Terax Energy (TEXG) 10QSB/A 2006 Q3 Quarterly report (small business) (amended)

UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-QSB/A

(Mark One)

[ x ] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934
for the quarterly period endedMarch 31, 2006

[] Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ______________ to ______________

Commission file number333-72230

TERAX ENERGY, INC.
(Name of Small Business Issuer in Its Charter)

Nevada	88-0475757
(State of Incorporation)	(IRS Employer Identification No.)

13355 Noel Road
1370 One Galleria Tower
Dallas, TX 75240
(Address of Principal Executive Offices)

(972) 503-0900
(Issuer's Telephone Number)

_________________________________________
(Former name, former address and former fiscal year, if changed since last report)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act
during the past 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 a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [] No [ x ]

As of May 12, 2006, the Company had 60,482,600 shares of its par value $0.001 common stock issued and
outstanding.

Transitional Small Business Disclosure Format (check one):
Yes [] No [ x ]

EXPLANATORY NOTE

This quarterly report on Form 10-QSB/A (“Form 10-QSB/A”) is being filed to amend our quarterly report on Form 10-QSB for the quarter ended March 31, 2006 (the “Original Form 10-QSB”), which was originally filed with the Securities and Exchange Commission (“SEC”) on May 15, 2006 and amended on May 25, 2006. Accordingly, pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended, the Form 10-QSB/A contains current dated certifications from the Principal Executive Officer and the Principal Financial Officer.

We have revised the weighted average number of shares outstanding in our Consolidated Statements of Operations, basic and diluted, for the three months ended March 31, 2005 and the nine months ended March 31, 2006 and 2005, to correct errors in prior calculations. We have also clarified that we are responsible for making certain production payments.

We have not updated the information contained herein for events occurring subsequent to May 15, 2006, the filing date of the Original Form 10-QSB.

2

Quarterly Report on Form 10-QSB for the
Quarterly Period Ending March 31, 2006

Table of Contents

PART I. FINANCIAL INFORMATION
	Item 1.	Financial Statements		3
			Balance Sheets: March 31, 2006 and June 30, 2005 (Unaudited)	4
			Statements of Operations: Three and Nine Months Ended March 31, 2006 and 2005 and Period from October 17, 2000 (Date of Inception) to March 31, 2006 (Unaudited)	5
			Statements of Cash Flows: Nine Months Ended Nine 31, 2006 and 2005 and Period from October 17, 2000 (Date of Inception) to March 31, 2006  (Unaudited)	6
			Notes to Unaudited Consolidated Financial Information: March 31, 2006	7
	Item 2.	Plan of Operation		11
	Item 3.	Controls and Procedures		18
PART II. OTHER INFORMATION				19
	Item 1.	Legal Proceedings		19
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		19
	Item 3.	Defaults Upon Senior Securities		19
	Item 4.	Submission of Matters to a Vote of Security Holders		19
	Item 5.	Other Information		20
	Item 6.	Exhibits		20
Signatures				21

3

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

4

Terax Energy, Inc.
(an Exploration Stage Company)
Balance Sheets
(Unaudited)

		March 31,			June 30,
		2006			2005
Assets
Current assets:
Cash and cash equivalents	$	3,019,326		$	16,614
Prepaid expenses		28,269			49,339
Total current assets		3,047,595			65,953
Oil and gas properties:
Properties not subject to amortization		5,930,207			1,471,601
Properties subject to amortization		14,651,947			-
Total oil and gas properties		20,582,154			1,471,601
Other assets:
Office furniture and automobile equipment, net		134,582			-
Deposits		12,471			-
Total other assets		147,053			-
Total assets	$	23,776,802		$	1,537,554
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable	$	1,575,780		$	-
Accrued liabilities		994,256			27,769
Derivative liability		21,413,629			-
Total current liabilities		23,983,665			27,769
Stockholders' deficit:
Preferred stock, $0.001 par value, 5,000,000		-			-
shares authorized, zero shares issued and outstanding
Common stock, $0.001 par value, 300,000,000		60,483			46,165
shares authorized, 60,482,600 and 46,165,000 shares
issued and outstanding at March 31, 2006 and June 30, 2005
Additional paid-in capital		15,865,598			1,552,679
(Deficit) accumulated during exploration stage		(16,132,944	)		(89,059	)
Total stockholder' deficit		(206,863	)		1,509,785
Total liabilities and stockholders' deficit	$	23,776,802		$	1,537,554

The Accompanying Notes are an Integral Part of These Financial Statements

5

Terax Energy, Inc.
(a Exploration Stage Company)
Statements of Operations
(Unaudited)

		Three-Months Ended						Nine-Months Ended						October 17, 2000
		March 31,						March 31,						(Inception) to
		2006			2005			2006			2005			March 31, 2006
Revenue	$	-		$	-		$	-		$	-		$	-
Expenses:
Depreciation expense		7,475			-			10,864			-			10,864
Investor relations expenses		25,821			-			136,895			-			136,895
Professional fees		409,139			-			748,061			-			748,061
Payroll expense		128,168			-			1,158,807			-			1,158,807
General and administrative expenses		269,100			3,531			428,985			5,942			518,044
Total expenses		839,703			3,531			2,483,612			5,942			2,572,671
Net operating (loss)		(839,703	)		(3,531	)		(2,483,612	)		(5,942	)		(2,572,671	)
Other income (expense):
Dividend income		43,902			-			74,841			-			74,841
Interest (expense)		(460,702	)		-			(493,251	)		-			(493,251	)
Loss on derivative liability		(13,115,985	)		-			(13,115,985	)		-			(13,115,985	)
Other		(243	)		-			(25,878	)		-			(25,878	)
Total other income (expenses)		(13,533,028	)		-			(13,560,273	)		-			(13,560,273	)
Net (loss)	$	(14,372,731	)	$	(3,531	)	$	(16,043,885	)	$	(5,942	)	$	(16,132,944	)
Net (loss) per share	$	(0.26	)	$	(0.00	)	$	(0.33	)	$	(0.00	)
Weighted average number of
common shares outstanding
basic and fully diluted		54,763,418			144,225,000			48,679,913			144,225,000

The Accompanying Notes are an Integral Part of These Financial Statements

6

Terax Energy, Inc.
(an Exploration Stage Company)
Statements of Cash Flows
(Unaudited)

								October 17, 2000
		For the Nine-Months Ended						(Inception) to
		March 31,						March 31,
		2006			2005			2006
Cash flows from operating activities:
Net (loss)	$	(16,043,885	)	$	(5,942	)	$	(16,132,944	)
Adjustments to reconcile net loss :
Shares issued for services								7,500
Shares issued for interest expense		375,000						375,000
Depreciation expense		10,864			-			10,864
Unrealized Loss on derivative liability		13,115,985			-			13,115,985
Changes in current assets and liabilities:
Increase (Decrease) in prepaid expenses		21,070			-			(28,269	)
Increase in accounts payable		1,575,780			-			1,575,780
Increase in accrued liabilities		966,486			-			994,255
Increase in deposits		(12,471	)		-			(12,471	)
Net cash used in operating activities		8,829			(5,942	)		(94,300	)
Cash flows from investing activities
Purchase of oil and gas leases		(4,458,606	)		-			(4,458,606	)
Increase in drilling and equipment		(14,651,945	)		-			(14,651,945	)
Increase in furniture and automobiles		(145,446	)		-			(145,446	)
Net cash used in investing activities		(19,255,997	)		-			(19,255,997	)
Cash flows from financing activities
Proceeds from notes payable		7,825,000			-			7,825,000
Payments on notes payable		(7,825,000	)		-			(7,825,000	)
Debt conversion		-			-			1,800
Issuance of common stock, net of offering cost		22,249,880			-			22,367,823
Net cash provided by financing activities		22,249,880			-			22,369,623
Net (decrease) increase in cash		3,002,712			(5,942	)		3,019,326
Cash – beginning of period		16,614			20,660			-
Cash – ending of period	$	3,019,326		$	14,718		$	3,019,326
		-
Supplemental disclosures:
Interest paid	$	118,251			-		$	118,251
Income taxes paid	$	-		$	-		$	-
Non-cash investing and financing activities:
Common Stock for Asset Acquistion	$	-		$	-		$	1,471,601
Common Stock for Interest Expense	$	375,000		$	-		$	375,000
Warrant issued in connection with issuance of stock	$	8,297,644		$	-		$	8,297,644

The Accompanying Notes are an Integral Part of These Financial Statements

7

Terax Energy, Inc.
(An Exploration Stage Company)
Notes to Unaudited Interim Financial Statements

Note 1 - Basis of Presentation

The consolidated interim financial statements included herein are presented in accordance with United States generally accepted accounting principles, and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Notes to the financial statements which would substantially duplicate the disclosure contained in the audited financial statements for the period ended June 30, 2005 as reported in Form 10-KSB have been omitted.

These statements reflect all adjustments, consisting of normal recurring adjustments, which, in the opinion of management, are necessary for fair presentation of the information contained therein. It is suggested that these consolidated interim financial statements be read in conjunction with the financial statements of Terax Energy, Inc. (“the Company”) for the period ended June 30, 2005 and notes thereto included in Company’s Form 10-KSB.

Note 2 – Stockholders' Equity

Sale of Securities

From August 8, 2005 through September 14, 2005, the Company issued 739,000 Units at a price of $10.00 per Unit for gross proceeds to the Company of $7,390,000. Each Unit consists of eight shares of the Company’s common stock and four non-transferable share purchase warrants. Each warrant is exercisable at a price of $1.75 per share, subject to acceleration upon certain conditions. The value of the warrants, using the Black Scholes method of calculation, was $1,192,608. In addition, the Company incurred fees totaling $285,000 in connection with the offering.

With respect to Units discussed above, the Company agreed to use its best efforts to file a registration statement with the Securities and Exchange Commission on or before March 14, 2006 to register the resale of the shares of common stock sold in the offering and issuable upon exercise of the warrants. In addition, the Company agreed to use its best efforts to cause the registration statement to be declared effective by the SEC as soon as practicable after filing. The Company filed the registration statement with the Securities and Exchange Commission on March 9, 2006. In the event the registration statement is not declared effective, the Company is not obligated to pay any liquidated damages and there are no requirements to settle in cash if the Company cannot deliver registered shares.

The Company evaluated the application of Statement of Financial Accounting Standard (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities” and Emerging Issues Task Force (“EITF”) 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” for the units issued. Based on the guidance of SFAS No. 133 and EITF 00-19, the Company concluded that the warrants issued in connection with the 739,000 Unites were properly classified as equity instruments and were not required to be accounted for as derivatives.

On February 7, 2006, the Company entered into securities purchase agreements to sell to four institutional investors an aggregate of 12,805,600 shares of the Company’s common stock and warrants to purchase an additional 12,805,600 shares of common stock, for an aggregate purchase price of $16,007,000. The unit purchase price of the common stock and corresponding warrant was $1.25. The warrants are exercisable at an exercise price of $1.50 per share and expire on February 6, 2011. The Company has the right to require exercise of all of the warrants in the event that (i) a registration statement registering the resale of the warrants is then in effect and (ii) the volume weighted average trading price per share of the Company’s common stock for each of the previous thirty trading days is in excess of $2.50.

The aggregate commissions paid in connection with the February 7, 2006 private placement were approximately $862,120. In addition, warrants to purchase 574,120 shares of common stock, identical to those sold to the investors, except with an exercise price of $1.25 per share were issued to the placement agent. The pricing of the securities was agreed to with the lead institutional buyer in early January 2006 when the Company’s stock was trading in the $1.75 range and represents an approximate 30% discount to the market price at that time. The fair value of the warrants, as determined using the Black Scholes pricing model, issued to the placement agent was $1,198,353 and was recorded as an equity issuance cost and is reflected in the balance sheet as a reduction to paid-in capital.

With respect to February 7, 2006 private placement, the Company also entered into registration rights agreements with the investors to register the resale of the shares of common stock sold in the offering and issuable upon exercise of the warrants. Subject to the terms of the registration rights agreement, the Company is required to file the registration statement with the Securities and Exchange Commission within 30 days of the closing, to use its best efforts to cause the Registration Statement to be declared effective under the Securities Act of 1933 (the “Act”) within 60 days following the closing date of the offering, or 120 days following the closing of the offering if the registration statement is reviewed by the Securities and Exchange Commission. In the event the registration statement is not filed or declared effective when due, the Company is obligated to pay the investors liquidated damages in the amount of 1.5% of the purchase price for each month in which the Company is in default. See Form 8-K filed on February 7, for a more detailed explanation of the transaction.

8

The Company is accounting for the warrants associated with the sale of its common stock in the February 7, 2006 private placement, in accordance with SFAS 133 “Accounting for Derivative instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock”. The accounting treatment of these derivative financial instruments requires that the Company record the derivatives at their fair values as of the date of the sale of the common stock and at fair value as of each subsequent balance sheet date as a liability. At February 7, 2006 the proceeds were allocated between the common stock and the warrants. The allocation was based on the value of the common stock issued utilizing the closing price of the common stock on February 7, 2006 and the fair market value of the warrants as determined using the Black Scholes pricing model. The proceeds were allocated $7,099,291, to the fair value of the warrants and recorded as a liability, and the remaining $8,907,709 was allocated to the common stock. The allocated value of the common stock was recorded as $8,894,903 in additional paid in capital, and $12,806 in common stock. The Company is required to record the unrealized changes in fair value in subsequent periods as an adjustment to the current liability with unrealized changes in the fair value of the derivative reflected in the statement of operations as “(gain)/loss on derivative liabilities”.. The Company estimates fair value using the Black Scholes option pricing model. This model requires the use of estimates such as the expected holding period, the expected future volatility of the Company’s common stock and the risk-free rate of return over the holding period. These estimates directly affect the reported amounts of the derivative instrument liabilities. The fair value of the warrants at February 7, 2006, was $27,045,484. The excess of the fair value of the warrants over the allocated purchase price was $19,946,193, of which $1,198,353 representing the fair value of the warrants issued to the placement agent was recorded as an equity issuance cost and is reflected in the balance sheet as a reduction to the paid in capital and the remaining $18,747,840 was recorded in the statement of operations as a loss on derivative liability. The significant assumptions used in the valuation were: the exercise price as noted above; Terax’s common stock price on February 7, 2006, which was $2.65; expected volatility of 79.92%; risk free interest rate of approximately 4.5%, and a term of 5 years. At March 31, 2006 the fair value of the warrants was again determined utilizing the Black Scholes valuation model. The fair value of the warrants at March 31, 2006 was $21,413,629. The significant assumptions used in the valuation were: the exercise price as noted above; Terax’s common stock price on March 31, 2006, which was $2.20; expected volatility of 79.35%; risk free interest rate of approximately 4.8%, and a term of four years and eight months. The resulting unrealized change in fair value of $5,631,855 from February 7, 2006 to March 31, 2006 was recorded in the statement of operations as a gain on derivative liability resulting in a net loss on derivative liability for the period of $13,115,985.

On February 2, 2006 the Company and certain current and former directors, officers and agents of the Company entered into a Master Compromise and Settlement Agreement with J. William Rhea, IV pursuant to which the parties resolved all outstanding claims between them. As part of the resolution, 800,000 shares of the Company’s common stock were issued to Mr. Rhea. In addition, the Company paid Mr. Rhea $800,000 on account of compensation due to him under his employment agreement with the Company.

Stock Return to Treasury

In March 2005, Mr. Chester acquired 105,150,000 shares which had been previously issued by the Company from October 2000 through August 2003 from one of our former officers. Subsequently, Mr. Chester sold 5,000,000 shares to Mr. Rhea.

On June 7, 2005, Mr. Rhea and Mr. Chester returned, without consideration, 5,000,000 and 500,000 shares, respectively, to the treasury pursuant to a Management Stock Pool Agreement which is discussed below.

On June 13, 2005,,to facilitate our private placement offering, discussed below, Mr. Chester agreed to cancel 99,650,000 shares held by him. There were no additional terms with respect to such Mr. Chester’s agreement to cancel the 99,650,000 shares.

Management Compensation

         Management Group Stock Plan

Pursuant to the terms of the Management Stock Pool Agreement between the Company and certain of its officers and directors dated June 7, 2005, the officers and directors agreed that in the event of resignation or, in the event of termination for cause, the officers and directors would forfeit the opportunity to earn any additional stock under the plan.

On October 26, 2005, Mr. Chester resigned his positions of Director and Vice President of the Company. As provided for in the Management Group Stock Agreement, Mr. Chester’s resignation resulted in forfeiture to earn 500,000 shares under the plan.

On November 10, 2005, Mr. Rhea was terminated for cause and was removed as officer and director of the Company. As provided for in the Management Group Stock Agreement, Mr. Rhea’s termination resulted in forfeiture to earn 5,000,000 shares under the plan.

9

There are currently no shares held in escrow which are subject to the Management Group Stock Plan.

         Management Stock and Options Grants

On October 17, 2005, the Company hired a VP of Operations on an “at will” basis. In addition the Company agreed to issue options to acquire 500,000 in common stock at a price of $2.80 per share for a period of 5 years. The options will vest in equal amounts, over three years from the date of issue.

On November 15, 2005, the Company hired a Chief Financial Officer and interim Chief Executive Officer on an “at will” basis. The Company has agreed to issue 500,000 shares of common stock as a stock bonus.

On February 8, 2006, the Company retained the services of a Controller and Chief Accounting Officer on an “at will” basis. The Company has agreed to issue 200,000 shares of common stock as a stock bonus to be earned 100,000 at December 31, 2006 and 100,000 at December 31, 2007. In addition the Company has agreed to issue options to acquire 200,000 shares of common stock at a price of $2.43 per share for a period of 5 years. The options will vest in equal amounts, over two years from the date of issue.

The holders of the stock and option grants discussed above have agreed to waive their rights to the stock and option grants provided that the 2006 Incentive Stock Plan is approved by the Company's shareholders. Upon the approval in May 2006 by shareholders owning a majority of the Company’s Stock, the holders waived their rights to the stock and option grants. In exchange for the waiver of their rights to the stock and option grants, the holders received stock grants pursuant to the 2006 Incentive Stock Plan, which is discussed below.

         2006 Incentive Stock Plan

The 2006 Incentive Stock Plan has initially reserved 3,200,000 shares of common Stock for issuance. Under the 2006 Incentive Stock Plan, options may be granted which are intended to qualify as Incentive Stock Options under Section 422 of the Internal Revenue Code of 1986 or which are not intended to qualify as Incentive Stock Options thereunder. Under the 2006 Stock Incentive Plan, options, stock grants, or restricted stock may be granted to key employees, officers, directors or consultants of the Company, as provided in the 2006 Stock Incentive Plan.

On February 27, 2006, the Board of Directors approved certain stock grants to four employees, subject to the approval of shareholders of the Company. With respect to each of the following grants, 40% of such shares would be earned on January 1, 2007 and 60% would be earned on January 1, 2008.

Grantee	Position	Shares
Lawrence J. Finn	CEO and CFO	1,500,000
Richard C. Binz	Controller and CAO	300,000
Sam M. Governale	VP Field Operations	250,000
Joyce Moore	Secretary	100,000

The Company’s 2006 Stock Incentive Stock Plan was approved by shareholders owning a majority of the Company’s stock in May 2006.

Note 3 – Oil and Gas Properties
In the nine months ended March 31, 2006, the Company acquired additional gross acres of oil and gas leasehold interests in Erath and Comanche Counties, Texas. These acquisition costs for the three and nine months ended March 31, 2006 were $739,310 and $4,458,606, respectively.

10

Note 3 – continued

In October, 2005, the Company began development of its oil and gas leases in Erath County Texas. Through the quarter ended March 31, 2006, the Company had drilled four wells to total depth and began installation of its gathering system. At March 31, 2006, the Company was completing one well and the remaining three wells were waiting on completion of the gathering or a fracture stimulation crew before they can be completed and begin production. The total cost incurred for drilling and gathering system for the three and nine months ended March 31, 2006, was $9,567,288 and $14,651,947, respectively.

Note 4 – Related Party Transactions

For the Nine months ended March 31, 2006, $298,844, of legal fees and reimbursable expenses, were incurred with a law firm in which a Director is a partner of the law firm.

For the Nine months ended March 31, 2006, fees totaling $138,962 were paid by the Company to a Director for services rendered in managing certain litigation matters.

Note 5 – Note Payable

During the quarter ended September 30, 2005, the Company borrowed $325,000 bearing interest at 6% per annum. The amount, including $1,110 in interest, was repaid during the first quarter.

On December 2, 2005 for $2,500,000, December 19, 2005 for $1,600,000, and January 26, 2006 for $900,000, the Company issued promissory notes (the “Notes”) to an investor with aggregate principal amounts of $5,000,000. The Notes bear interest at the rate of 12.5% per annum, and are due on demand after May 31, 2006. The Notes may be repaid at any time by the Company. The Notes are secured by a security interest in all of the Company’s oil and gas leases and pipeline right of ways and easements in Erath County, Texas, as well as well and pipeline equipment and personal property, contracts and agreements, and production from the Company’s wells located on the leases.

On February 1, 2006, the Company issued an additional promissory note (the “Additional Note”) with a principal amount of $2,500,000 to an investor. The Additional Note has the same terms as the Notes as follows: it bears interest at the rate of 12.5% per annum, it is due on demand after May 31, 2006, and it may be repaid at any time by the Company. On February 2, 2006, the Company issued a total of 215,517 shares of the Company’s common stock as further consideration for the Notes and the Additional Note. The Company has agreed to issue an additional 84,483 share of common stock as further compensation for the Notes and the Additional Note. In the Event of Default, the holder of the Notes and the Additional Note has the right but not the obligation to seek remedies for repayment of the notes including but not limited to foreclosure and sale of the secured assets.

On February 17, 2006, the Company repaid $7,500,000 principal plus accrued interest of $117,106. In addition, $375,000 was charged to interest expense for common stock issued in connection with the notes. As result of the repayment, the holder of the notes released all his security interest in the properties.

Note 6 – Other Obligations

On December 8, the Company entered into a one (1) year lease for a field office in Stephenville, Texas, The office space has approximately 1,188 square feet, and rental is rate is approximately $1,300 per month. The Company has the right to renew the lease for up to two (2) years.

On January 24, 2006 the Company signed a three (3) year office lease for approximately 2,893 square feet. The month rental rate is $5,726 per month.

Note 7- Subsequent Events

On May 12, 2006, the Company issued a promissory note in the principal amount of $2,500,000 to an investor. The Note bears interest at the rate of 12.5% per annum, payable on repayment of the Note. The Note is due on demand after December 31, 2006. In addition, interest in the amount of $125,000.00 is due and payable in 71,429 shares of the Company’s common stock at closing. The Note is secured by a security interest in all of the Company’s oil and gas leases and pipeline right of ways and easements in Erath County, Texas, as well as well and pipeline equipment and personal property, contracts and agreements, and production from the Company’s wells located on the leases. In the Event of Default, the holder of the note has the right but not the obligation to seek remedies for repayment of the notes including but not limited to foreclosure and sale of the secured assets.

11

ITEM 2. PLAN OF OPERATIONS

Forward-Looking Statements

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws, including, but not limited to, any projections of earnings, revenue or other financial items; any statements of the plans, strategies and objections of management for future operations; any statements concerning proposed new services or developments; any statements regarding future economic conditions or performance; any statements or belief; and any statements of assumptions underlying any of the foregoing.

Forward-looking statements may include the words “may”, “could”, “estimate”, “intend”, “continue”, “believe”, “expect” or “anticipate” or other similar words. These forward-looking statements present our estimates and assumptions only as of the date of this report. Except for our ongoing securities laws, we do not intend, and undertake no obligation, to update any forward-looking statement.

Although we believe that the expectations reflected in any of our forward-looking statements are reasonable, actual results could differ materially from those projected or assumed in any of our forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and inherent risks and uncertainties. The factors impacting these risks and uncertainties include, but are not limited to:

o increased competitive pressures from existing competitors and new entrants;

o increases in interest rates or our cost of borrowing or a default under any material debt agreements;

o deterioration in general or regional economic conditions;

o adverse state or federal legislation or regulation that increases the costs of compliance, or adverse findings by a regulator with respect to existing operations;

o loss of customers or sales weakness;

o inability to achieve future sales levels or other operating results;

o fluctuations of oil and gas prices;

o the unavailability of funds for capital expenditures; and

o operational inefficiencies in distribution or other systems.

For a detailed description of these and other factors that could cause actual results to differ materially from those expressed in any forward-looking statement, please see “Factors That May Affect Our Results of Operation” in this document and in our Report on Form 10-KSB for the period ended June 30, 2005.

Overview and Outlook

We are an oil and gas exploration, development and production company. Our properties are located in the Fort Worth Basin. Our corporate strategy is to continue building value in the Company through the development and acquisition of gas and oil assets that exhibit consistent, predictable, and long-lived production. Our current focus is exploring the gas reserves located in the Barnett Shale formations of the Fort Worth Basin.

We have consolidated mineral lease positions in both Erath and Comanche counties. Our current focus is on the development and production of our Erath County properties. However, we have begun the

12

evaluation process of our Comanche County properties and expect to develop strategy for those leases and the value in them, in the second half of 2006.

We intend to continue seeking acquisition opportunities which compliment our current focus. We intend to fund our development activity primarily through proceeds from various private placements sufficient enough to evaluate a greater portion of our mineral leases.

Our revenue, profitability, and future growth rate depend substantially on factors beyond our control, such as economic, political, and regulatory developments and competition from other sources of energy. Oil and natural gas prices historically have been volatile and may fluctuate widely in the future. Sustained periods of low prices for oil or natural gas could materially and adversely affect our financial position, our results of operations, the quantities of oil and natural gas reserves that we can economically produce and our access to capital.

Results of Operations

Third Quarter of 2006 Compared to Third Quarter of 2005

The following overview provides a summary of key information concerning our financial results for the third quarter of our fiscal year ending June 30, 2006.

		Three Months			Three Months			Increase
		March 31, 2006			March 31,2005			(Decrease)
Revenue	$	-		$	-		$	-
Expenses:
General and administrative		269,100			3,531			265,569
Payroll expenses		128,168			-			128,168
Professional fees		409,139			-			409,139
Investor relations expenses		25,821			-			25,821
Depreciation expenses		7,475			-			7,475
Total expenses		839,703			3,531			836,172
(Loss) from operations		(839,703	)		(3,531	)		(836,172	)
Other income (expense):
Other expenses		(243	)		-			(243	)
Interest and other income		43,902			-			43,902
Interest expense		(460,702	)		-			(460,702	)
Loss on derivative liability		(13,115,985	)		0			(13,115,985	)
Net ( loss)	$	(14,372,731	)	$	(3,531	)	$	(14,369,200	)

Revenue

Total revenue for the third quarter of 2006 and 2005 was $.0 and $.0. Currently, we are in a development stage, developing various mineral leases and implementing all necessary capital improvements in order to become efficient in our production efforts.

13

Expenses

The General and Administrative Expenses, Payroll Expenses, Professional Fees, and Investor Relations Expenses for the third quarter of 2006 as compared to the third quarter of 2005 were $832,228 and 3,531, respectively, for an increase of $828,697. The remainder of increase in overhead was incurred in connection with the continued acquisition of leases, reporting to stockholders and the beginning of field operations necessary for the evaluation of our oil and gas leases. The increase is a result of our endeavors to obtain the necessary capital required to ultimately to begin production and generate revenue from our oil and gas properties.

Depreciation expenses for the third quarter of 2006 was $7,475 as compared to the third quarter 2005 which was $.0, for an increase of $7,475. The increase was due to the Company’s acquisition of certain office assets and vehicles to support the Company’s operations.

Other Income (Expense)

Interest and other income for the third quarter of 2006 and 2005 was $43,902 and $.0, respectively, for an increase of $43,902 which was the result of the placement of proceeds from the sale of securities in an interest bearing money market account.

Interest Expense for the third quarter of 2006 and 2005 was $460,702 and $.0, respectively, for an increase of $460,702. During the second and third quarter of 2006, we entered into a short-term promissory note(s) in order to meet our operating cost requirements.

Loss on derivative liability for the third quarter of 2006 and 2005 was $13,115,985 and $.0, respectively, for an increase of $13,115,985. This increase is fully described and reference in Note 2, Stockholders’ Equity.

Net Loss

Our net loss for the third quarter of 2006 and 2005 was $14,372,731 and $3,531, respectively, for an increase loss in the amount of $14,369,200. Of these losses, approximately $385,864 was attributable to non-cash costs associated depreciation expenses and non-cash interest expenses. Additionally, a loss on derivative liability of $13,115,985 was recognized in the third quarter of 2006, as is fully described and referenced in Note 2, Stockholder’s Equity.

First Nine Months of 2006 Compared to the First Nine Months of 2005

The following overview provides a summary of key information concerning our financial results for the first nine months of our fiscal year ending June 30, 2006.

14

		Nine Months			Nine Months			Increase
		March 31, 2006			March 31,2005			(Decrease)
Revenue	$	-		$	-		$	-
Expenses:
General and administrative		428,985			5,942			423,043
Payroll expenses		1,158,807			-			1,158,807
Professional fees		748,061			-			748,061
Investor relations expenses		136,895			-			136,895
Depreciation expenses		10,864			-			10,864
Total expenses		2,483,612			5,942			2,477,670
(Loss) from operations		(2,483,612	)		(5,942	)		(2,477,670	)
Other income (expense):
Other expenses		(25,878	)		-			(25,878	)
Interest and other income		74,841			-			74,841
Interest expense		(493,251	)		-			(493,251	)
Loss on derivative liability		(13,115,985	)		0			(13,115,985	)
Net Income ( loss)	$	(16,043,885	)	$	(5,942	)	$	(16,037,943	)

Revenue

Total revenue for the first nine months of 2006 and 2005 was $.0 and $.0.Currently, we are in a development stage, developing various mineral leases and implementing all necessary capital improvements in order to become efficient in our production efforts.

Expenses

The General and Administrative Expenses, Payroll Expenses, Professional Fees, and Investor Relations Expenses for the first Nine months of 2006 as compared to the first nine months of 2005 were $2,472,748 and $5,942, respectively, for an increase of $2,466,806. Of this increase, $817,740 was due the settlement with a former officer of the Company. The remainder of increase in overhead was incurred in connection with the continued acquisition of leases, reporting to stockholders and the beginning of field operations necessary for the evaluation of our oil and gas leases. The increase is a result of our endeavors to obtain the necessary capital required to ultimately to begin production and generate revenue from our oil and gas properties.

The increase in depreciation expenses for the nine months 2006 was $10,864 as compared to the first nine months of 2005 which was $.0, for an increase of $10,864. The increase was due to the Company’s acquisition of certain office assets and vehicles to support the Company’s operations.

Other Income (Expense)

Interest and other income for the first nine months of 2006 and 2005 was $74,841 and $.0, respectively, for an increase of $74,841, which was the result of the placement of proceeds from the sale of securities in an interest bearing money market account.

Interest Expense for the first nine months of 2006 and 2005 was $493,251 and $.0, respectively, for an increase of $493,251. During the first nine months of 2006, we entered into a short-term promissory note(s) in order to meet our operating cost requirements.

15

Loss on derivative liability for the first nine months of 2006 and 2005 was $13,115,985 and $.0, respectively, for an increase of $13,115,985. This increase is fully described and reference in Note 2, Stockholder’s Equity.

Net Loss

Our net loss for the first nine months of 2006 and 2005 was $16,043,885 and $5,942, respectively, for an increase loss in the amount of $16,037,943. Of these losses, approximately $385,864 was attributable to non-cash depreciation costs associated with the purchase of certain office furniture and vehicles to support our operations. Additionally, a loss on derivative liability of $13,115,985 was recognized in the third quarter of 2006, as is fully described and referenced in Note 2, Stockholder’s Equity.

Operation Plan

During the next twelve months we plan to continue to focus our efforts on the current business plan, which is the sustained development of our existing properties. The Company may consider pursuing strategic acquisitions of producing properties and additional oil and gas leases provided we have access to capital resources which will not interfere with continued evaluation and development of our existing assets.

We intend to fund our field operations and development program through a combination of equity financing, proceeds of anticipated exercise of warrants and options and the use of commercial or mezzanine debt as necessary to complete our business plan. Our strategy is to seek financing alternatives which will yield the lowest cost of capital while maintaining the flexibility necessary to fully realize the value in our own oil and gas leased acreage holdings. Before the Company can seek strategic acquisitions of additional leases, producing properties, or acquisition of other companies, the Company must first develop its existing properties to the stage which they can sustain their own development or develop financing alternatives which will not hinder the development of its current assets.

Our future financial results will depend primarily on: (i) the ability to produce gas and oil from existing and future wells; (ii) the ability to discover commercial quantities of natural gas and oil; (iii) the market price for oil and gas; and (iv) the ability to fully implement our exploration and development program, which is dependent on the availability of capital resources. In order to be successful in all or any of these respects, the prices of oil and gas prevailing at the time of production must be at a level allowing for profitable production, and we must be able to obtain additional funding to increase our capital resources.

Liquidity and Capital Resources

There is limited historical financial information about our Company upon which to base an evaluation of our performance. We are a development stage company and have not generated any revenues from operations.

Our continued existence and plans for future growth depend on our ability to continue obtain the capital necessary to develop our existing assets, and the generation of revenue from our current assets. We will need to raise additional capital to fund our development efforts. If we are not able to generate sufficient revenues and cash flows or obtain additional or alternative funding, we will be unable to continue as a going concern.

At March 31, 2006 we had current assets of $3,047,595 and current liabilities of $23,983,665 for a negative net working capital of $20,936,070. The net working capital would be positive $447,559 net of the derivative liability $21,413,629. We will need additional working capital to complete our first six wells and complete the gathering system in order to begin production on all six wells. We completed our first well in March 2006 and have been selling some gas in April while the well continued to unload its fracture stimulation water. If we secure sufficient capital we may have all six wells on production in June 2006. We will need to obtain additional funds to supplement our expected revenues from the first six wells

16

in order to continue the implementation of our planned exploration and development programs on our existing properties over the next twelve months. Furthermore, should the pace of our acquisitions and/or drilling activities differ from our current plans, we may require additional capital sooner. Failure to obtain such additional financing will result in our inability to accelerate the planned exploration programs on our properties or to acquire additional properties. Should the pace of our acquisitions and/or drilling activities differ from our current plans, we may require additional capital sooner. Failure to obtain such additional financing will result in our inability to accelerate the planned exploration programs on our properties or to acquire additional properties. We have no agreements or understandings with any person for additional financing.

Cash Flows

Since inception, we have financed cash flow requirements through debt financing and the issuance of common stock for cash and services. As we continue our development activities, we may continue to experience net negative cash flows from operations, pending receipt of sales or development fees, and will be required to obtain additional financing to fund operations through common stock offerings and debt borrowings to the extent necessary to provide working capital.

Satisfaction of our cash obligations for the next 12 months.

Our oil and gas properties do not have any commercial production. We have no history of earnings or cash flow from our operations. A critical component of our operating plan impacting our continued existence is to efficiently manage the costs associated with exploratory drilling efforts, our ability to obtain additional capital through additional equity and/or debt financing, and JV or WI partnerships will also be important to our expansion plans. In the event we experience any significant problems assimilating acquired assets into our operations or cannot obtain the necessary capital to pursue our strategic plan, we may have to significantly curtail our operations. This would materially impact our ability to continue operations.

We will need additional capital to proceed with the current phase of our operations and the continued field development of our Erath County properties

Over the next twelve months, our existing capital combined with cash flow from operations will be not be sufficient to sustain operations and our planned expansion.

We may incur operating losses over the next twelve months. Our lack of operating history makes predictions of future operating results difficult to ascertain. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development and production, particularly companies in the oil and gas industry. Such risks include, but are not limited to, an evolving and unpredictable business model and the management of growth. To address these risks we must, among other things, implement and successfully execute our business and marketing strategy, continue to develop and upgrade technology and products, respond to competitive developments, and attract, retain and motivate qualified personnel. There can be no assurance that we will be successful in addressing such risks, and the failure to do so can have a material adverse effect on our business prospects, financial condition and results of operations.

All of the leases purchased by the Company are paid up oil and gas leases which do not require future payments. If we begin production of oil or natural gas on a lease before the end of the primary lease term, we may retain that lease without additional cost. If production is established, we are required to pay the leaseholder a portion of the oil or gas production as “royalty payments” which range from 16.66% to 21.5%. If production is not established during the primary term of the lease, in most cases, we have the right but not the obligation to extend the lease for an additional 2 years by making an addition lump sum payment to the leaseholder, as provided for in each lease. If oil and gas production is not established within the additional two years period, the lease is returned to the leaseholder and we have no additional rights to the lease.

The following table summarizes the maximum additional lease option payments by quarter that would be required to be made by the Company if it was to choose to extend the leases by making these additional payments.

Period	Erath County	Comanche County	Total
2nd Quarter 2007	$0.00	$2,715,075.43	$2,715,075.43
3rd Quarter 2007	$565,068.50	$141,987.50	$707,056.00
4th Quarter 2007	$75,836.25	$0.00	$75,836.25
1st Quarter 2008	$0.00	$0.00	$0.00
2nd Quarter 2008	$0.00	$0.00	$0.00
3rd Quarter 2008	$167,064.00	$173,367.22	$340,431.22
4th Quarter 2008	$144,126.35	$238,018.69	$382,145.04
1st Quarter 2009	$0.00	$0.00	$0.00
2nd Quarter 2009	$9,300.00	$0.00	$9,300.00
		Grand Total	$4,229,843.94

17

As of March 31, 2006, we had assets of $23,776,802, and $23,983,665 in current liabilities; resulting in a stockholders’ deficit of $(206,863).

Field Development

Our original plan of operation for field development started with identifying the most promising and cost-effective drill sites on our current leased acres, drilling and testing wells to prove reserves, completing the more promising test wells, extracting the gas, oil and other hydrocarbons that we find, and delivering them to market. We believe that we have leased enough land to move forward with our field development and are proceeding with the next phase of our operations, which is field development.

In the field development stages of our plan, each new well will be drilled and tested individually. The well, upon a favorable evaluation of its producing capabilities, will be fully completed and connected to local gas gathering and water disposal pipelines.

When we have identified a proposed drilling site, we as a licensed operator in the State of Texas, will be engaged in all aspects of well site operations. As the operator we will be responsible for permitting the well, which will include obtaining permission from the Texas Oil and Gas commission relative to spacing requirements and any other state and federal environmental clearances required at the time that the permitting process commences. Additionally, we will formulate and deliver to all interest owners an operating agreement establishing each participant’s rights and obligations in that particular well based on the location of the well and the ownership. In addition to the permitting process, we as the operator will be responsible for hiring the driller, geologist, and land men to make final decisions relative to the zones to be targeted, confirming that we have good title to each leased parcel covered by the spacing permit and to actually drill the well to the target zones. We will be responsible for completing each successful well and connecting it to the most appropriate portion of our gas gathering system.

As the operator we will be the caretaker of the well once production has commenced. As the operator, we will be responsible for paying bills related to the well, billing working interest owners for their proportionate expenses in drilling and completing the well, and selling the production from the well. Once the production has been sold, the Company will have legal council determine ownership of that production and will send out a division order to confirm the nature and amount of each interest owned by each interest owner. Once a division order has been established and confirmed by the interest owners, the Company will issue the checks to each interest owner in accordance with its appropriate interest. From that point forward, we as operator will be responsible for maintaining the well and the wellhead site during the entire term of the production or until such time as we have been replaced or the site appropriately abandoned.

Significant changes in the number of employees.

During the three month period ended March 31, 2006 there were no significant changes in the number of employees. We currently have 4 employees and 6 full-time consultants.

Our proposed personnel structure could be divided into three broad categories: management and professional, administrative, and project field personnel. As in most small companies, the divisions between these three categories are somewhat indistinct, as employees are engaged in various functions as projects and work loads demand.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results or operations, liquidity, capital expenditures or capital resources that is material to investors.

18

Critical Accounting Policies and Estimates

Our discussion of financial condition and results of operations is based upon the information reported in our financial statements. The preparation of these statements requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses as well as the disclosure of contingent assets and liabilities at the date of our financial statements. We base our assumptions and estimates on historical experience and other sources that we believe to be reasonable at the time. Actual results may vary from our estimates due to changes in circumstances, weather, politics, global economics, mechanical problems, general business conditions, and other factors. Our significant accounting policies are detailed in Note 1 to our financial statements included in this Annual Report. We have outlined below certain of these policies as being of particular importance to the portrayal of our financial position and results of operations and which require the application of significant judgment by our management.

Revenue Recognition

It is our policy to recognize revenue when production is sold to a purchaser at a fixed or determinable price.

Successful Efforts Method of Accounting

We account for our oil and natural gas operations using the successful efforts method of accounting. Under this method, all costs associated with property acquisition, exploration, and development of oil and gas reserves are capitalized. Costs capitalized include acquisition costs, geological and geophysical expenditures, lease rentals on undeveloped properties and cost of drilling and equipping productive wells. In the event we do not find proved reserves, geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed. All of our properties are located within the continental United States.

Oil and Natural Gas Reserve Quantities

Reserve quantities and the related estimates of future net cash flows affect our periodic calculations of depletion and impairment of our oil and natural gas properties. Proved oil and natural gas reserves are the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future periods from known reservoirs under existing economic and operating conditions. Reserve quantities and future cash flows included in the Form 10-KSB are prepared in accordance with guidelines established by the SEC and FASB.

ITEM 3. CONTROLS AND PROCEDURES

a) Evaluation of Disclosure Controls and Procedures: As of the end of the period covered by this report, our management carried out an evaluation, under the supervision of our Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operation of our system of disclosure controls and procedures pursuant to the Securities and Exchange Act, Rule 13a- 15(e) an 15d-15(e) under the Exchange Act). Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and, Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Subsequent to the end of the period covered by this report, the Company implemented additional procedures to require two signatures on all checks over $5,000.

19

b) Change in Internal controls:There were changes in internal controls over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially effect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. Except as disclosed below, we are currently not aware of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse affect on our business, financial condition or operating results which were not previously reported in Form 8-K filings by the Company.

On November 7, 2005, J. William Rhea IV, a former member of the Board of Directors and Chief Executive Officer of the Company filed a petition and application for temporary restraining order and preliminary injunctive relief against the Company and individually against current and former members of the Company’s Board of Directors. The action was filed in the District Court of Travis County, Texas. Mr. Rhea was removed as a member of the Board of Directors on October 28, 2005 and he was terminated as Chief Executive Officer on October 31, 2005, for cause.

On February 2, 2006 the Company and certain current and former directors, officers and agents of the Company entered into a Master Compromise and Settlement Agreement with Mr. Rhea pursuant to which the parties resolved all outstanding claims between them. As part of the resolution, 800,000 of the 5,000,000 shares of the Company’s common stock registered in Mr. Rhea’s name and held in escrow were released to Mr. Rhea and 4,200,000 of the 5,000,000 shares of the Company’s common stock registered in Mr. Rhea’s name and held in escrow were returned to treasury of the Company for cancellation, without consideration. In addition, the Company paid Mr. Rhea $800,000 on account of compensation due to him under his employment agreement with the Company. The parties agreed to the following joint statement: In January 2006, J. William Rhea, IV and Terax Energy, Inc., Phillip A. Wylie, Andrew Hromyk, Eric Boehnke, John W. Legg, and Billy Wayne Chester resolved all outstanding claims between them. None of the Parties accepted any liability or admitted any wrongdoing. The Parties no longer desire to pursue any claims against each other. As part of the resolution, Mr. Rhea will be paid $800,000. Furthermore, Terax Energy, Inc. will release from the management stock pool 800,000 shares of Terax Energy, Inc. common stock to Mr. Rhea. The 800,000 shares of the Company’s common stock released to Mr. Rhea are subject to restrictions on resale as detailed in the Form 8-K filed on February 3, 2006

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

During the period covered by this Report the Company has not sold any securities not registered under the Securities Act which were not previously reported in Form 8-K filings made by the Company.

Item 3. Defaults Upon Senior Securities.

None.

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

During the period covered by this report, approval by written consent was obtained from shareholders owning a majority of the Company’s stock for the Company’s 2006 Stock Incentive Stock Plan. The 2006 Incentive Stock Plan has initially reserved 3,200,000 shares of common Stock for issuance. Under the 2006 Incentive Stock Plan, options may be granted which are intended to qualify as Incentive Stock Options under Section 422 of the Internal Revenue Code of 1986 or which are not intended to qualify as

20

Incentive Stock Options thereunder. Under the 2006 Stock Incentive Plan, options, stock grants, or restricted stock may be granted to key employees, officers, directors or consultants of the Company, as provided in the 2006 Stock Incentive Plan.

Item 5. Other Information.

None.

Item 6. Exhibits.

31.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer and Chief Financial Officer)

SIGNATURES

    ��     In accordance with requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	TERAX ENERGY, INC.
Date: August 2, 2006	By:	/s/ Lawrence J. Finn
		Lawrence J. Finn
		President and Chief Executive Officer (Principal
		Executive Officer) and Chief Financial Officer
		(Principal Financial Officer)

21