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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

For the transition period from              to                

Commission File Number: 0-8877

CREDO PETROLEUM CORPORATION

(Exact name of registrant as specified in its charter)

303-297-2200

(Registrant’s telephone number, including area code)

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 has submitted electronically and posted on its corporate web site, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)  Yes  o  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  (See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Act.)

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, net of treasury stock, as of the latest practicable date.

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CREDO PETROLEUM CORPORATION AND SUBSIDIARIES

Quarterly Report on Form 10-Q For the Period Ended April 30, 2010

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The terms “CREDO”, “Company”, “we”, “our”, and “us” refer to CREDO Petroleum Corporation and its subsidiaries unless the context suggests otherwise.

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PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

CREDO PETROLEUM CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

ASSETS

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

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LIABILITIES AND STOCKHOLDERS‘ EQUITY

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

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CREDO PETROLEUM CORPORATION AND SUBSIDIARIES

Consolidated Statements of Operations

(Unaudited)

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

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CREDO PETROLEUM CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

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

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CREDO PETROLEUM CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements (Unaudited)

April 30, 2010

1.             BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with U. S. generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U. S. generally accepted accounting principles for complete financial statements. In the opinion of management, the consolidated financial statements contain all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the company’s results for the periods presented.  For a more complete understanding of the company’s financial condition and accounting policies, these consolidated financial statements should be read in conjunction with the company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2009.  The results for interim periods are not necessarily indicative of annual results.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  The company bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances.  Although actual results may differ from these estimates under different assumptions or conditions, the company believes that its estimates are reasonable and that actual results will not vary significantly from the estimated amounts.

2.             CONCENTRATION OF CREDIT RISK

Credo’s accounts receivable are primarily from purchasers of the company’s oil and natural gas production and from other exploration and production companies which own joint working interests in the properties that the company operates.  This industry concentration could adversely impact the company’s overall credit risk because the company’s customers and working interest owners may be similarly affected by changes in economic and financial market conditions, commodity prices, and other conditions.  Credo’s oil and gas production is sold to various purchasers in accordance with the company’s credit policies and procedures.  These policies and procedures take into account, among other things, the creditworthiness of potential purchasers and concentrations of credit risk.  For most joint working interest partners, the company has the right of offset against related oil and natural gas revenues.

3.             OIL AND NATURAL GAS PROPERTIES

Depreciation, depletion and amortization of oil and natural gas properties for the six months ended April 30, 2010 and 2009 were $1,485,000 and $2,273,000 respectively, and were $740,000 and $1,081,000 for the three months ended April 30, 2010 and 2009, respectively.  The company uses the full cost method of accounting for costs related to its oil and natural gas properties.  Capitalized costs included in the full cost pool are depleted on an aggregate basis using the units-of-production method.  All costs incurred in the acquisition, exploration, and development of properties (including costs of surrendered and abandoned leaseholds, delay lease rentals, dry holes, and overhead related to exploration and development activities) and the fair value of estimated future costs of site restoration, dismantlement, and abandonment activities are capitalized.  Costs for unevaluated properties, which typically include lease rentals, geology and seismic costs, are capitalized but are excluded from the amortizable pool during the evaluation period. When determinations are made whether the property has proved recoverable reserves or not, or if there is an impairment, the costs are reclassified to the full cost pool.

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The capitalized costs in the full cost pool are subject to a quarterly ceiling test that limits such pooled costs to the aggregate of the present value of future net revenues attributable to proved oil and natural gas reserves discounted at 10 percent plus the lower of cost or market value of unproved properties less any associated tax effects.  The ceiling test is calculated using oil and natural gas prices in effect as of the balance sheet date.  If such capitalized costs exceed the ceiling, the company will record a write-down to the extent of such excess as a non-cash charge to earnings, unless the company considers price increases subsequent to the balance sheet date which may reduce or eliminate a write-down.  A write-down may not be reversed in future periods, even though higher oil and natural gas prices may subsequently increase the ceiling.

At April 30, 2010 the estimated present value of future net revenues from proved reserves, net of related income tax considerations, exceeded the capitalized costs of the company’s oil and natural gas properties.  Therefore, a ceiling test write-down was not required.  For the three and six months ended April 30, 2009, the company recorded non-cash ceiling test write-downs of $8,030,000 and $23,726,000 respectively.

Changes in oil and natural gas prices have historically had the most significant impact on the company’s ceiling test.  In general, the ceiling is lower when prices are lower.  Even though oil and natural gas prices can be highly volatile over weeks and even days, the ceiling calculation dictates that prices in effect as of the last day of the test period be used and held constant.  The resulting valuation is a snapshot as of that day and, thus, is generally not indicative of a true fair value that would be placed on the company’s reserves by the company or by an independent third party.  Therefore, the future net revenues associated with the estimated proved reserves are not based on the company’s assessment of future prices or costs, but rather are based on prices and costs in effect as of the end of the test period.  See Footnote 12 for description of new SEC rules which Credo will adopt, effective October 31, 2010.

4.             STOCK-BASED COMPENSATION

For the six months ended April 30, 2010 and 2009, the company recognized stock based compensation expense of $34,000 and $16,000, respectively.  For the three months ended April 30, 2010 and 2009, the company recognized stock based compensation expense of $27,000 and $8,000, respectively.  The estimated unrecognized compensation cost from unvested stock options as of April 30, 2010 was approximately $171,000 which is expected to be recognized over an average of 2.7 years.

No options were granted during fiscal year 2009.  The fair value of the 50,000 options granted during the six months ended April 30, 2010 was estimated as of the grant date using the Black-Scholes option pricing model with the following assumptions:  volatility, 51.6%; expected option term, 3 years; risk-free interest rate, 2.69% and; expected dividend yield, 0%.  If option grants are made in the future, compensation expense for all such share-based payments granted, based upon the grant-date fair value estimated in accordance with the provisions of FASB ASC 718 will also be included in compensation expense.

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Plan activity for the six months ended April 30, 2010 is set forth below:

5.             OIL AND NATURAL GAS DERIVATIVES

The company is exposed to certain commodity price risks relating to its ongoing operations.  The company periodically uses oil and natural gas derivatives as economic hedges of the price of a portion of its estimated production when the potential for significant downward price movement is anticipated.  These transactions typically take the form of costless collars for oil, and forward short positions based upon the NYMEX futures market for natural gas, and are closed by purchasing offsetting positions.  Such contracts do not exceed estimated production volumes and are authorized by the company’s Board of Directors.  Contracts are expected to be closed as related production occurs but may be closed earlier if the anticipated downward price movement occurs or if the company believes that the potential for such movement has abated.

For the six months ended April 30, 2010 and 2009, the company had realized gains on natural gas derivatives of $3,000 and $2,275,000, respectively, and unrealized gains (losses) of $36,000 and ($348,000) respectively.  For the quarters ended April 30, 2010 and 2009 the company had realized gains on natural gas derivatives of $12,000 and $1,350,000 respectively, and unrealized gains (losses) of $41,000 and ($889,000), respectively.

At April 30, 2010 the company held open derivative contracts representing natural gas short sales positions for 400,000 MMBtus at NYMEX basis prices ranging from $5.31 to $7.27 and covering the production months of May 2010 through December 2010.  The company also held open derivative contracts with the same counterparty representing natural gas long positions for 360,000 MMBtus at NYMEX basis prices ranging from $4.26 to $5.83 and covering the production months of May 2010 through December 2010.  These positions are presented net due to the contractual netting provisions with the counterparty.  The open derivative contracts net to 40,000 MMBtus with a net unrealized gain of $206,000 at April 30, 2010. 

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Average natural gas prices received in the company’s primary market have historically been 15% - 17% below NYMEX prices due to basis differentials compared to the current differentials of about 4%.

At April 30, 2010 the company also held natural gas basis differential hedges on 280,000 MMBtus with NYMEX vs. Panhandle Eastern Pipeline basis differentials of $0.47 and covering the production months of May 2010 through December 2010.  These open basis differential contracts represent unrealized losses of $66,000 at April 30, 2010.

Subsequent to April 30, the May and June natural gas related derivative contracts closed, resulting in realized derivative gains of $32,000.

At April 30, 2010 the company also held costless collar derivative contracts for 6,000 barrels of oil for the production months of May through October 2010, priced at NYMEX WTI $75.00 floor and $95.00 ceiling.  There were no realized gains or losses on these derivatives for the three or six months ended April 30, 2010.  Unrealized losses on oil derivative contracts were $12,000 for the three and six month periods ended April 30, 2010.  There were no oil hedges in 2009.  Subsequent to April 30, the May contract closed, resulting in a realized gain of $1,000.  There were no oil hedges in 2009.

The company has a hedging line of credit with its bank which is available, at the discretion of the company, to meet margin calls.  To date, the company has not used this facility and maintains it only as a precaution related to possible margin calls.  The maximum credit line available is $7,200,000 with interest calculated at the prime rate.  The facility is unsecured and has covenants that require the company to maintain $3,000,000 in cash or short term investments, none of which are required to be maintained at the company’s bank, and prohibits funded debt in excess of $500,000.  The line expires May 1, 2013.

The company has elected not to designate its commodity derivatives as cash flow hedges for accounting purposes.  Accordingly, such contracts are recorded at fair value on the balance sheet and changes in fair value are recorded in the statement of operations as they occur.

The location and amount of derivative fair values and related gain (loss) are indicated in the following tables:

Derivatives not designated as hedging instruments:

Amount of Gain or (Loss) Recognized in Income on Derivatives:

Derivatives not designated as hedging instruments:

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6.             EARNINGS PER SHARE

The company’s calculation of earnings per share of common stock is as follows:

The company’s outstanding options were not included in the calculation of diluted loss per share for the three and six month periods ended April 30, 2009 as their inclusion would have an antidilutive effect.

7.             INCOME TAXES

The company uses the asset and liability method of accounting for deferred income taxes.  Deferred tax assets and liabilities are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities.  Deferred tax assets or liabilities at the end of each period are determined using the tax rate in effect at that time.  The effective tax rate varies from the statutory rate primarily due to utilization of percent depletion deductions.

The total future deferred income tax liability is complicated for any energy company to estimate due in part to the long-lived nature of depleting oil and gas reserves and variables such as product prices.  Accordingly, the liability is subject to continual recalculation, revision of the numerous estimates required, and may change significantly in the event of such things as major acquisitions, divestitures, product price changes, changes in reserve estimates, changes in reserve lives, and changes in tax rates or tax laws.

As of April 30, 2010, the company remains subject to examination of its 2006 and 2008 Federal and 2006 through 2008 state tax returns, except Colorado, in which the 2005 tax year also remains open.

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8.             INTANGIBLE ASSETS

The company owns all of the patents underlying the Calliope Gas Recovery Technology and patents covering a new fluid lift technology for shallow wells known as Tractor Seal.  The patents are being amortized on a straight line basis over the remaining lives ranging from 7.1 to 16.4 years.

The company reviews the value of its intangible assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate.  For the six months ended April 30, 2009, the company recorded a non-cash impairment expense of $926,000 related to other intangible assets.

9.             FAIR VALUE MEASUREMENTS

The company utilizes derivative contracts to hedge against the variability in cash flows associated with the forecasted sale of its anticipated future natural gas production.  These derivatives are carried at fair value on the consolidated balance sheets.  Additionally, the company’s short-term investments consist primarily of professionally managed limited partnerships which include investments that are not publicly traded and may have less readily determinable market values.  Accounting standards established a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value.  This hierarchy prioritizes the inputs into three broad levels as follows:

·      Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.

·      Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.

·      Level 3 inputs are measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources.

The classification of financial assets or liabilities within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.  The determination of the fair values below incorporates various factors required under fair value accounting guidance, including the impact of the counterparty’s non-performance risk with respect to the company’s financial assets and the company’s non-performance risk with respect to the company’s financial liabilities.  The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of April 30, 2010:

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Level 3 instruments are comprised of the company’s investments in professionally managed limited partnerships.  The fair value represents the net asset value of the company’s share in each partnership.  The company identified the investments as Level 3 instruments due to the fact that quoted prices for the underlying investments in the partnerships cannot be obtained and there is not an active market for the underlying investments or the partnerships shares.  The company utilizes periodic fund statements along with current fund redemption activity and communication with investment advisors to determine the valuation of its investment.

The following table sets forth a reconciliation of changes in the fair value of financial assets and liabilities classified as Level 3 in the fair value hierarchy for the three and six months ended April 30, 2010:

(1)  This amount is included in short-term investments on the balance sheet.

(2)  This amount is included in investment and other income (loss) on the statement of operations.

10.          COMMON STOCK

On September 22, 2008, the company’s Board of Directors authorized a stock repurchase program.  Under the program, the company could acquire up to $2,000,000 of its common stock.  On April 9, 2009, the Board authorized expanding the repurchase program to $4,000,000.  The repurchases may be made on the open market, in block trades or otherwise.  The stock repurchase program may be expanded, suspended or discontinued at any time.  During the quarter ended April 30, 2010, the company acquired 47,978 shares of its common stock at an aggregate cost of $448,000.  For the six months ended April 30, 2010, the company acquired 115,435 shares of its common stock at an aggregate cost of $1,114,000.  A total of 410,869 shares have been repurchased under the program at an average price per share of $8.90.  Subsequent to April 30, 2010 through May 20, 2010, 18,600 shares have been acquired at an average cost per share of $9.25.

11.          COMMITMENTS AND CONTINGENCIES

The company has been named as a defendant in a lawsuit alleging breach of contract, and other issues, arising in the normal course of its oil and gas activities.  The company believes that a contractual agreement requires that disputes be resolved by arbitration.  Although the company believes the allegations are without merit and that the company will ultimately prevail, the ultimate outcome of this lawsuit, or arbitration, cannot be determined at this time.

The company has also been named as a defendant in a lawsuit brought by a former employee.  The suit alleges breach of contract and other employment issues.  Although the company believes the allegations are without merit and that the company will ultimately prevail, the ultimate outcome of this lawsuit cannot be determined at this time.

The company has no material outstanding commitments at April 30, 2010.

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12.          RECENT ACCOUNTING PRONOUNCEMENTS

In February 2010, the FASB issued authoritative guidance that eliminated the requirement to disclose the date through which management evaluated subsequent events in the financial statements.  Such subsequent events must still be evaluated by management through the date that financial statements are issued.  The new guidance was effective immediately and the company adopted the guidance for financial statements issued subsequent to February 24, 2010.  There was no impact on the company’s financial position or results of operations as a result of the adoption.

In January 2010, the FASB issued authoritative guidance titled “Improving Disclosures about Fair Value Measurements.”  This guidance amends existing authoritative guidance to require additional disclosures regarding fair value measurements, including the amounts and reasons for significant transfers between Level 1 and Level 2 of the fair value hierarchy, the reasons for any transfers into or out of Level 3 of the fair value hierarchy, and presentation on a gross basis of information regarding purchases, sales, issuances, and settlements within the Level 3 rollforward.  This guidance also clarifies certain existing disclosure requirements.  The guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements within the Level 3 rollforward, which are effective for interim and annual reporting periods beginning after December 15, 2010.  The adoption of this authoritative guidance had no impact on our financial position or results of operations, but may require expanded disclosure about fair value measurements.

In December 2008, the Securities and Exchange Commission (“SEC”) adopted revisions to its oil and gas disclosure requirements that are intended to align them with current practices and changes in technology. Among other things, the amendments will: replace the single-day year-end pricing assumption with a twelve-month average pricing assumption; permit the disclosure of probable and possible reserves; allow the use of certain technologies to establish reserves; require the disclosure of the qualifications of the technical person primarily responsible for preparing the reserves estimates or conducting a reserves audit; require the filing of the independent reserve engineers’ summary report; and permit the disclosure of a reserves sensitivity analysis table to illustrate the impact of different price and/or cost assumptions on reserves. These amendments are effective for registration statements filed on or after January 1, 2010, and for annual reports on Form 10-K for fiscal years ending on or after December 31, 2009 (October 31, 2010 for the company) with early adoption prohibited. The company is currently evaluating the impact that the adoption of these amendments will have on the company’s financial position, results of operations, and disclosures.  In January 2010, the Financial Accounting Standards Board (“FASB”) issued oil and gas reserve estimation and disclosure authoritative accounting guidance effective for reporting periods ending on or after December 31, 2009.  This guidance was issued to align the accounting oil and gas reserve estimation and disclosure requirements with the requirements in the Securities and Exchange Commission’s (“SEC”) final rule.  The new FASB guidance includes changes to pricing used to estimate oil and gas reserves, broaden the types of technologies that a company may use to establish oil and gas reserves estimates, and broaden the definition of oil and gas producing activities to include the extraction of non-traditional resources.

ITEM 2.         MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  All statements included in this Quarterly Report on Form 10-Q, other than statements of historical facts, address matters that the company

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reasonably expects, believes or anticipates will or may occur in the future.  Forward-looking statements may relate to, among other things:

·      the company’s future financial position, including working capital and anticipated cash flow;

·      amounts and nature of future capital expenditures;

·      operating costs and other expenses;

·      wells to be drilled or reworked;

·      oil and natural gas prices and demand;

·      existing fields, wells and prospects;

·      diversification of exploration;

·      estimates of proved oil and natural gas reserves;

·      reserve potential;

·      development and drilling potential;

·      expansion and other development trends in the oil and natural gas industry;

·      the company’s business strategy;

·      production of oil and natural gas;

·      matters related to the Calliope Gas Recovery System;

·      effects of federal, state and local regulation;

·      insurance coverage;

·      employee relations;

·      investment strategy and risk; and

·      expansion and growth of the company’s business and operations.

LIQUIDITY AND CAPITAL RESOURCES

At April 30, 2010, working capital was $12,178,000 compared to $13,542,000 at October 31, 2009.  For the six months ended April 30, 2010, net cash provided by operating activities was $2,144,000 compared to $4,007,000 for the same period in 2009.  The principle difference resulted from transfers between cash and short term investments.  Income before taxes increased $25,593,000 primarily due to impairment losses of $24,652,000 in 2009, an increase in revenue of $1,626,000 and decreased other costs and expenses of $1,052,000 in 2010.

For the six months ended April 30, 2010 and 2009, net cash used in investing activities was $3,596,000 and $14,809,000, respectively.  Last year’s investment expenditures included $4,400,000 purchase of Calliope patents, $1,600,000 North Dakota Bakken acreage acquisition expenditures, $2,859,000 seismic and drilling expenditures in Central Kansas and $2,235,000 Oklahoma drilling project expenditures.  Investing activities primarily included oil and gas exploration and development expenditures, including Calliope, totaling $3,555,000 and $10,368,000 respectively.

Existing working capital and anticipated cash flow are expected to be sufficient to fund operations and capital commitments for at least the next 12 months.  At April 30, 2010, the company had no lines of credit or other bank financing arrangements except for the hedging line of credit discussed in Note 5.  Because earnings are anticipated to be reinvested in operations, cash dividends are not expected to be paid.  The company has no defined benefit plans and no obligations for post retirement employee benefits.

The company’s adjusted earnings before interest, taxes, depreciation, depletion and amortization, including impairment losses, (“EBITDA”) was $3,380,000 for the six months ended April 30, 2010 compared to $3,256,000 for the six months ended April 30, 2009.  EBITDA is not a GAAP measure of operating performance.  The company uses this non-GAAP performance measure primarily to compare its performance with other companies in the industry that make a similar disclosure.  The company believes that this performance measure may also be useful to investors for the same purpose.  Investors should not

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consider this measure in isolation or as a substitute for operating income, or any other measure for determining the company’s operating performance that is calculated in accordance with GAAP.  In addition, because EBITDA is not a GAAP measure, it may not necessarily be comparable to similarly titled measures employed by other companies.  Reconciliation between EBITDA and net income is provided in the table below:

OFF-BALANCE SHEET FINANCING

The company has no off-balance sheet arrangements at April 30, 2010.

PRODUCT PRICES AND PRODUCTION

Although product prices are key to the company’s ability to operate profitably and to budget capital expenditures, they are beyond the company’s control and are difficult to predict.  Since 1991, the company has periodically hedged the price of a portion of its estimated natural gas production when the potential for significant downward price movement is anticipated.  Hedging transactions typically take the form of forward short positions, swaps and collars which are executed on the NYMEX futures market or by indexing to regional index prices associated with pipelines in proximity to the company’s production.  The company’s current hedges are indexed to NYMEX, except basis hedges which are over the counter.

The oil and natural gas average sales prices reflected in the tables below exclude the effects of commodity derivative instruments. See Note 5 of the Notes to Consolidated Financial Statements and comments at “Results of Operations for more information on gains and losses relating to commodity derivative instruments.