2004, Contango Venture Capital Corporation committed to invest $0.1 million as a limited partner in Trulite, L.P. As of September 30, 2004, Contango has invested $28,860. In October 2004, Contango invested an additional $40,000, bringing the Company’s total investment to approximately $69,000. Trulite is a developer of lightweight hydrogen generators for fuel cell systems. The general partner of Trulite is Contango Capital Partnership Management LLC. Contango Capital Partnership Management LLC assisted Trulite in raising $0.5 million of seed equity. The proceeds of this initial financing will be used to develop Trulite technology and to fund general operations.

7. Sale of Properties

In September 2003, the Company completed the sale of certain reserves in Brooks County, Texas for $5 million and recorded a gain of $984,000 for the year ended June 30, 2004. Proved reserves were 1.5 Bcfe and accounted for approximately $5 million of the Company’s discounted present value at 10% per annum as of June 30, 2003.

8. Repurchase of Certain Stock Options and Warrants

In September 2003, Contango paid $757,498 to certain related parties and cancelled certain stock options and warrants to purchase 336,666 shares of Contango common stock exercisable at $2.00 per share. These stock options and warrants were fully vested. Options to purchase an additional 33,334 shares of Contango common stock were also cancelled. In accordance with the terms of these stock options, vesting would never occur. Contango paid $2.25 per option. The fair market value of each option at the date of cancellation, using the Black-Scholes options-pricing model, was estimated at $2.69. Assumptions used in this estimate were: (i) risk-free interest rate of 3.28 percent; (ii) expected volatility of 36 percent; (iii) expected dividend yield of zero percent; and (iv) underlying stock price at the date of cancellation of $4.55.

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

9. Subsequent Events

In October 2004, the Company agreed to sell substantially all of its south Texas natural gas and oil interests to Edge Petroleum Corporation (“Edge”) for $50 million. The purchase price is subject to adjustment to reflect title defects, environmental remediation costs, and any failure to obtain third-party consents. The sale of these assets is subject to rights of first refusal held by the lessor of these interests, a right of the lessor to prohibit assignment of the interests, and the approval of a majority of the Company’s stockholders. The interests are leased by the Company under the terms of a number of leases. The lessor has a right of first refusal to purchase the Company’s interests in each of these leased premises on the same terms as contained in any bona fide third party offer for such interests accepted by the Company. In connection with the proposed sale to Edge, the lessor may exercise its right of first refusal under any or all of these leases. In the event lessor exercises the rights of first refusal under any such lease, such interests would be sold to lessor on substantially the same terms as set forth in the asset purchase agreement with Edge. Subject to the conditions to Edge’s obligations under its asset purchase agreement, Edge would purchase the remainder of the interests.

The Company has filed with the Securities and Exchange Commission a preliminary proxy statement that solicits stockholder approval of the proposed sale. The Securities and Exchange Commission has elected to review the preliminary proxy statement. Once the Company completes the review process, it intends to file a definitive proxy statement and mail the definitive proxy statement to stockholders to solicit their approval of the sale at a special meeting. We expect to hold the special meeting and complete the proposed asset sale by December 31, 2004.

The Company is selling its working and net revenue interests in natural gas and oil leases, wells, equipment, contracts, and seismic rights related to substantially all of its south Texas natural gas and oil properties. Current net production from the south Texas properties is approximately 11 million cubic feet of natural gas per day and 150 barrels of condensate per day. Total proved producing reserves attributable to the properties as of June 30, 2004 totaled approximately 14.4 Bcf of natural gas and 266,000 barrels of oil. Based on relevant spot prices at June 30, 2004 of $5.90 per MMbtu for natural gas at the Houston Ship Channel (which equates to a NYMEX price of $6.16 per MMbtu) and to a NYMEX oil price of $37.05 per barrel, in each case before adjusting for basis, transportation, and BTU content, the proved producing reserves had a present value of approximately $54.3 million, assuming a 10% discount rate. The south Texas natural gas and oil interests represent approximately 93% of the Company’s proved onshore reserves and 80% of its current production. Following the sale, the Company will have remaining production of approximately 3 MMcfe per day. Based on current prices and production rates, the Company anticipates production revenues of $400,000 to $500,000 per month, a level believed to be sufficient to pay its on-going cash general and administrative expenses of $175,000 to $200,000 per month.

The effective date of the sale will be July 1, 2004. Assuming the sale is completed in December 2004, the Company will have received approximately $7 million in net revenues for production during the four months of July, August, September and October. The Company thus would anticipate receiving approximately $43 million in pre-tax proceeds, with estimated taxes owed as a result of this sale of approximately $9 million. The Company anticipates net proceeds after tax and before debt repayment of approximately $34 million.

Initially, the Company expects to invest the proceeds from the sale in short-term U.S. government securities. These funds will provide working capital for ongoing operations and allow the Company to continue investing in its existing onshore exploration programs and to maintain its 10% limited partnership interest in the Freeport LNG plant, including any potential expansion in the plant’s capacity. The additional liquidity will give the Company the ability to consider acquiring a 5% to 20% working interest position on a prospect by prospect basis in the offshore Gulf of Mexico exploration opportunities being developed by its two partially owned subsidiaries, Republic Exploration, LLC and Contango Offshore Exploration, LLC and continue to invest in alternative energy projects.

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Under accounting principles generally accepted in the United States of America, upon stockholder approval of the proposed transaction, the Company expects to reflect the results of operations of the south Texas natural gas and oil interests sold as discontinued operations, including the related gain on the sale, net of any applicable taxes, commencing with the quarter during which the proposed sale closes.

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and the accompanying notes and other information included elsewhere in this Form 10-Q and in our Form 10-K for the fiscal year ended June 30, 2004, previously filed with the Securities and Exchange Commission.

Cautionary Statement about Forward-Looking Statements

Some of the statements made in this Form 10-K may contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, as amended. The words and phrases “should be”, “will be”, “believe”, “expect”, “anticipate”, “estimate”, “forecast”, “goal” and similar expressions identify forward-looking statements and express our expectations about future events. These include such matters as:

•

Our financial position

•

Business strategy and budgets

•

Anticipated capital expenditures

•

Drilling of wells

•

Natural gas and oil reserves

•

Timing and amount of future production of natural gas and oil

•

Operating costs and other expenses

•

Cash flow and anticipated liquidity

•

Prospect development

•

Property acquisitions and sales

•

Hedging results

•

Development and financing of our LNG receiving terminal

•

Anticipated sale of our south Texas natural gas and oil assets

Although we believe the expectations reflected in such forward-looking statements are reasonable, we cannot assure you that such expectations will occur. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from actual future results expressed or implied by the forward-looking statements. These factors include among others:

•

Low and/or declining prices for natural gas and oil

•

Natural gas and oil price volatility

•

The risks associated with exploration, including cost overruns and the drilling of non-economic wells or dry holes

•

Availability of capital and the ability to repay indebtedness when due

•

Ability to raise capital to fund capital expenditures

•

The ability to find, acquire, market, develop and produce new natural gas and oil properties

•

Uncertainties in the estimation of proved reserves and in the projection of future rates of production and timing of development expenditures

•

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 or pipeline mishaps

•

Weather

•

Availability and cost of material and equipment

•

Delays in anticipated start-up dates

•

Actions or inactions of third-party operators of our properties

•

Ability to find and retain skilled personnel

•

Strength and financial resources of competitors

•

Federal and state regulatory developments and approvals

•

Environmental risks

•

Worldwide economic conditions

•

Ability of LNG to become a competitive energy supply in the United States

•

Ability to fund our LNG project, cost overruns and third party performance

You should not unduly rely on these forward-looking statements in this Form 10-Q, as they speak only as of the date of this Form 10-Q. Except as required by law, we undertake no obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances occurring after the date of this Form 10-Q or to reflect the occurrence of unanticipated events. See the information under the heading “Risk Factors” in our Form 10-K for the year ended June 30, 2004 for some of the important factors that could affect our financial performance or could cause actual results to differ materially from estimates contained in forward-looking statements.

Overview

We are an independent natural gas and oil company engaged in the exploration, production and acquisition of natural gas and oil in the United States, both onshore Gulf Coast and offshore in the Gulf of Mexico. Our primary source of natural gas and oil production currently is in south Texas. We also own a 10% partnership interest in Freeport LNG Development, L.P., which is developing a 1.5 Bcf per day LNG receiving terminal in Freeport, Texas, and have a 32% interest in Contango Capital Partnership Management, LLC, which was formed to invest in the alternative energy venture capital market.

Our Strategy

Our exploration strategy is predicated upon two core beliefs: (1) that the only competitive advantage in the commodity-based natural gas and oil business is to be among the lowest cost producers and (2) that virtually all the exploration and production industry’s value creation occurs through the drilling of successful exploratory wells. As a result, our business strategy includes the following elements:

Funding exploration prospects developed by our alliance partners. Because we only have four employees, we depend on alliance partners for exploration, development and production expertise. Our four alliance partners, Juneau Exploration, L.P. (“JEX”), Alta Resources, LLC, Ameritex Minerals and Exploration, Ltd. and Coastline Exploration, Inc. perform all of our prospect generation and evaluation functions.

Negotiated acquisitions of proved properties. We continue to seek negotiated producing property acquisitions based on our view of the pricing cycles of natural gas and oil and available exploitation opportunities of probable and possible reserves. Since January 1, 2002, we have acquired approximately 14 Bcfe of proved developed producing reserves of natural gas and oil for approximately $26 million.

Sale of proved properties. From time-to-time as part of our business strategy, we may sell some or a substantial portion of our proved reserves to capture current value, using the sales proceeds to further our exploration activities. In July 2003, we sold producing properties consisting of 10 wells in south Texas for $5 million. In December 2003, Contango and its 33%-owned subsidiary, Republic Exploration LLC, sold all of their then producing Gulf of Mexico leases for approximately $12 million. In October 2004, we entered into an agreement to sell substantially all of our south Texas production for $50 million. We expect to close this transaction by year end 2004.

Controlling general and administrative and geological and geophysical costs. Our goal is to be among the highest in the industry in revenue and profit per employee and among the lowest in general and administrative costs. We plan to continue outsourcing our geological, geophysical, reservoir engineering and land functions, and partnering with cost efficient operators whenever possible. We have four employees.

Structuring transactions to minimize front-end investments. We seek to maximize returns on capital by minimizing our up-front investments in acreage, seismic data and prospect generation whenever possible. We want our partners to share in both the risk and the reward of our success.

Diversified energy investments. While our core focus is the domestic exploration and production business, we will continue to seek opportunities that may include foreign exploration prospects or investments related to new and developing energy sources such as LNG and alternative energy (see below).

Structuring incentives to drive behavior. We believe that equity ownership aligns the interests of our partners, employees, and stockholders. Our directors and executive officers beneficially own approximately 22% of our common stock. In addition, our alliance partners co-invest in prospects that they recommend to us.

Exploration Alliances with JEX, Alta Resources, Ameritex and Coastline

Alliance with JEX. JEX was our first alliance partner. Under our agreement with JEX, JEX generates natural gas and oil prospects and evaluates exploration prospects generated by others. In exchange, we have committed, within various parameters, to invest along with JEX up to 95% of the available working interest in the recommended prospects. In the Gulf of Mexico, JEX brings offshore exploration prospects directly to our affiliated companies, Republic Exploration, LLC and Contango Offshore Exploration, LLC (see “Offshore Gulf of Mexico Exploration Joint Ventures” below).

If JEX recommends an onshore prospect to Contango, we pay the lease and seismic costs, and JEX generally pays the remaining costs of generating and preparing a prospect to drill ready status. When drilling begins on a prospect, we are obligated to assign to the JEX geoscientists an overriding royalty interest equal to 3¹/3 % of our working interest in the prospect. In addition, when our revenues from prospects we invest in under the agreement, net of taxes, royalties and other expenses equals our capital expenditure related to the exploration and development of the prospects on a well-by-well basis, JEX is entitled to an assignment of 25% of our working interest in the well.

We may terminate the agreement upon 30 days written notice, and JEX may terminate the agreement upon 180 days notice. If we are in default under the agreement, however, JEX may terminate the agreement upon 30 days written notice.

Offshore prospects are typically generated by our partially owned subsidiaries, Republic Exploration LLC and Contango Offshore Exploration LLC. JEX is the managing partner of both entities. See “Offshore Gulf of Mexico Exploration Joint Ventures” below.

Alliance with Alta Resources. Alta Resources is a private company formed for the purpose of assembling domestic, onshore natural gas and oil prospects. Our arrangement with Alta Resources generally provides for us to pay our share of seismic and lease costs, with Alta Resources generally receiving a negotiated overriding royalty interest and a carried or back-in working interest.

Alliance with Ameritex. In February 2004, we entered into an exploration agreement with Ameritex, a privately held San Antonio based prospect generation and exploration company. Our participation percentage is typically a 33.3% working interest, with Ameritex being carried to casing point. Ameritex’s activities are concentrated on the generation of exploration opportunities utilizing 3-D seismic technology. The annual geological and geophysical cost to Contango for this prospect generation effort is approximately $80,000 per year.

Alliance with Coastline. Coastline is a private company engaged in domestic, onshore natural gas and oil exploration and production. In late 2003, we entered into our original agreement with Coastline to explore for and develop natural gas and oil prospects in Kenedy County, Texas. Our arrangement with Coastline generally provides for us to pay all leasehold costs, with Coastline generally receiving a negotiated overriding royalty interest and a carried working interest to casing point.

Domestic Onshore Exploration and Properties

JEX Activities

JEX was our first alliance partner. Between May 2000 and March 2004, we drilled 49 wells with JEX on our south Texas properties in Jim Hogg and Brooks Cos., Texas, resulting in 34 successes. We have no further drilling plans on this acreage.

While JEX continues a limited onshore exploration effort for us, JEX’s principle activity is the exploration management of our affiliated offshore Gulf of Mexico exploration companies. See “Offshore Gulf of Mexico Exploration and Joint Ventures”.

Alta Resources Activities

Contango and Alta Resources completed a 3-D seismic shoot covering approximately 40 square miles in southern Duval County, Texas. Using this data, Contango and Alta successfully drilled two Queen City prospects that commenced production in September 2004. Two additional shallow prospects have been identified and are expected to be drilled prior to calendar year end 2004.

During the quarter we participated with Alta in a second exploratory Queen City well in Jim Hogg County, Texas, which has been plugged and abandoned. Our 45% share of the dry hole cost is estimated at $0.4 million. We have recently elected to participate in an exploratory well in Bandera County, Texas that we expect to drill by mid-year 2005. Our 50% share of the dry hole cost is estimated at $0.6 million.

Ameritex Activities

In February 2004, we entered into an exploration agreement with Ameritex. Ameritex has currently identified eight prospect areas. Amertiex has successfully drilled an 11,400-foot Wilcox test in one prospect area in Zapata County, Texas. We have a 14% net revenue interest in this well. Another Wilcox test is planned for a second prospect area in Zapata County, Texas next year. Our 18.8% share of the dry hole cost is estimated at approximately $0.8 million. Prospect generation is continuing on identified prospect areas.

Coastline Activities

In September 2004, we entered into an agreement with Coastline to generate prospects in Jim Hogg County, Texas using available 3-D seismic data. Contango has reimbursed Coastline $100,000 for geological and geophysical costs. If drillable prospects are identified, we will pay all of the prospect leasehold costs and carry Coastline on a portion of the drilling costs on a specified number of wells. In addition, Coastline will receive an overriding royalty interest.

Proposed Sale of South Texas Properties

In October 2004, we agreed to sell substantially all of our south Texas natural gas and oil interests to Edge Petroleum Corporation for $50 million. The purchase price is subject to adjustment to reflect title defects, environmental remediation costs, and any failure to obtain third-party consents. The sale of these assets is subject to rights of first refusal held by the lessor of these interests, a right of the lessor to prohibit assignment of the interests, and the approval of a majority of our stockholders. The interests are leased by us under the terms of a number of leases. The lessor has a right of first refusal to purchase our interests in each of these leased premises on the same terms as contained in any bona fide third party offer for such interests accepted by us. In connection with our proposed sale to Edge, the lessor may exercise its right of first refusal under any or all of these leases. In the event lessor exercises the rights of first refusal under any such lease, such interests would be sold to lessor on substantially the same terms as set forth in the asset purchase agreement with Edge. Subject to the conditions to Edge’s obligations under its asset purchase agreement, Edge would purchase the remainder of the interests.

We have filed with the Securities and Exchange Commission a preliminary proxy statement that solicits stockholder approval of the proposed sale. The Securities and Exchange Commission has elected to review the preliminary proxy statement. Once we complete the review process, we intend to file a definitive proxy statement and mail the definitive proxy statement to our stockholders to solicit their approval of the sale at a special meeting. We expect to hold the special meeting and complete the proposed asset sale by December 31, 2004.

We are selling our working and net revenue interests in natural gas and oil leases, wells, equipment, contracts, and seismic rights related to substantially all of our south Texas natural gas and oil properties. Current net production from the south Texas properties is approximately 11 million cubic feet of natural gas per day and 150 barrels of condensate per day. Total proved producing reserves attributable to the properties as of June 30, 2004 totaled approximately 14.4 Bcf of natural gas and 266,000 barrels of oil. Based on relevant spot prices at June 30, 2004 of $5.90 per MMbtu for natural gas at the Houston Ship Channel (which equates to a NYMEX price of $6.16 per MMbtu) and to a NYMEX oil price of $37.05 per barrel, in each case before adjusting for basis, transportation, and BTU content, the proved producing reserves had a present value of approximately $54.3 million, assuming a 10% discount rate. The south Texas natural gas and oil interests represent approximately 93% of our proved onshore reserves and 80% of our current production. Following the sale, we will have remaining production of approximately 3 MMcfe per day. Based on current prices and production rates, we anticipate production revenues of $400,000 to $500,000 per month, a level believed to be sufficient to pay our on-going cash general and administrative expenses of $175,000 to $200,000 per month.

The effective date of the sale will be July 1, 2004. Assuming the sale is completed in December 31, 2004, we estimate we will have received approximately $7 million in net revenues for production during the four months of July, August, September and October. We thus would anticipate receiving approximately $43 million in pre-tax proceeds, with estimated taxes owed as a result of this sale of approximately $9 million. We anticipate net proceeds after tax and before debt repayment of approximately $34 million.

Initially, we expect to invest the proceeds from the sale in short-term U.S. government securities. These funds will provide working capital for ongoing operations and allow us to continue investing in our existing onshore exploration programs and to maintain our 10% limited partnership interest in the Freeport LNG plant, including any potential expansion in the plant’s capacity. The additional liquidity will give us the ability to consider acquiring a 5% to 20% working interest position on a prospect by prospect basis in the offshore Gulf of Mexico exploration opportunities being developed by our two partially owned subsidiaries, Republic Exploration, LLC and Contango Offshore Exploration, LLC and continue to invest in alternative energy projects.

Under accounting principles generally accepted in the United States of America, upon stockholder approval of the proposed transaction, we expect to reflect the results of operations of the south Texas natural gas and oil interests sold as discontinued operations, including the related gain on the sale, net of any applicable taxes, commencing with the quarter during which the proposed sale closes.

Offshore Gulf of Mexico Exploration Joint Ventures

Contango directly and through affiliated companies conducts exploration activities in the Gulf of Mexico. Currently, Contango and its affiliates have interests in 42 offshore leases. See “Offshore Properties” below for additional information on our offshore properties.

Contango owns an equity interest in Republic Exploration and Contango Offshore Exploration, formed for the purpose of generating exploration opportunities in the Gulf of Mexico. These companies have collectively licensed approximately 4,000 blocks of 3-D seismic data and have focused on identifying prospects, acquiring leases at federal and state lease sales and then selling the prospects to third parties, subject to timed drilling obligations plus retained reversionary interests in favor of Republic Exploration and Contango Offshore Exploration. In the future, Contango may choose to take a direct working interest in some of these prospects under the same arms-length terms available to industry partners. JEX is the managing member of Republic Exploration and Contango Offshore Exploration.

Republic Exploration LLC. Contango has invested approximately $5.8 million in Republic Exploration for a 33.3% ownership interest. The other members of Republic Exploration are JEX, its managing member, and a privately held seismic company. Both have comprehensive offshore experience. Republic Exploration holds a non-exclusive license to approximately 1,700 blocks of 3-D seismic data in the shallow waters of the Gulf of Mexico. This data is used to identify, acquire and exploit natural gas and oil prospects. All leases owned by Republic Exploration are subject to a 3.3% overriding royalty interest in favor of the JEX exploration team. See “Offshore Properties” below for more information on Republic Exploration’s offshore properties.

Contango Offshore Exploration LLC. Contango purchased a 66.7% interest in Contango Offshore Exploration in September 2002. JEX is the only other member and acts as the managing member. Contango Offshore Exploration’s activities will be focused on identifying and purchasing prospects in the Gulf of Mexico and selling them to third parties, retaining a reversionary interest. Contango Offshore Exploration has invested approximately $13.6 million to acquire and reprocess 2,294 blocks of 3-D seismic data and to acquire leases in the Gulf of Mexico. All leases will be subject to a 3.3% overriding royalty interest in favor of the JEX exploration team. See “Offshore Properties” below for additional information on Contango Offshore Exploration’s properties.

Current Activities. In May 2003, Contango and Republic Exploration farmed out Eugene Island 113B. This well is currently being prepared for testing. Republic Exploration and Contango Offshore Exploration recently farmed out seven lease blocks, Vermilion 73, West Cameron 174, Eugene Island 76, Vermilion 154, Main Pass 221and East Breaks 369 and 370. An exploratory well to test a deep sand on Vermilion 73 was unsuccessfully drilled earlier this year, and a recently drilled shallower formation was a dry hole. West Cameron 174, Eugene Island 76 and Main Pass 221 are expected to be drilled in 2005. A timetable for drilling Vermilion 154 and East Breaks 369 and 370 has not been determined at this time. Republic Exploration has sold the NE/4 of West Cameron 133. The remainder of the block is available for farm-out.

The Minerals Management Service (“MMS”) has implemented a rule on royalty relief for shallow water, deep natural gas production from certain Gulf of Mexico leases. “Deep shelf gas” refers to natural gas produced from depths greater than 15,000 feet in waters of 200 meters or less. Royalty relief is available on the first 15 Bcf of natural gas production if produced from an interval between 15,000 to less than 18,000 feet. Royalty relief is available on the first 25 Bcf of natural gas production if produced from well depths greater than 18,000 feet. This royalty relief is expected to have a positive impact on the economics of deep gas wells drilled on the shelf of the Gulf of Mexico.

Offshore Properties

The following table sets forth the interests owned by Contango and related entities in the Gulf of Mexico as of November 11, 2004:


Area/Block	WI		NRI		Acquired	Status
Contango Oil & Gas Company:
East Cameron 107	33.8	%	27.0	%	May-01	Available for farm-out
Eugene Island 113B	(2	)	(2	)	May-01	Farmed-out, being prepared for testing

Area/Block	WI		NRI		Acquired	Status
Republic Exploration (1):
East Cameron 107	66.2	%	53.0	%	May-01	Available for farm-out
Eugene Island 113B	(2	)	(2	)	May-01	Farmed-out, being prepared for testing
West Delta 36	100.0	%	80.0	%	May-02	Available for farm-out
Vermilion 73	(3	)	(3	)	Jul-02	Dry hole
West Cameron 174	(4	)	(4	)	Jun-03	Farmed out; drilling expected 1Q2005
High Island 113	100.0	%	80.0	%	Sep-03	Available for farm-out
South Timbalier 191	50.0	%	40.0	%	May-04	Available for farm-out
Vermilion 36	100.0	%	80.0	%	May-04	Available for farm-out
Vermilion 109	100.0	%	80.0	%	May-04	Available for farm-out


Vermilion 134	100.0	%	80.0	%	May-04	Available for farm-out
West Cameron 179	100.0	%	80.0	%	May-04	Available for farm-out
West Cameron 185	100.0	%	80.0	%	May-04	Available for farm-out
West Cameron 200	100.0	%	80.0	%	May-04	Available for farm-out
West Delta 18	100.0	%	80.0	%	May-04	Available for farm-out
West Delta 33	100.0	%	80.0	%	May-04	Available for farm-out
West Delta 34	100.0	%	80.0	%	May-04	Available for farm-out
West Delta 43	100.0	%	80.0	%	May-04	Available for farm-out
Ship Shoal 220	50.0	%	40.0	%	May-04	Available for farm-out
South Timbalier 240	50.0	%	40.0	%	May-04	Available for farm-out
Eugene Island 76	(4	)	(4	)	Jul-04	Farmed out; drilling expected 1Q2005
South Marsh Island 247	(5	)	(5	)	Jul-04	Subject to farm-out option
Vermilion 130	100.0	%	80.0	%	Jul-04	Available for farm-out
West Cameron 80	100.0	%	80.0	%	Jul-04	Available for farm-out
West Cameron 133	(6	)	(6	)	May-04	NE/4 sold, remainder available for farm-out
West Cameron 167	100.0	%	80.0	%	Jul-04	Available for farm-out
Vermilion 154	(7	)	(7	)	Jul-04	Farmed out; drilling schedule undetermined

Area/Block	WI		NRI		Acquired	Status
Contango Offshore Exploration (1):
Vermilion 231	100.0	%	80.0	%	May-03	Available for farm-out
Viosca Knoll 167	100.0	%	80.0	%	May-03	Available for farm-out
Eugene Island 209	100.0	%	80.0	%	Jun-03	Available for farm-out
Viosca Knoll 161	100.0	%	80.0	%	Jun-03	Available for farm-out
High Island A16	100.0	%	80.0	%	Nov-03	Available for farm-out
East Breaks 283	100.0	%	80.0	%	Nov-03	Available for farm-out
East Breaks 369	(8	)	(8	)	Nov-03	Farmed out; drilling schedule undetermined
East Breaks 370	(8	)	(8	)	Nov-03	Farmed out; drilling schedule undetermined
South Timbalier 191	50.0	%	40.0	%	May-04	Available for farm-out
Grand Isle 63	100.0	%	80.0	%	Jun-04	Available for farm-out
Grand Isle 72	100.0	%	80.0	%	Jun-04	Available for farm-out
Grand Isle 73	100.0	%	80.0	%	Jun-04	Available for farm-out
Ship Shoal 220	50.0	%	40.0	%	May-04	Available for farm-out
South Timbalier 240	50.0	%	40.0	%	May-04	Available for farm-out
Main Pass 221	(9	)	(9	)	Jul-04	Farmed out; drilling expected 2005
Viosca Knoll 118	100.0	%	80.0	%	May-04	Available for farm-out
Vermilion 154	(7	)	(7	)	Jul-04	Farmed out; drilling schedule undetermined
Ship Shoal 358, A-3 well	10.0	%	7.7	%	May-04	Producing

Area/Block	WI		NRI		Acquired	Status
Magnolia Offshore Exploration (1):
Ship Shoal 155	100.0	%	80.0	%	May-02	Available for farm-out
Viosca Knoll 75	100.0	%	80.0	%	May-02	Available for farm-out

(1)	Contango has a 33.3% interest in Republic Exploration, 50% interest in Magnolia Offshore Exploration (subject to a third party net profits interest) and 66.7% interest in Contango Offshore Exploration. Magnolia Offshore Exploration does not intend to acquire any additional leases.

(2)	Contango (33.75%) and Republic Exploration (66.25%) will collectively have a 5% overriding royalty interest (1.7% and 3.3%, respectively).

(3)	Republic Exploration has a 5% of 8/8 ORRI before payout. At payout, Republic Exploration has the option, but not the obligation, to convert the ORRI to a 25% WI (20% NRI).

(4)	Republic Exploration has a 5% of 8/8 ORRI in the lease before payout. Upon payout, Republic Exploration will elect to either (i) escalate its ORRI in the lease from 5% to 8-1/3% of 8/8 or (ii) convert the 5% ORRI to a 25% WI (20% NRI).

(5)	If optionee elects to drill a well on this block, it will be subject to the terms set forth under (3) above.

(6)	Republic Exploration has no interest in the NE/4 of the block. The remainder of the block, which is available for farm-out, is owned by Republic Exploration 100% WI (80% NRI).

(7)	Republic Exploration and Contango Offshore Exploration will split a 25% back-in WI after payout.

(8)	Contango Offshore Exploration has a 4.267% ORRI before payout and a 7.27% ORRI after payout.

(9)	Contango Offshore Exploration has a 5% of 8/8 ORRI in lease before payout. Upon payout, Contango Offshore Exploration’s ORRI will escalate to 7.2% of 8/8.

Freeport LNG Development, L.P.

In March 2003, we exercised an option to purchase from Cheniere Energy, Inc. a 10% limited partnership interest in Freeport LNG Development, L.P. (“Freeport LNG Project” and “Freeport LNG”), a limited partnership formed to develop a 1.5 billion cubic feet per day LNG receiving terminal in Freeport, Texas. The $2.3 million cost to acquire our 10% limited partnership interest was paid as of June 30, 2004, including a final payment of $0.4 million paid in June 2004 upon receipt of Federal Energy Regulatory Commission (“FERC”) approval for the project.

In June 2003, Dow Chemical Company signed an agreement with Freeport LNG for the potential long-term use of the receiving terminal. Under the agreement, Dow had regasification rights to 500 million cubic feet per day beginning with commercial start-up of the facility expected in 2007. On March 1, 2004, Freeport LNG and Dow entered into a 20-year Terminal Use Agreement providing for a firm commitment by Dow for the use of 250 million cubic feet per day of regasification capacity and an option to acquire an additional 250 million cubic feet per day of regasification capacity. Dow has exercised its rights to the full 500 million cubic feet per day of regasification capacity.

In June 2004, FERC issued an Order under Section 3 of the Natural Gas Act authorizing Freeport LNG to site, construct and operate a liquefied natural gas receiving terminal in Freeport, Texas. In September 2004, FERC extended until June 2009 the time Freeport LNG has to put the LNG terminal into service.

Although we believe that a majority of the Freeport LNG financing will be provided by construction funding through ConocoPhillips, we anticipate that we may, from time-to-time, be required to provide funds to the project. Moreover, if the plant’s capacity were to be expanded beyond its current anticipated 1.5 Bcf per day, we would likely be required to provide our pro rata 10% equity participation to help secure the funds required for expanding the plant’s capacity.

Contango Venture Capital Corporation

In July 2004, Contango Venture Capital Corporation committed to invest $0.1 million as a limited partner in Trulite, L.P. To date, Contango Venture Capital has invested approximately $69,000. Trulite is a developer of lightweight hydrogen generators for fuel cell systems. The general partner of Trulite is Contango Capital Partnership Management LLC. Contango Capital Partnership Management LLC assisted Trulite in raising $0.5 million of seed equity. The proceeds of this initial financing will be used to develop Trulite technology and to fund general operations. Over time, it is likely that we will increase our investment in Trulite, L.P.

Critical Accounting Policies

Principles of Consolidation. The Company’s consolidated financial statements include the accounts of Contango Oil & Gas Company and its subsidiaries and affiliates, after elimination of all intercompany balances and transactions. Wholly owned subsidiaries are fully consolidated. Subsidiaries not wholly owned, such as 33.3% owned Republic Exploration LLC (“Republic Exploration”), 50% owned Magnolia Offshore Exploration LLC (“Magnolia Offshore Exploration”) and 66.7% owned Contango Offshore Exploration LLC (“Contango Offshore Exploration”) are not controlled by the Company and are proportionately consolidated. By agreement, Republic Exploration, Magnolia Offshore Exploration and Contango Offshore Exploration have disproportionate allocations of their profits and losses among the owners. Accordingly, the Company determines its income or losses from the ventures based on a hypothetical liquidation determination of how increases or decreases in the book value of the ventures’ net assets will ultimately affect the cash payments to the Company in the event of dissolution.

•

The equity investors (if any) do not have a controlling financial interest; or

•

The equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from other parties.

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

Selected Financial Data


	Three Months Ended September 30,
	2004			2003
	(Dollar amounts in 000s, except per share amounts)
Financial Data:
Revenues:
Natural gas and oil sales	$	6,672		$	8,253
Gain from hedging activities		—			82

Total revenues	$	6,672		$	8,335

Net income	$	1,483		$	3,058
Preferred stock dividends		105			150

Net income attributable to common stock	$	1,378		$	2,908

Net income per share:
Basic	$	0.11		$	0.31
Diluted	$	0.10		$	0.25

Weighted average shares outstanding:
Basic		12,868			9,299
Diluted		14,581			12,426
EBITDAX (1)	$	4,967		$	8,005

Production Data:
Natural gas (million cubic feet)		979			1,363
Oil and condensate (thousand barrels)		19			36
Total (million cubic feet equivalent)		1,093			1,579
Natural gas (thousand cubic feet per day)		10,641			14,814
Oil and condensate (barrels per day)		207			387
Total (thousand cubic feet equivalent per day)		11,883			17,136

Average sales price:
Natural gas (per thousand cubic feet)	$	5.98		$	5.29
Oil and condensate (per barrel)	$	42.27		$	29.23

Selected data per Mcfe:
Production and severance taxes	$	(0.02	)	$	0.37
Lease operating expenses	$	0.80		$	0.67
General and administrative expenses	$	0.74		$	0.24
Depreciation, depletion and amortization of natural gas and oil properties	$	1.55		$	1.12

(1)

EBITDAX represents earnings before interest, income taxes, depreciation, depletion and amortization, impairment expenses, exploration expenses, including gain (loss) from hedging activities, and sale of assets and other. We have reported EBITDAX because we believe EBITDAX is a measure commonly reported and widely used by investors as an indicator of a company’s operating performance and ability to incur and service debt. We believe EBITDAX assists investors in comparing a company’s performance on a consistent basis without regard to depreciation, depletion and amortization, impairment of natural gas and oil properties and exploration expenses, which can vary significantly depending upon accounting methods. EBITDAX is not a calculation based on U.S. generally accepted accounting principles and should not be considered an alternative to net income (loss) in measuring our performance or used as an exclusive measure of cash flow because it does not consider the impact of working capital growth, capital expenditures, debt principal reductions and other sources and uses of cash, which are disclosed in our statements of cash flows. Investors should carefully consider the specific items included in our computation of EBITDAX. While we have disclosed our EBITDAX to permit a more

complete comparative analysis of our operating performance and debt servicing ability relative to other companies, investors should be cautioned that EBITDAX as reported by us may not be comparable in all instances to EBITDAX as reported by other companies. EBITDAX amounts may not be fully available for management’s discretionary use, due to requirements to conserve funds for capital expenditures, debt service, preferred stock dividends and other commitments.

A reconciliation of EBITDAX to income from operations for the periods indicated is presented below.


	Three Months Ended September 30,
	2004			2003
	($000)
Income from operations	$	2,355		$	3,155
Exploration expenses		811			1,356
Depreciation, depletion and amortization		1,730			1,794
Impairment of natural gas and oil properties		112			—
Gain on sale of marketable securities		—			645
Gain (loss) on sale of assets and other		(41	)		1,055

EBITDAX	$	4,967		$	8,005

Overview

We are an independent natural gas and oil company engaged in the exploration, production and acquisition of natural gas and oil in the United States, both onshore Gulf Coast and offshore in the Gulf of Mexico. Our primary source of natural gas and oil production currently is in south Texas. We also own a 10% partnership interest in Freeport LNG Development, L.P., which is developing a 1.5 Bcf per day LNG receiving terminal in Freeport, Texas and have a 32% interest in Contango Capital Partnership Management, LLC, which was formed to invest in the alternative energy venture capital market.

Revenues and Profitability. Our revenues, profitability and future growth depend substantially on prevailing prices for natural gas and oil and on our ability to find, develop and acquire natural gas and oil reserves that are economically recoverable and the completion and successful operation of our Freeport LNG project. The preparation of our financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect our reported results of operations and the amount of reported assets, liabilities and proved natural gas and oil reserves. We use the successful efforts method of accounting for our natural gas and oil activities.

Reserve Replacement. Generally, our producing properties onshore Gulf Coast and offshore in the Gulf of Mexico have high initial production rates, followed by steep declines. As a result, we must locate and develop or acquire new natural gas and oil reserves to replace those being depleted by production. Substantial capital expenditures are required to find, develop and acquire natural gas and oil reserves.

Use of Estimates. The preparation of our financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates with regard to these financial statements include estimates of remaining proved natural gas and oil reserves and the timing and costs of our future drilling, development and abandonment activities.

Three Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003

Natural Gas and Oil Sales. We reported natural gas and oil sales of approximately $6.7 million for the three months ended September 30, 2004, down from approximately $8.3 million reported for the three months ended September 30, 2003. This decrease was attributable to normal production declines in existing fields and the sale of certain production in Brooks County, Texas in 2003 that were partially offset by higher prices for our natural gas and oil production.

Natural Gas and Oil Production and Average Sales Prices. Our net natural gas production for the three months ended September 30, 2004 was approximately 10.6 million cubic feet of natural gas per day, down from approximately 14.8 million cubic feet of natural gas per day for the three months ended September 30, 2003. Net oil production for the comparable periods decreased from 387 barrels of oil per day to 207 barrels of oil per day. This decrease was due to the natural decline in production from our south Texas properties as well as the sale of certain production in Brooks County, Texas in 2003. For the three months ended September 30, 2004, prices for natural gas and oil were $5.98 per Mcf and $42.27 per barrel, compared to $5.29 per Mcf and $29.23 per barrel for the three months ended September 30, 2003.

Operating Expenses. Operating expenses, including severance taxes, for the three months ended September 30, 2004 were approximately $0.9 million. Included in this amount was approximately $0.8 million of lease operating expense, approximately $0.1 million for workover costs and a $22,000 credit for production and severance taxes. The Railroad Commission of Texas has extended the natural gas incentive allowing for severance tax reduction on tight sand gas wells. As a result, some of our south Texas Queen City formation properties are eligible for severance tax reduction. The $22,000 credit for production and severance taxes for the three months ended September 30, 2004 was attributable to lower severance taxes and historic adjustments as a result of this severance tax reductions and to lower overall costs of operations resulting from lower production. You should not necessarily expect comparable low levels of production and severance taxes in future reporting periods.

Operating expenses, including severance taxes, for the three months ended September 30, 2003 were approximately $1.7 million. Of the $1.7 million reported, approximately $0.9 million was attributable to lease operating expense, approximately $0.6 million was attributable to production and severance taxes and $0.2 million was attributable to workover costs.

Exploration Expense. We reported approximately $0.8 million of exploration expenses for the three months ended September 30, 2004. Of this amount, approximately $0.3 million was attributable to the cost to acquire and reprocess 3-D seismic data both onshore and offshore in the Gulf of Mexico, $0.2 million was spent on various other geological and geophysical activities, and $0.3 million was related to unsuccessful wells drilled in south Texas during the period. We reported approximately $1.4 million of exploration expenses for the three months ended September 30, 2003. Of this amount, approximately $0.9 million was attributable to the cost to shoot, acquire and reprocess 3-D seismic data in south Texas, approximately $0.3 million was attributable to the cost to acquire and reprocess 3-D seismic data offshore in the Gulf of Mexico and $0.1 million was related to a shallow dry hole drilled in south Texas during the period.

Depreciation, Depletion and Amortization. Depreciation, depletion and amortization for the three months ended September 30, 2004 was approximately $1.7 million. For the three months ended September 30, 2003, we recorded approximately $1.8 million of depreciation, depletion and amortization. The decrease in depreciation, depletion and amortization was primarily the result of lower production from our south Texas properties.

Impairment of Natural Gas and Oil Properties. We reported an impairment of natural gas and oil properties of approximately $0.1 million for the three months ended September 30, 2004. This was attributable to a writedown of costs associated with a small Barnett Shale exploratory play undertaken during the summer of 2003 that has had only marginal success.

General and Administrative Expenses. General and administrative expenses for the three months ended September 30, 2004 were approximately $0.8 million, up from $0.4 million for the three months ended September 30, 2003. Major components of general and administrative expenses for the three months ended September 30, 2004 included approximately $0.3 million in salaries and benefits, $0.1 million in legal, accounting, engineering and other professional fees, $0.1 million of office administration, $0.1 million of insurance costs and $0.1 million in other expenses. Also included in total general and administrative expenses for the three months ended September 30, 2004 was approximately $0.1 million related to the cost of expensing stock options. The increase in general and

administrative expenses was attributable to overall higher expenses including higher salaries primarily resulting from bonuses paid, increases in legal fees related to business transactions, greater office administration costs, increases in premiums for directors and officers insurance and increased stock option expense resulting from a higher level of option grants.

Interest Expense. We reported interest expense of approximately $49,000 for the three months ended September 30, 2004, down from the approximate $0.2 million reported for the three months ended September 30, 2003. This decrease primarily was attributable to lower average levels of borrowings under our bank line of credit.

Gain (loss) on Sale of Assets and Other. We reported a loss of approximately $40,500 for the three months ended September 30, 2004, representing operating losses related to our alternative energy investments. Effective July 1, 2003, we sold properties within our south Texas exploration program consisting of 10 wells in Brooks County, Texas for $5 million, resulting in a gain of approximately $1.1 million at September 30, 2003.

Capital Resources and Liquidity

During the three months ended September 30, 2004, we funded our activities with internally generated cash flow and bank borrowings. We currently expect to spend $10 million to $20 million on natural gas and oil exploration activities during fiscal year 2005. The majority of our spending will be for various exploration activities. We reported total revenues and EBITDAX for the three months ended September 30, 2004 of approximately $6.7 million and $5 million, respectively. Our current production rate is approximately 14 MMBtue per day. At anticipated production levels and current commodity price levels, we expect to have EBITDAX of $1.5 million to $2 million per month through December 31, 2004.

In October 2004, we agreed to sell substantially all of our south Texas natural gas and oil interests for $50 million. Following the sale, which we expect to close by December 31, 2004, we will have remaining production of approximately 3.0 MMcfe per day. Based on current prices and production rates, we anticipate going forward production revenues will be $400,000 to $500,000 per month, a level believed to be sufficient to pay our on-going cash general and administrative expenses of $175,000 to $200,000 per month. Assuming the sale is completed by year end 2004, we anticipate receiving net proceeds of approximately $34 million after tax and before debt repayment, if any. Initially, we expect to invest the proceeds from the sale in short-term U.S. government and other short-term investment grade securities. These funds will provide working capital for ongoing operations and allow us to continue investing in our existing onshore exploration programs and to maintain our 10% limited partnership interest in the Freeport LNG plant, including any potential expansion in the plant’s capacity. The additional liquidity will give us the ability to consider acquiring a 5% to 20% working interest position on a prospect by prospect basis in the offshore Gulf of Mexico exploration opportunities being developed by our two partially owned subsidiaries, Republic Exploration and Contango Offshore Exploration and continue to invest in alternative energy projects.

We believe that our cash on hand, our anticipated cash flow from operations and funds available under our credit facility will be adequate over the next twelve months to satisfy planned capital expenditures to fund drilling activities, our share of construction costs related to the Freeport LNG receiving terminal and incremental investments in Contango Venture Capital Corporation and to satisfy general corporate needs. We may seek additional equity, sell assets or seek other financing to fund our exploration program and to take advantage of other opportunities that may become available. The availability of such funds will depend upon prevailing market conditions and other factors over which we have no control, as well as our financial condition and results of operations.

Credit Facility

Our credit facility is a secured, reducing revolving line of credit with Guaranty Bank, FSB, secured by our natural gas and oil reserves. In September 2004, the borrowing base was redetermined to $21 million in two tranches. Tranche A provides for a borrowing base of $19 million and matures on June 29, 2006. This amount reduces by $595,000 per month the first day of each month beginning November 1, 2004. Borrowings under Tranche A bear interest, at our option, at either (i) LIBOR plus two percent (2%) or (ii) the bank’s base rate plus one-fourth percent (1/4%) per annum. Additionally, we pay a quarterly commitment fee of three-eighths percent

(3/8%) per annum on the average availability of Tranche A. Tranche B provides for a borrowing base of $2 million and matures on April 1, 2005. Borrowings under Tranche B will reduce by $595,000 per month the first day of each month following the month in which Tranche B is funded, with the final reduction on April 1, 2005. Further, any amounts borrowed and repaid under Tranche B cannot be reborrowed. Borrowings under Tranche B bear interest, at the Company’s option, at either (i) LIBOR plus three percent (3%) or (ii) the bank’s base rate plus three-quarters percent (3/4%) per annum. Additionally, we pay a quarterly commitment fee of one-half percent (1/2%) per annum on the average availability under Tranche B.

The hydrocarbon borrowing base is subject to semi-annual redetermination based primarily on the value of our proved reserves. The credit facility requires the maintenance of certain ratios, including those related to working capital, funded debt to EBITDAX, and debt service coverage, as defined in the credit facility. Additionally, the credit facility contains certain negative covenants that, among other things, restrict or limit our ability to incur indebtedness, sell assets, pay dividends and reacquire or otherwise acquire or redeem capital stock. Failure to maintain required financial ratios or comply with the credit facility’s covenants can result in a default and acceleration of all indebtedness under the credit facility.

As of September 30, 2004, the Company’s long-term debt totaled $1.3 million, all of which was outstanding under Tranche A of the line of credit. The average interest rate on the Company’s long-term debt at June 30, 2004 was 3.7%. As of September 30, 2004, the Company was in compliance with its financial covenants, ratios and other provisions of the credit facility.

In October 2004, we agreed to sell substantially all of our south Texas natural gas and oil interests. Our south Texas properties included in the proposed sale constitute the bulk of the assets used to secure our existing bank line, which recently was reviewed and approved at $21 million. The revolving line of credit currently available to us declines at approximately $0.6 million per month and in December 2004 is projected to be $19.8 million. After completion of the proposed transaction, our remaining bank credit line, if any, will likely be less than $2 million.

On November 11, 2004, we had approximately $1.0 million in cash on hand, had no borrowings under our credit facility and had approximately $20.4 million of unused bank borrowing capacity.

Natural Gas and Oil Reserves

The following table presents our estimated net proved, developed producing natural gas and oil reserves and the pre-tax net present value of our reserves at March 31, 2004, based on a reserve report generated by W.D. Von Gonten & Co. The pre-tax net present value is not intended to represent the current market value of the estimated natural gas and oil reserves we own.

The pre-tax net present value of future cash flows attributable to our proved reserves as of September 30, 2004 was determined by the September 30, 2004 prices of $6.05 per MMbtu for natural gas at the Houston Ship Channel and $49.64 per barrel of oil at West Texas Intermediate Posting, in each case before adjusting for basis and transportation costs. Over 99% of our proved reserves are classified as proved developed producing.


	Proved Reserves as of September 30, 2004
Natural gas (MMcf)		14,799
Oil and condensate (MBbls)		287
Total proved reserves (MMcfe)		16,521

Pre-tax net present value, SEC guidelines ($000)	$	64,556

The process of estimating natural gas and oil reserves is complex. It requires various assumptions, including natural gas and oil prices, drilling and operating expenses, capital expenditures, taxes and availability of

funds. Our third party engineers must project production rates and timing of development expenditures, as well as analyze available geological, geophysical, production and engineering data. The extent, quality and reliability of this data can vary. Therefore, estimates of natural gas and oil reserves are inherently imprecise. Actual future production, natural gas and oil prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable natural gas and oil reserves most likely will vary from estimates. Any significant variance could materially affect the estimated quantities and net present value of reserves. In addition, our third party engineers may adjust estimates of proved reserves to reflect production history, results of exploration and development, prevailing natural gas and oil prices and other factors, many of which are beyond our control. Because most of our reserve estimates are not based on a lengthy production history and are calculated using volumetric analysis, these estimates are less reliable than estimates based on a lengthy production history.

It should not be assumed that the pre-tax net present value is the current market value of our estimated natural gas and oil reserves. In accordance with requirements of the Securities and Exchange Commission, we base the estimated discounted future net cash flows from proved reserves on prices and costs on the date of the estimate. Actual future prices and costs may differ materially from those used in the present value estimate.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Commodity Risk. Our major commodity price risk exposure is to the prices received for our natural gas and oil production. Realized commodity prices received for our production are the spot prices applicable to natural gas and crude oil. Prices received for natural gas and oil are volatile, unpredictable and are beyond our control. For the three months ended September 30, 2004, a 10% fluctuation in the prices received for natural gas and oil production would have had an approximate $0.7 million impact on our revenues.

Item 4. Controls and Procedures

Kenneth R. Peak, our Chief Executive Officer and Chief Financial Officer, has carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this quarterly report. Based upon his evaluation, he has concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic Securities and Exchange Commission filings.

There were no changes in the Company’s internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

On November 4, 2004, the Company held its annual meeting of stockholders. At the annual meeting, the following matter was voted upon and passed:

•

The election of the Company’s board of directors to serve until the annual meeting of stockholders in 2005.

Each nominee for director received at least 12,402,500 votes for, which is greater than 50% of the total votes entitled to be cast by common stockholders of record. Mr. Peak had 34,665 votes withheld and Messrs. Brehmer, Compofelice and Williams each had 27,998 votes withheld. There were no votes against any nominee. Included in the total above is an equivalent of 1,166,662 shares of common stock cast by Series C preferred stock, which is 100% of the total votes entitled to be cast by holders of Series C preferred stock, voted for each nominee for director.

Item 5. Other Information

None.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits:

The following is a list of exhibits filed as part of this Form 10-Q. Where so indicated by a footnote, exhibits, which were previously filed, are incorporated herein by reference.


Exhibit Number		Description
3.1		Certificate of Incorporation of Contango Oil & Gas Company, a Delaware corporation. (7)

3.2		Bylaws of Contango Oil & Gas Company, a Delaware corporation. (7)

3.3		Agreement of Plan of Merger of Contango Oil & Gas Company, a Delaware corporation, and Contango Oil & Gas Company, a Nevada corporation. (7)

3.4		Amendment to the Certificate of Incorporation of Contango Oil & Gas Company, a Delaware corporation. (15)

4.1		Facsimile of common stock certificate of the Company. (1)

4.2		Certificate of Designations, Preferences and Relative Rights and Limitations for Series C Senior Convertible Cumulative Preferred Stock of Contango Oil & Gas Company, a Delaware corporation. (19)

10.1		Agreement, dated effective as of September 1, 1999, between Contango Oil & Gas Company and Juneau Exploration, L.L.C. (2)

10.2		Securities Purchase Agreement between Contango Oil & Gas Company and Trust Company of the West, dated December 29, 1999. (12)

10.3		Warrant to Purchase Common Stock between Contango Oil & Gas Company and Trust Company of the West, dated December 29, 1999. (3)

10.4		Co-Sale Agreement among Kenneth R. Peak, Contango Oil & Gas Company and Trust Company of the West, dated December 29, 1999. (3)

10.5		Securities Purchase Agreement dated August 24, 2000 by and between Contango Oil & Gas Company and Trust Company of the West. (4)

10.6		Securities Purchase Agreement dated August 24, 2000 by and between Contango Oil & Gas Company and Fairfield Industries Incorporated. (4)

10.7		Securities Purchase Agreement dated August 24, 2000 by and between Contango Oil & Gas Company and Juneau Exploration Company, L.L.C. (4)

10.8		Amendment dated August 14, 2000 to agreement between Contango Oil & Gas Company and Juneau Exploration Company, LLC. dated effective as of September 1, 1999. (5)


10.9		Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (8)

10.10		First Amendment dated as of January 8, 2002 to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (9)

10.11		Asset Purchase Agreement by and among Juneau Exploration, L.P. and Contango Oil & Gas Company dated January 4, 2002. (9)

10.12		Asset Purchase Agreement by and among Mark A. Stephens, John Miller, The Hunter Revocable Trust, Linda G. Ferszt, Scott Archer and the Archer Revocable Trust and Contango Oil & Gas Company dated January 9, 2002. (10)

10.13		Second Amendment dated as of February 13, 2002 to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (11)

10.14		Waiver dated as of March 25, 2002 to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (11)

10.15		Option Purchase Agreement between Contango Oil & Gas Company and Cheniere Energy, Inc. dated June 4, 2002. (13)

10.16		Waiver and Third Amendment dated as of April 26, 2002 to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (14)

10.17		Fourth Amendment dated as of September 9, 2002 to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (14)

10.18		Fifth Amendment, effective June 1, 2003, to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (16)

10.19		Sixth Amendment, effective September 1, 2003, to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (18)

10.20		Seventh Amendment, effective September 1, 2003, to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (21)

10.21		Securities Purchase Agreement dated December 12, 2003 by and between Contango Oil & Gas Company and the Purchasers Named Therein. (19)

10.22		Freeport LNG Development, L.P. Amended and Restated Limited Partnership Agreement dated February 27, 2003. (20)

10.23		Partnership Purchase Agreement among Contango Sundance, Inc., Contango Oil & Gas, Cheniere LNG, Inc. and Cheniere Energy, Inc. dated March 1, 2003. (20)

10.24		First Amendment, dated December 19, 2003, to Freeport LNG Development, L.P. Amended and Restated Limited Partnership Agreement dated February 27, 2003. (20)

10.25		Eighth Amendment, effective February 13, 2004, to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (22)

10.26		Ninth Amendment, effective July 29, 2004, to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. (23)

10.27		Tenth Amendment, effective September 23, 2004, to Credit Agreement between Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29, 2001. †

10.28		Asset Purchase Agreement, dated as of October 7, 2004, by and between Contango Oil & Gas Company; Contango STEP, L.P.; Edge Petroleum Exploration Company; and Edge Petroleum Corporation. (24)

14.1		Code of Ethics. (17)

21.1		List of Subsidiaries. (23)

23.1		Consent of W.D. Von Gonten & Co. †

31.1		Certification required by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934. †

32.1		Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. †

†	Filed herewith.

1.	Filed as an exhibit to the Company’s Form 10-SB Registration Statement, as filed with the Securities and Exchange Commission on October 16, 1998.

2.	Filed as an exhibit to the Company’s Form 10-QSB for the quarter ended December 31, 1999, as filed with the Securities and Exchange Commission on November 11, 1999.

3.	Filed as an exhibit to the Company’s Form 10-QSB for the quarter ended December 31, 1999, as filed with the Securities and Exchange Commission on February 14, 2000.

4.	Filed as an exhibit to the Company’s report on Form 8-K, dated August 24, 2000, as filed with the Securities and Exchange Commission of September 8, 2000.

5.	Filed as an exhibit to the Company’s annual report on Form 10-KSB for the fiscal year ended June 30, 2000, as filed with the Securities and Exchange Commission on September 27, 2000.

6.	Filed as an exhibit to the Company’s report on Form 8-K, dated September 27, 2000, as filed with the Securities and Exchange Commission on October 3, 2000.

7.	Filed as an exhibit to the Company’s report on Form 8-K, dated December 1, 2000, as filed with the Securities and Exchange Commission on December 15, 2000.

8.	Filed as an exhibit to the Company’s annual report on Form 10-KSB for the fiscal year ended June 30, 2001, as filed with the Securities and Exchange Commission on September 21, 2001.

9.	Filed as an exhibit to the Company’s report on Form 8-K, dated January 4, 2002, as filed with the Securities and Exchange Commission on January 8, 2002.

10.	Filed as an exhibit to the Company’s Form 10-QSB for the quarter ended March 31, 2002, as filed with the Securities and Exchange Commission on February 14, 2002.

11.	Filed as an exhibit to the Company’s report filed on Form 10-QSB for the quarter ended March 31, 2002, dated May 2, 2002, as filed with the Securities and Exchange Commission.

12.	Filed as an exhibit to the Company’s Form 10-QSB/A for the quarter ended December 31, 1999, as filed with the Securities and Exchange Commission on June 4, 2002.

13.	Filed as an exhibit to the Company’s Registration Statement on Form S-1 (Registration No. 333-89900) as filed with the Securities and Exchange Commission on June 14, 2002.

14.	Filed as an exhibit to the Company’s annual report on Form 10-KSB for the fiscal year ended June 30, 2002, as filed with the Securities and Exchange Commission on September 26, 2002.

15.	Filed as an exhibit to the Company’s report filed on Form 10-QSB for the quarter ended December 31, 2002, dated November 14, 2002, as filed with the Securities and Exchange Commission.

16.	Filed as an exhibit to the Company’s report on Form 8-K, dated June 17, 2003, as filed with the Securities and Exchange Commission on June 18, 2003.

17.	Filed as an exhibit to the Company’s annual report on Form 10-KSB for the fiscal year ended June 30, 2003, as filed with the Securities and Exchange Commission on September 22, 2003.

18.	Filed as an exhibit to the Company’s report filed on Form 10-Q for the quarter ended September 30, 2003, dated November 12, 2003, as filed with the Securities and Exchange Commission.

19.	Filed as an exhibit to the Company’s report on Form 8-K, dated December 12, 2003, as filed with the Securities and Exchange Commission on December 17, 2003.

20.	Filed as an exhibit to the Company’s report on Form 8-K, dated December 19, 2003, as filed with the Securities and Exchange Commission on December 23, 2003.

21.	Filed as an exhibit to the Company’s report filed on Form 10-Q for the quarter ended December 31, 2003, dated February 13, 2004, as filed with the Securities and Exchange Commission.

22.	Filed as an exhibit to the Company’s report filed on Form 10-Q for the quarter ended March 31, 2004, dated May 12, 2004, as filed with the Securities and Exchange Commission.

23.	Filed as an exhibit to the Company’s annual report on Form 10-K for the fiscal year ended June 30, 2004, as filed with the Securities and Exchange Commission on September 27, 2003.

24.	Filed as an exhibit to the Company’s report on Form 8-K, dated September 27, 2004, as filed with the Securities and Exchange Commission on October 8, 2004.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized.


	CONTANGO OIL & GAS COMPANY

Date: November 12, 2004	By:	/s/ KENNETH R. PEAK
		Kenneth R. Peak
		Chairman and Chief Executive Officer
		(Principal Executive and Financial Officer)

Date: November 12, 2004	By:	/s/ LESIA BAUTINA
		Lesia Bautina
		Vice President and Controller
		(Principal Accounting Officer)

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