Milagro Energy Inc.
TSX : MIG

Milagro Energy Inc.

August 10, 2005 09:00 ET

Milagro Energy Inc.: Interim Report for the Six Months Ended June 30, 2005

CALGARY, ALBERTA--(CCNMatthews - Aug. 10, 2005) - Milagro Energy Inc. (TSX:MIG)



HIGHLIGHTS

Three months ended June 30, Six months ended June 30,
(Unaudited) 2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------

FINANCIAL
($000s except
per share amounts)
Oil and gas revenue 1,696 2,297 (26) 3,590 4,728 (24)
Cash flow from
operations 598 892 (33) 1,259 1,820 (31)
Per share
- basic
and diluted 0.01 0.02 (33) 0.03 0.04 (31)
Net earnings
(loss) 737 (170) 533 601 (454) 232
Per share
- basic
and diluted 0.02 - 200 0.01 (0.01) 200
Capital
expenditures 3,365 1,309 257 4,034 4,591 (12)
Debt and working
capital 3,798 2,063 84
Shareholders'
equity 23,776 26,297 (10)
Total assets 32,564 33,501 (3)
------------------------------------------------------------------------

OPERATING
Average daily
production
Oil & NGLs
(bbls per day) 305 440 (31) 346 481 (28)
Natural gas
(mcf per day) 831 1,402 (41) 885 1,456 (39)
Equivalent
barrels
(boe per day) 443 673 (34) 493 724 (32)
Average Selling
Prices
Oil & NGLs
($ per bbl) 41.16 35.54 16 39.32 34.14 15
Natural gas
($ per mcf) 7.32 6.86 7 7.05 6.56 8
Equivalent
barrels
($ per boe) 42.02 37.49 12 40.21 35.90 12
Field Netbacks
Oil & NGLs
($ per bbl) 17.52 20.10 (13) 16.93 17.50 (3)
Natural gas
($ per mcf) 4.49 4.35 3 4.34 3.93 10
Equivalent
barrels
($ per boe) 20.47 22.18 (8) 19.66 19.55 1
Corporate
Netbacks
($ per boe) 14.83 14.55 2 14.11 13.82 2
Wells Drilled
Gross 2 4 (50) 2 4 (50)
Net 2.0 4.0 (50) 2.0 4.0 (50)
Undeveloped
land
(net acres) 45,652 52,200 (12)
------------------------------------------------------------------------

SHARE DATA
Weighted average
outstanding (000s)
Basic 48,155 41,568 16 48,117 41,532 16
Diluted 48,764 41,568 17 48,766 41,532 17

Equity outstanding
(at June 30, 2005)
Common shares 48,161 47,780 1
Stock options 1,327 1,053 26
Warrants 0 300 (100)
------------------------------------------------------------------------
Diluted 49,488 49,133 1


REPORT TO SHAREHOLDERS

Revenue for the first half of 2005 was $3,590,000. During the six months ended June 30, 2005, Milagro generated cash flow from operations of $1,259,000 ($0.03 per diluted share), and recorded net earnings of $601,000 ($0.01 per diluted share). The results in Q2 can be attributed to the future income recovery associated with the sale of CO2 assets recorded in Q1.

Production for the six months ended June 30, 2005 averaged 493 boe per day. Second quarter 2005, Saskatchewan production averaged 422 boe per day comprised of 301 barrels of oil per day and 726 mcf of natural gas per day. Production from Alberta averaged 71 boe per day during the first half 2005.

To direct our capital spending to the highest rate of return projects, Milagro farmed out development and exploration drilling programs at Battle Creek and Bittern Lake. Seven wells have been drilled to-date with potentially one or two more locations to be drilled in either Q3 or Q4. The seven wells drilled were all cased and completion programs are planned for Q3.

OUTLOOK

Milagro continues to work on its exploration and development drilling program. As of June 30, $4 million of this year's $16 million CAPEX budget has been spent. Two wells were drilled at Judy Creek in the first half of 2005 and a third well was drilled in July. Milagro is currently shooting a forty-six kilometer seismic program over the lands at Judy Creek to further delineate uphole potential identified from previous drilling. To facilitate year round production in the future, production facilities and sales lines are budgeted to be installed in 2005.

The 2005 plans targeted 17 wells for drilling, of which eight are at Judy Creek. Three of the eight wells at Judy Creek have been drilled with encouraging results and the five remaining wells are scheduled to begin drilling in September 2005. An operational update on Judy Creek, pending completion and test data, is anticipated to be collected for release by mid to late August. After the interpretation of the Judy Creek seismic program additional wells may be added to this years drilling program.

In Q3 Milagro raised $6.8 million net from the sale of securities, and will utilize those funds for development of petroleum and natural gas reserves.

Milagro continues to look for ways to enhance shareholder value with the addition of new production through the drill bit or an accretive acquisition that adds to the cash flow per share from operating activities.



On behalf of the Board of Directors


Signed "Jeffrey C. Rekunyk"
President and CEO
July 29, 2005


MANAGEMENT'S DISCUSSION AND ANALYSIS

The following discussion should be read in conjunction with the unaudited financial statements for the six months ended June 30, 2005, the audited financial statements and accompanying notes for the year ended December 31, 2004 and management's discussion and analysis for the year ended December 31, 2004.

This MD&A contains forward-looking statements. Forward-looking statements are based on current expectations that involve a number of risks and uncertainties, which could cause actual events or results to differ materially from those reflected in the MD&A. Forward-looking statements are based on the estimates and opinions of Milagro's management at the time the statements were made.

Per barrel of oil equivalent ("boe") amounts have been calculated using a conversion rate of six thousand cubic feet of natural gas to one barrel of oil ("6:1"). The 6:1 conversion ratio is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. Boe disclosure may be misleading, particularly if used in isolation. Readers should be aware that historical results are not necessarily indicative of future performance.

The MD&A contains the term cash flow from operations, which should not be considered an alternative to, or more meaningful than, cash flow from operating activities as determined in accordance with Canadian generally accepted accounting principles as an indicator of the Company's performance. Milagro's calculation of cash flow from operations may not be comparable to that reported by other companies. Cash flow from operations per share is calculated using the same weighted average number of shares outstanding used in the calculation of earnings per share. All references to cash flow throughout the MD&A are based on cash flow before changes in non-cash working capital.

OVERVIEW - SIX MONTHS ENDED JUNE 30, 2005

Production averaged 443 boe per day during the second quarter of 2005, comprised of 305 barrels per day of oil and NGLs and 831 mcf per day of natural gas. Compared to the second quarter of 2004, average daily oil and NGL production decreased 31 percent and natural gas production declined 41 percent. Production declines of oil in Saskatchewan were due to power outages, while Alberta had pump problems and wet lease conditions limiting the ability to truck oil to market. The Saskatchewan property is experiencing natural gas declines while the Alberta gas property shut in due to a fire at its connected gas plant.

Second quarter 2005 results were highlighted by strong commodity prices. Milagro's second quarter 2005 average selling prices were $41.16 per barrel of oil and NGL and $7.32 per mcf of natural gas. Compared to the first quarter of 2005, oil and NGL prices increased 8 percent and natural gas prices increased 10 percent. None of Milagro's 2005 production is hedged so changes in selling prices reflect current market conditions.

Oil and gas revenue was $1,696,000 in the second quarter of 2005, down 11 percent from the first quarter of 2005. Quarter-over-quarter there was a decrease in oil revenue and a small decrease in natural gas revenue.

Oil and NGL field netbacks were $17.52 per barrel in the second quarter of 2005, down marginally from the first quarter. Compared to the previous quarter, higher selling prices were offset by higher royalties and production expenses. Natural gas netbacks were $4.49 per mcf in the second quarter, up from $3.52 in the first quarter 2005. Higher selling prices in the second quarter of 2005 were the reason for the increase in the natural gas netbacks when compared to the first quarter 2005 natural gas netbacks.

Cash flow from operations for the six months ended June 30, 2005 was $1,259,000 or $0.03 per share (basic and diluted). The net earnings for the six months ended June 30, 2005 was $601,000 ($0.01 per share basic and diluted).

Capital expenditures were $3,365,000 during the second quarter of 2005. Milagro spent $2,767,000 on intangible drilling and completions and $375,000 on production equipment and facilities. In the second quarter of 2005, completion and equipping work was done on two wells in Alberta. All of Milagro's 2005 capital work to date was done at a 100 percent working interest.



SUMMARY OF QUARTERLY RESULTS

2005 2004 2003
-------------- --------------------------- -----------
Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3

Financial Highlights
($000s except per share amounts)
Oil and gas
revenue 1,696 1,894 1,987 2,491 2,297 2,430 1,832 1,802
Cash flow from
operations 598 661 587 1,051 892 928 219 978
Per share
- basic 0.01 0.01 0.01 0.02 0.02 0.02 - 0.03
Per share
- diluted 0.01 0.01 0.01 0.02 0.02 0.02 - 0.03
Net earnings
(loss)(1) 737 (136)(2,029) (16) (170) (284) (691) 562
Per share
- basic 0.02 - (0.04) - - (0.01) (0.02) 0.02
Per share
- diluted 0.02 - (0.04) - - (0.01) (0.02) 0.01
Capital
expenditures
(net) 3,365 669 3,279 2,090 1,309 3,282 8,096 5,757
Debt and
working
capital 3,798 1,253 5,702 3,117 2,063 5,253 2,879 (58)
Shareholders'
equity(1) 23,776 22,986 24,280 26,289 26,297 22,774 23,026 19,805
Total assets(1) 32,564 29,918 34,152 34,750 33,501 33,470 31,897 27,885
------------------------------------------------------------------------
Operating Highlights
Average daily
production
volumes
Oil & NGLs
(bbls/day) 305 388 427 457 440 522 339 242
Natural gas
(mcf/day) 831 940 1,044 1,383 1,402 1,510 2,015 2,198
--------------------------------------------------------
Oil equivalent
(boe/day) 443 545 601 687 673 774 675 608
--------------------------------------------------------

Field netbacks
- oil & NGLs
($/bbl)
Selling price 41.16 38.13 34.78 40.62 35.54 32.97 27.32 29.37
Royalties (6.90) (5.46) (4.92)(10.28) (5.92) (8.48) (6.32) (6.69)
Production
expenses (15.70)(12.08) (9.79) (7.44) (7.23) (7.00)(12.12) (9.89)
Transportation (1.04) (2.48) (1.72) (1.98) (2.29) (2.18) (2.07) (2.09)
--------------------------------------------------------
Field netback 17.52 18.11 18.35 20.92 20.10 15.31 6.81 10.70
--------------------------------------------------------

Field netbacks
- natural gas
($/mcf)
Selling price 7.32 6.67 6.45 6.16 6.86 6.29 5.82 6.12
Royalties (0.60) (0.57) (0.60) (0.85) (0.70) (0.96) (0.97) (0.92)
Production
expenses (2.04) (2.41) (2.33) (1.79) (1.63) (1.56) (1.26) (0.96)
Transportation (0.18) (0.17) (0.20) (0.18) (0.18) (0.22) (0.19) (0.22)
--------------------------------------------------------
Field netback 4.49 3.52 3.32 3.34 4.35 3.55 3.40 4.02
--------------------------------------------------------

Field netbacks
- equivalent
units ($boe)
Selling price 42.02 38.67 35.91 39.39 37.49 34.52 31.11 33.80
Royalties (5.87) (4.87) (4.54) (8.54) (5.32) (7.60) (6.06) (5.99)
Production
expenses (14.63)(12.76)(11.01) (8.54) (8.12) (7.76) (9.87) (7.42)
Transportation (1.05) (2.06) (1.57) (1.68) (1.87) (1.91) (1.62) (1.61)
--------------------------------------------------------
Field netback 20.47 18.98 18.79 20.63 22.18 17.25 13.56 18.78
--------------------------------------------------------

Corporate cash
netbacks ($/boe)
Field netback 20.47 18.98 18.79 20.63 22.18 17.25 13.56 18.78
General and
administrative
expenses (3.88) (4.39) (4.43) (2.34) (5.66) (2.83) (5.85) (2.53)
Financing
charges (0.59) (0.62) (0.84) (0.75) (1.15) (0.35) (0.01) (0.31)
Current income
and capital
taxes (1.17) (0.49) (0.99) (0.92) (0.82) (0.89) (4.18) 1.53
--------------------------------------------------------
Cash flow from
operating
activities 14.83 13.48 12.53 16.62 14.55 13.18 3.52 17.47
--------------------------------------------------------

Common Share
Information
Shares
outstanding
(000s)
Weighted
average during
the period 48,155 48,077 47,780 47,780 41,568 41,497 40,366 31,145
Period end
- basic 48,161 48,131 47,780 47,780 47,780 41,499 41,465 36,909
Period end
- diluted 49,488 49,458 49,458 48,883 49,133 42,969 42,969 38,694
--------------------------------------------------------
--------------------------------------------------------

(1) Certain 2003 amounts have been restated to reflect the retroactive
application of adopting CICA Handbook Section 3110, Asset
Retirement Obligations in the fourth quarter of 2003.


THREE MONTHS ENDED JUNE 30, 2005
COMPARED TO
THREE MONTHS ENDED MARCH 31, 2005


Quarter-over-quarter oil and NGL production decreased 21 percent to 305 barrels per day and natural gas production declined 12 percent to 831 mcf per day. On a barrel-of-equivalent basis, second quarter production of 443 boe per day is down 19 percent from first quarter volumes of 545 boe per day. Milagro's average daily production by area for the second quarter of 2005 is broken down as follows:



Three months ended June 30, 2005
------------------------------------------------------------------------
Oil & NGLs Gas Total
(bbls/day) (mcf/day) (boe/day)
------------------------------------------------------------------------
Southwest Saskatchewan 272 683 386
Alberta 33 148 57
------------------------------------------------------------------------
Total 305 831 443
------------------------------------------------------------------------
------------------------------------------------------------------------


Southwest Saskatchewan oil production decreased due to the shut in of two wells during the second quarter of 2005. Quarter-over-quarter natural gas production in southwest Saskatchewan declined 87 mcf per day. In Alberta, oil production decreased 24 boe per day quarter over-quarter as result of wet lease conditions.

Compared to the first quarter of 2005, second quarter oil and NGL selling prices increased 8 percent to $41.16 per barrel and natural gas prices increased 10 percent to $7.32 per mcf. Milagro has not hedged any production in 2005 so changes in North American oil and natural gas prices and US/Canadian currency exchange rates will have an immediate impact on the company's selling prices. Comparing the first quarter of 2005 to the second quarter of 2005, changing spot prices far outweighed the effect of the US/Canadian dollar exchange rate on Milagro's selling prices.

Royalties were $238,000 in the second quarter of 2005, consistent with $238,000 in the first quarter. On a unit of production basis, oil and NGL royalties increased 26 percent to $6.90 per barrel (Q1 2005 - $5.46 per barrel) and natural gas royalties increased 5 percent to $0.60 per mcf (Q1 2005 - $0.57 per mcf). The quarter-over-quarter increase was due to increased production and higher prices increasing the royalties at freehold oil wells.

Production expenses were $590,000 in the second quarter, down 6 percent from $625,000 in the first quarter. The quarter-over-quarter decrease in production expenses is attributable to the decrease in production volumes and this was partially offset by workovers required at the Saskatchewan property. Oil and NGL costs increased 30 percent to $15.70 per barrel (Q1 2005 - $12.08 per barrel) and natural gas costs decreased 15 percent to $2.04 per mcf (Q1 2005 - $2.41 per mcf). In southwest Saskatchewan, which generated 87 percent of Milagro's second quarter 2005 production volumes, production expenses were $13.82 per barrel of oil and $1.76 per mcf of natural gas. In Alberta, second quarter 2005 production expenses were $31.37 per barrel of oil and NGL and $3.34 per mcf of natural gas. Production expenses for oil in Alberta increased due to lower production volumes.

During the second quarter of 2005, Milagro incurred transportation costs of $43,000, down 58 percent from the $101,000 incurred in the first quarter. Milagro's transportation costs are 100 percent variable, based on volumes shipped. During the second quarter of 2005, transportation costs were $1.04 per barrel of oil and NGL (Q1 2005 - $2.48 per barrel) and $0.18 per mcf of natural gas (Q1 2005 - $0.17 per mcf). Compared to the first quarter, oil transportation costs in Q2 are smaller due to the receipt of a credit to 2004 transportation costs.

Second quarter 2005 oil and NGL field netbacks decreased 8 percent to $17.52 per barrel (Q1 2005 - $18.11 per barrel) as higher selling prices were exceeded by higher royalties and production expenses. Natural gas field netbacks increased 28 percent to $4.49 per mcf (Q1 2005 - $3.52 per mcf) as a result of higher selling prices.

Second quarter 2005 general and administrative costs expensed decreased 27 percent to $156,000 from $213,000 in the first quarter. In Q2 Milagro's annual reporting costs decreased thereby reducing the general and administrative costs booked in the second quarter. On a quarter-over-quarter basis, lower expenses, which were partially offset by lower production volumes, resulted in a decrease in unit costs to $3.88 per boe in the second quarter of 2005 from $4.39 per boe in the first quarter.

Financing charges were $24,000 ($0.59 per boe) in the second quarter of 2005, down from $30,000 ($0.62 per boe) in the first quarter. Lower average debt levels caused the overall decrease.

Second quarter 2005 depletion, depreciation and accretion expense ("DD&A expense") was $715,000 ($17.72 per boe) compared to $788,000 ($16.07 per boe) for the first quarter. Depletion and depreciation of oil and gas properties, which is calculated using the unit-of-production method based on proved reserves, accounts for over 96 percent of DD&A expense. The lower second quarter 2005 DD&A expense rate was caused primarily by a reduction in the production of the petroleum and natural gas reserves from the first quarter of 2005.

For the first half of 2005, Capital taxes are comprised exclusively of Saskatchewan capital taxes, and are estimated until the year end tax returns are prepared. Taxes for the second quarter of 2005 were $47,000 ($1.17 per boe), up from $24,000 ($0.49 per boe) in the first quarter. Saskatchewan capital taxes are up in the second quarter due to an increase in the actual 2004 calculation. From the first quarter 2005 to second quarter of 2005, Milagro's revenue from Saskatchewan decreased.

Cash flow from operations was $598,000 in the second quarter of 2005, down 10 percent from first quarter cash flow of $661,000. Compared to the first quarter of 2005, second quarter 2005 cash flow was positively affected by lower general and administrative expenses, financing and cash taxes and negatively affected by lower revenue and higher production expenses. Cash flow from operations was $0.01 per share (basic and diluted) for the second quarter, unchanged from the first quarter.

For the second quarter of 2005, Milagro recorded net income of $737,000 ($0.02 per share), a significant improvement over the first quarter loss of $136,000 ($nil per share). The net income can be attributed to a recovery of future tax.

Capital expenditures totaled $3,365,000 in the second quarter of 2005, up 403 percent from $669,000 in the first quarter of the year. Capital expenditures by quarter and by area for the three months ended June 2005 and March 2005 are as follows:



------------------------------------------------------------------------
($000s) Q2 2005 Q1 2005
------------------------------------------------------------------------

Southwest Saskatchewan 61 5
Alberta 3,265 583
Corporate 39 81
------------------------------------------------------------------------
Total 3,365 669
------------------------------------------------------------------------
------------------------------------------------------------------------


18 percent of Milagro's second quarter 2005 capital expenditure program was funded by cash flow from operations, compared to first quarter funding by cash flow of 98 percent. 82 percent of Milagro's second quarter 2005 capital expenditure program was funded from cash reserves. During the second quarter, bank debt increased by $279,000. At June 30, 2005, Milagro's net debt (bank debt adjusted for working capital) was $3,798,000.



THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2005
COMPARED TO
THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2004

Production

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
Oil & NGLs
(bbls/day) 305 440 (31) 346 481 (28)
Natural gas
(mcf/day) 831 1,402 (41) 885 1,456 (39)
------------------------------------------------------------------------
Boe (boe/day) 443 673 (34) 493 724 (32)
------------------------------------------------------------------------
------------------------------------------------------------------------


Average daily production decreased 32 percent to 493 boe per day in the six months ended June 30, 2005 compared to 724 boe per day during the same period of 2004. The 28 percent decrease in oil and NGL production to 346 barrels per day was caused primarily by shut in oil production in southwest Saskatchewan during the second quarter of 2005. The 39 percent decrease in natural gas production was caused by natural declines in southwest Saskatchewan, and shut-in Alberta gas production.



Selling Prices

Milagro Average Prices

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
Oil & NGLs
($ per bbl) 41.16 35.54 16 39.32 34.14 15
Natural gas
($ per mcf) 7.32 6.86 7 7.05 6.56 8
------------------------------------------------------------------------
Boe ($ per boe) 42.02 37.49 12 40.21 35.90 12
------------------------------------------------------------------------
------------------------------------------------------------------------


Average Benchmark Prices

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
Oil - Edmonton
Light ($/bbl) 65.76 49.60 33 63.61 48.10 32
Oil - Flint
Medium ($/bbl) 41.89 35.66 17 39.84 34.02 17
Gas - AECO-C
daily spot
($/mcf) 7.37 7.04 5 7.03 6.74 4
------------------------------------------------------------------------
------------------------------------------------------------------------


During the six months ended June 30, 2005, oil and NGL selling prices averaged $39.32 per barrel, a 15 percent increase compared to the same period in 2004. Milagro sold all of its 2004 and 2005 oil and NGL production at market prices.

Natural gas prices during the first half of 2005 averaged $7.05 per mcf, up 8% from the $6.56 per mcf realized during the same period last year. All of Milagro's 2005 natural gas production was sold at spot prices.



Revenue

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
($000s) 2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
Oil & NGLs 1,132 1,422 (20) 2,462 2,989 (18)
Natural gas 564 875 (35) 1,128 1,739 (35)
------------------------------------------------------------------------
Total 1,696 2,297 (26) 3,590 4,728 (24)
------------------------------------------------------------------------
------------------------------------------------------------------------


Compared to the same periods in 2004, oil and NGL revenue for the six months ended June 30, 2005 decreased 18 percent. These decreases were caused by lower production volumes. Compared to the same periods in 2004, natural gas revenue for the six months ended June 30, 2005 decreased 35 percent. Lower production is the primary reason for the decrease in natural gas revenue.



Royalties

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
($000s)
Crown 166 242 (32) 324 641 (49)
Overriding
& freehold 72 84 (15) 152 220 (31)
------------------------------------------------------------------------
Total 238 326 (27) 476 861 (45)
------------------------------------------------------------------------
Royalty rate
(% of revenue) 14% 14% - 13% 18% (28)
------------------------------------------------------------------------

(per unit)
Oil & NGLs
($ per bbl) 6.90 5.92 17 6.10 7.31 (17)
Natural gas
($ per mcf) 0.60 0.70 (14) 0.59 0.83 (29)
------------------------------------------------------------------------
BOE ($ per boe) 5.87 5.32 10 5.33 6.54 (19)
------------------------------------------------------------------------
------------------------------------------------------------------------


Royalties for the six months ended June 30, 2005 were $476,000 (13 percent of revenue), down from $861,000 (18 percent of revenue) for the six months ended June 30, 2004. Comparing the first six months of 2005 to the same period in 2004, the decline in production, and the royalty free period on the new production in West central Alberta both contributed to lowering the royalty payments.



Production Expenses

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
Oil & NGLs
($ per bbl) 15.70 7.23 217 14.47 7.11 203
Natural gas
($ per mcf) 2.04 1.63 25 1.93 1.59 21
------------------------------------------------------------------------
Boe ($ per boe) 14.63 8.12 80 13.62 7.93 72
------------------------------------------------------------------------
------------------------------------------------------------------------


Compared to the same periods in 2004, per unit oil and NGL production expenses for the six months ended June 30, 2005 increased 203 percent. Milagro experienced an increase in oil and NGL production expenses per bbl during the first half of 2005 primarily as a result of decreased production in southwest Saskatchewan.

Compared to the same periods in 2004, per unit natural gas production expenses for the six months ended June 30, 2005 increased 21 percent. Higher per unit natural gas expenses are primarily the result of fixed expenses in southwest Saskatchewan spread over lower volumes.



Transportation Expenses

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
Oil & NGLs
($ per bbl) 1.04 2.29 (55) 1.82 2.22 (18)
Natural gas
($ per mcf) 0.18 0.18 - 0.18 0.20 (10)
------------------------------------------------------------------------
Boe ($ per boe) 1.05 1.87 (34) 1.61 1.89 (15)
------------------------------------------------------------------------
------------------------------------------------------------------------


For the six months ended June 30, 2005 transportation expenses were $143,000 ($1.61 per boe) down 15 percent from $249,000 ($1.89 per boe) for the same period in 2004. The six month comparative decrease is due to lower transportation costs.



Field Netbacks

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
Oil & NGLs
($ per bbl) 17.52 20.10 (13) 16.93 17.50 (3)
Natural gas
($ per mcf) 4.49 4.35 3 4.34 3.93 10
------------------------------------------------------------------------
Boe ($ per boe) 20.47 22.18 (8) 19.66 19.55 1
------------------------------------------------------------------------
------------------------------------------------------------------------


Compared to the same periods in 2004, field netbacks for the six months ended June 30, 2005 increased 1 percent. The six month comparative small increase was caused primarily by higher selling prices, which were offset by higher production expenses.



General and Administrative Expenses

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
($000s) 2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
Total 297 434 (32) 571 750 (24)
Overhead recoveries (102) (56) 82 (140) (142) (1)
Capitalized (38) (31) 22 (61) (62) (1)
------------------------------------------------------------------------
Expensed 157 347 (55) 370 546 (32)
------------------------------------------------------------------------
------------------------------------------------------------------------


Total general and administrative costs were $370,000 in the first half of 2005, down 32 percent from the same period last year. Costs were higher in 2004 due to severance costs paid to reduce staff. Overhead recoveries and capitalized general and administrative costs had no significant changes. The six month unit rate of $4.15 per boe is down from $5.66 per boe for the same period last year.

Financing Charges

Compared to the same periods in 2004, financing charges for the six months ended June 30, 2005 decreased 43 percent to $54,000 ($0.61 per boe) compared to financing charges for the six months ended June 30, 2004 at $95,000 ($0.72 per boe).



Depletion, Depreciation and Accretion Expense

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
($000s)
Depletion and
depreciation
of oil and
gas properties 679 1,069 (36) 1,449 2,259 (36)
Accretion of
asset retirement
obligations 28 21 33 42 42 -
Depreciation
of office
equipment 8 6 33 12 12 -
------------------------------------------------------------------------
Total 715 1,096 (35) 1,503 2,313 (35)
------------------------------------------------------------------------
($/boe)
Depletion and
depreciation
of oil and gas
properties 16.84 17.44 (3) 16.24 17.15 (5)
Accretion of
asset retirement
obligations 0.69 0.34 103 0.47 0.32 47
Depreciation
of office
equipment 0.19 0.10 90 0.13 0.09 44
------------------------------------------------------------------------
Total 17.72 17.88 (1) 16.84 17.56 (4)
------------------------------------------------------------------------
------------------------------------------------------------------------


Depletion, depreciation and accretion expense ("DD&A expense") was $1,503,000 for the six months ended June 30, 2005, down 35 percent from $2,313,000 for the six months ended June 30, 2004. Lower DD&A expense was caused by the 32 percent decrease in the production volumes. Depletion and depreciation of the carrying amount of oil and gas properties is calculated using the unit-of-production method based on proved reserves.

Taxes

Current taxes of $71,000 for the six months ended June 30, 2005 are exclusively Saskatchewan Resource Surcharge and Capital taxes. Saskatchewan Resource Surcharge and Capital tax is calculated as a percentage of the corporation's Saskatchewan based production revenues adjusted to approximate well head prices.

Future income taxes for the six months ended June 30, 2005 resulted in a recovery of $908,000. This is primarily as a result of the treatment of the gain on the sale of the CO2 asset as a capital gain which is subject to tax on 50 percent of the gain.

Cash Flow from Operations

Cash flow from operations for the first six months of 2005 was $1,259,000, down 31 percent from the $1,820,000 recorded for the first six months of 2004. Compared to 2004, cash flow for 2005 was positively affected by higher product prices, and negatively affected by decreases in production volumes and higher operating expenses. Cash flow from operations per share decreased 25 percent to $0.03 per share (basic and diluted) for the six months ended June 30, 2005 from $0.04 per share (basic and diluted) for the same period in 2004. The decrease in cash flow from operations per share was caused by the 32 percent decrease in sales volumes.



Corporate Cash Netbacks

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
($ per boe) 2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------
Field netbacks 20.47 22.18 (8) 19.66 19.55 1
General & admin.
expenses (3.88) (5.66) (32) (4.15) (4.15) -
Financing charges (0.59) (1.15) (49) (0.61) (0.72) (15)
Capital taxes (1.17) (0.82) 42 (0.79) (0.86) (8)
------------------------------------------------------------------------
Cash flow from
operations 14.83 14.55 2 14.11 13.82 2
------------------------------------------------------------------------
------------------------------------------------------------------------


Net Earnings (Loss)

For the six months ended June 30, 2005, Milagro had net earnings of $601,000 ($0.01 per share) compared to a net loss of $454,000 ($0.01 per share) for the same period of 2004. Compared to the same period in 2004, results for the first six months of 2005 were positively affected by a recovery of future income taxes.



Capital Expenditures

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
(000's) 2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------

Lease acquisitions
and retention 154 50 208 185 134 38
Geological and
geophysical 26 1 2600 83 57 46
Drilling and
completions 2,770 606 357 3,045 1,858 64
Production equipment
and facilities 375 621 (40) 658 2,480 (73)
Capitalized overhead 38 31 23 61 62 (2)
Office 2 - 200 2 - 200
------------------------------------------------------------------------
Total 3,365 1,309 157 4,034 4,591 (12)
------------------------------------------------------------------------
------------------------------------------------------------------------


Capital expenditures for the six months ended June 30, 2005 were $4,034,000, a 12 percent decrease compared to the first six months of 2004. The six months of 2005 expenditures by area were: Southwest Saskatchewan - $66,000; Alberta - $3,848,000; and Corporate - $120,000. Milagro drilled 2 wells in the first six months of 2005 and spudded 1 well late in June that continued drilling in July 2005.



LIQUIDITY AND CAPITAL RESOURCES

------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
(000's) 2005 2004 % Change 2005 2004 % Change
------------------------------------------------------------------------

Cash flow from
operations 598 892 (33) 1,259 1,819 (31)
Proceeds on sale of
property & equipment 199 - 4,534 -
Increase (decrease)
in bank debt 279 (3,138) 1225 (1,755) (38) 4618
Issue of common shares 22 3,648 (99) 144 3,672 (96)
Working capital 2,267 (52) 4460 (148) (778) (80)
Abandonment costs - (41) 100 - (84) 100
------------------------------------------------------------------------
Total funding 3,365 1,309 257 4,034 4,591 (12)
------------------------------------------------------------------------
------------------------------------------------------------------------


Milagro's capital expenditure program for the six months ended June 30, 2005 was funded 31 percent by cash flow from operations. The remaining $2,775,000 was funded from the $4,534,000 million in proceeds from the sale of undeveloped lands, with balance used to reduce bank debt.

At June 30, 2005 Milagro's net debt (bank debt adjusted for working capital) was $3,798,000. This amount is expected to increase marginally during the balance of 2005 as Milagro has raised $6,790,000 in new equity to augment the cash flow in funding planned capital expenditures. Milagro has a $7.0 million demand revolving production loan with its principal lender.

On June 30, 2005, Milagro had the following securities outstanding: 48,161,314 common shares; 1,326,774 stock options with a weighted average exercise price of $0.63 per share.

OUTSTANDING SHARE DATA

As of July 29, 2005, Milagro had 53,473,072 common shares and 1,289,516 stock options outstanding.

CONTRACTUAL OBLIGATIONS

Milagro's identified contractual obligations as at June 30, 2005 have not changed materially since December 31, 2004. At June 30, 2005, Milagro had satisfied all expenditure obligations related to the June 2004 issuance of flow-through common shares.

OFF-BALANCE SHEET ARRANGEMENTS

Milagro does not have any special purposes entities nor is it a party to any arrangement that would be excluded from the balance sheet.

RELATED PARTY TRANSACTIONS

During the first six months of 2005, Milagro entered into commercial business transactions with two related parties, both of whom are Milagro directors. One of the related parties is a partner of a law firm that provides legal services to Milagro and the other is the President and significant shareholder of a corporation that provides well logging and perforating services to Milagro. The following table summarizes the payments made by Milagro to these two entities during the first six months of 2005 and 2004.



------------------------------------------------------------------------
Three months Six months
ended June 30, ended June 30,
------------------------------------------------------------------------
2005 2004 2005 2004

Legal fees $ 21,658 $ 50,366 $ 36,972 $ 62,625
Well logging and
perforating services $ 15,352 $ 6,293 $ 15,747 $ 54,927
------------------------------------------------------------------------
------------------------------------------------------------------------


All legal fees paid were charged to general and administrative expenses. All well logging and perforating services paid were charged to property and equipment.

DATE

This Management's Discussion and Analysis is dated July 29, 2005.

ADDITIONAL INFORMATION

Additional information regarding Milagro, including the Annual Information Form for the year ended December 31, 2004, is available on SEDAR at www.sedar.com.



BALANCE SHEETS

June 30, December 31,
2005 2004
------------------------------------------------------------------------
Assets (Unaudited) (Audited)
Current asset
Accounts receivable $ 957,880 $ 702,716
Property and equipment 31,606,267 33,449,393
------------------------------------------------------------------------
$ 32,564,147 $ 34,152,109
------------------------------------------------------------------------

Liabilities
Current liabilities
Accounts payable and accrued
liabilities $ 3,277,175 $ 3,170,472
Bank debt (Note 2) 1,479,149 3,234,164
------------------------------------------------------------------------
4,756,324 6,404,636

Future income taxes 2,700,000 2,295,000
Asset retirement obligations 1,332,105 1,172,005
------------------------------------------------------------------------
8,788,429 9,871,641
------------------------------------------------------------------------

Shareholders' equity
Share capital (Note 3) 24,395,448 25,564,487
Contributed surplus 126,400 63,300
Deficit (746,130) (1,347,319)
------------------------------------------------------------------------
23,775,718 24,280,468
------------------------------------------------------------------------
$ 32,564,147 $ 34,152,109
------------------------------------------------------------------------
------------------------------------------------------------------------
See accompanying notes


STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (DEFICIT)

Three months Six months
ended June 30, ended June 30,
(Unaudited) 2005 2004 2005 2004
------------------------------------------------------------------------
Revenue


Oil and gas sales $ 1,695,695 $ 2,297,427 $ 3,589,755 $ 4,727,767
Royalties (236,805) (325,782) (475,527) (861,054)
------------------------------------------------------------------------
1,458,890 1,971,645 3,114,228 3,866,713
------------------------------------------------------------------------

Expenses
Production 590,364 497,543 1,215,640 1,043,964
Transportation 42,537 114,809 143,454 248,604
General and
administrative 156,455 346,631 370,210 546,313
Financing charges 23,802 70,693 54,023 95,114
Depletion,
depreciation and
accretion 715,200 1,096,000 1,503,200 2,313,000
Stock-based
compensation 30,100 8,100 63,100 16,200
------------------------------------------------------------------------
1,558,458 2,133,776 3,349,627 4,263,195
------------------------------------------------------------------------

Loss before taxes (99,568) (162,131) (235,399) (396,482)
------------------------------------------------------------------------

Taxes
Capital taxes 47,306 50,443 71,451 113,190
Future income
taxes recovery (884,039) (43,000) (908,039) (56,000)
------------------------------------------------------------------------
(836,733) 7,443 (836,588) 57,190
------------------------------------------------------------------------

Net earnings
(loss) 737,165 (169,574) 601,189 (453,672)
Retained earnings
(deficit),
beginning
of period (1,483,295) 867,993 (1,347,319) 1,152,091
------------------------------------------------------------------------
Retained earnings
(deficit), end
of period $ (746,130) $ 698,419 $ (746,130) $ 698,419
------------------------------------------------------------------------

Net earnings (loss)
per share (Note 4)
Basic $ 0.02 $ - $ 0.01 $ (0.01)
Diluted $ 0.02 $ - $ 0.01 $ (0.01)
------------------------------------------------------------------------
------------------------------------------------------------------------
See accompanying notes


STATEMENTS OF CASH FLOWS
Three months Six months
ended June 30, ended June 30,
(Unaudited) 2005 2004 2005 2004
------------------------------------------------------------------------
Cash provided by
(used for)

Operations
Net earnings (loss) $ 737,165 $ (169,574) $ 601,189 $ (453,672)
Items not affecting
cash
Depletion,
depreciation
and accretion 715,200 1,096,000 1,503,200 2,313,000
Future income
taxes recovery (884,039) (43,000) (908,039) (56,000)
Stock-based
compensation 30,100 8,100 63,100 16,200
Abandonment
costs - (40,655) - (84,363)
------------------------------------------------------------------------
598,426 850,871 1,259,450 1,735,165
Net change in
non-cash working
capital (Note 5) 2,266,386 (52,553) (148,461) (778,380)
------------------------------------------------------------------------
2,864,812 798,318 1,110,989 956,785
------------------------------------------------------------------------

Financing
Issue of common
shares 22,200 3,751,540 144,000 3,775,207
Increase (decrease)
in bank debt 279,066 (3,137,612) (1,755,015) (37,739)
Share issue costs - (103,357) - (103,357)
------------------------------------------------------------------------
301,266 510,571 (1,611,015) 3,634,111
------------------------------------------------------------------------

Investing
Expenditures on
property and
equipment (3,364,828) (1,308,889) (4,034,014) (4,590,896)
Proceeds on sale
of property and
equipment 198,750 - 4,534,040 -
------------------------------------------------------------------------
(3,166,078) (1,308,889) 500,026 (4,590,896)
------------------------------------------------------------------------

Change in cash - - - -
Cash, beginning
and end of period $ - $ - $ - $ -
------------------------------------------------------------------------
------------------------------------------------------------------------

See accompanying notes


NOTES TO FINANCIAL STATEMENTS
Six Months Ended June 30, 2005
(Unaudited)


1. Basis of Presentation

The interim financial statements of Milagro Energy Inc. ("Milagro") have been prepared in accordance with Canadian generally accepted accounting principles and are consistent with the presentation and disclosure in the audited financial statements and notes thereto for the year ended December 31, 2004. The interim financial statements contain disclosures which are supplemental to Milagro's annual financial statements. Certain disclosures, which are normally required to be included in the notes to the annual financial statements, have been condensed or omitted. The interim financial statements should be read in conjunction with Milagro's audited financial statements and notes thereto for the year ended December 31, 2004.

2. Bank Debt

Milagro's revolving production loan was renegotiated with its existing lender in June 2005. The loan's interest rate has been reduced to prime plus 0.375%. The loan is secured by a general security agreement covering all present and after acquired property, accounts, and proceeds. Subsequent to the June 2005 quarter end Milagro repaid the balance outstanding on this loan facility.



3. Share Capital

Common shares issued
------------------------------------------------------------------------
Number of Shares Stated Value
------------------------------------------------------------------------

Balance outstanding, December 31, 2004 47,779,646 $ 25,564,487
Exercise of stock options 381,668 144,000
Tax benefits renounced to shareholders - (1,313,039)
------------------------------------------------------------------------
Balance outstanding, June 30, 2005 48,161,314 24,395,448
------------------------------------------------------------------------
------------------------------------------------------------------------


At June 30, 2005, Milagro has satisfied all expenditure obligations related to the issuance of flow-through common shares during 2004.



Stock options
------------------------------------------------------------------------
Weighted Average
Exercise Price
Number of Shares (per share)
------------------------------------------------------------------------

Balance outstanding,
December 31, 2004 1,678,442 $ 0.56
Exercised (381,668) 0.38
Cancelled (15,000) 0.74
Granted 45,000 0.96
------------------------------------------------------------------------
Balance outstanding, June 30, 2005 1,326,774 0.63
------------------------------------------------------------------------
------------------------------------------------------------------------


4. Per Share Amounts

The following table summarizes the weighted average number of common shares used in calculating net earnings (loss) per share.



------------------------------------------------------------------------
Three months Six months
ended June 30, ended June 30,
2005 2004 2005 2004
------------------------------------------------------------------------

Weighted average
number of shares
outstanding:
Basic 48,155,380 41,567,822 48,116,581 41,532,213
Diluted 48,763,976 41,567,822 48,765,731 41,532,213
------------------------------------------------------------------------
------------------------------------------------------------------------


The calculation of diluted earnings (loss) per share for the three months ended June 30, 2005 does not include 75,000 (2004 - 1,053,441) stock options priced at $1.19 (2004 - $0.60) as the inclusion of these items would be anti-dilutive. The calculation of diluted earnings (loss) per share for the six months ended June 30, 2005 does not include NIL (2004 - 1,053,441) stock options (2004 priced at $0.60) as the inclusion of these items would be anti-dilutive.



5. Supplemental Cash Flow Information

------------------------------------------------------------------------
Three months Six months
ended June 30, ended June 30,
2005 2004 2005 2004
------------------------------------------------------------------------

Changes in non-cash
working capital:

Accounts receivable $ (67,183) $ 202,907 $ (255,164) $ 715,908
Accounts payable
and accrued
liabilities 2,333,569 (255,460) 106,703 (1,494,288)
------------------------------------------------------------------------
$ 2,266,386 $ (52,553) $ (148,461) $ (778,380)

Cash payments
included in the
statements of
cash flows:

Capital taxes 60,000 $ 81,588 120,000 $ 81,588
Financing charges 23,802 $ 54,169 54,023 $ 75,590
------------------------------------------------------------------------
------------------------------------------------------------------------


6. Related Party Transactions

A director of Milagro is a partner of a law firm that provides legal services to Milagro. During the three months ended June 30, 2005, Milagro paid this firm $21,658 (2004 - $50,366) for legal fees charged to general and administrative expense, of which $21,658 is included in accounts payable and accrued liabilities at June 30, 2005 (2004 - $28,468).

During the six months ended June 30, 2005, Milagro paid this firm $36,972 (2004 - $62,625) all of which was charged to general and administrative expense.

A director of Milagro is the President and significant shareholder of a corporation that provides well logging and perforating services to Milagro. During the three months ended June 30, 2005, Milagro paid this corporation $15,352 (2004 - $6,293) for well logging and perforation services, all of which is included in accounts payable and accrued liabilities, and was charged to property and equipment. During the six months ended June 30, 2005, Milagro paid this corporation $15,747 (2004 - $54,927) all of which was charged to property and equipment.

These transactions have been recorded at the exchange amount, which is the amount of consideration established and agreed to by the related parties.

7. Subsequent Event

On July 20, 2005 Milagro closed a bought deal private placement of 5,274,500 common shares for gross proceeds of $7,179,530. This transaction consisted of 2,143,000 common shares at $1.19, 1,131,500 CDE flow through common shares at $1.44 and 2,000,000 CEE flow through common shares at $1.50. The flow through shares are subject to a hold period which expires on November 21, 2005.

Milagro is an exploration and production company engaged in the acquisition, exploration, development and production of oil and gas reserves in western Canada. Milagro is listed for trading on the Toronto Stock Exchange.

Contact Information

  • Milagro Energy Inc.
    Jeffrey Rekunyk
    President and CEO
    (403) 693-4000 or Toll Free: 1-866-693-4022
    or
    Milagro Energy Inc.
    Brad Haack
    CFO
    (403) 693-4000 or Toll Free: 1-866-693-4022
    Website: www.milagroenergy.com