UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q ---------------------------- (Mark One) /X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2004 or / / Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition period from ___________ to____________ -------------------- COMMISSION FILE NUMBER 0-13305 ------------------- PARALLEL PETROLEUM CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 75-1971716 (State of other jurisdiction (I.R.S. Employer Identification of incorporation or organization) Number) 1004 N. Big Spring, Suite 400, Midland, Texas 79701 (Address of principal executive offices) (Zip Code) (432) 684-3727 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- ---- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X --- ---- At August 4, 2004, 25,414,293 shares of the Registrant's Common Stock, $0.01 par value, were outstanding. INDEX PART I. - FINANCIAL INFORMATION Page No. ----- ITEM 1. FINANCIAL STATEMENTS Reference is made to the succeeding pages for the following consolidated financial statements: - Consolidated Balance Sheets as of June 30, 2004 (unaudited) and December 31, 2003 1 - Unaudited Consolidated Statements of Income for the three months and six months ended June 30, 2004 and 2003 2 - Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003 3 - Unaudited Consolidated Statements of Comprehensive Income (Loss)for the three months and six months ended June 30, 2004 and 2003 4 - Notes to Consolidated Financial Statements 5 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 14 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 28 ITEM 4. CONTROLS AND PROCEDURES 31 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 32 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 32 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 33 SIGNATURES (i) PARALLEL PETROLEUM CORPORATION Consolidated Balance Sheets (dollars in thousands) <table> June 30, December 31, Assets 2004 2003 ------------------ ------------------- (unaudited) <s> <c> <c> Current assets: Cash and cash equivalents $ 4,943 $ 17,378 Accounts receivable: Oil and gas 4,718 4,610 Others, net of allowance for doubtful account of $9 715 316 --------- --------- 5,433 4,926 Other current assets 297 210 Deferred tax asset 1,982 1,098 --------- --------- Total current assets 12,655 23,612 --------- --------- Property and equipment, at cost: Oil and gas properties, full cost method 177,375 162,621 Other 1,930 1,414 --------- --------- 179,305 164,035 Less accumulated depreciation and depletion (74,116) (70,070) --------- --------- Net property and equipment 105,189 93,965 --------- --------- Other assets, net of accumulated amortization of $245 and $182 907 766 --------- --------- $ 118,751 $ 118,343 ========= ========= Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued liabilities $ 5,049 $ 3,965 Derivative obligations 6,167 3,231 --------- --------- Total current liabilities 11,216 7,196 --------- --------- Long-term debt 34,000 39,750 Asset retirement obligations 1,943 1,701 Derivative obligations 4,666 2,655 Deferred tax liability 6,485 5,809 --------- --------- Total long-term liabilities 47,094 49,915 --------- --------- Commitments and contingencies Stockholders' equity: Series A preferred stock -- par value $0.10 per share , authorized 50,000 shares - - Preferred stock -- 6% convertible preferred stock -- par value of $.10 per share, (liquidation preference of $10 per share) authorized 10,000,000 shares, issued and outstanding 957,000 and 959,500 96 96 Common stock -- par value $0.01 per share, authorized 60,000,000 shares, issued and outstanding 25,263,405 and 25,216,863 253 253 Additional paid-in capital 47,724 47,544 Retained earnings 19,358 17,060 Accumulated comprehensive loss (6,990) (3,721) --------- --------- Total stockholders' equity 60,441 61,232 --------- --------- $ 118,751 $ 118,343 ========= ========= </table> The accompanying notes are an integral part of these Consolidated Financial Statements. 1 PARALLEL PETROLEUM CORPORATION Consolidated Statements of Income (Unaudited) (in thousands, except per share data) <table> Three Months Ended June 30, Six Months Ended June 30, ----------------------------- --------------------------- 2004 2003 2004 2003 ---------- ---------- ---------- --------- <s> <c> <c> <c> <c> Oil and gas revenues $ 7,917 $ 8,532 $ 15,918 $ 17,025 ---------- ---------- --------- --------- Cost and expenses: Lease operating expense 2,014 1,741 3,543 2,631 Production taxes 471 445 949 1,010 General and administrative 1,221 968 2,443 1,770 Depreciation and depletion 1,969 1,989 4,046 4,055 ---------- ---------- --------- --------- Total costs and expenses 5,675 5,143 10,981 9,466 ---------- ---------- --------- --------- Operating income 2,242 3,389 4,937 7,559 ---------- ---------- --------- --------- Other income (expense), net: Change in fair market value of derivatives - (105) - (124) Ineffective portion of hedges 17 379 7 196 Interest and other income 18 1 158 46 Interest expense (487) (522) (955) (1,008) Other expense (59) (25) (85) (46) ---------- ---------- --------- --------- Total other expense, net (511) (272) (875) (936) ---------- ---------- --------- --------- Income before income taxes 1,731 3,117 4,062 6,623 Income tax expense, deferred (628) (447) (1,477) (1,639) ---------- ---------- --------- --------- Net income before cumulative effect of change in accounting principle 1,103 2,670 2,585 4,984 Cumulative effect on prior years of a change in accounting principle, net of tax of $32 - - - (62) ---------- ---------- --------- --------- Net income 1,103 2,670 2,585 4,922 Cumulative preferred stock dividend (144) (146) (287) (292) ---------- ---------- --------- --------- Net income available to common stockholders $ 959 $ 2,524 $ 2,298 $ 4,630 ========== ========== ========= ========= Net income per common share: Basic - before cumulative effect of a change in accounting principle $ 0.04 $ 0.12 $ 0.09 $ 0.22 Cumulative effect of a change in accounting principle, net of tax - - - - ---------- ---------- --------- --------- Basic - after cumulative effect of a change in accounting principle $ 0.04 $ 0.12 $ 0.09 $ 0.22 ========== ========== ========= ========= Diluted - before cumulative effect of a change in accounting principle $ 0.04 $ 0.11 $ 0.09 $ 0.20 Cumulative effect of a change in accounting principle, net of tax - - - - ---------- ---------- --------- --------- Diluted - after cumulative effect of a change in accounting principle $ 0.04 $ 0.11 $ 0.09 $ 0.20 ========== ========== ========= ========= Weighted average common share outstanding: Basic 25,246 21,145 25,235 21,144 ========== ========== ========= ========= Diluted 28,330 24,078 28,296 24,051 ========== ========== ========= ========= </table> The accompanying notes are an integral part of these Consolidated Financial Statements. 2 <page> PARALLEL PETROLEUM CORPORATION Consolidated Statements of Cash Flows Six Months Ended June 30, 2004 and 2003 (Unaudited) (dollars in thousands) <table> 2004 2003 ---------------- ----------------- <s> <c> <c> Cash flows from operating activities: Net income $ 2,585 $ 4,922 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and depletion 4,046 4,055 Accretion of asset retirement obligation 53 68 Deferred income taxes 1,477 1,639 Change in fair value of derivative instruments - 21 Ineffective portion of hedges (7) (93) Stock option expense 84 - Cumulative effect on prior years of a change in accounting principle, net of tax - 62 Changes in assets and liabilities: Other, net (141) (80) Increase in accounts receivables (507) (1,728) Increase in other current assets (87) (111) Increase in accounts payable and accrued liabilities 1,084 186 ------------ ------------- Net cash provided by operating activities 8,587 8,941 ------------ ------------- Cash flows from investing activities: Additions to oil and gas property (14,590) (7,241) Proceeds from disposition of oil and gas property 25 20 Additions to other property and equipment (516) (292) ------------ ------------- Net cash used in investing activities (15,081) (7,513) ------------ ------------- Cash flows from financing activities: Net payments on bank line of credit (5,750) (7,000) Proceeds from exercise of stock options 103 12 Deferred stock offering costs (7) - Payment of preferred stock dividend (287) (292) ------------ ------------- Cash used in financing activities (5,941) (7,280) ------------ ------------- Net decrease in cash and cash equivalents (12,435) (5,852) Cash and cash equivalents at beginning of period 17,378 11,812 ------------ ------------- Cash and cash equivalents at end of period $ 4,943 $ 5,960 ============ ============= Non-cash financing and investing activities: Oil and gas properties asset retirement obligations, net $ 189 $ 1,221 Accrued preferred stock dividend $ - $ 24 </table> The accompany notes are an integral part of these Consolidated Financial Statements. 3 <page> PARALLEL PETROLEUM CORPORATION Consolidated Statements of Comprehensive Income (Loss) (Unaudited) (dollars in thousands) <table> Three Months Ended June 30, Six Months Ended June 30, ------------------------------------- ------------------------------------ 2004 2003 2004 2003 ------------------ ------------------ ------------------ ----------------- <s> <c> <c> <c> <c> Net income $ 1,103 $ 2,670 $ 2,585 $ 4,922 ------- ------- ------- ------- Other comprehensive loss: Unrealized losses on derivatives (3,782) (1,214) (8,125) (3,065) Reclassification adjustments for losses on derivatives included in net income 1,952 - 3,171 - ------ ------ ------- ------- Change in fair value of derivatives (1,830) (1,214) (4,954) (3,065) Income tax benefit 624 392 1,685 1,021 ------ ------ ------- ------- Total other comprehensive loss (1,206) (822) (3,269) (2,044) ------ ------ ------- ------- Total comprehensive income (loss) $ (103) $ 1,848 $ (684) $ 2,878 ====== ======= ======= ======= </table> The accompany notes are an integral part of these Consolidated Financial Statements. 4 <page> PARALLEL PETROLEUM CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. DESCRIPTION OF BUSINESS - NATURE OF OPERATIONS AND BASIS OF PRESENTATION Parallel Petroleum Corporation ("Parallel", "we", "us", or "the Company") was incorporated in Texas on November 26, 1979, and reincorporated in the State of Delaware on December 18, 1994. We are engaged in the acquisition, development, exploitation and production of oil and natural gas and, to a lesser extent, the domestic exploration for oil and natural gas. These activities are concentrated in the Permian Basin of west Texas and New Mexico, east Texas, the onshore gulf coast area of south Texas and the Fort Worth Basin of north Texas. The financial information included herein, except the balance sheet as of December 31, 2003, is unaudited. However, such information includes all adjustments (consisting solely of normal recurring adjustments), which are, in the opinion of management, necessary for a fair statement of the results of operations and financial condition for the interim periods. The results of operations for the interim period are not necessarily indicative of the results to be expected for an entire year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in this Form 10-Q Report pursuant to certain rules and regulations of the Securities and Exchange Commission. These financial statements should be read in conjunction with the financial statements and notes included in our 2003 Form 10-K Report. NOTE 2. STOCKHOLDERS' EQUITY Options Prior to September 2003, Parallel accounted for stock-based compensation utilizing the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations. In September, 2003, Parallel adopted the provisions of Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment to SFAS No. 123, whereby certain transitional alternatives are available for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Parallel uses the prospective method which applies prospectively the fair value recognition method to all employee and director awards granted, modified or settled after the beginning of the fiscal year in which the fair value based method of accounting for stock-based compensation is adopted. The potential impact of using the fair value method, on a pro forma basis, is presented in the table that follows. As Parallel adopted the fair value recognition provisions of SFAS No. 123 prospectively for all employee awards granted, modified or settled after January 1, 2003, the charge for stock-based compensation included in the determination of 5 <page> income for the three and six month period ended June 30, 2003 is less than that which would have been recognized if the fair value method had been applied to all awards since the original effective date of SFAS No. 123. For the three and six months ended June 30, 2004, Parallel recognized compensation expense of approximately $42,000 and $84,000 respectively associated with its stock option grants. No options were granted during the quarter ended June 30, 2004. The following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each period. The fair value of each grant is estimated on the date of grant using the Black-Scholes option-pricing model. <table> Three Months Ended Six Months Ended June 30, June 30, ------------------------------ ------------------------------- 2004 2003 2004 2003 --------------- -------------- -------------- -------------- (dollars in thousands, except per share data) <s> <c> <c> <c> <c> Net income, as reported $ 1,103 $ 2,670 $ 2,585 $ 4,922 Add: Expense recorded in 2004 42 - 84 - Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax (48) (62) (95) (109) -------------- ------------- ------------- -------------- Pro forma net income $ 1,097 $ 2,608 $ 2,574 $ 4,813 ============== ============= ============= ============== Net income per common share: Basic - as reported $ 0.04 $ 0.12 $ 0.09 $ 0.22 ============== ============= ============= ============== Basic - pro forma $ 0.04 $ 0.11 $ 0.09 $ 0.21 ============== ============= ============= ============== Diluted - as reported $ 0.04 $ 0.11 $ 0.09 $ 0.20 ============== ============= ============= ============== Diluted - pro forma $ 0.04 $ 0.10 $ 0.09 $ 0.20 ============== ============= ============= ============== </table> NOTE 3. LONG TERM DEBT Long term debt as of June 30, 2004, was $34.0 million which is due and payable in December 2006. Revolving Credit Facility. Under our revolving credit facility (the "Facility"), we may borrow the lesser of $100.0 million or the "borrowing base" then in effect. The borrowing base calculation is based upon the estimated discounted present value of our oil and gas reserves. The borrowing base at June 30, 2004 was $52.0 million, which was reduced to $51.5 million effective August 5, 2004 following our sale of non-core oil and gas assets. All borrowings are collateralized by our oil and gas reserves. The total outstanding principal amount of our bank indebtedness at June 30, 2004 was $34.0 million, excluding $250,000 reserved for our letters of credit. The borrowing base is subject to redetermination semi-annually on or about April 1 and October 1 or at other times required by the banks or at our request. All indebtedness matures December 20, 2006. 6 <page> Unpaid principal balances outstanding under the Facility bear interest, at our election, at a rate equal to (i) the agent bank's base lending rate, or (ii) the LIBOR rate plus a LIBOR margin of 2.25% to 2.75%. However, the interest rate may never be less than 4.50%. Interest is due and payable on the day which the related LIBOR interest period ends. We are required to pay a commitment fee of .25% times the daily average of the unadvanced amount of the commitment. The Facility includes various restrictive covenants and compliance requirements. Among these restrictions are limitations on our ability to: . dispose of assets; . incur additional indebtedness; . create liens on our assets; . enter into specified investments or acquisitions; . repurchase, redeem or retire our capital stock or other securities; . merge or consolidate, or transfer all or substantially all of our assets and the assets of our subsidiaries; . engage in specified transactions with subsidiaries and affiliates; . engage in other specified corporate activities; and . the Facility also contains restrictions on all retained earnings and net income for payment of dividends on our common stock. Our revolving credit facility also requires that we have: . at the end of each quarter, a current ratio (as defined in the credit agreement) of at least 1.1 to 1.0; . at the end of each quarter, a funded debt ratio (as defined in the credit agreement) of not more than 3.0 to 1.0; and . at all times, adjusted consolidated net worth (as defined in the credit agreement) of at least (a) $40.0 million, plus (b) seventy-five percent (75%) of the net proceeds from any equity securities issued by Parallel, plus (c) fifty percent (50%) of Parallel's consolidated net income for each fiscal quarter, if positive, and zero percent (0%) if negative. As of June 30, 2004, we were in compliance with all covenants. 7 <page> NOTE 4. PREFERRED STOCK We have outstanding 957,000 shares of 6% Convertible Preferred Stock, $0.10 par value per share. Cumulative annual dividends of $0.60 per share are payable semi-annually on June 15 and December 15 of each year. Each share of 6% Convertible Preferred Stock may be converted, at the option of the holder, into 2.8571 shares of common stock at an initial conversion price of $3.50 per share, subject to adjustment in certain events. The 6% Convertible Preferred Stock has a liquidation preference of $10 per share and has no voting rights, except as required by law. We may redeem the 6% Convertible Preferred Stock, in whole or part, for $10 per share plus accrued and unpaid dividends. NOTE 5. FULL COST CEILING TEST We use the full cost method to account for our oil and gas producing activities. Under the full cost method of accounting, the net book value of oil and gas properties, less related deferred income taxes and asset retirement obligations, may not exceed a calculated "ceiling". The ceiling limitation is the discounted estimated after-tax future net cash flows from proved oil and gas properties. In calculating future net cash flows, current prices and costs are generally held constant indefinitely as adjusted for qualifying cash flow hedges. The net book value of oil and gas properties, less related deferred income taxes and asset retirement obligation over the ceiling, is compared to the ceiling on a quarterly and annual basis. Any excess of the net book value, less related deferred income taxes, is generally written off as an expense. Under rules and regulations of the SEC, the excess above the ceiling is not written off if, subsequent to the end of the quarter or year but prior to the release of the financial results, prices have increased sufficiently that such excess above the ceiling would not have existed if the increased prices were used in the calculations. At June 30, 2004 the net book value of our oil and gas properties, less related deferred income taxes, was below the calculated ceiling. As a result, we were not required to record a reduction of our oil and gas properties under the full cost method of accounting. Under the full cost method of accounting, all costs incurred in the acquisition, exploration and development of oil and natural gas properties, including a portion of our overhead, are capitalized. In the six month periods ended June 30, 2004 and 2003, overhead costs capitalized were approximately $522,000 and $431,000 respectively. NOTE 6. DERIVATIVE INSTRUMENTS General We enter into derivative contracts to provide a measure of stability in our oil and gas revenues and interest rate payments and to manage exposure to commodity price and interest rate risk. Our objective is to lock in a range of oil and gas prices and a fixed interest rate for certain notional amounts. We designate our interest rate swaps, costless collars and commodity swaps as cash flow hedges. The effective portion of the unrealized gain or loss on cash flow hedges is 8 recorded in other comprehensive income until the forecasted transaction occurs. During the term of a cash flow hedge, the effective portion of the quarterly change in the fair value of the derivatives is recorded in stockholders' equity as other comprehensive income (loss) and then transferred to oil and gas revenues when the production is sold and interest expense when the interest payment is made. Ineffective portions of hedges (changes in realized prices that do not match the changes in the hedge price) are recognized in other expense as they occur. While the hedge contract is open, the ineffective gain or loss may increase or decrease until settlement of the contract. As of June 30, 2004, we have recorded unrealized losses of $10.6 million ($7.0 million, net of tax) related to our derivative instruments, which represented the estimated aggregate fair values of our open derivative contracts as of that date. These unrealized losses are presented on the Consolidated Balance Sheet as a current liability of $5.9 million and long-term liabilities of $4.7 million and $7.0 million, net of tax, as accumulated comprehensive loss in Stockholders' Equity. We recorded an ineffective portion of the derivative instruments of approximately $200,000 in current liabilities. During the twelve month period ending June 30, 2005, we expect approximately $3.9 million, net of tax, to be transferred out of accumulated comprehensive loss and charged to earnings. We are exposed to credit risk in the event of nonperformance by the counterparty to these contracts, BNP Paribas. However, we periodically assess the creditworthiness of the counterparty to mitigate this credit risk. Interest Rate Sensitivity In January, 2003, we entered into a 45-month LIBOR fixed interest rate swap contract with BNP Paribas. We receive a fixed interest rate, as noted in the table below, for the 45-month period beginning March 31, 2003 through December 20, 2006. Under our Revolving Credit Facility, we may elect an interest rate based upon the agent bank's base lending rate, or the LIBOR rate, plus a margin ranging from 2.25% to 2.75% per annum, depending on our borrowing base usage. The interest rate we are required to pay, including the applicable margin, may never be less than 4.50%. 9 A recap for the period of time, notional amounts, LIBOR fixed interest rates, expected margin rates and expected fixed interest rates for the contract are as follows: <table> Libor Expected Expected Notional Fixed Margin Fixed Period of Time Amounts (1) Interest Rates (2) Rates (3) Interest Rates (4) - ----------------------------------------------- ----------------- ------------------- ----------- ------------------ <s> <c> <c> <c> <c> July 1, 2004 thru December 31, 2004 $ 30,000,000 2.660% 2.500% 5.160% January 1, 2005 thru December 31, 2005 $ 20,000,000 4.050% 2.250% 6.300% January 1, 2006 thru December 20, 2006 $ 10,000,000 4.050% 2.250% 6.300% ___________________ </table> (1) Based on the anticipated principal reductions under our facility. (2) Parallel's swap contract with BNP Paribas. (3) Based on the anticipated borrowing base usage under our facility. (4) Total of the LIBOR fixed rate plus the expected margin rate under our facility. Our credit agreement requires the interest rate to not be below 4.50%. Commodity Price Sensitivity Costless Collars. Collars are created by purchasing puts to establish a floor price and then selling a call which establishes a maximum amount the producer will receive for the oil or gas hedged. Calls are sold to offset the premium paid for buying the put. We have entered into several costless Houston ship channel gas collars. A majority of our natural gas production is sold based on Houston ship channel prices. A recap for the period of time, number of MMBtu's and average gas prices is as follows: <table> Houston Ship Channel gas prices --------------------------- MMBtu of Period of Time Natural Gas Floor Cap - ------------------------------------------- -------------- ------------ ------------- <s> <c> <c> <c> July 1, 2004 thru October 31, 2004 123,000 $ 4.40 $ 5.50 April 1, 2005 thru October 31, 2005 428,000 $ 5.00 $ 7.26 </table> Swaps. Generally, swaps are an agreement to buy or sell a specified commodity for delivery in the future, but at an agreed fixed price. Swap transactions convert a floating price into a fixed price. For any particular swap transaction, the counterparty is required to make a payment to the hedge party if the reference price for any settlement period is less than the swap price for such hedge, and the hedge party is required to make a payment to the counterparty if the reference price for any settlement period is greater than the swap price for such hedge. 10 We have entered into oil and gas swap contracts with BNP Paribas. A recap for the period of time, number of MMBtu's, number of barrels, and swap prices are as follows: <table> Houston Ship Barrels of Nymex Oil MMBtu of Channel Period of Time Oil Swap Prices Natural Gas Gas Swap Price - -------------------------------------------- ------------ --------------- ------------- ----------------- <s> <c> <c> <c> <c> July 1, 2004 thru December 31, 2004 220,800 $ 24.27 491,000 $ 4.694 January 1, 2005 thru December 31, 2005 365,000 $ 23.35 - $ - January 1, 2005 thru March 31, 2005 - $ - 180,000 $ 4.705 January 1, 2006 thru December 20, 2006 265,500 $ 23.04 - $ - </table> NOTE 7. NET INCOME PER COMMON SHARE Basic net income per share exclude any dilutive effects of option, warrants and convertible securities and are computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net income per share is computed similar to basic net income per share. However, diluted net income per share reflects the assumed conversion of all potentially dilutive securities. The following table provides the computation of basic and diluted net income per common share for the three and six months ended June 30, 2004 and 2003: 11 <page> <table> Three Months Ended Six Months Ended June 30, June 30, ------------------------- ------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ (dollars in thousands, except per share data) <s> <c> <c> <c> <c> Basic Earnings Per Share Computation: Numerator- Income before cumulative effect of a change in accounting principle $ 1,103 $ 2,670 $ 2,585 $ 4,984 Cumulative effect of a change in accounting principle, net of tax - - - (62) ------- ------- ------- ------- 1,103 2,670 2,585 4,922 Preferred stock dividend (144) (146) (287) (292) ------- ------- ------- ------- Net income available to common stockholders $ 959 $ 2,524 $ 2,298 $ 4,630 ======= ======= ======= ======= Denominator- Weighted average common shares outstanding 25,246 21,145 25,235 21,144 ======= ======= ======= ======= Basic Earnings Per Share: Income before cumulative effect of a change in accounting principle $ 0.04 $ 0.12 $ 0.09 $ 0.22 Cumulative effect of a change in accounting principle, net of tax - - - - ------- ------- ------ ------- Net income per common share $ 0.04 $ 0.12 $ 0.09 $ 0.22 ======= ======= ====== ======= Diluted Earnings Per Share Computation: Numerator- Income before cumulative effect of a change in accounting principle $ 1,103 $ 2,670 $ 2,585 $ 4,984 Cumulative effect of a change in accounting principle, net of tax - - - (62) ------- ------- ------- ------- 1,103 2,670 2,585 4,922 Preferred stock dividend - - - - ------- ------- ------- ------- Net income available to common stockholders $ 1,103 $ 2,670 $ 2,585 $ 4,922 ======= ======= ======= ======= Denominator - Weighted average common shares outstanding 25,246 21,144 25,235 21,144 Employee stock options 285 150 268 123 Warrants 65 - 59 - Preferred stock 2,734 2,784 2,734 2,784 -------- ------- ------- ------- Weighted average common shares for diluted earnings per share assuming conversion 28,330 24,078 28,296 24,051 ======== ======= ======= ======= Diluted Earnings Per Share: Income before cumulative effect of a change in accounting principle $ 0.04 $ 0.11 $ 0.09 $ 0.20 Cumulative effect of a change in accounting principle, net of tax - - - - -------- ------- ------- ------- Net income per common share $ 0.04 $ 0.11 $ 0.09 $ 0.20 ======== ======= ======= ======= </table> 12 <page> NOTE 8: ASSET RETIREMENT OBLIGATIONS On January 1, 2003, we adopted Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations "SFAS No. 143". SFAS No. 143 requires us to recognize a liability for the present value of all obligations associated with the retirement of tangible long-lived assets and to capitalize an equal amount as a cost of the related oil and gas properties The following table summarizes our asset retirement obligation activity: <table> Three Months Ended Six Months Ended ---------------------------- ---------------------------- June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003 -------------- ------------- ------------- ------------- (in thousands) <s> <c> <c> <c> <c> Beginning asset retirement obligation $ 1,864 $ 1,727 $ 1,701 $ 1,693 Additions related to new properties 59 16 231 16 Deletions related to property disposals - - (42) - Accretion expense 20 34 53 68 ------- ------- ------- ------- Ending asset retirement obligation $ 1,943 $ 1,777 $ 1,943 $ 1,777 ======= ======= ======= ======= </table> NOTE 9: RECENTLY ANNOUNCED ACCOUNTING PRONOUNCEMENTS FIN No. 46, Consolidation of Variable Interest Entities. In December 2003, the FASB issued Interpretation No. 46R, which requires the consolidation of certain entities that are determined to be variable interest entities ("VIE"). An entity is considered to be a VIE when either (i) the entity lacks sufficient equity to carry on its principal operations, (ii) the equity owners of the entity cannot make decisions about the entity's activities or (iii) the entity's equity neither absorbs losses or benefits from gains. We own no interests in variable interest entities, and therefore this new interpretation has not affected our consolidated financial statements. In March 2004, the Financial Accounting Standards Board ("FASB") issued an exposure draft entitled "Share-Based Payment, an Amendment of FASB Statements No. 123 and 95." This proposed statement addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. The proposed Statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued to Employees", and generally would require instead that such transactions be accounted for using a fair-value-based method. As proposed, this statement would apply to Parallel effective January 1, 2005. We are currently unable to determine what effect this statement will have on our financial position or results of operations. 13 NOTE 10.COMMITMENTS AND CONTINGENCIES From time to time, we are a party to ordinary routine litigation incidental to our business. We are not currently a party to any pending litigation, and we are not aware of any threatened litigation. We have not been a party to any bankruptcy, receivership, reorganization, adjustment or similar proceeding. As previously reported, the Compensation Committee has approved in principle the adoption of an employee incentive and retention plan which, generally, would provide for a one-time cash payment to all officers and employees upon the occurrence of a merger, sale or other change of control of the company. The Committee is still working on finalizing the specific compensatory features of the plan, which we expect will include features tied more closely to the market price of Parallel's common stock. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and the related notes. OVERVIEW Strategy Our primary objective is to increase stockholder value of our common stock through increasing reserves, production, cash flow from operations and earnings. We have shifted the balance of our investments from properties having high rates of production in early years to properties with more consistent production over a longer term. We attempt to reduce our financial risks by dedicating a smaller portion of our capital to high risk projects, while reserving the majority of our available capital for exploitation and development drilling opportunities. Obtaining positions in long-lived oil and gas reserves are given priority over properties that might provide more cash flow in the early years of production, but which have shorter reserve lives. We also attempt to further reduce risk by emphasizing acquisition possibilities over high risk exploration projects. Since the latter part of 2002, we have reduced our emphasis on high risk exploration efforts and focused on established geologic trends where we utilize the engineering, operational, financial and technical expertise of our entire staff. Although we anticipate participating in exploratory drilling activities in the future, reducing financial, reservoir, drilling and geological risks and diversifying our property portfolio are important criteria in the execution of our business plan. In summary, our current business plan: . focuses on projects having less geological risk; . emphasizes exploitation and enhancement activities; . focuses on acquiring producing properties; and 14 <page> . expands the scope of operations by diversifying our exploratory and development efforts, both in and outside of our current areas of operation. Although the direction of our exploration and development activities has shifted from high risk exploratory activities to lower risk development opportunities, we will continue our efforts, as we have in the past, to utilize advanced technologies, serve as operator in appropriate circumstances, and reduce operating costs. The extent to which we are able to pursue our business plan is influenced by: . the prices we receive for the oil and gas we produce; . the results of reprocessing and reinterpreting our 3-D seismic data; . the results of our drilling activities; . the costs of obtaining high quality field services; . our ability to find and consummate acquisition opportunities; and . our ability to negotiate and enter into work to earn arrangements, joint venture or other similar agreements on terms acceptable to us. Significant changes in the prices we receive for the oil and gas we produce or the occurrence of unanticipated events beyond our control may cause us to defer or deviate from our business plan, including the amounts we have budgeted for our activities. Operating Performance Our operating performance is influenced by several factors, the most significant of which are the prices we receive for our oil and gas and the volumes of oil and gas that we are able to produce. The world price for oil has overall influence on the prices that we receive for our oil production. The prices received for different grades of oil are based upon the world price for oil, which is then adjusted based upon the particular grade. Typically, light oil is sold at a premium, while heavy grades of crude are discounted. Gas prices we receive are influenced by: . seasonal demand; . weather; . hurricane conditions in the Gulf of Mexico; . availability of pipeline transportation to end users; and . to a lesser extent, world oil prices. 15 <page> Additional factors influencing our overall operating performance include: . production expenses; . overhead requirements; and . costs of capital. Our oil and gas exploration, development and acquisition activities require substantial and continuing capital expenditures. Historically, the sources of financing to fund our capital expenditures have included: . cash flow from operations; . sales of our equity securities; . bank borrowings; and . industry joint ventures. For the three months ended June 30, 2004, the sales price we received for our crude oil production (excluding hedges) averaged $35.70 per barrel compared to $26.09 per barrel for the three months ended June 30, 2003. The average sales price we received for natural gas for the three months ended June 30, 2004 (excluding hedges), was $5.94 per Mcf compared to $6.10 per Mcf for the three months ended June 30, 2003. For the six months ended June 30, 2004, the sales price we received for our crude oil production (excluding hedges) averaged $34.31 per barrel compared to $29.28 for the six months period ended June 30, 2003. The average sales price we received for natural gas for the six months ended June 30, 2004 (excluding hedges), was $5.55 per Mcf compared to $5.96 for the six months ended June 30, 2003. For information regarding prices received, including our hedges, you should refer to the selected operating data set forth in the table on page 18. Our oil and gas producing activities are accounted for using the full cost method of accounting. Under this accounting method, we capitalize all costs incurred in connection with the acquisition of oil and gas properties and the exploration for and development of oil and gas reserves. These costs include lease acquisition costs, geological and geophysical expenditures, costs of drilling productive and non-productive wells, and overhead expenses directly related to land and property acquisition and exploration and development activities. Proceeds from the disposition of oil and gas properties are accounted for as a reduction in capitalized costs, with no gain or loss recognized unless a disposition involves a material change in reserves, in which case the gain or loss is recognized. Depletion of the capitalized costs of oil and gas properties, including estimated future development costs, is provided using the equivalent unit-of-production method based upon 16 <page> estimates of proved oil and gas reserves and production, which are converted to a common unit of measure based upon their relative energy content. Unproved oil and gas properties are not amortized, but are individually assessed for impairment. The cost of any impaired property is transferred to depletable oil and gas properties. Depletion per BOE for the six months ending June 30, 2004 and 2003 was $6.92 and $7.07, respectively, excluding the FAS 143 adjustment in 2003. Results of Operations Our business activities are characterized by frequent, and sometimes significant, changes in our: . reserve base; . sources of production; . product mix (gas versus oil volumes); and . the prices we receive for our oil and gas production. 17 Year-to-year or other periodic comparisons of the results of our operations can be difficult and may not fully and accurately describe our condition. The following table shows selected operating data for the three and six months ended June 30, 2004 and 2003. <table> Three Months Ended Six Months Ended ----------------------- ----------------------- 6/30/2004 6/30/2003 6/30/2004 6/30/2003 ------------ ---------- ----------- ----------- <s> <c> <c> <c> <c> Sales Volumes: Oil (MBbls) 166 160 327 313 Natural gas (MMcf) 644 805 1,376 1,587 Equivalent barrels of oil (MBOE)(1) 273 294 556 578 Equivalent barrels of oil (BOE) per day 3,006 3,230 3,057 3,192 Average Sales Prices: per Bbl (unhedged)(2) $ 35.70 $ 26.09 $ 34.31 $ 29.28 per Bbl (hedged)(3) $ 26.54 $ 24.00 $ 26.21 $ 27.82 per MCF (unhedged)(2) $ 5.94 $ 6.10 $ 5.55 $ 5.96 per MCF (hedged)(3) $ 5.45 $ 5.84 $ 5.34 $ 5.24 per BOE (unhedged)(2) $ 35.72 $ 30.89 $ 33.92 $ 32.25 per BOE (hedged)(3) $ 29.00 $ 29.03 $ 28.63 $ 29.46 Revenues: (dollars in thousands) Oil revenue $ 5,928 $ 4,168 $11,218 $ 9,174 Oil hedge $(1,522) $ (335) $(2,646) $ (457) Gas revenue $ 3,824 $ 4,910 $ 7,640 $ 9,459 Gas hedge $ (313) $ (211) $ (294) $(1,151) ------------ ---------- ----------- ----------- Total oil and gas revenues $ 7,917 $ 8,532 $15,918 $17,025 ============ ========== =========== =========== Cost per BOE: Lease operating expense $ 7.37 $ 5.92 $ 6.37 $ 4.56 Production taxes $ 1.72 $ 1.51 $ 1.71 $ 1.75 General and administrative $ 4.47 $ 3.36 $ 4.39 $ 3.06 Depreciation and depletion $ 7.20 $ 6.77 $ 7.28 $ 7.02 </table> ________________ (1) A BOE means one barrel of oil equivalent using the ratio of six Mcf of gas to one barrel of oil. "MBOE" means one thousand BOE. (2) Unhedged price is the actual price received at the wellhead for our oil and natural gas. (3) Hedged price is the actual price received at the wellhead for our oil and natural gas plus or minus the settlements on our derivatives. 18 RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003: Oil and Gas Revenues. Our combined oil and gas revenues decreased $615,000 or 7%, to $7.9 million for the three months ended June 30, 2004, from $8.5 million for the same period of 2003. Derivative transactions resulted in hedge losses on oil and gas of approximately $1.8 million for the three months ended June 30, 2004 compared to $546,000 for the same period in 2003. Gas revenue decreased by $1.1 million due to decreased prices and natural production declines in the Yegua/Frio, Cook Mountain areas. This decrease was partially offset by an increase in oil revenue of $1.8 million which was due to increased prices and increased production in the Diamond M and Fullerton Fields. Lease Operating Costs. Lease operating costs increased approximately $273,000, or 16%, to $2.0 million during the three months ended June 30, 2004, compared with $1.7 million for the same period of 2003. The increase was primarily associated with our waterfloods on our oil properties. General and Administrative Expenses. General and administrative expenses increased approximately $253,000, or 26%, to $1.2 million for the three months ended June 30, 2004 from $968,000 for the same period of 2003. The increase was primarily due to costs associated with additional personnel hired, current year salary increases and increased public reporting costs. General and administrative expense capitalized to oil and gas properties is approximately $235,000 and approximately $167,000 for 2004 and 2003 respectively. Depreciation and Depletion. Depreciation and depletion expenses were substantially the same for the three months ended June 30, 2004 compared with the same period of 2003. Change in Fair Market Value of Derivatives. A loss of approximately $105,000 was recognized for the three months ended June 30, 2003 along with the expiration of our put options. Ineffective Portion of Hedges. The ineffective portion of our hedges was approximately $17,000 for the three months ended June 30, 2004 compared to $379,000 for the same period in 2003. The decrease in the ineffective portion of our hedges reflects an improved correlation between our hedge contract price and market price. Interest and Other Income. Interest and other income is approximately $18,000 for the three month period ended June 30, 2004 compared to approximately $1,000 for the same period of 2003. Interest Expense. Interest expense decreased $35,000, or 7%, to approximately $487,000 for the three months ended June 30, 2004 compared with approximately $522,000 for the same period of 2003. Although we reduced borrowings during the first quarter 2004, our interest rate hedges added approximately $117,000 to interest expense during the second quarter of 2004. 19 <page> Income Tax Expense. Income tax expense increased approximately $181,000 or 40%, to $628,000 for the three months ended June 30, 2004 compared to $447,000 for the same period in 2003. For the second quarter 2003, we recognized state income tax, net operating loss carryover and certain federal income tax credits not previously recognized. Net Income. We reported net income of $1.1 million for the three months ended June 30, 2004 compared with net income of $2.6 million for the three months ended June 30, 2003. The decrease of $1.5 million or 59% is mainly associated with the 7% decrease in oil and gas revenues, the 16% increase in lease operating expense, a 26% increase in general and administrative expense and a 32% increase in income tax expense. RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003: Oil and Gas Revenues. Our combined oil and gas revenues decreased $1.1 million or 7%, to $15.9 million for the six months ended June 30, 2004, from $17.0 million for the same period of 2003. Derivative transactions resulted in hedge losses on oil and gas of approximately $2.9 million for the six months ended June 30, 2004 compared to $1.6 million for the same period in 2003. Gas revenue decreased by $1.8 million due to decreased prices and natural production declines in the Yegua/Frio, Cook Mountain areas. This decrease was partially offset by an increase in oil revenue of $2.0 million which was due to increased prices and increased production in the Diamond M and Fullerton Fields. Lease Operating Costs. Lease operating costs increased $912,000 or 35%, to $3.5 million during the first six months of 2004, compared with $2.6 million for the same period of 2003. The increase was primarily due to increased costs associated with our waterfloods on our oil properties. General and Administrative Expenses. General and administrative expenses increased approximately $673,000, or 38%, to $2.4 million during the six months ended June 30, 2004, compared with $1.8 million for the same period of 2003. The increase was primarily due to costs associated with additional personnel hired, current year salary increases and increased public reporting costs. General and administrative expense capitalized to oil and gas properties is $522,000 and $431,000 for 2004 and 2003, respectively. Depreciation and Depletion Expense. Depreciation and depletion expenses were substantially the same for the six months period ending June 30, 2004 compared to the same period of 2003. Change in Fair Market Value of Derivatives. A loss of approximately $124,000 was recognized for the six months ended June 30, 2003 along with the expiration of our put options. Ineffective Portion of Hedges. The ineffective portion of our hedges was approximately $7,000 for the six months ending June 30, 2004 compared to $196,000 for the 20 <page> same period in 2003. The decrease in the ineffective portion of our hedges reflects an improved correlation between our hedge contract price and market price. Interest and Other Income. Interest and other income is $158,000 for the six month period ended June 30, 2004 compared to $46,000 for the same period of 2003. Interest Expense. Interest expense decreased $53,000 or 5%, to $955,000 for the six months ended June 30, 2004 compared with $1.0 million for the same period of 2003; due to decreased bank borrowings. Although we reduced net borrowings by approximately $5.7 million, our interest rate hedges added approximately $231,000 to interest expense during the six months ended June 30, 2004. Income Tax Expense. Income tax expense declined $162,000 for the six months period ending June 30, 2004 compared to the same period of 2003. Our effective rate for the six months ended June 30, 2004 was 36%, which is greater than the 25% rate in 2003. In 2003, we recognized state income tax, net operating loss carryover and certain federal income tax credits not previously recognized. Net Income. We reported net income of $2.6 million for the six months ended June 30, 2004 compared to $5.0 million for the six months ended June 30, 2003. The decrease of $2.4 million or 48% is primarily associated with the 7% decrease in oil and gas revenues, 35% increase in lease operating expense and 38% increase in general and administrative expense. LIQUIDITY AND CAPITAL RESOURCES Our capital resources consist primarily of cash flows from our oil and gas properties and bank borrowings supported by our oil and gas reserves. Our level of earnings and cash flows depends on many factors, including the prices we receive for oil and gas we produce. Working capital decreased 91% or approximately $15.0 million as of June 30, 2004 compared with December 31, 2003. Current assets exceeded current liabilities by $1.4 million at June 30, 2004. The working capital decrease was primarily due to the net payments on our revolving credit facility of $5.7 million, increased current maturity of derivative obligations of approximately $2.8 million and working capital requirements associated with our increased drilling program in 2004. We incurred net property costs of $15.0 million for the six months ended June 30, 2004 compared to $7.5 million for the same period in 2003. This is a result of our increased capital budget from $15.5 million in 2003 to an estimated $25.3 million in 2004. Included in our property basis for the six months ending June 30, 2004 and 2003 were asset retirement costs of approximately $189,000 and $1.2 million respectively, net of disposals, for the adoption of SFAS 143 (see Note 8 to Consolidated Financial Statements). Our property leasehold acquisition, development and enhancement activities were financed by the utilization of cash flows provided by operations and cash on hand. 21 <page> Stockholders' equity is $60.4 million for June 30, 2004, compared to $61.2 million at December 31, 2003, a decrease of 1%. The decline is attributable to a reduction in value of our derivative instruments (see Note 6 to Consolidated Financial Statements) partially offset by net income. Based on our projected oil and gas revenues and related expenses, available bank borrowings and expected cash derived from non-strategic asset divestitures, we believe that we will have sufficient capital resources to fund normal operations and capital requirements, interest expense and principal reduction payments on bank debt, if required, and preferred stock dividends. We continually review and consider alternative methods of financing. Bank Borrowings Parallel and its subsidiary, Parallel, L.P., are parties to a credit agreement with First American Bank, SSB, Western National Bank and BNP Paribas which provides for revolving loans. This means that we can borrow, repay and reborrow funds drawn under the credit facility. However, the aggregate amount that we can borrow and have outstanding at any one time is subject to a borrowing base. Generally, we can borrow only up to the borrowing base in effect from time to time. The borrowing base amount is redetermined by the banks on or about April 1 and October 1 of each year or at other times required by the banks or at our request. At June 2004, the borrowing base was $52.0 million, which was reduced to $51.5 million effective August 5, 2004 following our sale of non-core oil and gas assets. If, as a result of the banks' redetermination of the borrowing base, the outstanding principal amount of our loan exceeds the borrowing base, we must either provide additional collateral to the banks or prepay the principal of the note in an amount equal to the excess. Except for principal payments that may be required because of our outstanding loans being in excess of the borrowing base, interest only is payable monthly. The principal amount outstanding under the revolving credit facility bears interest at First American Bank's base rate or the LIBOR rate, at our election. Generally, First American Bank's base rate is equal to the prime rate published in the Wall Street Journal, but not less than 4.50%. The LIBOR rate is generally equal to the sum of (a) the rate designated as "British Bankers Association Interest Settlement Rates" and offered in one, two, three or six month interest periods for deposits of $1.0 million, and (b) a margin ranging from 2.25% to 2.75%, depending upon the outstanding principal amount of the loans. The interest rate we are required to pay, including the applicable margin, may never be less than 4.50%. If the principal amount outstanding is equal to or greater than 75% of the borrowing base established by the banks, the margin is 2.75%. If the principal amount outstanding is equal to or greater than 50%, but less than 75% of the borrowing base, the margin is 2.50%. If the principal amount outstanding is less than 50% of the borrowing base, the margin is 2.25%. In the case of base rate loans, interest is payable on the last day of each month. In the case of LIBOR loans, interest is payable on the last day of each applicable interest period. If the total outstanding borrowings under the revolving credit facility are less than the borrowing base, an unused commitment fee is required to be paid to the bank lenders. The amount 22 <page> of the fee is .25% of the daily average of the unadvanced amount of the borrowing base. The fee is payable quarterly. All outstanding principal under the revolving credit facility is due and payable on December 20, 2006. The loan is secured by substantially all of our oil and gas properties, including the properties of Parallel, L.P. Parallel, L.L.C., a subsidiary of Parallel, guaranteed payment of the loans. We are highly dependent on bank borrowings to fund our exploration and drilling activities. Our borrowing base calculation is based upon the estimated value of oil and gas reserves. If our borrowing base declines significantly, our liquidity would be suddenly and materially limited. If the borrowing base is increased, we are required to pay a fee of .25% on the amount of any increase in the borrowing base. Our bank borrowings have been incurred to finance our property acquisition, 3-D seismic surveys, enhancement and drilling activities. In addition to customary affirmative covenants, the credit agreement contains various restrictive covenants and compliance requirements, including: . maintaining certain financial ratios; . limitations on incurring additional indebtedness; . prohibiting the payment of dividends on our common stock; . limitations on the disposition of assets; and . prohibiting liens (other than in favor of the banks) to exist on any of our properties. Our revolving credit facility also requires that we have: . at the end of each quarter, a current ratio (as defined in the credit agreement) of at least 1.1 to 1.0; . at the end of each quarter, a funded debt ratio (as defined in the credit agreement) of not more than 3.0 to 1.0; and . at all times, adjusted consolidated net worth (as defined in the credit agreement) of at least (a) $40.0 million, plus (b) seventy-five percent (75%) of the net proceeds from any equity securities issued by Parallel, plus (c) fifty percent (50%) of Parallel's consolidated net income for each fiscal quarter, if positive, and zero percent (0%) if negative. As of June 30, 2004, we were in compliance with all covenants. 23 <page> If we have borrowing capacity under our credit agreement, we intend to borrow, repay and reborrow under the revolving credit facility from time to time as necessary, subject to borrowing base limitations, to fund: . interpretation and processing of 3-D seismic survey data; . lease acquisitions and drilling activities; . acquisitions of producing properties or companies owning producing properties; and . general corporate purposes. Preferred Stock At June 30, 2004, we had 957,000 shares of 6% Convertible Preferred Stock outstanding. The 6% Convertible Preferred Stock: . requires us to pay dividends of $.60 per annum, semi-annually on June 15 and December 15 of each year; . is convertible into common stock at any time, at the option of the holder, into 2.8751 shares of common stock at an initial conversion price of $3.50 per shares, subject to adjustment in certain events; . is redeemable at our option, in whole or in part, for $10 per share, plus accrued and unpaid dividends; . has no voting rights, except as required by applicable law, and except that as long as any shares of preferred stock remain outstanding, the holders of a majority of the outstanding shares of the preferred stock may vote on any proposal to change any provision of the preferred stock which materially and adversely affects the rights, preferences or privileges of the preferred stock;. . is senior to the common stock with respect to dividends and on liquidation, dissolution or winding up of Parallel; and . has a liquidation value of $10 per share, plus accrued and unpaid dividends. Commodity Price Risk Management Transactions The purpose of our hedges is to provide a measure of stability in our oil and gas prices and interest rate payments and to manage exposure to commodity price and interest rate risk. Our objective is to lock in a range of oil and gas prices and a fixed interest rate for certain notional amounts. Under cash flow hedge accounting, the quarterly change in the fair value of the commodity derivatives is recorded in stockholders' equity as other comprehensive income (loss) and then transferred to revenue when the production is sold. Ineffective portions of cash flow hedges (changes in realized prices that do not match the changes in the hedge price) are 24 <page> recognized in other expense as they occur. While the cash flow hedge contract is open, the ineffective gain or loss many increase or decrease until settlement of the contract. Under cash flow hedge accounting for interest rate swaps, the quarterly change in the fair value of the derivatives is recorded in stockholders' equity as other comprehensive income (loss) and then transferred to interest expense when the contract settles. Ineffective portions of cash flow hedges are recognized in other expense as they occur. We are exposed to credit risk in the event of nonperformance by the counterparty in its derivative instruments. However, we periodically assess the creditworthiness of the counterparty to mitigate this credit risk. Certain of our commodity price risk management arrangements have required us to deliver cash collateral or other assurances of performance to the counterparties in the event that our payment obligations with respect to our commodity price risk management transactions exceed certain levels. Outlook The oil and gas industry is capital intensive. We make, and anticipate that we will continue to make, substantial capital expenditures in the exploration for, development and acquisition of oil and gas reserves. Historically, our capital expenditures have been financed primarily with: . internally generated cash from operations; . proceeds from bank borrowings; and . proceeds from sales of equity securities. The continued availability of these capital sources depends upon a number of variables, including: . our proved reserves; . the volumes of oil and gas we produce from existing wells; . the prices at which we sell oil and gas; and . our ability to acquire, locate and produce new reserves. 25 <page> Each of these variables materially affects our borrowing capacity. We may from time to time seek additional financing in the form of: . increased bank borrowings; . sales of Parallel's securities; . sales of non-core properties; or . other forms of financing. Except for the revolving credit facility we have with our bank lenders, we do not have agreements for any future financing and there can be no assurance as to the availability or terms of any such financing. Inflation Inflation has not had a significant impact on our financial condition or results of operations. We do not believe that inflation poses a material risk to our business. Recent Accounting Pronouncements FIN No. 46, Consolidation of Variable Interest Entities. In December 2003, the FASB issued Interpretation No. 46R, which requires the consolidation of certain entities that are determined to be variable interest entities ("VIE"). An entity is considered to be a VIE when either (i) the entity lacks sufficient equity to carry on its principal operations, (ii) the equity owners of the entity cannot make decisions about the entity's activities or (iii) the entity's equity neither absorbs losses or benefits from gains. We own no interests in variable interest entities, and therefore this new interpretation has not affected our consolidated financial statements. In March 2004, the Financial Accounting Standards Board ("FASB") issued an exposure draft entitled "Share-Based Payment, an Amendment of FASB Statements No. 123 and 95." This proposed statement addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. The proposed Statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued to Employees", and generally would require instead that such transactions be accounted for using a fair-value-based method. As proposed, this statement would apply to Parallel effective January 1, 2005. We are currently unable to determine what effect this statement will have on our financial position or results of operations. Effects of Derivative Instruments As of January 1, 2003, we designated our costless collars, oil and gas swaps and interest rate swaps as cash flow hedges under the provisions of SFAS 133, as amended. The adoption of cash flow hedge accounting allows us to record changes in fair value of contracts 26 <page> designated as cash flow hedges through other comprehensive income until realized. When realized, we reflect the gain or loss on commodity derivatives designated as cash flow hedges in revenue and on interest rate derivatives designated as cash flow hedges in interest expense. We utilize mark-to-market accounting for our put positions. The purpose of our hedges is to provide a measure of stability in our oil and gas prices and interest rate payments and to manage exposure to commodity price and interest rate risk. Our objective is to lock in a range of oil and gas prices and a fixed interest rate for certain notional amounts. Under cash flow hedge accounting, the quarterly change in the fair value of the derivatives is recorded in stockholders' equity as other comprehensive income (loss) and then transferred to earnings when the production is sold. Ineffective portions of cash flow hedges (changes in realized prices that do not match the changes in the hedge price) are recognized in other expense as they occur. While the cash flow hedge contract is open, the ineffective gain or loss many increase or decrease until settlement of the contract. We are exposed to credit risk in the event of nonperformance by the counterparty in its derivative instruments. However, we periodically assess the creditworthiness of the counterparty to mitigate this credit risk. TRENDS AND PRICES Changes in oil and gas prices significantly affect our revenues, cash flows and borrowing capacity. Markets for oil and gas have historically been, and will continue to be, volatile. Prices for oil and gas typically fluctuate in response to relatively minor changes in supply and demand, market uncertainty, seasonal, political and other factors beyond our control. We are unable to accurately predict domestic or worldwide political events or the effects of other such factors on the prices we receive for our oil and gas. Our capital expenditure budgets are highly dependent on future oil and gas prices and will be consistent with internally generated cash flows. During fiscal year 2003, the average realized sales price for our oil and gas was $30.66 (unhedged) per BOE. For the six months ended June 30, 2004, our average realized price was $33.92 (unhedged) per BOE. Rising costs in the services and supply sectors, including but not limited to tubular goods, will adversely affect our cash flow and amounts available for capital expenditures. FORWARD-LOOKING STATEMENTS Cautionary Statement Regarding Forward Looking Statements Some statements contained in this Quarterly Report on Form 10-Q are "forward-looking statements". All statements other than statements of historical facts included in this report, including, without limitation, statements regarding planned capital expenditures, the availability of capital resources to fund capital expenditures, estimates of proved reserves, our financial position, business strategy and other plans and objectives for future operations, are forward- 27 <page> looking statements. You can identify forward-looking statements by the use of forward-looking terminology like "may," "will," "expect," "intend," "anticipate," "budget", "estimate," "continue," "present value," "future" or "reserves" or other variations or comparable terminology. We believe the assumptions and expectations reflected in these forward-looking statements are reasonable. However, we cannot give any assurance that our expectations will prove to be correct or that we will be able to take any actions that are presently planned. All of these statements involve assumptions of future events and risks and uncertainties. Risks and uncertainties associated with forward-looking statements include, but are not limited to: . fluctuations in prices of oil and gas; . future capital requirements and availability of financing; . geological concentration of our reserves; . risks associated with drilling and operating wells; . competition; . general economic conditions; . governmental regulations; . receipt of amounts owed to us by purchasers of our production and counterparties to our hedging contracts; . hedging decisions, including whether or not to hedge; . events similar to 911; . actions of third party co-owners of interests in properties in which we also own an interest; and . fluctuations in interest rates and availability of capital. While we believe our forward-looking statements are based upon reasonable assumptions, these are factors that are difficult to predict and that are influenced by economic and other conditions beyond our control. Investors are urged to consider such risks and other uncertainties discussed in documents filed by us with the SEC. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following quantitative and qualitative information is provided about market risks and derivative instruments to which Parallel was a party at June 30, 2004, and from which Parallel may incur future earnings, gains or losses from changes in market interest rates and oil and natural gas prices. 28 Interest Rate Sensitivity as of June 30, 2004 Our only financial instrument sensitive to changes in interest rates is our bank debt. As the interest rate is variable and reflects current market conditions, the carrying value approximates the fair value. The table below shows principal cash flows and related weighted average interest rates by expected maturity dates. Weighted average interest rates were determined using weighted average interest paid and accrued in June, 2004. You should read Note 2 to the Consolidated Financial Statements for further discussion of our debt that is sensitive to interest rates. <table> July July July July July July 2004 2005 2006 2007 2008 2009 Total ---------- ---------- ---------- ---------- --------- --------- ---------- (In 000's, except interest rates) <s> <c> <c> <c> <c> <c> <c> <c> Variable rate debt: Revolving facility (secured) $ - $ - $ 34,000 $ - $ - $ - $ 34,000 Average interest rate 4.50% 4.50% 4.50% - - - ______________ </table> At June 30, 2004, we had bank loans in the amount of approximately $34.0 million outstanding under our revolving credit facility at an average interest rate of 4.50%. Borrowings under our revolving credit facility bear interest, at our election, at (i) the bank's base rate or (ii) the LIBOR rate, plus LIBOR margin, but in no event less than 4.50%. As a result, our annual interest cost in 2004 will fluctuate based on short-term interest rates. As the interest rate is variable and is reflective of current market conditions, the carrying value approximates the fair value. Under our revolving credit facility, we may elect an interest rate based upon the agent lender's base lending rate, or the LIBOR rate, plus a margin ranging from 2.25% to 2.75% per annum, depending on our borrowing base usage. The interest rate we are required to pay, including the applicable margin, may never be less than 4.50%. In January, 2003, we entered into a 45-month LIBOR fixed interest rate swap contract with BNP Paribas. We receive fixed 90-day LIBOR interest rates for the 45-month period beginning March 31, 2003 through December 20, 2006. 29 A recap for the period of time, notional amounts, LIBOR fixed interest rates, expected margin rates and expected fixed interest rates for the contract are as follows: <table> Libor Expected Expected Notional Fixed Margin Fixed Period of Time Amounts (1) Interest Rates (2) Rates (3) Interest Rates (4) - ----------------------------------------------- ----------------- ------------------- ----------- ------------------ <s> <c> <c> <c> <c> July 1, 2004 thru December 31, 2004 $ 30,000,000 2.660% 2.500% 5.160% January 1, 2005 thru December 31, 2005 $ 20,000,000 4.050% 2.250% 6.300% January 1, 2006 thru December 20, 2006 $ 10,000,000 4.050% 2.250% 6.300% </table> ___________________ (1) Based on the anticipated principal reductions under our facility. (2) Parallel's swap contract with BNP Paribas. (3) Based on the anticipated borrowing base usage under our facility. (4) Total of the LIBOR fixed rate plus the expected margin rate under our facility. Our credit agreement requires the interest rate to not be below 4.50%. Commodity Price Sensitivity as of June 30, 2004 Our major market risk exposure is in the pricing applicable to our oil and natural gas production. Market risk refers to the risk of loss from adverse changes in oil and natural gas prices. Realized pricing is primarily driven by the prevailing domestic price for crude oil and spot prices applicable to the region in which we produce natural gas. Historically, prices received for oil and gas production have been volatile and unpredictable. We expect pricing volatility to continue. Oil prices ranged from a low of $16.49 per barrel to a high of $36.60 per barrel during 2003. Natural gas prices we received during 2003 ranged from a low of $1.98 per Mcf to a high of $10.28 per Mcf. During 2004, oil prices ranged from a low of $26.76 to a high of $40.06. Natural gas prices we received during 2004 ranged from a low of $2.31 per Mcf to a high of $7.85 per Mcf. A significant decline in the prices of oil or natural gas could have a material adverse effect on our financial condition and results of operations. Costless Collar. Collars are created by purchasing puts to establish a floor price and then selling a call which establishes a maximum amount the producer will receive for the oil or gas hedged. Calls are sold to offset or reduce the premium paid for buying the put. We have entered into several costless, Houston ship channel gas collars. A majority of our natural gas production is sold based on Houston ship channel prices. A recap for the period of time, number of MMBtu's and gas prices is as follows: <table> Houston Ship Channel gas prices --------------------------- MMBtu of Period of Time Natural Gas Floor Cap - ------------------------------------------- -------------- ------------ ------------- <s> <c> <c> <c> July 1, 2004 thru October 31, 2004 123,000 $ 4.40 $ 5.50 April 1, 2005 thru October 31, 2005 428,000 $ 5.00 $ 7.26 </table> 30 <page> Swaps. Generally, swaps are an agreement to buy or sell a specified commodity for delivery in the future, but at an agreed fixed price. Swap transactions convert a floating price into a fixed price. For any particular swap transaction, the counterparty is required to make a payment to the hedge party if the reference price for any settlement period is less than the swap price for such hedge, and the hedge party is required to make a payment to the counterparty if the reference price for any settlement period is greater than the swap price for such hedge. We have entered into oil and gas swap contracts with BNP Paribas. A recap for the period of time, number of MMBtu's, number of barrels, and swap prices are as follows: <table> Houston Ship Barrels of Nymex Oil MMBtu of Channel Period of Time Oil Swap Prices Natural Gas Gas Swap Price - -------------------------------------------- ------------ --------------- ------------- ----------------- <s> <c> <c> <c> <c> July 1, 2004 thru December 31, 2004 220,800 $ 24.27 491,000 $ 4.694 January 1, 2005 thru December 31, 2005 365,000 $ 23.35 - $ - January 1, 2005 thru March 31, 2005 - $ - 180,000 $ 4.705 January 1, 2006 thru December 20, 2006 265,500 $ 23.04 - $ - </table> ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this Quarterly Report on Form 10-Q, the effectiveness of our disclosure controls and procedures was evaluated by our management, with the participation of our chief executive officer, Larry C. Oldham (principal executive officer), and our chief financial officer, Steven D. Foster (principal financial officer). Our disclosure controls and procedures are designed to help ensure that information we are required to disclose in reports that we file with the SEC is accumulated and communicated to our management and recorded, processed, summarized and reported within the time periods prescribed by the SEC. Mr. Oldham and Mr. Foster have concluded that our disclosure controls and procedures are effective for their intended purposes. There were no changes in internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. While preparing and reviewing this Form 10Q report, we identified a need to implement a new control procedure. This new control procedure is designed to help ensure that our accruals for hedge gains or losses are made timely. 31 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time, we are a party to ordinary routine litigation incidental to our business. We are not currently a party to any pending litigation, and we are not aware of any threatened litigation. We have not been a party to any bankruptcy, receivership, reorganization, adjustment or similar proceeding. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Our annual meeting of stockholders was held on June 22, 2004. At the meeting, the following persons were elected to serve as directors of Parallel for a term of one year expiring in 2005 and until their respective successors are duly qualified and elected: (1) Thomas R. Cambridge, (2) Dewayne E. Chitwood, (3) Larry C. Oldham, (4) Martin B. Oring, (5) Ray M. Poage, and (6) Jeffrey G. Shrader. Set forth below is a tabulation of votes with respect to each nominee for director. <table> BROKER NAME VOTES CAST FOR VOTES WITHHELD NON-VOTES - ---------------------------- ------------------------ ----------------------- ---------------- <s> <c> <c> <c> Thomas R. Cambridge 21,108,318 833,955 - Dewayne E. Chitwood 21,269,825 672,448 - Larry C. Oldham 21,113,784 828,489 - Martin B. Oring 21,357,076 585,197 - Ray M. Poage 21,568,151 374,122 - Jeffrey G. Shrader 21,275,227 667,046 - </table> In addition to electing directors, the stockholders also voted to approve Parallel's Non-Employee Director Stock Grant Plan. Set forth below is a tabulation of votes with respect to the approval of Parallel's Non-Employee Director Stock Grant Plan: <table> BROKER FOR AGAINST ABSTAIN NON-VOTES - ---------------------------- ------------------------ ----------------------- ---------------- <s> <c> <c> <c> 9,351,440 1,717,791 370,151 10,502,891 </table> Also, the stockholders voted upon and ratified the appointment of BDO Seidman, LLP to serve as our independent public accountants for 2004. Set forth below is a tabulation of votes with respect to the proposal to ratify the appointment of our independent public accountants: <table> FOR AGAINST ABSTAIN - ---------------------------- ------------------------ ----------------------- <s> <c> <c> 21,358,232 438,218 145,823 </table> 32 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits No. Description of Exhibit - ---- ---------------------- *3.1 Certificate of Incorporation of Registrant 3.2 Bylaws of Registrant (Incorporated by reference to Exhibit 3 to the Registrant's Form 8-K, dated October 9, 2000, as filed with the Securities and Exchange Commission on October 10, 2000.) *4.1 Certificate of Designations, Preferences and Rights of Serial Preferred Stock - 6% Convertible Preferred Stock 4.2 Certificate of Designation, Preferences and Rights of Series A Preferred Stock. (Incorporated by reference to Exhibit 4.2 of Form 10-K for the fiscal year ended December 31, 2000.) 4.3 Rights Agreement, dated as of October 5, 2000, between the Registrant and Computershare Trust Company, Inc., as Rights Agent (Incorporated by reference to Exhibit 4.3 of Form 10-K for the fiscal year ended December 31, 2000.) Executive Compensation Plans and Arrangements (Exhibit No.'s 10.1 through 10.8): 10.1 1992 Stock Option Plan (Incorporated by reference to Exhibit 28.1 to Form S-8 of the Registrant (File No. 33-57348) as filed with the Securities and Exchange Commission on January 25, 1993.) 10.2 Stock Option Agreement between the Registrant and Thomas R. Cambridge dated December 11, 1991 (Incorporated by reference to Exhibit 10.4 of Form 10-K of the Registrant for the fiscal year ended December 31, 1992.) 10.3 Merrill Lynch, Pierce, Fenner & Smith Incorporated Prototype Simplified Employee Pension Plan (Incorporated by reference to Exhibit 10.6 of the Registrant's Form 10-K for the fiscal year ended December 31, 1995.) 10.4 Non-Employee Directors Stock Option Plan (Incorporated by reference to Exhibit 10.6 of the Registrant's Form 10-K Report for the fiscal year ended December 31, 1997). 10.5 1998 Stock Option Plan (Incorporated by reference to Exhibit 10.7 of Form 10-K of the Registrant for the fiscal year ended December 31, 1998.) 33 <page> 10.6 Form of Incentive Award Agreements, dated December 12, 2001, between the Registrant and Thomas R. Cambridge, Larry C. Oldham, Eric A. Bayley and John S. Rutherford granting 2,394 Unit Equivalent Rights to Mr. Cambridge; 9,564 Unit Equivalent Rights to Mr. Oldham; 2,869 Unit Equivalent Rights to Mr. Bayley; and 7,173 Unit Equivalent Rights to Mr. Rutherford. (Incorporated by reference to Exhibit 10.8 of the Registrant's Form 10-K Report for the fiscal year ended December 31, 2001). 10.7 2001 Non-Employee Directors Stock Option Plan (Incorporated by reference to Exhibit 10.7 of the Registrant's Form 10-Q Report for the first fiscal quarter ended March 31, 2004). 10.8 2004 Non-Employee Director Stock Grant Plan (Incorporated by reference to Exhibit 10.1 of the Registrant's Form 8-K Report dated June 22, 2004). 10.9 Certificate of Formation of First Permian, L.L.C. (Incorporated by reference to Exhibit 10.1 of the Registrant's Form 8-K report dated June 30, 1999.) 10.10 Limited Liability Company Agreement of First Permian, L.L.C. (Incorporated by reference to Exhibit 10.2 of the Registrant's Form 8-K report dated June 30, 1999.) 10.11 Merger Agreement dated June 25, 1999. (Incorporated by reference to Exhibit 10.3 of the Registrant's Form 8-K report dated June 30, 1999.) 10.12 Agreement and Plan of Merger of First Permian, L.L.C. and Nash Oil Company, L.L.C. (Incorporated by reference to Exhibit 10.4 of the Registrant's Form 8-K report dated June 30, 1999.) 10.13 Certificate of Merger of First Permian, L.L.C. and Nash Oil Company, L.L.C (Incorporated by reference to Exhibit 10.5 of the Registrant's Form 8-K Report dated June 30, 1999.) 10.14 Amended and Restated Limited Liability Company Agreement of First Permian, L.L.C. dated as of May 31, 2000. (Incorporated by reference to Exhibit 10.16 of Form 10-K for the fiscal year ended December 31, 2000.) 10.15 Credit Agreement dated June 30, 1999, by and among First Permian, L.L.C., Parallel Petroleum Corporation, Baytech, Inc., and Bank One, Texas, N.A. (Incorporated by reference to Exhibit 10.6 of the Registrant's Form 8-K report dated June 30, 1999.) 10.16 Limited Guaranty, dated June 30, 1999, by and among First Permian, L.L.C., Parallel Petroleum Corporation, and Bank One, Texas, N.A. (Incorporated by reference to Exhibit 10.7 of the Registrant's Form 8-K report dated June 30, 1999.) 34 <page> 10.17 Intercreditor Agreement, dated as of June 30, 1999, by and among First Permian, L.L.C., Bank One, Texas, N.A., Tejon Exploration Company, and Mansefeldt Investment Corporation (Incorporated by reference to Exhibit 10.8 of the Registrant's Form 8-K report dated June 30, 1999.) 10.18 Subordinated Promissory Note, dated June 30, 1999, in the original principal amount of $8.0 million made by First Permian, L.L.C. payable to the order of Tejon Exploration Company (Incorporated by reference to Exhibit 10.9 of the Registrant's Form 8-K report dated June 30, 1999.) 10.19 Subordinated Promissory Note, dated June 30, 1999, in the original principal amount of $8.0 million made by First Permian, L.L.C. payable to the order of Mansefeldt Investment Corporation (Incorporated by reference to Exhibit 10.10 of the Registrant's Form 8-K report dated June 30, 1999.) 10.20 Second Restated Credit Agreement, dated October 25, 2000, among First Permian, L.L.C., Bank One, Texas, N.A., and Bank One Capital Markets, Inc. (Incorporated by reference to Exhibit 10.22 of Form 10-K for the fiscal year ended December 31, 2000.) 10.21 Loan Agreement, dated January 25, 2002, between the Registrant and First American Bank, SSB (Incorporated by reference to Exhibit 10.25 of Form 10-K for the fiscal year ended December 31, 2001.) 10.22 Purchase and Sale Agreement, dated as of November 27, 2002, among JMC Exploration, Inc., Arkoma Star L.L.C., Parallel, L.P. and Texland Petroleum, Inc. (Incorporated by reference to Exhibit 10.1 of Form 8-K of the Registrant, dated December 20, 2002) 10.23 First Amended and Restated Credit Agreement, dated December 20, 2002, by and among Parallel Petroleum Corporation, Parallel, L.P. Parallel, L.L.C., First American Bank, SSB, Western National Bank and BNP Paribas (Incorporated by reference to Exhibit 10.2 of Form 8-K of the Registrant, dated December 20, 2002) 10.24 Guaranty dated December 20, 2002, between Parallel, L.L.C. and First American Bank, SSB, as Agent (Incorporated by reference to Exhibit 10.3 of Form 8-K of the Registrant, dated December 20, 2002) 10.25 First Amendment to First Amended and Restated Credit Agreement, dated as of September 12, 2003, by and among Parallel Petroleum Corporation, Parallel, L.P., Parallel, L.L.C., First American, SSB, Western National Bank, and BNP Paribas (Incorporated by reference to Exhibit 10.29 of Form 10-Q of the Registrant for the quarter ended September 30, 2003). 35 14 Code of Ethics (Incorporated by reference to Exhibit 14 of Form 10-K of the Registrant for the fiscal year ended December 31, 2003). 21 Subsidiaries (Incorporated by reference to Exhibit 21 of Form 10-K of the Registrant for the fiscal year ended December 31, 2003) *31.1 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. *31.2 Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. *32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. *32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. - --------------- * Filed herewith. 36 (b) Reports on Form 8-K During the fiscal quarter ended June 30, 2004, we filed two reports on Form 8-K. On May 13, 2004, we filed a Current Report on Form 8-K, dated May 13, 2004, reporting matters furnished under Item 7 - Financial Statements and Exhibits, and Item 12 - Results of Operations and Financial Condition. This report included our May 13, 2004 press release announcing financial results for the first quarter ended March 31, 2004. On June 28, 2004, we filed a Current Report on Form 8-K, dated June 22, 2004, reporting matters furnished under Item 5 - Other Events. This report contains the results of voting at the annual meeting of stockholders held on June 22, 2004. 37 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PARALLEL PETROLEUM CORPORATION BY: /s/ Larry C. Oldham Date: August 12, 2004 --------------------------------- Larry C. Oldham President and Chief Executive Officer Date: August 12, 2004 BY: /s/ Steven D. Foster ----------------------------------- Steven D. Foster, Chief Financial Officer 38 INDEX TO EXHIBITS (a) Exhibits No. Description of Exhibit - ---- ---------------------- *3.1 Certificate of Incorporation of Registrant 3.2 Bylaws of Registrant (Incorporated by reference to Exhibit 3 to the Registrant's Form 8-K, dated October 9, 2000, as filed with the Securities and Exchange Commission on October 10, 2000.) *4.1 Certificate of Designations, Preferences and Rights of Serial Preferred Stock - 6% Convertible Preferred Stock 4.2 Certificate of Designation, Preferences and Rights of Series A Preferred Stock. (Incorporated by reference to Exhibit 4.2 of Form 10-K for the fiscal year ended December 31, 2000.) 4.3 Rights Agreement, dated as of October 5, 2000, between the Registrant and Computershare Trust Company, Inc., as Rights Agent (Incorporated by reference to Exhibit 4.3 of Form 10-K for the fiscal year ended December 31, 2000.) Executive Compensation Plans and Arrangements (Exhibit No.'s 10.1 through 10.8): 10.1 1992 Stock Option Plan (Incorporated by reference to Exhibit 28.1 to Form S-8 of the Registrant (File No. 33-57348) as filed with the Securities and Exchange Commission on January 25, 1993.) 10.2 Stock Option Agreement between the Registrant and Thomas R. Cambridge dated December 11, 1991 (Incorporated by reference to Exhibit 10.4 of Form 10-K of the Registrant for the fiscal year ended December 31, 1992.) 10.3 Merrill Lynch, Pierce, Fenner & Smith Incorporated Prototype Simplified Employee Pension Plan (Incorporated by reference to Exhibit 10.6 of the Registrant's Form 10-K for the fiscal year ended December 31, 1995.) 10.4 Non-Employee Directors Stock Option Plan (Incorporated by reference to Exhibit 10.6 of the Registrant's Form 10-K Report for the fiscal year ended December 31, 1997). <page> 10.5 1998 Stock Option Plan (Incorporated by reference to Exhibit 10.7 of Form 10-K of the Registrant for the fiscal year ended December 31, 1998.) 10.6 Form of Incentive Award Agreements, dated December 12, 2001, between the Registrant and Thomas R. Cambridge, Larry C. Oldham, Eric A. Bayley and John S. Rutherford granting 2,394 Unit Equivalent Rights to Mr. Cambridge; 9,564 Unit Equivalent Rights to Mr. Oldham; 2,869 Unit Equivalent Rights to Mr. Bayley; and 7,173 Unit Equivalent Rights to Mr. Rutherford. (Incorporated by reference to Exhibit 10.8 of the Registrant's Form 10-K Report for the fiscal year ended December 31, 2001). 10.7 2001 Non-Employee Directors Stock Option Plan (Incorporated by reference to Exhibit 10.7 of the Registrant's Form 10-Q Report for the first fiscal quarter ended March 31, 2004). 10.8 2004 Non-Employee Director Stock Grant Plan (Incorporated by reference to Exhibit 10.1 of the Registrant's Form 8-K Report dated June 22, 2004). 10.9 Certificate of Formation of First Permian, L.L.C. (Incorporated by reference to Exhibit 10.1 of the Registrant's Form 8-K report dated June 30, 1999.) 10.10 Limited Liability Company Agreement of First Permian, L.L.C. (Incorporated by reference to Exhibit 10.2 of the Registrant's Form 8-K report dated June 30, 1999.) 10.11 Merger Agreement dated June 25, 1999. (Incorporated by reference to Exhibit 10.3 of the Registrant's Form 8-K report dated June 30, 1999.) 10.12 Agreement and Plan of Merger of First Permian, L.L.C. and Nash Oil Company, L.L.C. (Incorporated by reference to Exhibit 10.4 of the Registrant's Form 8-K report dated June 30, 1999.) 10.13 Certificate of Merger of First Permian, L.L.C. and Nash Oil Company, L.L.C (Incorporated by reference to Exhibit 10.5 of the Registrant's Form 8-K Report dated June 30, 1999.) 10.14 Amended and Restated Limited Liability Company Agreement of First Permian, L.L.C. dated as of May 31, 2000. (Incorporated by reference to Exhibit 10.16 of Form 10-K for the fiscal year ended December 31, 2000.) 10.15 Credit Agreement dated June 30, 1999, by and among First Permian, L.L.C., Parallel Petroleum Corporation, Baytech, Inc., and Bank One, Texas, N.A. (Incorporated by reference to Exhibit 10.6 of the Registrant's Form 8-K report dated June 30, 1999.) <page> 10.16 Limited Guaranty, dated June 30, 1999, by and among First Permian, L.L.C., Parallel Petroleum Corporation, and Bank One, Texas, N.A. (Incorporated by reference to Exhibit 10.7 of the Registrant's Form 8-K report dated June 30, 1999.) 10.17 Intercreditor Agreement, dated as of June 30, 1999, by and among First Permian, L.L.C., Bank One, Texas, N.A., Tejon Exploration Company, and Mansefeldt Investment Corporation (Incorporated by reference to Exhibit 10.8 of the Registrant's Form 8-K report dated June 30, 1999.) 10.18 Subordinated Promissory Note, dated June 30, 1999, in the original principal amount of $8.0 million made by First Permian, L.L.C. payable to the order of Tejon Exploration Company (Incorporated by reference to Exhibit 10.9 of the Registrant's Form 8-K report dated June 30, 1999.) 10.19 Subordinated Promissory Note, dated June 30, 1999, in the original principal amount of $8.0 million made by First Permian, L.L.C. payable to the order of Mansefeldt Investment Corporation (Incorporated by reference to Exhibit 10.10 of the Registrant's Form 8-K report dated June 30, 1999.) 10.20 Second Restated Credit Agreement, dated October 25, 2000, among First Permian, L.L.C., Bank One, Texas, N.A., and Bank One Capital Markets, Inc. (Incorporated by reference to Exhibit 10.22 of Form 10-K for the fiscal year ended December 31, 2000.) 10.21 Loan Agreement, dated January 25, 2002, between the Registrant and First American Bank, SSB (Incorporated by reference to Exhibit 10.25 of Form 10-K for the fiscal year ended December 31, 2001.) 10.22 Purchase and Sale Agreement, dated as of November 27, 2002, among JMC Exploration, Inc., Arkoma Star L.L.C., Parallel, L.P. and Texland Petroleum, Inc. (Incorporated by reference to Exhibit 10.1 of Form 8-K of the Registrant, dated December 20, 2002) 10.23 First Amended and Restated Credit Agreement, dated December 20, 2002, by and among Parallel Petroleum Corporation, Parallel, L.P. Parallel, L.L.C., First American Bank, SSB, Western National Bank and BNP Paribas (Incorporated by reference to Exhibit 10.2 of Form 8-K of the Registrant, dated December 20, 2002) 10.24 Guaranty dated December 20, 2002, between Parallel, L.L.C. and First American Bank, SSB, as Agent (Incorporated by reference to Exhibit 10.3 of Form 8-K of the Registrant, dated December 20, 2002) 10.25 First Amendment to First Amended and Restated Credit Agreement, dated as of September 12, 2003, by and among Parallel Petroleum Corporation, Parallel, L.P., Parallel, L.L.C., First American, SSB, Western National Bank, and BNP Paribas (Incorporated by reference to Exhibit 10.29 of Form 10-Q of the Registrant for the quarter ended September 30, 2003). 14 Code of Ethics (Incorporated by reference to Exhibit 14 of Form 10-K of the Registrant for the fiscal year ended December 31, 2003). 21 Subsidiaries (Incorporated by reference to Exhibit 21 of Form 10-K of the Registrant for the fiscal year ended December 31, 2003) *31.1 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. *31.2 Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. *32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. *32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. - -------------------- *Filed herewith. EXHIBIT 31.1 CERTIFICATIONS I, Larry C. Oldham, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Parallel Petroleum Corporation. 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: August 12, 2004 /s/ Larry C. Oldham ---------------------------------------- Larry C. Oldham, President and Chief Executive Officer (principal executive officer) EXHIBIT 31.2 CERTIFICATIONS I, Steven D. Foster, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Parallel Petroleum Corporation. 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: August 12, 2004 /s/ Steven D. Foster ------------------------------------------ Steven D. Foster Chief Financial Officer (principal financial officer) Exhibit 32.1 CERTIFICATION (Not filed pursuant to the Securities Exchange Act of 1934) Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, Larry C. Oldham, the President and Chief Executive Officer of Parallel Petroleum Corporation ("Parallel"), hereby certifies that the Quarterly Report on Form 10-Q of Parallel for the quarter ended June 30, 2004 fully complies with the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, and the information contained in that Form 10-Q Report fairly presents, in all material respects, the financial condition and results of operations of Parallel. Dated: August 12, 2004 /s/ Larry C. Oldham ----------------------------------------- Larry C. Oldham, President and Chief Executive Officer A signed original of this written statement required by Section 906 has been provided to Parallel Petroleum Corporation and will be retained by Parallel Petroleum Corporation and furnished to the Securities and Exchange Commission or its staff upon request. Exhibit 32.2 CERTIFICATION (Not filed pursuant to the Securities Exchange Act of 1934) Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, Steven D. Foster, the Chief Financial Officer of Parallel Petroleum Corporation ("Parallel"), hereby certifies that the Quarterly Report on Form 10-Q of Parallel for the quarter ended June 30, 2004 fully complies with the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, and the information contained in that Form 10-Q Report fairly presents, in all material respects, the financial condition and results of operations of Parallel. Dated: August 12, 2004 /s/ Steven D. Foster ---------------------------------------- Steven D. Foster, Chief Financial Officer A signed original of this written statement required by Section 906 has been provided to Parallel Petroleum Corporation and will be retained by Parallel Petroleum Corporation and furnished to the Securities and Exchange Commission or its staff upon request.