SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

x        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

o        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 1-10262

HARKEN ENERGY CORPORATION

(Exact name of registrant as specified in its charter)

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

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  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The number of shares of Common Stock, par value $0.01 per share, outstanding as of November 1, 2006 was 221,933,142.

HARKEN ENERGY CORPORATION

INDEX TO QUARTERLY REPORT

September 30, 2006

			Page
PART I. FINANCIAL INFORMATION
Item 1.		Condensed Financial Statements
		Consolidated Condensed Balance Sheets	4
		Consolidated Condensed Statements of Operations	5
		Consolidated Condensed Statement of Stockholders’ Equity	6
		Consolidated Condensed Statements of Cash Flows	7
		Notes to Consolidated Condensed Financial Statements	8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	29
Item 3.		Quantitative and Qualitative Disclosures about Market Risk	45
Item 4.		Controls and Procedures	46
PART II. OTHER INFORMATION
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 6.		Exhibits	48
SIGNATURES			50

 

2

PART I – FINANCIAL INFORMATION

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ITEM 1. CONDENSED FINANCIAL STATEMENTS

HARKEN ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(in thousands, except for share amounts)

		December 31, 2005			September 30, 2006
					(unaudited)
Assets
Current Assets:
Cash and temporary investments		$	22,482		$	16,149
Short term investments		15,000			17,950
Margin deposits held by broker		—			1,357
Accounts receivable, net		11,718			8,322
Assets of discontinued operations		8,904			—
Available for sale investments, current		—			891
Prepaid expenses and other current assets		1,605			1,618
Total Current Assets		59,709			46,287
Property and Equipment, net		90,999			48,505
Available for Sale Investment		—			30,496
Other Assets, net		2,720			664
		$	153,428		$	125,952
Liabilities and Stockholders’ Equity
Current Liabilities:
Trade payables		$	6,803		$	1,841
Accrued liabilities and other		5,038			3,576
Liabilities of discontinued operations		53			—
Derivative liabilities		—			617
Revenues and royalties payable		2,521			1,922
Total Current Liabilities		14,415			7,956
Asset Retirement Obligation		6,301			7,303
Share Based Compensation Liability		10,687			—
Global Senior Convertible Notes Payable		12,500			—
Preferred Stock Dividends		—			49
Minority Interest in Consolidated Company		17,363			—
Total Liabilities		61,266			15,308
Commitments and Contingencies (Note 14)
Stockholders’ Equity:
Series G1 Preferred Stock, $1.00 par value; $160 liquidation value 700,000 shares authorized; 1,600 shares outstanding		2			2
Series G2 Preferred Stock, $1.00 par value; $100 liquidation value 100,000 shares authorized; 1,000 shares outstanding		1			1
Series M Preferred Stock, $1.00 par value; $5,000 and $4,400 liquidation value, respectively 50,000 shares authorized; 50,000 and 44,000 shares outstanding, respectively		50			44
Common stock, $0.01 par value; 325,000,000 shares authorized; 223,575,732 and 223,379,042 shares issued, respectively		2,236			2,234
Additional paid-in capital		446,643			447,083
Accumulated deficit		(356,889		)	(359,131		)
Accumulated other comprehensive income		119			20,909
Treasury stock, at cost, 0 and 877,100 shares held, respectively		—			(498		)
Total Stockholders’ Equity		92,162			110,644
		$	153,428		$	125,952

 

The accompanying Notes to Consolidated Condensed Financial Statements are

an integral part of these Statements.

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HARKEN ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Unaudited, in thousands except for share and per share amounts)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2005			2006			2005			2006
Revenues and other:
Oil and gas operations		$	10,733		$	6,907		$	29,558		$	21,702
Interest and other income		227			500			364			1,193
		10,960			7,407			29,922			22,895
Costs and Expenses:
Oil and gas operating expenses		3,113			2,130			7,962			7,163
General and administrative expenses (including share-based compensation expense of ($6,907, $0, $11,375 and $2,184, respectively)		9,106			1,337			17,951			7,649
Depreciation, depletion, and amortization		3,187			2,423			9,061			8,262
Increase in Global warrant liability		5,099			—			13,297			—
Accretion expense		100			116			285			310
Interest expense and other		(24		)	5			(18		)	331
		20,581			6,011			48,538			23,715
Gain on exercise of Global warrants		28,341			—			28,341			—
Gain on sale of Global shares		11,841			—			32,185			—
Income (loss) from continuing operations before income taxes		$	30,561		$	1,396		$	41,910		$	(820	)
Income tax expense		187			—			543			187
Income (loss) from continuing operations before minority interest		$	30,374		$	1,396		$	41,367		$	(1,007	)
Minority interest of consolidated company		2,552			—			3,073			2,175
Income from continuing operations before cumulative effect of change in accounting principle		$	32,926		$	1,396		$	44,440		$	1,168
Loss from discontinued operations, net of taxes		(116		)	(3		)	(2,158		)	(1,223		)
Cumulative effect of a change in accounting principle		—			—			—			(868		)
Net income (loss)		$	32,810		$	1,393		$	42,282		$	(923	)
Accrual of dividends related to preferred stock		(255		)	(47		)	(858		)	(154		)
Modification and dividend payments of preferred stock and common stock warrants		111			—			323			(1,165		)
Net income (loss) attributed to common stock		$	32,666		$	1,346		$	41,747		$	(2,242	)
Basic net income (loss) per common share:
Net income (loss) per common share from continuing operations before cumulative effect of change in accounting principle		$	0.15		$	0.01		$	0.20		$	—
Discontinued operations		—			—			(0.01		)	(0.01		)
Cumulative effect of change in accounting principle		—			—			—			—
Net income (loss) per common share		$	0.15		$	0.01		$	0.19		$	(0.01	)
Weighted average common shares outstanding		217,251,270			223,342,658			218,041,835			223,383,117
Diluted income (loss) per common share:
Net income (loss) per common share from continuing operations before cumulative effect of change in accounting principle		$	0.14		$	0.01		$	0.18		$	—
Discontinued operations		—			—			(0.01		)	(0.01		)
Cumulative effect of change in accounting principle		—			—			—			—
Net income (loss) per common share		$	0.14		$	0.01		$	0.17		$	(0.01	)
Weighted average common shares outstanding		242,904,248			223,342,658			247,087,405			223,383,117

 

The accompanying Notes to Consolidated Condensed Financial Statements are

an integral part of these Statements.

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HARKEN ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS’ EQUITY

(in thousands)

(Unaudited)

																							Accumulated
														Additional									Other
		Preferred Stock									Common			Paid-In			Treasury			Accumulated			Comprehensive
		G1			G2			M			Stock			Capital			Stock			Deficit			Income			Total
Balance, December 31, 2005		$	2		$	1		$	50		$	2,236		$	446,643		$	—		$	(356,889	)	$	119		$	92,162
Adjustment of preferred stock and common stock warrant terms		—			—			—			—			1,147			—			(1,147		)	—			—
Conversions of preferred stock to common stock		—			—			(6		)	10			3			—			—			—			7
Conversions of common stock warrants to common stock		—			—			—			1			40			—			—			—			41
Accrual of preferred stock dividends		—			—			—			—			—			—			(154		)	—			(154		)
Issuance of preferred stock dividends		—			—			—			—			1			—			(18		)	—			(17		)
Options exercised for common stock of consolidated company		—			—			—			—			139			—			—			—			139
Treasury stock repurchase		—			—			—			—			—			(1,401		)	—			—			(1,401		)
Treasury stock retirements		—			—			—			(13		)	(890		)	903			—			—			—
Comprehensive income:
Net loss		—			—			—			—			—			—			(923		)	—
Unrealized gain on available for sale investments																							16,427
Unrealized foreign currency gain																							4,363
Total comprehensive income																										19,867
Balance, September 30, 2006		$	2		$	1		$	44		$	2,234		$	447,083		$	(498	)	$	(359,131	)	$	20,909		$	110,644

 

The accompanying Notes to Consolidated Condensed Financial Statements

are an integral part of these Statements.

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HARKEN ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 

		Nine Months Ended September 30,
		2005			2006
Cash flows from operating activities:
Net income (loss)		$	42,282		$	(923	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation, depletion and amortization		9,061			8,262
Amortization of debt issuance costs and other		140			—
Accretion of asset retirement obligation		285			310
Share-based compensation		11,375			2,184
Increase in Global warrant liability		13,297			—
Loss from discontinued operations		2,158			1,223
Cumulative effect of a change in accounting principle		—			868
Gain on exercise of Global warrants		(28,341		)	—
Gain on sale of Global shares		(32,185		)	—
Minority interest		(3,073		)	(2,175		)
Other		(596		)	395
Change in operating assets and liabilities:
Increase in short-term investments		—			(2,950		)
Decrease (increase) in accounts receivable and other		(123		)	3,721
Increase in margin deposits posted with brokers		—			(1,357		)
Incease in derivative liabilities		—			577
Decrease in trade payables and other		(801		)	(3,452		)
Net cash provided by operating activities		13,479			6,683
Cash flows from investing activities:
Net proceeds from sales of assets		235			—
Capital expenditures		(22,861		)	(13,955		)
Deconsolidation of Global		—			(4,282		)
Cash received from redemption of IBA preferred shares		—			7,500
Purchase of available for sale investments		—			(831		)
Sale of Global shares		45,476			—
Net cash provided by (used in) investing activities		22,850			(11,568		)
Cash flows from financing activities:
Proceeds from issuances of common stock, net of issuance costs		365			41
Proceeds from issuances of long-term debt, net of issuance costs		(63		)	—
Proceeds from issuances of common stock of subsidiary, net of issuance costs		553			—
Repayments of debt, convertible notes and long-term obligations		(3,333		)	—
Payments of preferred dividends		(271		)	(88		)
Purchase of preferred stock		(9,136		)	—
Treasury shares purchased		(2,100		)	(1,401		)
Net cash used in financing activities		(13,985		)	(1,448		)
Net change in cash and temporary investments		22,344			(6,333		)
Cash and temporary investments at beginning of period		17,062			22,482
Cash and temporary investments at end of period		$	39,406		$	16,149
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest		$	207		$	169
Income taxes		$	1,622		$	800
Significant non-cash transactions:
Conversion of convertible notes into common stock, net of fees		$	3,120		$	—

 

The accompanying Notes to Consolidated Condensed Financial Statements

are an integral part of these Statements.

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HARKEN ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

September 30, 2005 and 2006

(Unaudited)

(1)                                 BASIS OF PRESENTATION

Our accompanying consolidated condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to these rules and regulations, although we believe that the disclosures made are adequate to prevent the information presented from being misleading.  In our opinion, these financial statements contain all adjustments necessary to present fairly our financial position as of December 31, 2005 and September 30, 2006 and the results of our operations and changes in its cash flows for all periods presented as of September 30, 2005 and 2006. The December 31, 2005 consolidated condensed balance sheet information is derived from audited financial statements. All adjustments represent normal recurring items. These condensed financial statements should be read in conjunction with the financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005. Certain prior year amounts have been reclassified to conform with the 2006 presentation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period.  Actual results could differ from these estimates. The results of operations for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results to be expected for the full year. Due to the cessation of the operations of International Business Associates, Ltd. (“IBA”), we have reclassified certain amounts to discontinued operations. See Note 4 – Discontinued Operations for further discussion.

Principles of Consolidation – The consolidated condensed financial statements include the accounts of all companies that we, through our direct or indirect ownership or shareholding, were provided the ability to control the operating policies and procedures at September 30, 2006. As previously reported, during the second quarter of 2006, we deconsolidated Global Energy Development Plc (“Global”) from our consolidated condensed financial statements. Under U.S. GAAP we reflected the deconsolidation prospectively and, accordingly, we did not restate prior period amounts. We have provided unaudited pro-forma condensed consolidated balance sheets and results of operations giving effect to the deconsolidation of Global’s operations as if it had been effective for all periods presented. See Note 2 – Investment in Global for further discussion.

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Comprehensive Income – Comprehensive income includes changes in stockholders’ equity during the periods that do not result from transactions with stockholders. Our total comprehensive income is as follows:

Financial Instruments - We carry our financial instruments including cash, auction rate bonds, equity securities and derivatives at their estimated fair values.  The fair values of our auction rate bonds, securities and exchange-traded derivatives are based on prices quoted in active markets; the fair values of our commodity derivatives are based on pricing provided by our counterparties.

Our investments in auction rate bonds have been designated trading securities, and their associated gains are recognized in earnings.  All of our investments in equity securities have been designated as available for sale. With the exception of our investment in Global, these securities have been classified as current assets in our accompanying balance sheets due to our ability to readily convert these investments into cash to fund current operations or satisfy other cash requirements as needed. Our investment in Global is classified as a non-current asset in our accompanying balance sheets. The associated unrealized gains and losses on our available for sale investments are recorded to other comprehensive income until realized.

We have not designated any of our derivative instruments as hedges under Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities.” All gains and losses related to these positions are recognized in earnings.

Recent Accounting Pronouncements – In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statement No. 133 and 140.” This Statement provides new accounting guidance for embedded derivatives and other issues. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of SFAS No. 155 is not expected to have a material impact on our financial statements.

In April 2006, the FASB issued FASB Staff Position (FSP) FIN 46(R)-6, “Determining the Variability to be Considered in Applying FASB Interpretation No. 46(R).” FSP FIN 46(R)-6 provides further accounting guidance in assessing whether an entity is subject to the accounting requirements of FIN 46(R). FSP FIN 46(R)-6 is effective for all entities with which an enterprise becomes involved and all existing entities when a reconsideration event has occurred, in each case, at the beginning of the first reporting period that starts after June 15, 2006. The adoption of FIN 46(R)-6 is not expected to have a material impact on our financial statements.

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In May 2006, the Governor of Texas signed into law a Texas margin tax (H.B. No. 3) which restructures the state business tax by replacing the taxable capital and earned surplus components of the current franchise tax with a new “taxable margin” component.  Specifically, we will be subject to a new entity level tax beginning in 2008 on the portion of our total revenue (as that term is defined in the legislation) that is generated in Texas beginning in our tax year ending December 31, 2007. Specifically, the Texas margin tax will be imposed at a maximum effective rate of 0.7% of our total revenue that is apportioned to Texas.  We are currently evaluating what impact (if any) this new tax law will have on our income tax expense and deferred tax assets (which are currently fully reserved).

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109 (“FIN 48”), which clarifies the accounting for uncertainty in tax positions taken or expected to be taken in a tax return, including issues relating to financial statement recognition and measurement. FIN 48 provides that the tax effects from an uncertain tax position can be recognized in the financial statements only if the position is “more-likely-than-not” of being sustained if the position were to be challenged by a taxing authority.  The assessment of the tax position is based solely on the technical merits of the position, without regard to the likelihood that the tax position may be challenged. If an uncertain tax position meets the “more-likely-than-not” threshold, the largest amount of tax benefit that is greater than 50 percent likely of being recognized upon ultimate settlement with the taxing authority, is recorded.  The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We are currently evaluating the impact of adopting FIN 48 on our financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value under Generally Accepted Accounting Principles and requires enhanced disclosures about fair value measurements. It does not require any new fair value measurements.  SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We are currently assessing whether we will early adopt SFAS No. 157 as of the first quarter of fiscal 2007 as permitted, and we are currently evaluating the impact adoption may have on our financial statements.

In September 2006, the FASB issued SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.”  This Statement amends Statement 87, FASB Statement No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, Statement 106, and FASB Statement No. 132 (revised 2003), Employers’ Disclosures about Pensions and Other Postretirement Benefits, and other related accounting literature. SFAS No. 158 requires an employer to recognize the over funded or under funded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through comprehensive income. This Statement also requires employers to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions.  Employers with publicly traded equity securities are required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006.  We have no defined benefit or other post retirement plans subject to this standard.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on how to evaluate prior period financial statement misstatements for purposes of assessing their materiality in the current period.  If the prior period effect is material to the current

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period, then the prior period is required to be corrected.  Correcting prior year financial statements would not require an amendment of prior year financial statements, but such corrections would be made the next time the company files the prior year financial statements.  Upon adoption, SAB 108 allows a one-time transitional cumulative effect adjustment to retained earnings for corrections of prior period misstatements required under this statement.  SAB 108 is effective for fiscal years beginning after November 15, 2006. The adoption of SAB 108 is not expected to be material to our consolidated financial statements.

(2)                                 INVESTMENT IN GLOBAL

At December 31, 2005 and September 30, 2006, we owned approximately 34% of Global’s ordinary shares. During the first quarter of 2006, Lyford Investments Enterprises Ltd. (“Lyford”) owned 17.01% of the ordinary shares of Global and also beneficially owned approximately 30% of the combined voting power of our common stock. Lyford’s representative, Alan Quasha, is the Chairman of our Board of Directors. During the first quarter of 2006, our direct equity interest of 33.67% combined with Lyford’s 17.01% equity interest in Global and the previous sharing of certain management and administrative functions between Global and us, were deemed to provide us with the legal power to control the operating policies and procedures of Global as of March 31, 2006, which required us to consolidate the operations of Global as of such date.

In April 2006, Global advised us that Lyford had sold a portion of its equity interest in Global, reducing Lyford ownership to 15.89% of the ordinary shares of Global such that our direct equity interest in Global combined with Lyford’s direct equity interest in Global was reduced to less than 50% of Global’s outstanding voting securities.  Based upon this reduction in ownership and the elimination of shared management and administrative functions between us and Global, we determined that we no longer had the legal power to control the operating policies and procedures of Global and that we were required to deconsolidate Global from our consolidated financial statements beginning effectively during the second quarter of 2006. Under US GAAP, we are required to reflect this deconsolidation prospectively, and, accordingly, we have not restated prior year amounts. As a result of this treatment, Global’s operations for the quarter ended March 31, 2006 are still included in our consolidated condensed financial statements at September 30, 2006.

Based upon our ownership percentage at September 30, 2006 of approximately 34% of Global’s outstanding common shares, we would normally treat our ownership of Global as an equity method investment if we had the ability to exercise significant influence over Global. However, there are certain information requirements needed from Global to permit us to comply with the requirements of the equity method.   Global’s common shares are listed on the AIM Market of the London Stock Exchange, and under AIM guidelines, Global publicly reports its financial results on a semi-annual basis (June 30 and December 31) in conformity with accounting principles generally accepted in the United Kingdom (“UK GAAP”). To comply with the requirements of the equity method we require adequate financial information from Global in order to conform Global’s UK GAAP financial statements to accounting principles generally accepted in the United States on a quarterly basis. We have made formal written requests to Global to provide us the needed financial information to apply the equity method, but Global has refused to provide to us this information, citing foreign securities exchange restrictions against providing more financial information to us than is available to their other shareholders.

As reflected in Global’s public announcements and filings, Global’s board of directors was expanded to six members.  One of the new directors, a member of the House of Lords of the United Kingdom, now heads Global’s audit committee and has taken an active role in the oversight of the committee’s functions and

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obligations with respect to restrictions imposed on Global regarding the disclosure of nonpublic information.  As a result, and due to Global’s continued refusal to provide the financial information required for us to treat Global as an equity method investment, we concluded that we do not have the ability to exercise significant influence over Global and cannot comply with the requirements of the equity method.  Therefore beginning April 1, 2006, we are accounting for our Global shares as an available-for-sale cost method investment.  We will recognize only dividend income beginning April 1, 2006, and our investment in Global will be adjusted to fair value every quarterly period with an offset to other comprehensive income in stockholders’ equity.

The deconsolidation of Global from our financial statements as of April 1, 2006 resulted in an adjusted carrying value of our investment in Global of $9.8 million which was then adjusted to market value on that same date. At April 1, 2006, our investment in Global of $58.5 million was equal to the market value of our 11.9 million shares of Global’s common stock based on Global’s closing share price of £2.83 (U.K. pounds sterling). The unrealized gain on investment of $48.8 million was recorded to other comprehensive income in stockholders’ equity at April 1, 2006.

At September 30, 2006, our investment in Global of $30.5 million was equal to the market value of our 11.9 million shares of Global’s common stock based on Global’s closing share price of £1.37. The foreign currency exchange rate changed from 1.74 U.S. dollars per U.K. pounds sterling at April 1, 2006 to 1.87 U.S. dollars per U.K. pounds sterling at September 30, 2006. The foreign currency translation adjustment of $4.2 million and the unrealized loss on investment of $32.3 million for these subsequent changes in market value are recorded to other comprehensive income in stockholders’ equity at September 30, 2006. At September 30, 2006, our total unrealized gain on Global shares recorded to other comprehensive income in stockholders equity was $20.7 million.

Pro Forma Information – The following unaudited pro forma combined condensed balance sheet at December 31, 2005 along with the pro forma combined condensed statement of operations for the three months ended September 30, 2005 and the nine months ended September 30, 2005 and 2006 gives effect to the deconsolidation of Global’s operations as if it had been effective for all periods presented.  The combined condensed balance sheet at September 30, 2006 and the combined condensed statement of operations for the three months ended September 30, 2006 are presented as reported.  The unaudited pro forma data is presented for illustrative purposes only and is not necessarily indicative of future operating results.

To arrive at our pro forma combined condensed balance sheet at December 31, 2005, we removed Global’s historical balance sheet at its previously-reported values and made an adjustment to the Investment in Global and Stockholders’ Equity to reflect our investment in Global at its fair market value based on its December 31, 2005 stock price and the foreign currency conversion factor as of December 31, 2005.

To arrive at our pro forma combined condensed statement of operations for each period presented, we removed Global’s historical results of operations at their previously-reported values and adjusted the Gain on Sale of Global shares and Gain on exercise of Global Warrants to the gains which would have been reported if Global was a cost-method investment at the time.

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HARKEN ENERGY CORPORATION AND SUBSIDIARIES

PRO FORMA CONSOLIDATED CONDENSED BALANCE SHEETS

(Unaudited, in thousands)

		December 31, 2005			September 30, 2006
Assets
Current Assets:
Cash and temporary investments		$	14,269		$	16,149
Short term investments		15,000			17,950
Margin deposits held by broker		—			1,357
Accounts receivable, net		6,566			8,322
Assets of discontinued operations		8,904			—
Available for sale investments, current		—			891
Prepaid expenses and other current assets		1,060			1,618
Total Current Assets		45,799			46,287
Property and Equipment, net		50,189			48,505
Available for sale investment		50,186			30,496
Other Assets, net		1,580			664
		$	147,754		$	125,952
Liabilities and Stockholders’ Equity
Current Liabilities:
Trade payables		$	4,267		$	1,841
Accrued liabilities and other		3,801			3,576
Liabilities of discontinued operations		53			—
Derivative liabilities		—			617
Revenues and royalties payable		2,521			1,922
Total Current Liabilities		10,642			7,956
Asset Retirement Obligation		5,502			7,303
Accrued Preferred Stock Dividends		—			49
Total Liabilities		16,144			15,308
Commitments and Contingencies (Note 14)
Stockholders’ Equity:		131,610			110,644
		$	147,754		$	125,952

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HARKEN ENERGY CORPORATION AND SUBSIDIARIES

PRO FORMA CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Unaudited, in thousands)

		Three Months Ended September 30,						Nine Months Ended September 30,
		2005			2006			2005			2006
Revenues and other:
Oil and gas operations		$	4,123		$	6,907		$	13,845		$	17,959
Interest and other income, net		208			500			342			1,139
		4,331			7,407			14,187			19,098
Costs and Expenses:
Oil and gas operating expenses		1,536			2,130			4,160			5,903
General and administrative expenses		1,305			1,337			4,153			4,276
Depreciation and amortization		1,269			2,423			4,638			7,203
Increase in Global warrant liability		5,100			—			12,947			—
Accretion expense		90			116			256			299
Interest expense and other, net		173			5			496			5
		9,473			6,011			26,650			17,686
Gain on exercise of Global warrants (A)		25,734			—			25,734			—
Gain on sale of subsidiary shares (A)		10,789			—			27,715			—
Net income before income taxes		$	31,381		$	1,396		$	40,986		$	1,412
Income tax expense		—			—			15			—
Net income from continuing operations		$	31,381		$	1,396		$	40,971		$	1,412
Loss from discontinued operations, net of taxes		(116		)	(3		)	(2,158		)	(1,223		)
Net income		$	31,265		$	1,393		$	38,813		$	189
Accrual of dividends related to preferred stock		(255		)	(47		)	(858		)	(154		)
Payment of preferred stock dividends/redemption of preferred stock		111			—			323			(1,165		)
Net income / (loss) attributed to common stock		$	31,121		$	1,346		$	38,278		$	(1,130	)
Basic net income /(loss) per common share:
Net income / (loss) per common share		$	0.14		$	0.01		$	0.18		$	(0.01	)
Weighted average common shares outstanding		217,251,270			223,342,658			218,041,835			223,383,117
Diluted income / (loss) per common share:
Net income/(loss) per common share		$	0.13		$	0.01		$	0.15		$	(0.01	)
Weighted average common shares outstanding		242,904,248			223,342,658			247,087,405			223,383,117

(A) Calculated under cost-method accounting.

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(3)                                 INVESTMENTS

Our short-term investments at December 31, 2005 consisted of $15 million in auction bonds.  At September 30, 2006, short-term investments consisted of approximately $18 million in auction bonds. These investments are classified as trading securities and recorded at their fair value in both periods. There was no significant unrealized gain or loss on these investments for any period covered by this report. Any unrealized gain or loss on these in the future will be recorded to earnings.

Our available-for-sale investments include our investment in common shares of Global as well as our investments in common shares of other publicly traded entities.  During the three and nine month periods ended September 30, 2006 we recorded the following unrealized holding gains and losses (in thousands):

		Three months ending September 30, 2006			Nine months ending September 30, 2006
Unrealized holding gain (loss) on Global investment		$	(11,510	)	$	20,730
Unrealized holding gain on other equity investments		60			60
Total unrealized holding gain (loss) on available for sale investments		$	(11,450	)	$	20,790

The fair value of our available-for-sale investments were as follows (in thousands):

		December 31, 2005			September 30, 2006
Investment in common shares of Global (A)		$	—		$	30,496
Investments in other equity securities		—			891
		$	—		$	31,387

(A) Please note that during the second quarter of 2006, we removed Global’s operations from our consolidated condensed financial statements and began to account for our ownership of Global common shares as an available-for-sale investment. At December 31, 2005, Global’s operations were consolidated in our financial statements. Please see Note 2 – Investment in Global for further discussion.

(4)                                 DISCONTINUED OPERATIONS

In February 2006, IBA redeemed 7,500 shares of its Series A Redeemable Preferred Stock, $0.01 par value per share, along with 24 shares of its common stock, $0.01 par value per share, held by us in exchange for cash consideration of $7.5 million.

In accordance with FIN 46R, “Consolidation of Variable Interest Entities (revised December 2003) – an interpretation of ARB No. 51,” we had designated IBA as a VIE and had previously consolidated the assets, liabilities and the results of operations of IBA.

During the second quarter of 2006, our Chief Executive Officer resigned from the board of directors of IBA.  During this same time, it also became evident that IBA would be unable to raise additional capital to continue their operations, and we have resolved not to provide any additional form of support. During the third quarter of 2006, IBA ceased operations.

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We determined that these events required us to treat our investment in IBA as a disposal of a subsidiary by means of abandonment.  Therefore we have accounted for IBA as a discontinued operation in our statement of operations as of September 30, 2006. During June 2006, we recorded an impairment loss of approximately $190 thousand on IBA’s assets which is included in our loss from discontinued operations in our statement of operations. As discontinued operations, the operations for IBA for all periods presented have been combined into a single line item, net of taxes.

The following tables provide summarized income statement information related to IBA’s discontinued operations:

		Three months ended September 30,						Nine months ended September 30,
		2006			2005			2006			2005
		(In thousands)						(In thousands)
Sales and other revenues from discontinued operations		$	—		$	608		$	19		$	594
Loss from discontinued operations before income tax (expense) benefit		(3		)	(124		)	(1,207		)	(2,115		)
Income tax (expense) benefit		—			8			(16		)	(43		)
Loss from discontinued operations, net		$	(3	)	$	(116	)	$	(1,223	)	$	(2,158	)

(5)           PROPERTY AND EQUIPMENT

A summary of property and equipment follows (in thousands):

		December 31, 2005			September 30, 2006
Unevaluated oil and gas properties, full cost method:
Unevaluated Peru properties (A)		$	1,530		$	—
Unevaluated Panama properties (A)		526			—
Unevaluated North American properties		1,319			1,186
Unevaluated Coal Bed Methane prospects		2,928			3,293
Evaluated oil and gas properties, full cost method:
Evaluated Colombian properties (A)		212,684			—
Evaluated North American properties		173,584			178,646
Facilities and other property (A)		28,701			10,135
Less accumulated depreciation, depletion and amortization		(330,273		)	(144,755		)
		$	90,999		$	48,505

(A) Please note that during the second quarter of 2006, we removed Global’s operations from our consolidated condensed financial statements. Please see Note 2 – Investment in Global for further discussion.

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Sales of Certain Non-Operated Producing Interests — In September 2006, wholly-owned subsidiaries of Harken sold interests in certain non-operated oil and gas producing properties located in Texas and Louisiana at auction for approximately $2.9 million. The effective date of the sale of these properties is October 1, 2006.  These proceeds have been allocated to the domestic full cost pool.

(6)           ASSET RETIREMENT OBLIGATION

Our oil and gas operations are conducted through our wholly-owned subsidiary, Gulf Energy Management Company (“GEM”). GEM recognizes the present value of asset retirement obligations beginning in the period in which they are incurred if a reasonable estimate of a fair value can be made.  The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset.

A summary of GEM’s assets with required asset retirement obligations as of September 30, 2006 is as follows: (in thousands)

		Asset
		Retirement
Asset Category		Liability			Estimated Life
Oil and gas producing properties		$	4,565		0-22 years
Facilities and other property		2,738			4-10 years
		$	7,303

The following table describes all changes to our asset retirement obligation liability during the nine months ended September 30, 2006. (in thousands)

Asset retirement obligation at December 31, 2005		$	6,301
Liabilities incurred during the nine months ended September 30, 2006		84
Liabillities settled during the nine months ended September 30, 2006		—
Liabilities disposed of during the nine months ended September 30, 2006		(317		)
Accretion expense		310
Deconsolidation of Global		(811		)
Revision in estimates		1,736
Asset retirement obligation at September 30, 2006		$	7,303

(7)           CONVERTIBLE NOTES PAYABLE

At September 30, 2006, we had no debt outstanding. At December 31, 2005, Global’s Senior Convertible Notes Payable due 2012 with a $12.5 million principal amount were included in our consolidated financial statements. We have deconsolidated Global’s operations. Please see Note 2 – Investment in Global for further discussion.

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(8)           REDEEMABLE PREFERRED STOCK AND COMMON STOCK WARRANTS

Series M Cumulative Convertible Preferred

In January 2006, we entered into an agreement with the holders of our Series M Cumulative Convertible Preferred (“Series M Preferred”), to do the following:

·                  Extend the expiration of the term required to occur before we may redeem the Series M Preferred for cash, at our sole option, by one year

·                  Modify the escalating dividend rates for the Series M Preferred to reflect a lower rate of 6% from 8%, for October 8, 2007 through October 7, 2008 and 8% from 9%, for October 8, 2008 to October 7, 2009

We accounted for the modification of the dividend rate in accordance with EITF Topic D-42, “The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock (“EITF D-42”),” and EITF Topic D-53, “Computation of Earnings per Share for a Period That Includes a Redemption or an Induced Conversion of a Portion of a Class of Preferred Stock (“EITF D-53”),” We recognized approximately $123 thousand in Modification of preferred stock and common stock warrants  as a decrease to Net loss attributed to common stock during the nine months ended September 30, 2006. This amount was equal to the fair value of the dividends given up by the holder for the modification of the Series M Preferred dividend rate.

During the nine months ended September 30, 2006, holders of 6,000 shares of the Series M Preferred voluntarily elected to exercise their conversion option, and such holders were issued 1,028,780 shares of our common stock.

Series L and M Common Stock Warrants

During January 2006, we also entered into an agreement with the holders of our Series L common stock warrants and Series M common stock warrants to extend the expiration term of the Series L warrants from August 12, 2006 to September 2, 2008 and to extend the expiration term of the Series M warrants from February 2, 2008 to September 2, 2008. We accounted for these extensions in accordance with EITF Topic D-42 and EITF Topic D-53 and recognized a charge to Modification of preferred stock and common stock warrants as an increase to Net loss attributed to common stock of approximately $1.3 million during the nine months ended September 30, 2006. This amount was equal to the incremental increase in the fair value of the warrants as a result of extending the expiration term.

During the nine months ended September 30, 2006, holders of 130,000 Series M common stock warrants voluntarily elected to exercise their warrants, and 130,000 shares of our common stock were issued for proceeds of $74 thousand.

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(9)           STOCKHOLDERS’ EQUITY

Treasury Stock – At December 31, 2005, we had no treasury stock outstanding. During the nine months ended September 30, 2006, we repurchased 2,234,400 shares of our common stock in the open market at a cost of approximately $1.4 million pursuant to our repurchase program. In August 2006, our Board of Directors approved the cancellation of 1,357,315 shares of treasury stock previously outstanding. Such treasury shares were cancelled in August 2006. At September 30, 2006, we held 877,100 shares of treasury stock, and approximately 5.4 million shares remain available for repurchase under our repurchase program.

The number of common and preferred shares and shares held in treasury at December 31, 2005 and during the nine months ended September 30, 2006 are as follows:

		Number of Shares
		Preferred		Preferred
Description		G1		G2		Preferred M		Common		Treasury
Balance at December 31, 2005		1,600		1,000		50,000		223,575,732		—
Issuances of common stock upon exercise of Series M common stock warrants		—		—		—		130,000		—
Treasury shares retired		—		—		—		(1,357,315	)	(1,357,315	)
Treasury shares purchased		—		—		—		—		2,234,415
Conversions of Series M Preferred		—		—		(6,000	)	1,028,780		—
Issuance of preferred dividends		—		—		—		1,845		—
Balance as of September 30, 2006		1,600		1,000		44,000		223,379,042		877,100

(10)         SHARE-BASED COMPENSATION

We have removed Global’s operations from our consolidated condensed financial statements. See Note 2 – Investment in Global for further discussion. Global’s operations for the quarter ended March 31, 2006 prior to this deconsolidation remain included in our consolidated condensed financial statements. At December 31, 2005 and September 30, 2006, we had no outstanding stock options. The following stock option information relates solely to Global’s stock option plan at March 31, 2006.

 Adoption of Statement of Financial Accounting Standard No. 123 (As Amended)

Effective January 1, 2006, we and our consolidated companies adopted SFAS No. 123 (R) using the modified prospective transition method.  In addition, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 “Share-Based Payment” (“SAB 107”) in March 2005, which provides supplemental SFAS 123(R) application guidance based on the views of the SEC. Under the modified prospective transition method, compensation cost recognized in the quarterly period ended March 31, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted beginning January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In accordance with the modified prospective transition method, results for prior periods have not been restated.

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The adoption of SFAS 123(R) resulted in a cumulative effect of a change in accounting principle on the consolidated condensed statement of operations ended March 31, 2006 for the amount of $868 thousand. This adjustment was recorded as an increase to Net loss. We did not recognize a tax benefit from the cumulative effect adjustment because Global, the only entity impacted by SFAS 123 (R), had net operating losses which will prevent any tax benefit from being received from any exercised options. In accordance with SFAS 123(R) tax benefits and/or credits to additional paid-in capital for any additional deduction would not be recognized until the deduction actually reduces the taxes payable.

Global Stock Options

At March 31, 2006, Global’s 2002 Stock Option Plan (the “Plan”) is authorized to grant shares for up to and/or equal to 15% of Global’s common stock outstanding on grant date, to its qualified and non-qualified employees and directors.  Under the Plan, all options granted expire in ten years, and vest and become fully exercisable at the end of three years of continued employment.  The Plan allows options to be exercised with written notification submitted to the secretary of Global. Within thirty days of receipt of notification Global, upon board approval, shall issue new shares to participant.  The Plan has had four different grant dates: January 31, 2002; August 30, 2002; December 3, 2004; and December 3, 2005.

In June 2005, four of our employees resigned their respective office positions of Global and were replaced with Global employees.  Global’s Board of Directors, acting under the discretionary provisions of the Plan, approved a resolution which resulted in the Global options granted to those four individuals to become fully vested.  In accordance with the terms of the Plan, as amended, the options granted to the four individuals expire on June 16, 2007.

In 2004 the Board of Directors of Global modified the Plan to include a cashless exercise feature, which changed the Plan from a fixed option plan to a variable option plan.  The cashless feature of the Plan classified the options as a liability award.  The liability award method required Global to account for the share-based payment arrangements as a liability on the consolidated condensed balance sheet according to SFAS 123(R).  Global was required to value each issuance of options at fair value on a quarterly basis and reflect any change in fair value as compensation expense on the consolidated condensed statement of operations.

Global opted to use the Black-Scholes option-pricing model to value its options on a quarterly basis and on the grant date of any options granted here within.  The Black-Scholes option-pricing model uses several criteria, some of which are known at time of valuation (strike price, market price, and risk-free rate) and some which require the use of assumptions such as the expected stock price volatility, the expected dividend rate, the expected pre-vesting forfeiture rate and the expected option term.  Global used an adjusted historical volatility based on the most recent years’ traded stock activity.  Global also used historical data to compute the expected pre-vesting forfeiture rate and the expected option term. The historical data was separated into groups of employees that have similar historical exercise behavior, to estimate the options expected term until exercised and/or forfeited.

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For the quarters ending March 31, 2005 and March 31, 2006, the fair value assumptions used were estimated at the quarter-end dates using the Black-Scholes option-pricing method described above with the following criteria:

		For the Three Months Ended March 31,
		2005									2006
Date of grant (A)		Historical volatility		Expected option term		Risk-free interest rate		Fair value			Historical volatility		Expected option term		Risk-free interest rate		Fair value
Jan. 31, 2002		131.73	%	4.44		4.33		£	1.69		50.22	%	3.44		4.83		£	2.41
Aug. 30, 2002		131.73	%	2.75		4.33		£	1.59		50.22	%	1.75		4.83		£	2.33
Dec. 3, 2004		131.73	%	3.68		4.50		£	1.50		50.22	%	2.86		4.86		£	1.67
Dec. 3, 2005		—		—		—		£	—		50.22	%	3.01		4.86		£	1.15

(A) The expected dividend rate for all grants in both periods presented is 0%.

Pro-Forma Stock Compensation Expense for the prior year period ended March 31, 2005

Prior to the adoption of SFAS 123 (R), Global applied the intrinsic value method of accounting for stock options as prescribed by Accounting Principles Board (“APB”) 25. For the quarter ended March 31, 2005 Global recorded share-based compensation expense under the intrinsic value method of approximately $2.0 million in the consolidated condensed statement of operations which was attributable to Global options that vested during the period and to the increase in the Global share price during the period from December 31, 2004 to March 31, 2005. The following table represents the pro forma effect on net loss and net loss per share as if Global had applied the fair value-based method and recognition provisions of SFAS 123 to stock-based employee compensation (in thousands, except for per share amounts):

			Three Months Ended March 31, 2005
Net loss attributed to common stock, as reported			$	(6,610	)
Add:	Total share-based employee compensation recognized under intrinsic value-based method for all amounts		2,020
Deduct:	Total share-based employee compensation determined under fair value-based method for all amounts		(99		)
Deduct:  Related minority interest and foreign currency gain			(424		)
Pro-forma net loss attributed to common stock			$	(5,113	)
Basic net loss per share, as reported			$	(0.03	)
Pro-forma basic net loss per share			$	(0.02	)
Diluted net loss per share, as reported			$	(0.03	)
Pro-forma diluted net loss per share			$	(0.02	)

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Pro-forma compensation expense under the previously issued SFAS 123, among other computational differences, does not consider potential pre-vesting forfeitures. Because of these differences, the pro-forma stock compensation expense presented above for the quarter ended March 31, 2005 under SFAS 123 and the stock compensation expense recognized during the current quarter ended March 31, 2006 for approximately $2.2 million under SFAS 123(R) are not directly comparable. In accordance with the modified prospective transition method of SFAS 123(R), the prior comparative quarterly results were not restated.

Stock options as of the quarter ended March 31, 2006

A summary of Global’s stock option activity, and related information for the quarter ended March 31, 2006 follows (in UK pounds sterling):

		For the quarter ended March 31, 2006
		Number of Options		Weighted- Average Exercise Price			Weighted- Average Remaining Contractual Term		Aggregate Intrinsic Value
							(in years)		(£000)
Outstanding-January 1, 2006		4,047,636		£	0.84
Granted		—		£	—
Exercised		(147,440	)	£	1.17
Forfeited		—		£	—
Expired		—		£	—
Outstanding-March 31, 2006		3,900,196		£	0.83		6.6		£	7,814
Exercisable-March 31, 2006		3,309,990		£	0.53		5.2		£	7,309

For the quarters ended March 31, 2005 and 2006, Global did not grant any options under the Plan.  The total intrinsic value, or the difference between the exercise price and the market price on the date of exercise, of all options exercised during the quarters ended March 31, 2005 and 2006, was approximately $174 thousand and $460 thousand, respectively.  Global did not receive or pay cash related to the exercise of options in the quarter ended March 31, 2005 and 2006, because the options are issued with a cashless exercisable feature.  However, Global did relieve the share-based liability recorded on the consolidated condensed balance sheet for the quarter ended March 31, 2005 and 2006 for $207 thousand and $466 thousand, respectively.  Total estimated unrecognized compensation cost from unvested stock options as of March 31, 2006 was approximately $1.5 million, which is expected to be recognized over a weighted average period of approximately 2.18 years. The aggregate fair value of the options that vested during the quarter ended March 31, 2005 was $544 thousand as compared to the aggregate fair value of the options vested during the quarter ended March 31, 2006 of $194 thousand.

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