LONE STAR INTERNATIONAL ENERGY INC, 10KSB, 1998-04-15

LONE STAR INTERNATIONAL ENERGY INC
10KSB, 1998-04-15
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<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-KSB

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Year Ended December 31, 1997

Commission File Number 0-17244
LONE STAR INTERNATIONAL ENERGY, INC.
(Name of small business issuer in its charter)

NEVADA 87-0434288
(State of incorporation) (IRS Employer Identification Number)

528 GRANT ROAD
MINERAL WELLS, TEXAS 76067
(Address of principal executive offices) (Zip code)

(940) 325-1700
Issuer's telephone number

Securities registered pursuant to Section 12(b) of the Exchange Act: None

Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock Par Value $.001

Check whether the issuer (1) filed all reports required to be filed by section
13 or 15(d) of the Exchange Act during the past 12 months, (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. [X] Yes [ ] No

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]

State issuer's revenues for 1997: $603,140

State the aggregate market value of the voting stock held by non-affiliates
computed using $.35, the price at which the stock was sold on April 13, 1998:
$4,675,355

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:

Common Stock, Par Value $.001; 20,005,283 Shares as of April 13, 1998

Transitional Small Business Disclosure Format: Yes [ ] No [X]

<PAGE> 2

PART I

ITEM 1. DESCRIPTION OF BUSINESS

HISTORICAL INFORMATION

Lone Star International Energy, Inc., a Nevada Corporation (the "Company"), was
incorporated in the state of Utah on April 11, 1986 as Quiescent Corporation.
The Company reincorporated as a Nevada corporation on October 12, 1995. The
Company had no operations until the completion of the reverse acquisition
described below on May 2, 1995.

Reverse Acquisition The Company entered into an Agreement dated as of April 10,
1995, with Cumberland Petroleum, Inc., a privately held Texas corporation
("Cumberland"), pursuant to which, on May 2, 1995 the Company acquired from C.E.
Justice, 100% of the capital stock of Cumberland in exchange for the issuance of
5,000,000 shares of the Company's common stock. Cumberland operated oil and gas
properties. The Company changed its name to Cumberland Holdings, Inc. on May 3,
1995, and to Cumberland Companies, Inc. on August 17, 1995, and to Lone Star
International Energy, Inc. on January 30, 1997.

In April 1997, the Company acquired all of the common stock of Energy Reclaim, a
privately held Texas corporation, from Calvin Cline in exchange for 3,333,333
shares of Common Stock and entered into an employment contract with Mr. Cline.
As a result of this acquisition, the Company through Energy Reclaim now owns the
rights to two energy saving absorption refrigeration technology processes, one a
process referred to as the "By-Pass Chiller(TM)" for which a patent application
is pending, and the second a process referred to as the "Fresh Catch(TM)" for
which a patent has been issued. In addition, Energy Reclaim has a patent on a
residential version of the By-Pass Chiller(TM).

CERTAIN STATEMENTS CONTAINED IN THIS DOCUMENT, INCLUDING WITHOUT LIMITATION
STATEMENTS CONTAINING THE WORDS "BELIEVES", "ANTICIPATES", "INTENDS", "EXPECTS",
AND WORDS OF SIMILAR IMPORT, CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT. SUCH FORWARD LOOKING
STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS THAT
MAY CAUSE THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY TO
MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS
EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS.

GENERAL

The Company is engaged in the production and sale of oil and gas. Principal
products are crude oil and natural gas, which are sold to various purchasers,
including pipeline companies that service the areas in which the producing wells
are located. Until 1997, the Company served as operator for most of the oil and
gas properties in which it owns an interest. The Company may enter into
farm-out, joint venture, drilling participation, limited partnership or any
other suitable arrangement with respect to developing its properties and
acquiring additional properties.

The Company, through its subsidiary Energy Reclaim Refrigeration, Inc. ("Energy
Reclaim"), is engaged in the development of energy reclamation products designed
to produce greater energy efficiency by harnessing heat exhaust to produce
refrigeration. These products have been initially developed to provide more
energy efficient refrigeration and freezing for the fishing industry, but have
additional applications.

The Company has no operations in foreign countries. The acquisition,
development, production and sale of oil and gas is subject to many factors which
are outside the Company's control, including national and international economic
conditions, the availability of drilling rigs, casing, pipe and other equipment
and supplies, proximity to the pipelines, the supply and price of other fuels,
and the regulation of production, transportation and pricing by state and
federal governmental regulatory agencies.

<PAGE> 3
During the second quarter of 1998, Energy Reclaim expects to complete the
testing of its production model of the Fresh Catch(TM), and will have it
installed on a fishing vessel in Louisiana for actual field test operation. Once
the installation and testing is completed, Energy Reclaim will commence
fabrication of the Fresh Catch(TM) units for sale and delivery, and expect the
first of such units to be available for existing purchase orders during the
third quarter of 1998. Energy Reclaim further plans to complete its pilot test
project with a utility company with the installation of its production model
By-Pass Chiller(TM) unit on a selected utility building during the second
quarter. Energy Reclaim expects to enter into several pilot test projects in
different parts of the country, with each such pilot test project providing
valuable beta test data on the performance of the units. Energy Reclaim believes
that by the mid third quarter it will be ready to fabricate the production model
By-Pass Chiller(TM) unit for sale and delivery, with the first units going to
supply existing purchase orders.

The Company has seventeen employees.

The address of the Company's principal executive office is 528 Grant Road,
Mineral Wells, Texas 76067. The Company's telephone number is (940) 325-1700.

During 1997 the Company spent $523,000 on research and development activities.

OTHER BUSINESS MATTERS

The Company has limited oil and gas operating history and its future success in
this area depends upon its ability to profitably operate its existing wells,
develop existing fields, and to expand its operations through the acquisition of
additional oil and gas producing properties and/or the acquisition of additional
oil and gas leases. No assurance can be given that the Company will be
successful in economically developing its existing fields or in making such
acquisitions. If the Company is successful in acquiring additional leases, it
faces the risk that the geology reports on which it relies are inaccurate, that
the oil and/or gas reserves are less than anticipated, that it will not have
sufficient funds to drill on the property, that it will not be able to market
the oil and/or gas due to a lack of a market or the lack of pipelines, and that
fluctuations in the prices of oil and/or gas will make development of those
leases uneconomical.

Also, through Energy Reclaim the Company is developing new, unproven products
with which it has no operating history and no manufacturing experience. The
Company's future success in this area will depend on its ability to economically
finance, manufacture and market its Fresh Catch(TM) and By-Pass Chiller(TM)
units, and to develop and market additional concepts for which patents may be
issued.

In both its oil and gas operations and with its Energy Reclaim operations, the
Company is also subject to all of the risks inherent in attempting to expand a
relatively new business venture. These risks include, but are not limited to,
possible inability to profitably operate its existing oil and gas properties or
properties to be acquired in the future, the inability to acquire additional
profitable oil and gas properties, the existence of undisclosed actual or
contingent liabilities, product design and manufacturing liabilities, and the
inability to fund the capital requirements of its businesses.

Competition for the sale of oil and gas is principally related to pricing as it
is affected by quality, availability of transportation and transportation costs.
The price for the oil is widely followed and is generally subject to worldwide
market factors. The Company's oil and gas exploration activities are centered in
a highly competitive field. In seeking any other suitable oil and gas properties
for acquisition, or drilling rig operators and related personnel and equipment,
the Company will be competing with a number of other companies, including large
oil and gas companies and other independent operators with greater financial
resources. Management does not believe that the Company's initial competitive
position in the oil and gas industry will be significant.

<PAGE> 4
The Company had sales to the following companies that amounted to 10% or more of
oil and gas revenues:

<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Team Energy Marketing Co. 29% 22%
Geer Tank Trucks, Inc. 32% 15%
Atoka Resources Corp. 29% 27%
Warren 1% 14%
</TABLE>

Because of the ready market for its oil and gas, the Company does not consider
itself dependent on any single customer or group of customers.

The Company's Fresh Catch(TM) and By-Pass Chiller(TM), and other energy reclaim
products which may be developed, will be marketed in a highly competitive field.
There can be no assurance that these products will gain a significant level of
acceptance from consumers or that significant sales will be realized to make the
Company's manufacturing and marketing of these products profitable. Further,
there can be no assurance that the Company's products will be able to compete
with existing energy efficiency products and processes currently marketed by
other companies, or that new and more attractive products and processes will not
be developed by competitors or that any new products will not diminish such
market share as the Company may build with its products.

The Company must comply with laws affecting the discharge of materials into the
environment. Compliance with such laws has not been a material factor in the
Company's operations.

No loss of oil and gas production insurance coverage has been sought by the
Company. Prior to 1997 contractors performed many of the oil and gas services
normally requiring employees. As a result the Company had only two officers in
1996. The Company had one employee in 1996. During 1997 the Company hired five
additional officers and 18 additional employees.

REGULATORY MATTERS

The Company's exploration, production and marketing operations are regulated at
the federal, state and local levels. Oil and gas exploration, development and
production activities are subject to various laws and regulations governing a
wide variety of matters. For example, there are statutes or regulations
addressing conservation practices and the protection of correlative rights, and
such regulations may affect the Company's operations and limit the quantity of
oil or gas that the Company may produce or sell. Other regulated matters include
marketing, transportation and valuation of royalty payments.

Among other regulatory matters at the federal level, the Federal Energy
Regulatory Commission ("FERC") regulates interstate transportation of natural
gas under the Natural Gas Act and regulates the maximum selling prices of
certain categories of gas sold in "first sales" in interstate commerce under the
Natural Gas Policy Act ("NGPA"). The Company's gas sales are affected by
regulation of intrastate and interstate gas transportation. In an attempt to
promote competition, the FERC has issued a series of orders that have altered
significantly the marketing and transportation of natural gas. To date, the
Company has not experienced any material adverse effect on gas marketing as a
result of these FERC orders. However, the Company cannot predict what effect
these or subsequent regulations may have on its future gas marketing.

As an owner and operator of oil and gas properties, the Company is additionally
subject to various federal, state and local environmental regulations, including
air and water quality control laws. These laws and regulations may, among other
things, impose liability on the lessee under an oil and gas lease for the cost
of pollution clean-up resulting from operations, subject the lessee to liability
for pollution damages, and require suspension or cessation of operations in
affected areas and impose restrictions on the injection of liquids into
subsurface aquifers that may contaminate groundwater. Although the Company
believes that it is in substantial compliance with existing applicable

<PAGE> 5

environmental laws and regulations, there can be no assurance that substantial
costs for compliance will not be incurred in the future. Moreover, it is
possible that other developments, such as stricter environmental laws,
regulations and enforcement policies thereunder, could result in additional,
presently unquantifiable, costs or liabilities to the Company.

OIL AND GAS PROPERTY ACQUISITION

The Company's oil and gas division has adopted the business philosophy of
acquiring existing oil and gas reserves that can add to the Company's cash flow.
The targeted property acquisitions are intended to be low risk with multiple
up-side potential for return on investment through further development of the
existing producing reserves.

After the reverse acquisition in 1995, the oil and gas properties that were
operated by Cumberland were acquired by the Company in the third quarter of 1995
in exchange for common stock and notes. These properties consisted of interests
in 39 wells in Texas.

In April 1997 the Company purchased leases with varying working interests in
approximately 60 wells from Northridge Oil Company, a Colorado corporation, and
related entities for consideration of 1,100,000 shares of common stock of the
Company. These wells were located in Clay, Jack, Wise and Parker Counties,
Texas, and were made up of a combination of oil and gas properties. The
majority of the acquired wells were shut-in and required remedial work on
equipment in order to restore production. The Company undertook a systematic
approach to the evaluation of each of these wells, to complete the remedial
work in an orderly fashion to restore production. Production on these wells
increased from a total of 3,875 equivalent barrels per day at the time of
acquisition to 13,609 equivalent barrels per day by December 1997.

Effective January 1, 1998, the Company acquired a 75% working interest
(approximately a 59.7% net revenue interest) in the Two Medicine Cut Bank Sand
Unit ("Cut Bank Unit") located in Glacier and Pondera Counties, Montana, from
the bankruptcy estate of Mont-Mill Operating Company. The acquisition was made
jointly with Prism Corporation ("Prism") of Tulsa, Oklahoma, who will own the
remaining 25% working interest in the Cut Bank Unit. Because the Company does
not operate oil and gas properties in the State of Montana, the decision was
made to form a limited liability company to take actual title to the Cut Bank
Unit, and to serve as the Unit operator. Consequently, the Company and Prism
formed Provident Energy Associates of Montana, L.L.C. of which the Company owns
75% while Prism owns the remaining 25%. Prism Corporation which has operating
experience in several states, and who was the operator of the Cut Bank Unit,
will serve as the Manager of the L.L.C. to oversee the daily field operations of
the Cut Bank Unit.

The Cut Bank Unit consists of just over 10,000 acres of oil and gas leases which
are held by production. The leases were unitized into the current Cut Bank Unit
in 1972, and includes mineral leases from the Blackfeet Tribe, the Bureau of
Indian Affairs, and the State of Montana. The production formation is the Cut
Bank Sand (the "Cut Bank Sand") which extends North into Canada. The Cut Bank
Unit represents the Southern end of the extensive Cut Bank Sand field. The field
was originally discovered in 1959, and was extended and developed through the
1970s. A pilot water flood project was begun in the Cut Bank Unit in late 1962
with favorable results, however, the secondary recovery project was never fully
developed. The limited water flood was abandoned in 1989 due to depressed oil
economies and the extensive water injection well bonding requirements of the
Environmental Protection Agency ("EPA"). The Cut Bank Unit has continued to
produce from a minimal number of wells through conventional primary recovery
methods thus maintaining the Cut Bank Unit as held by production.

The Company acquired its interest in the Cut Bank Unit for $300,000 in cash plus
1,628,571 shares of restricted stock valued at $3.50 per share. The total
purchase price was valued at $6,000,000. The Cut Bank Unit includes
approximately 82 existing wells, and all but 15 of which are currently shut-in.
The Company expects to maintain current production level of between 100-150
barrels of oil per day through the Winter months, and plans to restore
production in additional wells starting in the Spring of 1998, when the weather
permits utilization of a workover rig. Limited workover operations conducted in
late October and early November 1997 pursuant to an agreement between the
Company, Prism and the former owner were successful in increasing daily
production levels from just over 23 barrels per day to the current levels.

<PAGE> 6

In order to complete the Montana oil and gas property purchase and to begin the
restoration process three stockholders loaned $250,000 to the Company. In
addition, one stockholder is allowing the Company to utilize a $100,000
certificate of deposit to satisfy a bonding requirement in conjunction with the
purchase. These amounts are secured by the Texas properties, assignment of 40%
of the Company's net production revenue from the Montana property until the
stockholders have been repaid their investment plus 25%, and an assignment of a
carried working interest of 2.65% in the Montana property.

The Company intends to further develop this field through either restoring an
active water flood, or utilizing horizontal well technology. The horizontal
technology is currently being used on the Northern portion of the larger Cut
Bank Sand field.

The Company has determined that the horizontal secondary recovery method is the
best development approach, and expects to commence these operations during the
Spring of 1998. Prism Corporation on behalf of itself and the Company has had
preliminary discussions with another oil company to fund the horizontal
development costs for an equity position in the Cut Bank Unit after payout. The
Company expects to conclude these negotiations during the second quarter of
1998.

The Company is currently negotiating the renewal of its natural gas contracts,
which cover the sale of its natural gas production. The renewal contracts are
expected to increase cash flow from sale of production by up to 25% with no
increase in current volumes produced.

BUSINESS OF ENERGY RECLAIM REFRIGERATION

As a result of the acquisition of Energy Reclaim Refrigeration, Inc., the
company owns the rights to three energy saving absorption refrigeration
technology processes. The first known as the Fresh Catch, was patented on June
17, 1997, as United States Patent No. 5,638,696. The patent has claims directed
toward an improved refrigeration system for a boat in which an absorber unit is
powered by utilizing waste heat from the engine exhaust and the keel cool system
of the boat. There are also claims in the patent directed toward the general
construction of the absorption refrigeration unit that is utilized. The second
known as the Magnatron Process(TM) was patented on February 13, 1996 as United
States Patent No. 5,490,398. This patent is directed toward a stand-alone
refrigeration unit in which the efficiency of an absorption heating and cooling
unit is increased by utilizing a microwave energy source and an electromagnetic
vapor scrubber. The third process known as the By-Pass Chiller(TM) had its
patent application filed on November 4, 1997 under Serial No. 08/963,768 with
the U.S. Patent Office. This patent is directed toward the use of an absorption
refrigeration system to augment the cooling effect of a traditional compression
refrigeration system (chiller). The Company acquired all the two issued patents
along with the patent application currently filed when it acquired Energy
Reclaim. Upon closing the acquisition, the Company undertook to finance the
fabrication assembly and testing of the two primary products using the patented
technology. These were the By-Pass Chiller(TM) and the Fresh Catch(TM).

Based upon tests of the Company's prototype, the By-Pass Chiller(TM) when
retrofitted to an existing refrigeration unit may reduce the kilowatt demand
resulting in an energy consumption reduction of approximately 25% to 30%. Based
upon the test results of the By-Pass Chiller(TM) prototype, the Company has
begun development of the production model, and is engaged in discussions with
several major public utilities with a view to conducting pilot test projects.
Under the proposed pilot test projects, production models of the By-Pass
Chiller(TM) will be retrofitted to the refrigeration systems on some of the
utilities' buildings. The beta test of the production model during the pilot
test projects should provide performance and operational data necessary for the
commercial production of the By-Pass Chiller(TM). The Company believes the main
applications for the By-Pass Chiller(TM) include office complexes, skyscrapers,
power plants, factories, utility companies and any other facility interested in
reducing energy costs and that uses a minimum 25-ton air conditioning system.

The Company's patented latent heat absorption refrigeration system called the
Fresh Catch(TM) was designed initially for the fishing industry and can be
attached to any heat source (exhaust heat from the diesel engine, steam waste,
hot water waste pipe, etc.). Through the patented heat absorption process the
Fresh Catch(TM) provides freezing, refrigeration, as well as air conditioning
for the entire vessel. The resulting refrigeration from the Fresh Catch(TM)
system operates virtually free of outside energy cost, has no moving parts and
is completely environmentally friendly. A prototype model of

<PAGE> 7

the Fresh Catch(TM) was employed for testing on a shrimp trawler owned by
Offshore Vessel and Equipment, Inc. ("Offshore"), of Bourg, Louisiana, and a
production model is to be installed on the same shrimp trawler in the second
quarter of 1998 and is expected to be ready for production in the third quarter
of 1998. In addition to the commercial fishing industry, this technology has
applications for cargo ships, luxury cruise ships, and offshore drilling rigs.

Based upon the test results of the By-Pass Chiller(TM) prototype and the Fresh
Catch(TM) unit deployed on the shrimp trawler, the Company entered into an
exclusive marketing and distribution contract with Offshore, whereby Offshore
was granted the global marketing and distribution rights to the Fresh Catch(TM)
for commercial fishing and other maritime industry applications. In addition,
Offshore was granted non-exclusive marketing and distribution rights to the
By-Pass Chiller(TM) units for the States of Florida, Georgia, Alabama,
Mississippi, Louisiana, and the coastal areas of the State of Texas.

The Company also offers contract cutting and machining services to other
original equipment manufacturers through the use of the laser cutting equipment
originally purchased in 1997 to manufacture the By-Pass Chiller(TM) and the
Fresh Catch(TM). The Company believes these contract services will generate an
additional income stream for Energy Reclaim without any interference with the
fulfillment of the Company's own production needs.

ITEM 2. DESCRIPTION OF PROPERTIES

OIL AND GAS PROPERTIES

The principal oil and gas properties of the Company at the end of 1997 consisted
of working interests in producing oil and gas leaseholds located in Texas. The
Company owns these leasehold interests in percentages that vary. The terms of
producing oil and gas leaseholds are continuing and such leases remain in force
by virtue of, and for as long as, production from lands under each lease are
maintained. The terms of leases without production or production less than
required by the lease may expire at fixed dates in the future. These leases may
or may not be extended, depending upon the lease in question, by further
exploration and development within varying periods of time.

Effective September 1, 1995 the Company acquired working interests in oil and
gas properties in exchange for 750,000 shares of restricted common stock and
notes payable in the aggregate amount of $500,000. The notes payable were paid
in full plus interest during the third quarter of 1997.

The following table sets forth information concerning the Company's leasehold
ownership interests as of December 31, 1997.

TABLE I

<TABLE>
<CAPTION>
LEASEHOLD INTEREST
GROSS (b) NET (c)
--------- -------
<S> <C> <C>
Developed Acreage (a) 4,991 4,465
Undeveloped Acreage (d) 160 160
Active Working Interest Wells:
Oil 39.0 33.1
Gas 23.0 20.8
</TABLE>

(a) Developed acreage is acreage spaced for or assignable to productive wells.

(b) A gross well or acre is a well or acre in which a working interest is
owned. The number of gross wells is the total number of wells in which a
working interest is owned. The number of gross acres is the total number of
acres in which a working interest is owned.

(c) A net well or acre is deemed to exist when the sum of fractional ownership
working interests in gross wells or acres equals one. The number of net
wells or acres is the sum of the fractional working interests owned in
gross wells or acres expressed as whole numbers and fractions thereof.

(d) Undeveloped acreage is oil and gas acreage on which wells have not been
drilled or to which no Proved Reserves other than Proved Undeveloped
Reserves have been attributed.

<PAGE> 8
NET PRODUCTION, UNIT SALES AND PRODUCTION COSTS

The following table summarizes the net oil and natural gas production for the
Company, the average sales price per barrel (bbl) of oil and per 1000 cubic feet
(mcf) of natural gas produced and the average production (lifting) cost per unit
of production, for the year ended December 31, 1997.

TABLE II

PRODUCTION, PRICE AND COST DATA

<TABLE>
<CAPTION>
1997
- ----
<S> <C>
Oil (a):
Production (Bbls) 8,389
Revenue $136,875
Average Bbls per day 23
Average Sales price per Bbl $ 16.32
Gas:
Production (Mcf) 198,855
Revenue $312,737
Average Mcf per day 545
Average Sales price per Mcf $ 1.57
Production costs:
Production costs $484,898
Equivalent Bbls (b) 41,532
Production cost per equivalent Bbl $ 11.67
Production cost per sales dollar $ 1.08
Total Revenues $449,612
</TABLE>

(a) Includes condensate and natural gas liquids.

(b) Gas production is converted to equivalent bbls at the rate of six mcf per
bbl, representing the estimated relative energy content of natural gas to
oil.

ESTIMATED FUTURE NET REVENUES FROM PROVED OIL AND GAS RESERVES

A summary projection of the estimated future net revenues and present value of
future net reserve categories, as of December 31, 1997, is as follows:

TABLE III
ESTIMATED FUTURE NET REVENUES FROM PROVED RESERVES (A)
AS OF DECEMBER 31, 1997

<TABLE>
<CAPTION>
PROVED
-----------
<S> <C>
Estimated future net
revenues before income taxes
1998 $ 596,180
1999 572,593
2000 469,110
2001 380,224
2002 255,476
Thereafter 827,114
-----------

Total before estimated future income taxes $ 3,100,697
===========

Present value of estimated
future net revenues
before income taxes $ 2,184,142
===========
</TABLE>

<PAGE> 9

(a) Prepared in accordance with the rules and regulations of the SEC based on
the reserve reports and the Company's financial statement disclosures.
Estimated future net revenues represent estimated future gross revenues
from the production and sale of proved reserves, net of estimated
production costs and future development costs estimated to be required to
achieve estimated future production.

ESTIMATED NET PROVED OIL AND GAS RESERVES

The estimated proved developed oil and gas reserves for the Company are
summarized below:

TABLE IV
PROVED RESERVES
AS OF DECEMBER 31, 1997

<TABLE>
<CAPTION>
PROVED
----------
<S> <C>
Oil and liquids (bbls):
Proved developed 15,379
Proved undeveloped 59,621
----------

Total 75,000
==========

Natural gas (mcf):
Proved developed 797,084
Proved undeveloped 2,357,513
----------

Total 3,154,597
==========
</TABLE>

The table above should read in connection with the following definitions:

PROVED RESERVES Estimated quantities of crude oil, natural gas
and natural gas liquids which geological and engineering
data demonstrate with reasonable certainty to be
economically producible in future years from known
reservoirs under existing economic and operating
conditions, e.g., prices and costs as of the date the
estimate was made, assuming continuation of current
regulatory practices using conventional production
methods and equipment.

PROVED DEVELOPED
RESERVES Proved oil and gas reserves which are expected to be
recovered from existing wells with existing equipment
and operating methods. Developed reserves include both
producing and non-producing reserves. Producing reserves
are those reserves expected to be recovered from
existing completion intervals producing to a market as
of the date of the appropriate reserve report.
Non-producing reserves are reserves that are currently
shut-in awaiting a pipeline connection or in reservoirs
behind the casing or at minor depths above or below the
producing zone and are considered proved by production
either from wells in the field, by successful drill-stem
tests, or by core analyses from the particular zones.
Non-producing reserves require only moderate expense for
recovery.

<PAGE> 10
PROVED UNDEVELOPED
RESERVES Proved oil and gas reserves which are expected to be
recoverable from additional wells yet to be drilled or
from existing wells where a relatively major expenditure
is required for completion. For information concerning
costs incurred by the Company for oil and gas
operations, net revenues from oil and gas production,
estimated future revenues attributable to the Company's
oil reserves and present value of future net revenues on
a 10% discount rate and changes therein, refer to the
Company's Financial Statements and the related Notes.
The Company emphasizes that reserve estimates are
inherently imprecise and that estimates of new
discoveries are more imprecise than those of producing
oil and gas properties. Accordingly, the estimates are
subject to change, as further information becomes
available.

With the acquisition of Energy Reclaim in April 1997, the Company entered into a
long-term lease agreement with C. E. Justice, CEO, for the utilization of a
facility located in Mineral Wells owned by Mr. Justice. The facility consists of
two commercial buildings containing approximately 24,000 square feet located on
approximately six acres situated in the Wolters industrial park. This facility
served as the initial research and development location for Energy Reclaim's
By-Pass Chiller(TM) and Fresh Catch(TM) technologies, and after making certain
utility upgrades and repairs, currently serves as the continued product
development, testing, manufacturing and assembly facility. The facility lease
with Mr. Justice provides for an initial five (5) year term with automatic
renewals of additional five (5) year terms. The lease rate is $5,000.00 per
month, and also provides for a purchase option by the Company, on terms to be
mutually agreed upon and negotiated between the parties, but in no event more
than the fair market value of the property. All upgrades made to the facility
were done at the expense of the Company, and the lease provides that Mr. Justice
will reimburse the company the fair market value of the improvements upon
termination of the lease, or will credit the fair market value of the
improvements against the purchase price in the event the Company elects to
purchase the property.

In April 1997, the Company through its acquisition of properties from Northridge
Oil Company, acquired approximately three acres immediately north and east,
adjacent and contiguous to the existing Energy Reclaim facility being leased
from Mr. Justice. This acquisition included a commercial shop building
containing approximately 2,600 square feet. The acquisition of this property was
made with the utilization of restricted common stock of the Company as reported
in the Northridge Oil Company asset purchase. It is anticipated that this
building will be used for the expansion of Energy Reclaim's assembly and
warehousing of products ready for shipment, as these activities become
necessary.

In addition, in September 1997, the Company acquired a parcel of land
immediately adjacent to and contiguous to the leased manufacturing building to
the south and west. This addition included approximately two acres with a
commercial shop building of approximately 3,000 square feet and a small office
building of approximately 800 square feet. The Company plans to utilize the
additional shop building for the necessary expansion of the manufacturing and
assembly for its By-Pass Chiller(TM) and Fresh Catch(TM) Units.

<PAGE> 11

With the two additional property acquisitions during 1997, the Energy Reclaim
product development, manufacturing and assembly facility now consists of over
27,000 square feet of commercial building space located on approximately eleven
acres. Upon receipt of the Debenture funding in the second quarter of 1997, the
Company ordered the manufacturing equipment necessary for the fabrication and
production of its By-Pass Chiller(TM) and Fresh Catch(TM) units. The primary
equipment acquisition was that of the Bystronic CNC Laser, which allows Energy
Reclaim to custom cut all of its stainless and other steel components which make
up the By-Pass Chiller(TM) and Fresh Catch(TM) units. Once installation of the
laser was completed in the fourth quarter of 1997, Energy Reclaim was no longer
dependent upon outsourcing its component fabrication needs, thus creating better
quality control and eliminating scheduling delays while waiting on outsource
work to be completed.

<PAGE> 12
During the fourth quarter of 1997, Energy Reclaim also upgraded an outer
building at the facility for use as a product development and testing center.
The testing center is of particular importance since it provides the capability
of simulating the conditions that would be encountered onboard a commercial
fishing vessel, with the exception of the salt-water environment. Energy Reclaim
can now assemble and test over a prolonged period, its production model Fresh
Catch(TM) unit prior to having it retrofitted on the fishing vessel.
Additionally, the testing facility will provide the ability to test run each
Fresh Catch(TM) unit manufactured prior to sale and delivery. Portions of the
test facility have also been set up to test the By-Pass Chiller(TM) units before
delivery and installation. Once Energy Reclaim is in full production of its two
primary products, the development and testing center may also be utilized for
research and development of additional concepts for which patent applications
may be considered.

ITEM 3. LEGAL PROCEEDINGS

On July 18, 1997, Jane Holder filed a Petition for Breach of Contract, Estoppel
and Conversion in the 43rd Judicial District Court of Parker County, Texas,
against the Company and C. E. Justice. Ms. Holder alleges that she served as a
consultant to Mr. Justice and the Company for a period of time during 1995 and
1996, and that she introduced Mr. Justice to individuals in California that
resulted in the reverse merger with Quiescent Corporation, and that she assisted
in fund raising for the Company. Ms. Holder contends that Mr. Justice promised
that she would be given 250,000 shares of the Company's Common Stock in
consideration for her services, and that the parties had entered into a verbal
contract therefor. Ms. Holder seeks monetary damages for the value of the common
stock that was never issued, together with unpaid commissions on funds she
raised for the Company, plus reimbursement of expenses incurred in her travel
for the Company between Weatherford and California in assisting with the reverse
merger and the fund raising. The Company and Mr. Justice filed a timely answer
denying the allegations contained in the Petition, and the case is currently in
discovery.

In December 1997, Kenneth A. Freeman filed a Petition in the 43rd Judicial
District Court of Parker County, Texas, against the Company and C.E. Justice
alleging Breach of Contract of a Consulting Agreement entered into between Mr.
Freeman and the Company effective January 1, 1997. Mr. Freeman alleges that he
entered into a two year consulting agreement with the Company to provide
petroleum engineering services as requested from time to time by the Company in
exchange for 250,000 shares of the Company's common stock to be registered on
Form S-8. Mr. Freeman claims a loss of value of his common stock due to a
decline in share price, alleging that the Company was negligent in not filing
the S-8 Registration sooner than it did. The Company and Mr. Justice have filed
a timely answer to the Petition and deny each and every allegation contained
therein. This case is currently in discovery.

On October 21, 1997, Judson L. Whiting III, filed a Complaint alleging breach
of contract against the Company in the Supreme Court of the State of New York,
County of New York. Mr. Whiting was one of ten consultants hired as independent
contractors by the Company and was to receive 700,000 shares of the company's
Common Stock to be registered on Form S-8. In November 1997, the Company filed
a Petition for Removal, and the case was removed to the United States District
Court, Southern District of New York. The Company filed a timely answer to the
complaint, denying all the material allegations of the plaintiff. The Company
in January 1998 filed a Third Party Action against Michael Novielli, Dutchess
Capital Partners, Inc., and John Sloan. The Company alleges Mr. Novielli and
Dutchess Capital Partners, Inc. coordinated the consultants and that Mr. Sloan,
who was also one of the ten consultants, together with Mr. Novielli promulgated
a plan to defraud the Company. Mr. Sloan was responsible for locating Mr.
Whiting as one of the consultants. The Company believes that both Mr. Novielli
and Mr. Sloan are necessary parties, and that Mr. Novielli and Mr. Sloan should
indemnify the Company for any liability that may be incurred by the Company to
Mr. Whiting, if any. In its Third Party Action the Company alleges common law
fraud, securities fraud and breach of contract and seeks damages against Mr.
Novielli, Dutchess Capital Partners, Inc., and Mr. Sloan. A settlement of the
Judson L. Whiting, III v. Lone Star has been reached, and the final Settlement
Agreement and Stipulation and Order is currently being prepared. In accordance
with the settlement, Lone Star will release its stop order on 20,000 shares
previously issued to Mr. Whiting as full and complete settlement of all claims
and causes of action asserted by Mr. Whiting against the Company. The
settlement does not release any third party claims filed by the company against
Michael Novielle, Dutchess Capital Partners and John Sloan, the Third party
Defendants, and the Company is currently reviewing its options and position
relating to these third party complaints.

<PAGE> 13
On January 29, 1998, Eugene L. Bonacci, Donna Conley, Penelope Gallo, Robert
Gallo, Robert Maher, Sal Rausa, Randy Rufrano, Charles Stein, individually and
on behalf of Anthony Stein, J. Ralph Stein & Co. Pension Trust, Roni L. Stein,
Musser Enterprises Pension Trust and Renee Feitelberg, Louis Vaccaro and Judith
Vaccaro filed a complaint in the United States District Court, Southern District
of New York against the Company, C. E. Justice, Brian T. McKee, Scott
MacCaughern, Barbara Matalon, Robert Horrigan and Merit Capital Associates, Inc.
alleging securities fraud and common law fraud in connection with certain
activities relating to the sale of the Company's stock. The Company was served
with this action on February 3, 1998, and is currently reviewing the allegations
with its outside securities and litigation counsel. The Company will timely file
a denial of the plaintiffs' allegations. Mr. MacCaughern worked with Mr.
Novielli in the coordination of the services of the consultants and Mr. McKee
was a stockbroker in New York who was also introduced to the Company by Mr.
Novielli. Merit Capital Associates, Inc. is an investment firm that was
introduced to the Company by Mr. Novielli, and served as a market maker for the
Company at the request and direction of Mr. Novielli. Settlement discussions are
underway in the Bonacci, et al. v. Lone Star et al. litigation. Although
continuing to assert no liability to the plaintiffs, the Company is proposing to
offer certain stock consideration to the plaintiffs to release their claims
against the Company, and for the Company to acquire the plaintiffs causes of
action against the remaining defendants and third party defendants. Based upon
discussions currently in progress, the Company believes that the settlement can
be agreed upon prior to the April 23, 1998 schedule conference set by the
presiding Judge.

During the third quarter of 1997, information began to be received by the
Company from various individuals, including some of the named Plaintiffs in the
most recent complaint, that certain consultants and possibly others were making
improper offers in the market place of the Company's Common Stock originally
issued to the consultants as compensation and registered by the Company on Form
S-8. The Company began an immediate investigation of these matters, and through
its President, Mr. C. E. Justice, terminated the remaining term of all of the
ten consulting agreements still in place. The Company further terminated its
relationship with Mr. Novielli and Dutchess Capital. The Company has
communicated with every party known to the Company who has alleged that
inducements were offered to them to purchase Company stock in the open market
that the Company had no knowledge of this activity, it did not condone such
activity and believed the same to be a violation of securities laws, and that
the Company would not honor any promise or inducement offer made. As a part of
its investigation, the Company has sought to take sworn statements from
consultants and others, together with depositions and statements from investors
who claim to have been induced to make their investment. Facts developed thus
far through this investigation indicate that the Company was fraudulently
induced to enter into the original ten consulting agreements and filed a
registration statement on Form S-8. The Company has made demand to the
consultants to immediately return all such S-8 stock to the Company. As noted
above, the Company has filed actions against Mr. Novielli and Mr. Sloan and has
additionally filed a claim in arbitration against Merit Capital and may file
further actions as facts are revealed in the Company's investigation. The
Company is committed to the pursuit of any and all parties who may have been
involved in the inappropriate use of its S-8 stock.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Response is not required.

<PAGE> 14

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock is traded over the counter under the symbol LNST
effective January 1997. Prior to January 1997 the Company's symbol was CUMC. As
of April 13, 1998, there were 960 shareholders of record of the Company's
common stock. The transfer agent for the Company's common stock is National
Stock Transfer, Salt Lake City, Utah. The high and low bid range of the
Company's Common Stock as received by the Company from the National Association
of Securities Dealers is given below.

PRICE RANGE OF COMMON STOCK

<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C>
1995:
Third Quarter August 31, 1995 through
September 30, 1995 3.50000 0.01000
Fourth Quarter 5.50000 2.50000
1996:
First Quarter 0.63000 0.05000
Second Quarter 0.10000 0.06250
Third Quarter 0.15000 0.09375
Fourth Quarter 0.40000 0.09375
1997:
First Quarter 2.75000 0.40625
Second Quarter 5.75000 2.37500
Third Quarter 6.25000 1.37500
Fourth Quarter 1.87500 0.50000
1998:
First Quarter 0.68990 0.27000
</TABLE>

The Company has not paid dividends on its Common Stock, and it is the present
policy of the Company not to do so, but to retain earnings for future growth and
business activities.

RECENT SALES OF UNREGISTERED SECURITIES

Between April 6, 1995 and January 9, 1996 the Company issued in a single
offering 1,421,950 shares of its common stock at $0.50 per share to sixty-nine
investors in exchange for cash in the total amount of $710,975.00. The Company
relied upon Rule 505 of Regulation D promulgated under the Securities Act of
1933 for an exemption from registering the stock based upon there being no
public solicitation of offers or sales, the purchasers being accredited
investors, or having alone or with their purchaser representatives sufficient
financial knowledge and experience to evaluate the risks and merits of
investment in the stock, having financial ability to bear the risk, and
purchasing the stock for their own accounts.

On October 10, 1995 the Company issued 760,000 shares of its common stock valued
at $3.00 per share to eight investors in exchange for oil and gas interests
assigned to the Company by such investors. The Company relied upon Section 4(2)
under the Securities Act of 1933 for an exemption from registering the stock
based upon the non-public nature of the solicitation and the sophistication of
the investors.

<PAGE> 15
On November 10, 1995 the Company issued 200,000 shares of its common stock
valued at $.50 per share to two investors as compensation for services rendered
to the Company. The Company relied upon Section 4(2) under the Securities Act of
1933 for an exemption from registering the stock based upon the non-public
nature of the solicitation and the sophistication of the investors.

On December 11, 1995 the Company issued 40,000 shares of its common stock valued
at $.50 per share to three investors as compensation for services rendered to
the Company. The Company relied upon Section 4(2) under the Securities Act of
1933 for an exemption from registering the stock based upon the non-public
nature of the solicitation and the sophistication of the investors

On or about January 7, 1997, the Company entered into five year employment
agreements with five officers and key employees by which the Company issued to
the officers and employees 200,000 shares each for a total of 1,000,000 shares
of Common Stock in exchange for various services rendered by the individuals.
The Company relied on Section 4(2) under the Securities Act of 1933 for an
exemption from registering the stock based upon the non-public nature of the
transaction and the sophistication of the investors.

Between February 12, 1997 and April 11, 1997 the Company issued in a single
offering 1,800,000 shares of its common stock at $0.25 per share to twenty-nine
investors in exchange for cash in the total amount of $450,000.00. The Company
relied upon Regulation D under the Securities Act of 1933 for an exemption from
registering the stock based upon the purchasers' representing that they were
accredited investors as that term is defined in Regulation D.

On or about April 1, 1997 the Company issued 1,100,000 shares of its common
stock valued at $3,025,000.00 ($2.75 per share) to Northridge Oil Company,
Northridge LLC and Oil Fund 100 LLC in exchange for all of the assets of
Northridge Oil Company, 100% of the working interest including 2,200 barrels of
oil inventory of Northridge LLC and Oil Fund 100 LLC. The Company relied on
Section 4(2) under the Securities Act of 1933 for an exemption from registering
the stock based upon the non-public nature of the transaction and the
sophistication of the investors.

On or about April 7, 1997 the Company issued 3,333,333 shares of its common
stock valued at $3.00 per share to one investor for all of the issued and
outstanding common stock of Energy Reclaim Refrigeration, Inc. The Company
relied on Section 4(2) under the Securities Act of 1933 for an exemption from
registering the stock based upon the non-public nature of the transaction and
the sophistication of the investor.

On or about July 23, 1997, the Company entered into a Subscription Agreement
with the Selling Shareholders by which the Company issued to the Selling
Shareholders $2,500,000 principal amount of Debentures convertible into shares
of the Company's common stock. The Company relied on Section 4(2) under the
Securities Act of 1933 for an exemption from registering the stock based upon
the non-public nature of the transaction and the sophistication of the
investors. Thereafter, pursuant to agreements amending the Debentures, dated
August 25, 1997 the Registrant issued a total of 1,000,000 Warrants to purchase
Common Stock also in reliance on Section 4(2) under the Securities Act of 1933.

On or about September 2, 1997, the Company entered into a Consulting Agreement
with Capital Communications, Ltd. by which the Company issued to Capital
Communications, Ltd. 285,000 shares of Common Stock in exchange for consulting
services rendered by Capital Communications, Ltd. over a 12 month term. The
Company relied on Section 4(2) under the Securities Act of 1933 for an exemption
from registering the stock based upon the non-public nature of the transaction
and the sophistication of the investor.

<PAGE> 16
Effective January 1, 1998 the Company issued 1,628,571 shares of its common
stock valued at $5,700,000 ($3.50 per share) to Prism Corp. and others in
exchange for a 75% net revenue interest in the Two Medicine Cut Bank Sand Unit
located in Glacier and Pondera Counties, Montana. This interest is held in the
form of 75% membership interest of Provident Energy Associates of Montana, LLC,
a limited liability company formed for the purpose of holding these Montana
interests. The Company relied on Section 4(2) under the Securities Act of 1933
for an exemption from registering the stock based upon the non-public nature of
the transaction and the sophistication of the investors.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

This discussion should be read in conjunction with the audited financial
statements of Lone Star International Energy, Inc.

OIL AND GAS PLAN OF OPERATION

Effective May 2, 1995, the Company acquired Cumberland. Until January 1, 1997,
Cumberland acted as an operator of oil and gas properties. For accounting
purposes, the transaction has been treated as a recapitalization of Cumberland
with Cumberland as the acquirer (reverse acquisition). For purposes of
discussion the Company's operations will be considered those of Cumberland. The
reverse acquisition was accounted for under the pooling of interest method of
accounting.

The Company intends to increase production and reserves through development of
existing oil and gas properties and future acquisitions. Future acquisitions
will require additional capital and the Company believes it can raise such
capital through either public or private financing, or a combination of both and
including the issuance of Common Stock. The Company periodically evaluates other
businesses within what it broadly describes as the energy industry. The Company
does not expect that any associated costs to evaluate such business projects
will impair its liquidity.

The Company is in the process of receiving bids to liquidate certain of its oil
and gas properties located in the State of Texas. These targeted properties have
historically been marginal producers and the expense of operations has generally
exceeded the revenue. The Company has received a number of bids, and is
currently reviewing them with the intent to consummate sales within the late
first quarter and early second quarter of 1998. The liquidation will result in
the reduction of overhead and operating expenses attributable to the oil and gas
operations, and will provide needed capital for other Company operations.

Specific Oil and Gas Properties During the next year the Company plans to
continue the development of its newly acquired Two Medicine Cut Bank Sand Unit
in Montana in which it has a 59.7% net revenue interest. Various options are
available to the Company with regard to this development, and the option
selected will be determined in large part by the availability of operating
capital. In order to complete the acquisition and to begin the restoration of
the properties several of the Company's stockholders loaned the Company the
necessary funds. As consideration the Company gave the stockholders liens
against the Texas properties, assignment of 40% of the Company's net production
revenue from the Montana property until the Stockholders have been repaid their
investment plus 25%, and an assignment of a carried working interest of 2.65% in
the Montana property. The conservative option is to continue the

<PAGE> 17

gradual restoration program of the existing 82 wells located in the unit. This
approach can be achieved on a well by well basis with the use of revenue from
production to finance the ongoing program. The restoration program has proved
successful as shown by the increase from approximately 23 barrels per day to
over 100 barrels per day with the restoration of eight wells. Once the extreme
winter conditions in the area have passed, the Company expects to increase daily
production to approximately 150 barrels per day by the middle of the second
quarter 1998. By reinvesting the production income into the conservative
restoration program through the spring and summer, it is expected that daily
production can be increased to between 200 and 300 barrels per day by the third
quarter.

A more aggressive plan for restoration of the existing wells is available
through the process of using the property as collateral to secure a loan for
operating capital. The Company believes that a loan can be obtained on
reasonable terms that would allow the escrowing of the funds necessary to
complete the entire restoration program, plus provide additional capital for
other Company operations. This would allow the Company to take a more aggressive
restoration approach and employ multiple workover rigs during the Spring and
Summer. Doing so, the Company believes that daily production could be increased
to closer to 500 barrels per day by winter of 1998.

The final and most aggressive option currently under review by the Company is
the initiation of the horizontal secondary recovery program for the unit. The
Company's partner in this project has entered into discussions with an industry
partner specializing in horizontal technology who expressed a desire to
participate in the Montana project. The Company believes that an agreement can
be reached that would provide in part that secondary recovery operations would
be commenced during the second quarter of 1998, with the industry partner
bearing 100% of the cost of drilling and completion of the development wells.
The partner would receive a disproportional share of the revenue from production
on a well by well basis until the cost has been recovered, and would thereafter
earn an equity interest in the well. While the secondary development is being
conducted on parts of the unit, the Company would be able to continue its
conservative restoration program on other parts of the unit thus increasing
daily production and monthly revenue. This most aggressive approach if
implemented the Company believes would increase daily production from the unit
to over 1,000 barrels per day by winter of 1998.

The Company has also explored the possibility of simply selling a minority
interest in the Montana property, and has received some inquiry into that
possibility. Establishing a market value for such an interest is being discussed
and evaluated by the Company at this time. The Company believes that it can sell
a partial interest in the property and receive sufficient capital to finance
operations of the Company through the end of 1998, while continuing the
restoration and secondary recovery program in Montana. It is not expected that
the Company will invest more of its own capital into the development of the
property, but rather that the Company will utilize this asset to generate
capital needed for its overall operations. As revenues increase and capital is
made available, the Company intends to look at the possible acquisition of other
oil and gas properties that can add to the asset base, cash flow, and provide
similar upside potential to the Company.

ENERGY RECLAIM PLAN OF OPERATIONS

Energy Reclaim has been in the research and development stage of developing
products using its patented technology. With the acquisition of its precision
metal cutting Bystronic Laser and other manufacturing equipment, Energy Reclaim
is poised to move forward with the development of the production models of its
Fresh Catch(TM) and By-Pass Chiller(TM) Units. During the second quarter of
1998, Energy Reclaim expects to complete the testing of its production model of
the Fresh Catch(TM), and will have it installed on a fishing vessel in Louisiana
for actual field test operation. Once the installation is completed, Energy
Reclaim will commence fabrication of the Fresh Catch(TM) units for sale and
delivery, and expect the first of such units to be available for existing
purchase orders during the third quarter of 1998. Energy Reclaim further plans
to complete its pilot test project with a utility company with the installation
of its production model By-Pass Chiller(TM) unit on a selected utility building
during the second

<PAGE> 18

quarter. Energy Reclaim expects to enter into several pilot test projects in
different parts of the country, with each such pilot test project providing
valuable beta test data on the performance of the units. Energy Reclaim believes
that by the mid third quarter it will be ready to fabricate the production model
By-Pass Chiller(TM) unit for sale and delivery, with the first units going to
supply existing purchase orders.

The staff at Energy Reclaim has been actively engaged in the solicitation of
outside contract fabrication work for its laser cutting and other manufacturing
equipment. The Energy reclaim facility is set up so that outsource work can be
accomplished without hindrance to the work required to develop and manufacture
its own Fresh Catch(TM) and By-Pass Chiller(TM) units. This outsource work is
expected to become a valuable source of revenue for Energy Reclaim while it is
entering the production phase of the sale of the Fresh Catch(TM) units.

The Company has been approached and is exploring the possible sale or licensing
of distributorships, manufacturing rights, and other aspects of the national and
worldwide development of markets for its Fresh Catch(TM) and By-Pass Chiller(TM)
technology. The Company is developing a plan to pursue these possible sources of
income and revenue, and will continue to investigate these possibilities. The
Company believes that over the next year an important source of revenue can be
created through the development of marketing, distribution and manufacturing
rights not only in the United States but around the world.

OPERATING CAPITAL

Throughout its operational history, the Company has principally relied on
funding its operations through the sale of its stock through offerings
structured to be exempt from registration under the Act, and through the sale of
the Debentures. In addition, its President and Chairman, Mr. C. E. Justice has
funded operations through loans to the Company and through the sale of his
personal shares in certain private placements with the proceeds going directly
to the Company to cover operating expenses. Historically, these activities have
resulted in the Company being under funded at many times. Most of the key
administrative personnel have deferred portions of their agreed salary; in
addition, Mr. Justice has not received his salary for over two years in order to
help the Company achieve its goals. Additional capital will be required to fund
the planned capital needs of the Company over the next year and the Company
believes that sources for accessing capital will be available. These sources
include a possible renegotiation of the terms of the Debentures and/or their
redemption by the Company or a refinancing by a third party, possible debt
financing through typical financial sources, equity financing through the sale
of interests in current oil and gas assets, additional private sales of Common
Stock or other securities, and a line of credit which utilizes stock of the
Company to access the line. It is the desire of the Company to preserve the
equity and minimize dilution to current shareholders whenever possible.
Consequently, the Company will focus on building the income stream from
operations of both the oil and gas division and Energy Reclaim, with the
objective to become totally self-sufficient in its capital requirements within
two years. The Company will also continue to explore the possible advantages of
selling marketing, distribution and other rights pertaining to the Energy
Reclaim products throughout the world.

<PAGE> 19
RESULTS OF OPERATIONS

In 1997, cash flows used by operations decreased to ($1,425,909) from $14,525 in
1996. Cash flows provided by financing activities increased to $2,620,254 in
1997 from $77,437 in 1996. Cash flows used in investing activities were
($1,180,512) in 1997 as compared to ($90,565) in 1996. Net cash used by
operations increased by $1,440,434, reflecting the hiring of employees and
consultants during 1997 while operating virtually without employees during 1996.
Net cash used by investing activities increased by $1,089,947, reflecting the
acquisitions during 1997 and the deposit pertaining to the Montana acquisition.
Net cash provided by financing activities increased by $2,542,817, reflecting a
the issuance of the debenture.

Revenues increased from $285,940 in 1996 to $603,140 in 1997 primarily as a
result of the purchase of additional oil and gas properties. Expenses increased
from $495,749 in 1996 to $6,716,131 in 1997 reflecting impairment charges of
$2,546,000, wages of $1,220,000, research and development of $523,000 legal and
professional fees of $525,000 and consulting expenses of $650,000.

The following table sets forth a summary of historical financial information for
the Company. These tables should be read in conjunction with the consolidated
financial statements Lone Star international Energy, Inc. and Subsidiary (and
related notes).

<PAGE> 20

SUMMARY BALANCE SHEET DATA
AS OF DECEMBER 31,

<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Current assets $ 1,323,398 $ 392,568
Current liabilities 1,872,364 943,960
------------ ------------

Working capital (548,966) (551,392)
Properties and equipment (net) 3,000,705 1,545,753
Other assets 1,951,572 525
Total assets 6,275,675 1,938,846
Stockholder's equity 131,930 994,886
------------ ------------

Stockholder's equity per common share $ 0.007 $ 0.118
============ ============

Shares outstanding 19,805,283 8,396,950
============ ============

Summary of Operations
Oil and gas sales $ 449,612 $ 244,540
Other 153,528 41,400
------------ ------------

Total operating revenues 603,140 285,940
------------ ------------

Production costs 488,984 242,745
Depreciation, depletion and amortization 180,540 66,026
Research and development 523,000
General and administrative expenses 2,977,607 186,978
Impairment loss 2,546,000
------------ ------------

Total operating expenses 6,716,131 495,749
------------ ------------

Other income 5,035 920
Interest expense (202,135) (31,947)
------------ ------------

Net income (loss) $ (6,310,091) $ (240,836)
============ ============

Net income (loss) per common share $ (0.3649) $ (0.0305)
============ ============

Weighted average shares outstanding 17,292,310 7,888,000
============ ============
</TABLE>

ITEM 7. FINANCIAL STATEMENTS

Financial statements for 1996 and 1997 with the accountant's report are attached
hereto following the signature page.

ITEM 8. CHANGES IN DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE

None.

<PAGE> 21
\ PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.

CECIL E. JUSTICE (42), Chief Executive Officer and Chairman of the Board of
Directors of the Company since April 1995, has been employed in the oil and gas
industry since 1979. Mr. Justice worked for Pinto Petroleum, Inc., a Dallas,
Texas, based production and operating company with properties in Texas and
Oklahoma from 1979 through 1982. In 1983, Mr. Justice was founder and President
of Cherokee Oil, Inc. Cherokee's properties and operations were in North Central
Texas. In 1987 Cherokee was sold to Genex Resources, Inc., a public company
trading on the Vancouver, British Columbia exchange. From 1987 until present,
Mr. Justice put together joint ventures on many oil and gas prospects.

RICHARD C. BAKER (67), President and Chief Operating Officer joined the Company
on April 1, 1998. Mr. Baker has over four decades of business management
experience from the construction and real estate industries covering four
continents, including nine years as CEO of the Clint Murchison Jr., family
controlled activities in various parts of the world. Clint Murchison was the
owner of the Dallas Cowboys football franchise. Since 1990, Mr. Baker has been
self-employed serving as a management consultant to various companies through
Talbot Management Services, a Baker family owned corporation. Included in Mr.
Baker's client list since 1990 are Fletcher Challenge Ltd., Pacific Construction
Company Ltd., P.T. Semen Cibiniong, P.T. Tirtamas Majutama, Richard Scheinberg
Group of Companies, Huixing Industries Ltd., AMEC Ltd., Multi Plex Construction,
and Southern Quarries. All of these clients were engaged in the construction,
engineering, and real estate development industries. In addition, Mr. Baker
holds a real estate license and a class B general contractor license in the
state of California, where he served as a real estate broker through Prudential
California Real Estate. As the Chief Executive Officer of construction companies
with interests in Australia, new Zealand, Hawaii, Mainland U.S., Europe and
North Africa, he worked in close contact with the HVAC Industry, which will
provide valuable international contacts with that industry. Mr. Baker was
responsible for the acquisition and subsequent reorganization and operation of
the Marryat, Jackson and Norris Group (MJN) headquartered in the U.K., with
operations not only in England, but also in such diverse countries as Nigeria,
Egypt and other Middle East countries. MJN was a large mechanical engineering
contractor, and functioned in all areas of mechanical engineering design and
construction. Mr. Baker has also served as a director of General Industries,
Ltd. in Sydney, Australia, a major manufacturer of appliances and cast iron
foundry items.

WILLIAM D. JOSSERAND JR. (33), Vice President of Field Operations, joined the
Company in November 1995. Mr. Josserand was a director of the Company from
February 1997 until August 1997. From 1988 to 1994 Mr. Josserand worked for a
water and sewer plant construction company owned by his family. Mr. Josserand
has been employed in the oil and gas industry since 1994, and served as
President of The Cody Company, an oil and gas service company in Stephenville,
Texas, where he managed contract field services, field operations, and
production management. In 1996, Mr. Josserand formed Trace Management, Inc., a
Texas oil and gas production and operating company, where he acted as Chairman
and President. Trace Management, Inc. was primarily involved with field
production management and operations in the Fort Worth Basin area for both
public and private oil and gas companies. Mr. Josserand received a Bachelor of
Business Administration in Finance from the University of North Texas in 1988.

MICHAEL D. HERRINGTON (34), Chief Financial Officer and Treasurer had been
engaged in public and private accounting since 1992 prior to joining the Company
in February 1997. Mr. Herrington was a director of the Company from February
1997 until August 1997. A 1992 graduate of Tarleton State University with a
Bachelor's degree in Business Administration in Accounting, Mr. Herrington
brought to the Company a background in the oil and gas industry that included
revenue and joint interest accounting as well as the day-to-day field
operations. Prior to receiving his degree, Mr. Herrington worked in the
manufacturing industry.

DON R. PYLES (47), Senior Vice President, General Counsel and Corporate
Secretary, joined the Company in January 1997, and was elected a director in
August 1997. Mr. Pyles served as general counsel of Crossroads Oil Company from
September 1989 until September 1993, and thereafter until joining the Company he
was engaged in a private consulting and law practice with a client base in the
oil and gas industry and commercial real estate. Mr. Pyles received his
Bachelor's degree in Business Administration from Mississippi College in 1972,
after which he served in the United States Army until 1975, receiving an
Honorable Discharge. Mr. Pyles received a Doctor of Jurisprudence form
Mississippi College School of Law in 1979 and is licensed in the States of
Mississippi, Texas and Utah. Throughout

<PAGE> 22

his legal professional career, which began in 1979, Mr. Pyles has served as
General Counsel for three oil and gas exploration and development companies,
both in the public and private sectors.

CALVIN D. CLINE (44), President, Energy Reclaim Refrigeration, Inc., a wholly
owned subsidiary of the Company since its formation in 1997, and was its sole
shareholder prior to its acquisition by the Company in 1997. From December 1991
until the formation of Energy Reclaim Refrigeration, Inc., Mr. Cline was
President of Airex International, Inc., a company involved in development of
absorption refrigeration technology. Mr. Cline is a graduate of Ouachita
Vocational-Technical College in eastern Oklahoma where he studied air
conditioning and refrigeration technology. Mr. Cline has over twenty years
experience in air conditioning and refrigeration technology, including the
development and marketing of air conditioning and refrigeration systems for both
commercial and residential applications. This experience and knowledge has
gained Mr. Cline the distinction of Professional Master Refrigeration
Technician. Mr. Cline is the developer of the processes currently being utilized
by Energy Reclaim in the development of its By-Pass Chiller(TM) and Fresh
Catch(TM). In addition to overseeing the development and manufacture of the
Company's By-Pass Chiller(TM) and Fresh Catch(TM) units, Mr. Cline is active in
new product development where he is currently working on new patent
applications.

RICHARD P. GAZZOLA (30), Operations Director and Plant Manager for Energy
Reclaim, joined the Company in March 1997. Mr. Gazzola has been engaged in
manufacturing since 1986 and has completed various courses in AutoCAD, Pro
Engineer and other engineering fields. Mr. Gazzola has received special skills
training with various manufacturing machinery, including lasers, lathes, mills,
punch and break presses, and shears. He has worked since 1990 in design layout
and production of sheet metal products ranging from industrial refrigerators and
freezers to space capsule simulators. Mr. Gazzola previously owned and operated
RTA Engineering, where he provided drafting services for the general public.
During his career, Mr. Gazzola has been responsible for manufacturing products
from the initial design stage to production. He attended Tarrant County Junior
College and Weatherford College where he has also taught continuing education
courses.

HENRY TAYLOR GEORGE (71), Independent Investments and Tax Practitioner, joined
the Board of Directors of the Company in August 1997. Mr. George is a graduate
of Texas Christian University with a Bachelor of Science in Commerce Degree. Mr.
George is the former manager of the Coca-Cola Bottling Company of Cleburne,
Texas. He received his license as a Certified Public Accountant in 1959, and
subsequently established a public accounting firm now known as George, Morgan &
Sneed, P.C. where he served as Managing Partner until 1991. Subsequent to 1991
Mr. George engaged in independent investment and tax consultation. Mr. George is
the former Auditor for Parker County, Texas, and is a member of the American
Institute of Certified Public Accountants, Texas Society of Certified Public
Accountants and Fort Worth Chapter of the Texas Society of Public Accountants.

PAULA J. FLEMING (46), Senior Vice President, Sales and Acquisitions, joined the
Company in early 1997 after having served as senior landman, land manager and/or
exploration/acquisition project director for various mid-size independents with
international partners such as Trafalgar House, Grand Metropolitan Corporation
and Petrus Oil Company, with exploration and acquisition budgets in excess of
$20 million per year. From 1990 to 1995 she was President of Fleming Insurance
Agency, in Nashville and McMinnville, Tennessee. In 1995 she founded Fleming Oil
& Gas Land Services, which served clients such as Thomson International
Organization, U.S., AmBrit Energy Corporation, a division of United Energy,
U.K., and Torch Energy Advisors. In addition, Fleming Oil & Gas Land Services
served as liaison between the Houston Bankruptcy Court and various law firms.
Ms. Fleming is a native of Panola County, Texas, and attended Panola College and
the University of Texas - Dallas campus.

<PAGE> 23
ITEM 10. EXECUTIVE COMPENSATION

For 1997 Cecil E. Justice was the Chief executive officer and a director of the
Company. For 1996 Mr. Justice was the only officer of the Company and sole
director and did not receive a salary. The Company did make payments to Mr.
Josserand in 1996. See "Certain Relationships and Related Transactions." The
Company commenced operations in 1995. The compensation for Mr. Justice, the
Chief Executive Officer, and the next four most highly compensated executives
receiving over $100,000 per year, was paid primarily in 1997 in the form of
promissory notes.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
Long term Compensation
-------------------------------
Annual Compensation Awards Payouts
------------------------------------------------------------------
Other Securities
Name Annual Restricted Under- All Other
And Compen- Stock lying LTIP Compen-
Principal (1) sation Award(s) Options/ Payouts sation(2)
Position Year Salary($) Bonus($) ($) ($) SARs(#) ($) ($)
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Cecil E. Justice 1997 350,000 -0- -0- -0- -0- -0- 6,000
President, Director 1996 -0- -0- -0- -0- -0- -0- -0-
1995 131,718 -0- -0- -0- -0- -0- -0-

Calvin D. Cline 1997 250,000 -0- -0- -0- -0- -0- 1,500
President Energy Reclaim

Don R. Pyles, VP, Sec. 1997 150,000 -0- -0- 36,000 -0- -0- 1,500
General Council, Director

Michael D. Herrington 1997 120,000 -0- -0- 36,000 -0- -0- 600
Chief Financial Officer
and Treasurer

Richard P. Gazzola 1997 120,000 -0- -0- 36,000 -0- -0- 480
V.P. Operations
Energy Reclaim
</TABLE>

(1) Each of these individuals, including C.E. Justice, signed five year
employment contracts.

Mr. Justice's contract includes a salary of $350,000 per year. Mr. Justice
was paid actual cash wages of $16,473 for 1997 with the balance received in
the form of a note payable. The principal balance of the note is $333,527
with interest accruing at the rate of 8.25%. The note is renewable with a
term of one year payable at the holder's option in cash, stock or a
combination of cash and stock. Also, included in Mr. Justice's contract is
a five year assignable stock option for 5,000,000 shares exercisable at
$.01 per share.

Mr. Cline's contract includes a salary of $250,000 per year. Mr. Cline was
paid actual cash wages of $82,819 for 1997 with the balance received in the
form of a note payable. The principal balance of the note is $167,181 with
interest accruing at the rate of 8.25%. The note is renewable with a term
of one year payable at the holder's option in cash, stock or a combination
of cash and stock.

Mr. Pyles' contract includes 200,000 shares of restricted common stock
valued at $.18 per shares or $36,000, and a salary of $150,000 per year.
Mr. Pyles was paid actual cash wages of $64,430 for 1997 with the balance
received in the form of a note payable. The principal balance of the note
is $85,570 with interest accruing at the rate of 8.25%. The note is
renewable with a term of one year payable at the holder's option in cash,
stock or a combination of cash and stock.

Mr. Herrington's contract includes 200,000 shares of restricted common
stock valued at $.18 per shares or $36,000, and a salary of $120,000 per
year. Mr. Herrington was paid actual cash wages of $38,958 for 1997 with
the balance received in the form of a note payable. The principal balance
of the note is $81,042 with interest accruing at the rate of 8.25%. The
note is renewable with a term of one year payable at the holder's option in
cash, stock or a combination of cash and stock.

<PAGE> 24

Mr. Gazzola's contract includes 200,000 shares of restricted common stock
valued at $.18 per shares or $36,000, and a salary of $120,000 per year.
Mr. Gazzola was paid actual cash wages of $30,119 for 1997 with the balance
received in the form of a note payable. The principal balance of the note
is $89,881 with interest accruing at the rate of 8%.25. The note is
renewable with a term of one year payable at the holder's option in cash,
stock or a combination of cash and stock.

(2) The amounts in the column All Other Compensation include payments made by
the Company to the employees Simple IRA Plan. The Simple IRA Plan was
implemented by the Company in October of 1997. This plan requires that the
Company match the contributions of each participating employee up to three
percent of their salary or a maximum of $6,000.

Mr. Baker's contract, effective April 1, 1998 has a two year primary term, and
provides for a salary of $250,000 per year, and includes 200,000 shares of
restricted common stock valued at $.33 per share. Mr. Baker further entered into
a deferred compensation agreement with the company, whereby one-half ($125,000)
of the annual salary is deferred until such time as the company may reasonably
be in a better financial position to pay the same. All deferred compensation
under the agreement is to be reflected by a note payable of the company executed
at the end of each year, and may be redeemed in cash or stock or a combination
thereof.

Except for the IRA plan, the Company has no existing or proposed plan for the
provisions of annuity, pension or retirement benefits to its officers and
directors. The Company has no existing or proposed plan involving any incentive
compensation for officers and directors or for stock purchase, profit sharing or
thrift plans for any officer and director. The Company has no existing or
proposed plan or arrangement for any officer or director to receive remuneration
resulting from his resignation, retirement or termination or from a change in
control of the Company or a change individual's responsibilities after such a
change in control. Further, the Company has not engaged in any transaction with
third parties where the primary purpose of such transaction was to furnish
remuneration to any officer or director of the Company.

During 1997, the Company employed Michael D. Herrington as Vice President,
Treasurer and Chief Financial Officer, Don R. Pyles as Senior Vice President,
Secretary and General Council, Calvin D. Cline as President of Energy Reclaim
and Richard P. Gazzola as V.P. of Operations of Energy Reclaim. In 1998, the
Company employed Richard C. Baker as President and Chief operating Officer.

COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.

The following officers and directors filed a Form 3 on September 29, 1997.

Henry T. George
Cecil E. Justice
Michael D. Herrington
Don R. Pyles
Calvin D. Cline
Richard P. Gazzola

On October 7, 1997, a form 3 was filed by William D. Josserand, Jr.,
completing the filing requirements for all officers and directors through that
date. The Company is aware that all of these Form 3 filings were late. The
Company is aware that the following filings were not made and are subsequently
delinquent as of the date of this filing.

Paula Fleming Form 3
Cecil E. Justice Form 4
Calvin D. Cline Form 4
Don R. Pyles Form 4

During the fiscal year Cecil E. Justice completed the following private
transactions involving the sale of his personal shares requiring the filing of
Form 4.

July 1997 362,176 Shares
August 1997 20,000 Shares
November 1997 38,500 Shares
38,500 Shares
38,500 Shares
38,500 Shares

Calvin D. Cline completed four private placement transactions involving the sale
of his personal stock requiring the filing of Form 4, as follows.

August 1997 49,500 Shares
September 1997 24,200 Shares
November 1997 143,587 Shares
January 1998 150,000 Shares

Finally, Don R. Pyles completed three private placement transactions involving
the sale of his personal stock requiring the filing of Form 4, as follows.

October 1997 10,000 Shares
10,000 Shares
10,000 Shares
<PAGE> 25

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The following table sets forth, as of April 1, 1998, certain information
regarding beneficial ownership of Common Stock by (a) each person known by the
Company to own more than 5% of its outstanding Common Stock, (b) each director
of the Company, and (c) all directors and officers as a group. Each person
listed below is a director. Each person listed below has sole voting and
dispositive power over the shares indicated.

AMOUNT & NATURE PERCENT OF
NAME AND ADDRESS OF BENEFICIAL OUTSTANDING
OF BENEFICIAL OWNER OWNERSHIP SHARES
- -------------------- ---------------- ------------
<S> <C> <C>
Cecil E. Justice (1)(2)(3) 8,350,650 33.40
528 Grant Road
Mineral Wells, Texas 76067

Don R. Pyles (1)(2)(3) 170,000 .85
528 Grant Road
Mineral Wells, Texas 76067

Henry T. George (2) 30,300 .15
119 N. Main, Suite 108
Mineral Wells, Texas 76067

Michael D. Herrington (1)(3) 195,000 .97
528 Grant Road
Mineral Wells, Texas 76067

Calvin D. Cline (1)(4) 2,301,196 11.50
528 Grant Road
Mineral Wells, Texas 76067

Richard P. Gazzola (1)(4) 200,000 1.00
528 Grant Road
Mineral Wells, Texas 76067

Sovereign Partners, L.P. (5)(6) 4,197,949 17.34
49 Perry Lane
Ridgefield, Connecticut 06877

Canadian Advantage Limited Partnership (5)(6) 1,259,385 5.92
365 Bay Street
Toronto, Ontario M5H-2V2
Canada

Atlantis Capital Fund, Ltd. (5)(6) 839,590 4.02
c/o Thompson Kernaghan & Co. Ltd.
365 Bay Street
Toronto, Ontario M5H-2V2
Canada
</TABLE>

<PAGE> 26

<TABLE>
<S> <C> <C>
Dominion Capital Fund, Ltd. (5) (6) 4,197,949 17.34
c/o Thompson Kernaghan & Co. Ltd.
365 Bay Street
Toronto, Ontario M5H-2V2
Canada

Thompson Kernaghan & Co. Ltd. 412,176 2.06
365 Bay Street
Toronto, Ontario M5H-2V2
Canada

All officers and directors as a group (8 persons) 11,647,126 58.22
</TABLE>

(1) Owns directly, except in the case of Mr. Justice by whom 5,000,000 of
such shares are held beneficially through options to purchase common
stock of the Company.

(2) Director.

(3) Officer.

(4) Officer of Subsidiary.

(5) The Company issued the convertible debentures in exchange for
$2,500,000 as follows:

<TABLE>
<S> <C>
Sovereign Partners, L.P. $ 1,000,000
Canadian Advantage Limited Partnership 300,000
Atlantis Capital Fund, Ltd. 200,000
Dominion Capital Fund, Ltd. 1,000,000
</TABLE>

The Debentures may be converted into shares of the Company's common stock at
varying rates of conversion depending upon then current market prices of the
Common Stock. The Debentures are subject to conversion restrictions such that
upon the request of the holder, not more than one-third of the Debentures could
be converted on October 15, 1997 (the "Initial Conversion Date"), one-third 30
days following the Initial Conversion Date, and the remaining one-third 60 days
following the Initial Conversion Date. Thereafter, conversion of any remaining
Debentures remained optional with the holders provided that the Debentures are
subject to a mandatory conversion upon the second anniversary of the agreement.
Prior to mandatory conversion, however, the Subscription Agreement provides that
no optional conversion may be exercised which results in beneficial ownership by
the Debenture holders and their affiliates of more than 4.9% of the outstanding
shares of the Company. The Company believes these four Debenture holders are
affiliates of each other. The Company believes that the Subscription Agreement's
4.9% limitation applies, until the mandatory conversion, to all such Debenture
holders and their affiliates in the aggregate. The Debenture holders have
advised the Company by their counsel, that they disagree with such
interpretation and that they each expressly disclaim beneficial ownership of any
shares held by any other Debenture holder. The Company and the Debenture holders
entered into agreements on August 25, 1997. Under the terms of these agreements
the Debenture holders agreed not to sell or convert the Debentures for a period
of 90 days from the effective date of a registration statement and in addition
during such 90 day period the Company was granted the right to acquire the
Debentures for the stated principal amount plus accrued interest and a premium
payment totaling $832,500. The Company also issued a total of 1,000,000 warrants
exercisable for two years to purchase Company Common Stock at the market price
thereof on the effective date of the registration statement as follows:

<TABLE>
<S> <C>
Sovereign Partners, L.P. 400,000
Canadian Advantage Limited Partnership 120,000
Atlantis Capital Fund, Ltd. 80,000
Dominion Capital Fund, Ltd. 400,000
</TABLE>
The warrants are restricted as to transfer for six months from the effective
date of the above referenced registration statement. Given the restrictive
nature of these warrants beneficial

<PAGE> 27
ownership of the underlying Common Stock may be disclaimed by the holders,
however such ownership is included in the table.

(6) assumes the entire principal amount of the Debenture is exercised based
upon 75% of the five day average of the closing bid price on March 24, 1998
of $0.2639 per share, and that no other Debenture holder converts, no other
Debenture holder is an affiliate and there is no limitation on the amount
that can be converted. As discussed above in footnote (5) the Company
believes the Debenture holders are affiliates of each other and as such the
above table would be required to reflect the ownership of each debenture
holder as beneficially owning those shares owned by all other debenture
holders. The Debenture holders, through counsel, has informed the Company
they disagree they are affiliates of each other and they expressly disclaim
such beneficial ownership.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

On April 10, 1995 the Company entered into an agreement with Cumberland
Petroleum, Inc., a Texas corporation ("Cumberland") pursuant to which, on May
2, 1995 the Company acquired from Cecil E. Justice, 100% of the capital stock
of Cumberland in exchange for 5,000,000 shares of Company common stock. In
connection with this transaction Mr. Justice was elected president of the
Company and its sole director. Previous officers and directors resigned at the
time of the transaction. Also at the time of this transaction the Company paid
$100,000 and issued 200,000 shares to Capital General Corporation, the former
controlling shareholder of the Company. As a result of this transaction the
Company assumed an approximate $106,000 account receivable from Mr. Justice
that Cumberland incurred as a result of advances to Mr. Justice. In 1995 this
account receivable was reduced to $66,580 as a result of crediting Mr. Justice
for a portion of his salary. During 1996 this account receivable increased to
$138,717. During 1997 Mr. Justice repaid the balance of the receivable and
loaned the Company an additional $80,759. The loan and advances between Mr.
Justice and the Company were not reflected by written promissory notes. During
1996 the Company paid William Josserand $72,139, as compensation and reimbursed
expenses for services he provided as an independent contractor handling field
services. Certain of the payments in 1996 were to Trace Management, Inc.

With the acquisition of Energy Reclaim in April 1997, the Company entered into
a long-term lease agreement with C.E. Justice for the facility located in
Mineral Wells owned by Mr. Justice. The facility consists of two commercial
buildings containing approximately 24,000 square feet located on approximately
six acres. The lease provides for an initial five (5) year term with automatic
renewals of additional five (5) year terms. The lease rate is $5,000.00 per
month, and provides for a purchase option by the Company.

<PAGE> 28
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

On April 10, 1995 the Company entered into an agreement with Cumberland
Petroleum, Inc., a Texas corporation ("Cumberland") pursuant to which, on May 2,
1995 the Company acquired from Cecil E. Justice, 100% of the capital stock of
Cumberland in exchange for 5,000,000 shares of Company common stock. In
connection with this transaction Mr. Justice was elected president of the
Company and its sole director. Previous officers and directors resigned at the
time of the transaction. Also at the time of this transaction the Company paid
$100,000 and issued 200,000 shares to Capital General Corporation, the former
controlling shareholder of the Company. As a result of this transaction the
Company assumed an approximate $106,000 account receivable from Mr. Justice that
Cumberland incurred as a result of advances to Mr. Justice. In 1995 this account
receivable was reduced to $66,580 as a result of crediting Mr. Justice for a
portion of his salary. During 1996 this account receivable increased to
$138,717. During 1997 Mr. Justice repaid the balance of the receivable and
loaned the Company an additional $80,759. The loan and advances between Mr.
Justice and the Company were not reflected by written promissory notes. During
1996 the Company paid William Josserand $72,139, as compensation and reimbursed
expenses for services he provided as an independent contractor handling field
services. Certain of the payments in 1996 were to Trace Management, Inc.

With the acquisition of Energy Reclaim in April 1997, the Company entered into a
long-term lease agreement with C. E. Justice for the facility located in Mineral
Wells owned by Mr. Justice. The facility consists of two commercial buildings
containing approximately 24,000 square feet located on approximately six acres.
The lease provides for an initial five (5) year term with automatic renewals of
additional five (5) year terms. The lease rate is $5,000.00 per month, and
provides for a purchase option by the Company.

<PAGE> 29

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

2.1 Agreement dated as of April 10, 1995 between Cumberland Petroleum, Inc.
and Quiescent Corporation. (Previously filed as Exhibit 2.1 to the
Company's Report on Form 8-K dated May 19, 1995.) *

2.2 Article of Merger of Cumberland Companies. Inc. and Quiescent
Corporation, a Utah Corporation. (Previously filed as the same exhibit
number with the Company's Annual Report on Form 10-KSB dated December
31, 1995.) *

3.1 Articles of Incorporation of the Company and amendments filed with the
Secretary of State of Nevada. (Previously filed as the same exhibit
number with the Company's Annual Report on Form 10-KSB dated December
31, 1995.) *

3.2 Bylaws of the Company. (Previously filed as the same exhibit number
with the Company's Annual Report on Form 10-KSB dated December 31,
1995.) *

10.1 Oil and Gas Property Purchase Agreement between the Company and Ford
and Myrt Fullingim Trust dated September 18, 1995. (Previously filed as
the same exhibit number with the Company's Annual Report on Form 10-KSB
dated December 31, 1995.) *

10.2 General Promissory Note by the Company to Ford and Myrt Fullingim Trust
dated September 15, 1995 in the original principal amount of $89,643.
(Previously filed as the same exhibit number with the Company's Annual
Report on Form 10-KSB dated December 31, 1995.) *

10.3 Oil and Gas Property Purchase Agreement between the Company and O.O.
Thompson and Bea Thompson dated September 18, 1995. (Previously filed
as the same exhibit number with the Company's Annual Report on Form
10-KSB dated December 31, 1995.) *

10.4 General Promissory Note by the Company to and O.O. Thompson and Bea
Thompson dated September 15, 1995 in the original principal amount of
$104,198. (Previously filed as the same exhibit number with the
Company's Annual Report on Form 10-KSB dated December 31, 1995.) *

10.5 Oil and Gas Property Purchase Agreement between the Company Randy J.
Mason dated September 18, 1995. (Previously filed as the same exhibit
number with the Company's Annual Report on Form 10-KSB dated December
31, 1995.) *

10.6 General Promissory Note by the Company to Randy J. Mason dated
September 15, 1995 in the original principal amount of $210,001.
(Previously filed as the same exhibit number with the Company's Annual
Report on Form 10-KSB dated December 31, 1995.) *

10.7 Oil and Gas Property Purchase Agreement between the Company and J. L.
Keas dated September 18, 1995. (Previously filed as the same exhibit
number with the Company's Annual Report on Form 10-KSB dated December
31, 1995.) *

10.8 General Promissory Note by the Company to J. L. Keas dated September
15, 1995 in the original principal amount of $17,143. (Previously filed
as the same exhibit number with the Company's Annual Report on Form
10-KSB dated December 31, 1995.) *

10.9 Oil and Gas Property Purchase Agreement between the Company and Charles
and Romona Hibbs dated September 18, 1995. (Previously filed as the
same exhibit number with the Company's Annual Report on Form 10-KSB
dated December 31, 1995.) *

10.10 General Promissory Note by the Company to and Charles and Romona Hibbs
dated September 15, 1995 in the original principal amount of $55,357.
(Previously filed as the same exhibit number with the Company's Annual
Report on Form 10-KSB dated December 31, 1995.) *

10.11 Oil and Gas Property Purchase Agreement between the Company and J. L.
Thompson dated September 18, 1995. (Previously filed as the same
exhibit number with the Company's Annual Report on Form 10-KSB dated
December 31, 1995.) *

10.12 General Promissory Note by the Company to J. L. Thompson dated
September 15, 1995 in the original principal amount of $22,857.
(Previously filed as the same exhibit number with the Company's Annual
Report on Form 10-KSB dated December 31, 1995.) *

* Incorporated herein by reference.

<PAGE> 30

<TABLE>
<C> <C>
10.13 Purchase and Sale Agreement Between Northridge Oil Company and Lone
Star International Energy, Inc. (Previously filed as the exhibit
number 10.1 with the Company's report on Form 8-K dated April 23,
1997.)*

10.14 Purchase and Sale Agreement Between Northridge LLC and Lone
Star International Energy, Inc. (Previously filed as the exhibit
number 10.2 with the Company's report on Form 8-K dated April 23,
1997.)*

10.15 Purchase and Sale Agreement Between Oil Fund 100 LLC and Lone
Star International Energy, Inc. (Previously filed as the exhibit
number 10.3 with the Company's report on Form 8-K dated April 23,
1997.)*

10.16 Agreement of Acquisition (Previously filed as the exhibit
number 10.1 with the Company's report on Form 8-K dated April 7,
1997.)*

10.17 Employment Contract (Previously filed as the exhibit number 10.2
with the Company's report on Form 8-K dated April 7, 1997.)*

10.18 Agreement between Lone Star International Energy, Inc. and Prism
Corporation. (Previously filed as the exhibit
number 10.1 with the Company's report on Form 8-K dated January 21,
1998.)*
</TABLE>

<PAGE> 31

21 List of Subsidiaries

27 Financial Data Schedule

<PAGE> 32
SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

LONE STAR INTERNATIONAL ENERGY, INC.

By: /s/ Cecil E. Justice
Chief Executive Officer
April 15, 1998

In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.

/s/ Cecil E. Justice Chief Executive Officer, April 15, 1998
Director
(Principal executive
officer)

/s/ Michael D. Herrington Chief Financial Officer, April 15, 1998
Treasurer
(Principal accounting
officer)

/s/ Don R. Pyles Sr.Vice President, General April 15, 1998
Council, Secretary
and Director

/s/ Richard C. Baker President, Chief Operating April 15, 1998
Officer

/s/ Henry T. George Director April 15, 1998

<PAGE> 33
LONE STAR INTERNATIONAL
ENERGY, INC.

AND SUBSIDIARIES

CONSOLIDATED FINANCIAL

STATEMENTS AND AUDITOR'S

REPORTS

YEARS ENDED

DECEMBER 31, 1997 AND 1996

<PAGE> 34

LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARIES

CONTENTS

<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditor's Report 1

Consolidated Balance Sheet 2

Consolidated Statements of Operations 3

Consolidated Statements of Stockholders' Equity 4

Consolidated Statements of Cash Flows 5

Notes to Consolidated Financial Statements 6
</TABLE>

<PAGE> 35

INDEPENDENT AUDITOR'S REPORT

To the Board of Directors
Lone Star International Energy, Inc.
Mineral Wells, Texas:

We have audited the accompanying consolidated balance sheets of Lone Star
International Energy, Inc. and subsidiaries as of December 31, 1997 and 1996,
and the related consolidated statements of operations, stockholders' equity and
cash flows for the years then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Lone Star
International Energy, Inc. and subsidiaries as of December 31, 1997 and 1996,
and the results of its operations and its cash flows for the years then ended,
in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 21 to the
financial statements, the Company is experiencing difficulty in raising capital
and generating sufficient cash flow to meet its obligations and sustain its
operations, which raises substantial doubt about its ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 21. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

DAVIS, KINARD & CO., P.C.

Abilene, Texas,
February 26, 1998.

1
<PAGE> 36
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
ASSETS 1997 1996
----------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash $ 15,230 $ 1,397
Accounts receivable - oil and gas revenues 64,450 21,263
Accounts receivable - JIB, net of allowance of $20,500 in 1997 and 1996 8,827 22,319
Accounts receivable - other net of allowance of $209,337 and $0 in 1997 and 1996 367,413 347,589
Notes receivable - current 3,422
Unearned compensation 170,000
Prepaid expenses - lease 60,000
Prepaid expenses 634,056
----------- -----------

Total current assets 1,323,398 392,568
----------- -----------

Properties and equipment, at cost 5,819,895 1,638,403
Less - accumulated depreciation, depletion and amortization (2,819,190) (92,650)
----------- -----------

Property and equipment, net 3,000,705 1,545,753
----------- -----------

OTHER ASSETS:
Prepaid expenses - non current - lease 112,049
Prepaid expenses - non current 470,662
Unearned compensation 510,000
Note receivable - non current 5,433
Deposits on property purchase 582,625
Debenture issuance costs net of amortization of $43,000 215,000
Patents, net of amortization of $3,127 54,873
Deposits 930 525
----------- -----------

Total other assets 1,951,572 525
----------- -----------

TOTAL ASSETS $ 6,275,675 $ 1,938,846
=========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 833,897 $ 121,063
Production payable 328,698 232,272
Accrued interest payable 147,337 47,643
Accrued payroll taxes payable 111,904 672
Notes payable - related party 75,593 439,450
Current maturities of long-term debt 12,079
Advances due to officer 80,759
Obligation to stockholders 250,000
Notes payable 28,513
Accounts payable - interest owners 32,097 74,347
----------- -----------

Total current liabilities 1,872,364 943,960
----------- -----------

LONG TERM DEBT:
Long term debt 2,513,255
Accrued compensation - stock option 850,000
Notes payable officers and employees 908,126
----------- -----------

Total long term debt 4,271,381 0

STOCKHOLDERS' EQUITY:
Common stock - par value $.001, 100,000,000 shares authorized, 19,805,283 and
8,396,950 shares issued and outstanding in 1997 and 1996 19,805 8,397
Common shares to be issued 6,500 21,500
Stock subscriptions receivable (5,000) (5,000)
Additional paid in capital 7,248,172 1,797,445
Retained deficit (7,137,547) (827,456)
Treasury stock at cost 525,553 shares in 1997
----------- -----------

Total stockholders' equity 131,930 994,886
----------- -----------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 6,275,675 $ 1,938,846
=========== ===========
</TABLE>

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

2
<PAGE> 37
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
REVENUES:
Oil and gas production $ 449,612 $ 244,540
Operating income 150,325 41,400
Other sales 3,203
------------ ------------

Total revenues 603,140 285,940
------------ ------------

EXPENSES:
Production expenses 484,898 242,745
Supervision expenses 4,086
Depreciation, depletion and amortization 180,540 66,026
Research and development 523,000
General and administrative expenses 2,977,607 186,978
Oil and gas properties impairment charge 2,546,000
------------ ------------

Total expenses 6,716,131 495,749
------------ ------------

Operating income (loss) (6,112,991) (209,809)

OTHER INCOME (EXPENSE)
Other income 5,035 920
Interest expense (202,135) (31,947)
------------ ------------

Other income (expense), net (197,100) (31,027)
------------ ------------

Net income (loss) before income taxes (6,310,091) (240,836)

Provision (benefit) for income taxes

------------ ------------
Net income (loss) $ (6,310,091) $ (240,836)
============ ============

Basic Earnings (loss) per common share $ (0.3649) $ (0.0305)
============ ============

Diluted Earnings (loss) per common share $ (0.3649) $ (0.0305)
============ ============

Weighted average shares outstanding 17,292,310 7,888,000
============ ============

Adjusted weighted average shares outstanding 17,292,310 7,888,000
============ ============
</TABLE>

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

3
<PAGE> 38
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
Common Stock
----------------------------------- Stock to Subscriptions
Shares Par value be Issued Receivable
------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Balance December 31, 1995 7,796,000 $ 7,796 $ 271,475 $

Issuance of restricted common
stock 499,950 500 (249,975)

Issuance of restricted common
stock 91,000 91

Restricted common stock
subscribed 10,000 10 (5,000)

Net loss

------------- -------------- -------------- --------------
Balance December 31, 1996 8,396,950 8,397 21,500 (5,000)

Issuance of common stock
for services 7,000,000 7,000

Issuance of restricted common
stock for Energy Reclaim
Refrigeration, Inc. 3,333,333 3,333

Issuance of restricted common
stock for oil & gas properties 1,100,000 1,100

Issuance of restricted common
stock for cash 1,800,000 1,800

Issuance of restricted common stock
to employees under employment
contracts 1,000,000 1,000

Issuance of restricted common stock 30,000 30 (15,000)

Issuance of common stock
for services 1,250,000 1,250

Issuance of restricted common stock
for services 285,000 285

Shares acquired and retired at no cost (4,400,000) (4,400)

Correcting shares outstanding 10,000 10

425,000 shares reacquired at no cost

100,553 shares reacquired at no cost

Net loss

------------- -------------- -------------- --------------
Balance December 31, 1997 19,805,283 $ 19,805 $ 6,500 $ (5,000)
============= ============== ============== ==============

<CAPTION>
Additional Retained Treasury
Paid in Capital (Deficit) Stock
---------------- -------------- ----------------

Balance December 31, 1995 $ 1,497,571 $ (586,620) $

Issuance of restricted common
stock 249,475

Issuance of restricted common
stock 45,409

Restricted common stock
subscribed 4,990

Net loss (240,836)
---------------- -------------- ----------------

Balance December 31, 1996 1,797,445 (827,456)

Issuance of common stock
for services 693,000

Issuance of restricted common
stock for Energy Reclaim
Refrigeration, Inc. 54,667

Issuance of restricted common
stock for oil & gas properties 3,023,900

Issuance of restricted common
stock for cash 448,200

Issuance of restricted common stock
to employees under employment
contracts 179,000

Issuance of restricted common stock 14,970

Issuance of common stock
for services 919,250

Issuance of restricted common stock
for services 464,250

Shares acquired and retired at no cost (346,500)

Correcting shares outstanding (10)

425,000 shares reacquired at no cost --

100,553 shares reacquired at no cost --

Net loss (6,310,091)

---------------- -------------- ----------------
Balance December 31, 1997 $ 7,248,172 $ (7,137,547) $ --
================ ============== ================
</TABLE>

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

4
<PAGE> 39
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(6,310,091) $ (240,836)
Adjustments to reconcile net income (loss) to net cash provided by
by operating activities:
Depreciation, depletion and amortization 1,051,998 66,026
Oil & gas properties impairment charge 2,546,000
Notes payable issued to satisfy accrued payroll 908,126
Stock issued as compensation 180,000
Loss on sale of assets 5,500
Other (20,195)
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (49,519) 20,493
Increase (decrease) in prepaid expense (172,049)
Increase (decrease) in accounts payable and accrued expenses 337,895 62,601
Increase (decrease) in revenues payable 96,426 106,241
----------- -----------

Net cash flows provided (used) by operating activities (1,425,909) 14,525
----------- -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in other assets (405) (300)
Acquisition of property and equipment (597,872) (6,699)
Increase in note receivable (1,247)
Collection of note receivable 1,637
Increase in deposit on property acquisition (582,625)
Increase in due from related parties (83,566)
----------- -----------

Net cash flows (used) by investing activities (1,180,512) (90,565)
----------- -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings from interest owners 34,597
Proceeds from borrowings 287,034
Proceeds from obligations to stockholders 250,000
Proceeds from debentures 2,500,000
Cost of issuing debentures (258,000)
Advances from officer 80,759
Increase (decrease) in cash overdraft (2,660)
Proceeds from the sale of stock 450,000 45,500
Payment of notes payable (689,539)
----------- -----------

Net cash flows provided by financing activities 2,620,254 77,437
----------- -----------

Net (increase) in cash 13,833 1,397

Cash - beginning of year 1,397 0
----------- -----------

Cash - end of year $ 15,230 $ 1,397
=========== ===========

See notes 4 and 15 for information relating to stock issued for services and to
employees.

Non-cash financing and investing activities:
Acquisition of oil & gas properties for stock and notes payable
Properties $ 3,070,505 $ 1,608,067
Notes payable (45,505) (500,000)
Common stock (3,025,000) (1,108,067)

Acquisition of subsidiary for stock
Patents 58,000
Common stock (58,000)
Restricted common stock subscribed 5,000

Supplemental disclosures:
Interest paid 55,556 1,070
</TABLE>

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

5
<PAGE> 40
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Lone Star International Energy, Inc., a Nevada corporation (the
Company), was incorporated in the state of Utah on April 11, 1986 as
Quiescent Corporation. On December 31, 1993, the Company was
reincorporated in the State of Nevada. The Company was in the
development stage from incorporation until completion of the reverse
acquisition described in Note 2 on May 2, 1995. The Company is engaged
in the operation of oil and gas properties, as well as the acquisition
and development of oil and gas properties. Operations were located
entirely in Texas, until the Company entered into an agreement to
acquire certain oil and gas properties in Montana.

Basis of Presentation

The consolidated financial statements include the accounts of Lone Star
International Energy, Inc. and its wholly owned subsidiaries Cumberland
Petroleum, Inc. and Energy Reclaim Refrigeration, Inc. Significant
intercompany accounts and transactions have been eliminated in the
consolidation.

Oil and Gas Properties

The Company uses the full-cost method of accounting for oil and gas
properties. Under this method, all costs associated with property
acquisition, exploration and development activities are capitalized
within one cost center. For each cost center, the capitalized costs are
subject to a limitation so as not to exceed the present value of future
net revenues from estimated production of proved oil and gas reserves
net of income tax effect plus the lower of cost or estimated fair value
of unproved properties included in the cost center. Capitalized costs
within a cost center, together with estimates of costs for future
development, dismantlement and abandonment, are amortized on a
unit-of-production method using the proved oil and gas reserves. Gain or
loss is recognized only on the sale of oil and gas properties involving
significant reserves. Proceeds from the sale of insignificant reserves
and undeveloped properties are applied to reduce the costs in the cost
center.

Equipment and Property

Depreciation of other equipment and property is provided using the
straight line method over the estimated useful life of the asset.

Income Taxes

The Company accounts for certain income and expense items differently
for financial reporting and income tax purposes. Deferred tax assets and
liabilities are determined based on the difference between the financial
statement and tax basis of assets and liabilities applying enacted
statutory tax rates in effect for the year in which the differences are
expected to reverse.

Debenture Issuance Costs

The Company is amortizing the cost of issuing the debentures over the
life of the debentures using the straight-line method over the life of
the debentures which is two years.

6
<PAGE> 41
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)

Patents

The Company is amortizing patents over the expected life of the patents
which is 17 years.

Stock Based Compensation

The Company has recorded the compensation related to stock options as of
the measurement date as unearned compensation and accrued compensation
stock option. It is amortizing the cost to expense over five years (the
period of the employment contract granting the option).

Research and Development

Research and development costs are charged to operations in the year
incurred. The cost of equipment used in research and development
activities is charged to expense unless there are alternative uses for
the equipment.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results will differ from those estimates,
and such differences may be material to the financial statements.

Significant estimates inherent in the preparation of the accompanying
consolidated financial statements include the allowance for
uncollectible receivables, the impairment charge and the reserve
valuation of the oil and gas properties. It is reasonably possible that
future collections, oil and gas prices, future development and
production costs and the quantities produced will change. These changes
could change management's decisions regarding future development and
production of the reserves.

Income (Loss) Per Share

Basic earnings (loss) per share is based on 17,292,310 and 7,888,000
weighted average shares outstanding in 1997 and 1996. Diluted earnings
(loss) per share was based on the same numbers of shares outstanding
since the Company was reflecting a loss for 1997 and 1996 and any
changes would be anti-dilutive. In addition, cash received for stock
which had not been issued at December 31, 1997 and 1996 was treated as
if the shares had been issued. During 1996, 45,000 shares of stock were
issued in error. The Company is contacting the individual in order to
have the shares returned. Those shares are not included in the shares
issued. The shares are still outstanding at December 31, 1997.

7
<PAGE> 42
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2: REVERSE MERGER ACQUISITION

The Company entered into an Agreement dated April 10, 1995, with
Cumberland Petroleum, Inc., a Texas corporation (Cumberland), pursuant
to which, on May 2, 1995 the Company acquired from C.E. Justice, 100% of
the capital stock of Cumberland in exchange for the issuance of
5,000,000 shares of the Company's common stock. The Company changed its
name to Cumberland Holdings, Inc. on May 3, 1995, to Cumberland
Companies, Inc. on August 17, 1995, and Lone Star International Energy,
Inc. on January 30, 1997.

For accounting purposes, the transaction has been treated as a
recapitalization of Cumberland with Cumberland as the acquirer (reverse
acquisition). This business combination has been recorded as a pooling
of interests. The financial statements were restated to include the
Company and Cumberland.

NOTE 3: ACCOUNTS RECEIVABLE MERIT CAPITAL

During July 1997 the Company opened an account with Merit Capital. The
Company deposited $500,000 of the proceeds from the debentures in the
account. Shares of the Company's stock were purchased with the funds
without the authorization of the Company or its personnel. At December
31, 1997 the Company has recorded a receivable from Merit Capital of
$500,000 to recover these funds. At December 31, 1997 the account
consisted of $49 in cash and 114,125 shares of the Company's stock
which had a market value of $.594 per share for a total of $67,790. As
discussed in Note 14, the Company is negotiating with Merit to settle
this matter. The Company has recorded an allowance of $200,000 for
potential losses on the receivable.

NOTE 4: CONSULTING AGREEMENTS

During the year ended December 31, 1997, the Company entered into
various agreements to provide various types of consulting to the
Company. The following agreements were entered into during 1997:

The Company entered into agreements with 10 individuals to provide
services to assist the Company in creating awareness of the Company's
goods and services and to assist in locating suitable corporate partners
and consultants to assist the Company with its business plan. It
provided that the services were not to be in connection with an offer or
sale of the Company's securities in a capital raising transaction. The
term of each of the agreements is for one year and each individual was
to receive 700,000 shares with a total of 7,000,000 shares being issued.
The Company filed Form S-8 to register the shares on March 18, 1997. The
Company valued the shares issued at $.10 per share since the agreements
had been negotiated during the last quarter of 1996 and there was
minimal activity in the stock. During the second quarter the Company
reacquired and retired 3,480,000 shares of the stock issued at no cost
and the contract with the individual was canceled. In addition, the
Company placed a hold on an additional 20,000 shares and treated these
shares as also being retired. During the third quarter of 1997 the
Company terminated the remaining contracts and wrote off the remaining
unamortized cost. The Company subsequently obtained and retired at no
cost an additional 900,000 shares of the stock that had been issued.
See Note 14 for pending litigation.

8
<PAGE> 43
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4: CONSULTING AGREEMENTS - (continued)

The Company entered into an agreement with Kenneth Freeman to provide
petroleum engineering services to the Company for a two year period in
exchange for 250,000 shares of stock. The shares were valued at $.18 per
share which represented the market price of the stock when the agreement
was reached. The Company registered the shares issued on Form S-8 on
August 27, 1997. The Company has recorded prepaid expense of $45,000
which is being amortized over the term of the agreement. The unamortized
balance at December 31, 1997 was $22,932. See Note 14 for pending
litigation.

The Company entered into an agreement with Scott MacCaughern to provide
consulting services to assist the Company obtaining a NASDAQ listing,
searching for possible merger candidates with a current listing,
including the necessary due diligence, negotiate with the holders of the
Company's convertible debentures for a possible buy out, assist in
creating awareness of the Company's goods and services and assist the
Company in obtaining a new investment banking firm. The term of the
agreement is for 36 months. The Company issued 500,000 shares of common
stock which was registered on Form S-8 on August 27, 1997. The Company
has recorded prepaid expenses of $875,000 based on the stock price when
the shares were issued which is being amortized over the term of the
agreement. At December 31, 1997, the total prepaid amount was $762,328
with $470,662 being reflected as non-current.

The Company entered into an agreement with Brian McKee to provide
consulting services to assist the Company obtaining a NASDAQ listing,
searching for possible merger candidates with a current listing,
including the necessary due diligence, negotiate with the holders of the
Company's convertible debentures for a possible buy out, assist in
creating awareness of the Company's goods and services and assist the
Company in obtaining a new investment banking firm. The term of the
agreement is for 36 months. The Company issued 500,000 shares of common
stock which was registered on Form S-8 on August 27, 1997. The Company
settled a lawsuit with McKee over the consulting agreement and received
425,000 shares of the stock at no cost which are held in treasury. In
the settlement the Company also issued warrants to purchase 75,000
shares at $1 per share which expired November 13, 1997. Since the
contract was terminated shortly after it was issued the only cost
related to this agreement was the 75,000 shares at par value of $.001 or
$75.

The Company entered into an agreement with Capital Communications, Ltd.
to provide assistance with investor communications and public relation
services with existing shareholders and brokers, dealers and other
investment professionals as to the Company's current and proposed
activities. The term of the agreement is for twelve months beginning on
September 8, 1997 and ending September 8, 1998. The Company issued
285,000 shares of its restricted common stock as compensation. The
Company recorded a prepaid expense of $464,550 based on the current
market price of the stock which is being amortized over the term of the
contract. The balance at December 31, 1997 was $319,458.

9
<PAGE> 44
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5: DEPOSITS ON PROPERTY ACQUISITION

On August 22, 1997, the Company entered into an agreement with Mont-Mill
Operating Company and the Bankruptcy Court to acquire the Two Medicine
Cut Bank Sand Unit. On January 7, 1998, the Company closed the
acquisition. The Company exchanged cash of $300,000 and 1,628,571 shares
of restricted common stock valued at $5,700,000 to acquire the property.
The estimated reserves acquired are estimated to be approximately
7,200,000 barrels of oil. The property was contributed to Provident
Energy Associates of Montana, L.L.C. (PEAM) (owned 75% by the Company
and 25% by Prism Corporation) which will operate the property. Prism
presented the prospect to the Company and received the 25% interest in
the L.L.C. as compensation for presenting the prospect. The property
consists of 82 well bores of which all but 10 are currently shut-in and
it is located on Blackfeet Indian Tribal lands, State of Montana lands
and private lease lands. The Company will be responsible for 100% of the
costs to restore the wells with Prism being carried through the
restoration. The Company entered into an agreement with the Bankruptcy
Court which allowed the Company to begin to work over certain wells to
increase production beginning in October 1997 prior to closing the
acquisition. The agreement compensated PEAM $3,500 per month for
operating the lease and allowed them to retain production in excess of
23 barrels per day until the sale closed and required them to pay all
operating costs. The Company began the restoration wells in October
1997 due to the severe winters restricting the work until the spring.
The Company recognized production revenue in 1997 of $21,930, production
taxes of $653, production and other expenses of $24,923 and overhead
income of $7,875. At December 31, 1997, the Company had advanced
$582,625 for the acquisition and work over costs which are included in
Deposits on Property Purchase.

NOTE 6: RELATED PARTY LEASE

The Company entered into an agreement with its president, C.E. Justice
to lease a building in Mineral Wells for a term of five years beginning
April 1, 1997. The lease requires monthly payments of $5,000 which may
be increased during the agreement. The Company can extend the lease for
an additional five years under the same terms and conditions. The lease
also contains an option to purchase the building during the term of the
leaser or its extensions at fair market value. The Company paid for
various improvements to the building which become the property of the
lessor and the lessor is granting credit against the lease for these
improvements. During 1997 the Company paid for improvements totaling
$222,049 and has recorded lease expense of $50,000. The unamortized
improvements at December 31, 1997 was $172,049 of which $112,049 is
reflected as non-current. The remaining minimum lease payments due under
the lease are as follows:

<TABLE>
<CAPTION>
Amount
----------
<S> <C> <C>
1998 $ 60,000
1999 60,000
2000 60,000
2001 60,000
2002 10,000
</TABLE>

10
<PAGE> 45
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7: ACQUISITION OF SUBSIDIARY

On April 2, 1997 the Company entered into an agreement with Energy
Reclaim Refrigeration, Inc. (ERR) and its sole shareholder to acquire
all of the outstanding shares of ERR (50,000,000 shares) in exchange
for 3,333,333 shares of the Company's restricted common stock. The only
asset of ERR at the time of the acquisition were patents for the
"By-Pass Chiller" and "Fresh Catch". These were contributed to ERR by
its sole stockholder and are reflected at the shareholder's cost of
$58,000. The acquisition was treated as a pooling of interest, however,
there were no operations prior to acquisition. The Company is
testing the proto type units for each of the patents and has not begun
commercial manufacturing of the units at December 31, 1997.

NOTE 8: NOTES PAYABLE

Notes payable include the following at December 31, 1997 and 1996:

<TABLE>
<CAPTION>
1997 1996
--------- --------
<S> <C> <C>
Unsecured notes payable to two stockholders,
due December 31, 1995, with interest at 8.5%. The notes payable have
been extended under the same terms, although no formal agreements have
been drafted. The terms described are the same as the existing
Note agreements. $ 75,593 $ 75,593

Notes payable to five stockholders, secured by oil and gas properties,
interest at 7% due monthly beginning November 15, 1995 with the
principal due September 15, 1996. At the option of the stockholders, the
maturity date can be extended. The notes payable were extended under the
same terms, although no
formal agreements have been drafted. 363,857
--------- --------

Total related party notes payable $ 75,593 $439,450
--------- --------

Unsecured loans, non-interest bearing, payable on demand $ $ 28,513
========= ========
</TABLE>

11
<PAGE> 46
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9: LONG-TERM DEBT

Long-term debt includes the following at December 31, 1997 and 1996:

<TABLE>
<CAPTION>
1997 1996
---------- ---------

Note payable to bank due in monthly installments of $569 including
<S> <C> <C>
interest at 10%, secured by a vehicle $ 18,468 $

Note payable secured by real estate, payable monthly with interest,
maturing in 1998 6,866

Debentures payable, due July 23, 1999, interest at 8%, unsecured.
Convertible to common stock 2,500,000
---------- ---------

2,525,334

Less: current maturities 12,079
---------- ---------

Long-term debt, net $2,513,255 $
========== ==========
</TABLE>

Future maturities of long term debt are $12,079 in 1998, $2,505,761 in
1999, $6,365 in 2000 and $1,129 in 2001.

The Company has also issued to the debenture holders warrants to
purchase 1,000,000 shares of common stock of the Company at the market
price of the stock on the effective date of the registration statement
registering the shares issued on conversion of the debentures to common
stock. The warrants are exercisable for two years from the date of the
registration statement.

NOTE 10:INCOME TAXES

Income before taxes and provisions for income tax expense (benefit) from
operations at December 31, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
1997 1996
-------------- --------------
<S> <C> <C>
Current federal income taxes $ -- $ --

Deferred federal income taxes -- --
-------------- --------------

Total $ -- $ --
============== ==============
</TABLE>

12
<PAGE> 47
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10: INCOME TAXES - (continued)

The actual income tax expense attributable to operations for the years
ended December 31, 1997 and 1996 differed from the amounts computed by
applying the U.S. federal tax rate of 34 percent to pretax earnings as
a result of the following:

<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Computed expected tax expense $(2,145,431) $ (81,884)

Effect of graduated tax rates 559,056 21,884

Valuation allowance related to deferred portion of tax (1,586,375) 60,000
----------- -----------

Provision (benefit) for income tax $ -- $ --
=========== ===========
</TABLE>

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Deferred tax assets:

Net operating loss $ 1,050,000 $ 195,000

Accounts receivable allowance 57,500 5,125

Stock option - compensation 42,500

Impairment charge on oil & gas properties 636,500

Less valuation allowance (1,786,500) (200,125)
----------- -----------

Net deferred tax assets $ $
=========== ===========
</TABLE>

Deferred income taxes reflect the tax consequences on future years of
differences between the tax basis of assets and liabilities and their
basis for financial reporting purposes. In addition, Statement of
Financial Accounting Standards No. 109 (SFAS 109) requires the
recognition of future tax benefits, such as net operating loss
carryforwards (NOLs), to the extent that realization of such benefits
are more likely than not.

The Company had NOLs of approximately $4,200,000 at December 31, 1997.
These NOLs expire in 2012 to 2014. A deferred tax asset was recorded
assuming that the benefits will be utilized at an average rate of 25%.
The full amount of the deferred tax asset was offset by a valuation
allowance due to the lack of operating history for the Company and the
need to raise additional funds to develop the current oil and gas
properties.

13
<PAGE> 48
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11: RELATED PARTY TRANSACTIONS

At December 31, 1997 and 1996, there were accounts receivable from
officers and stockholders for amounts advanced to them and for amounts
due on joint interest billings amounting to $0 and $345,026,
respectively. In addition, in 1996 there were amounts due to officers
and stockholders primarily for undistributed oil and gas production.
Substantially all of the liability can be offset against the joint
interest billing receivable noted above. As discussed in Note 8, at
December 31, 1997 and 1996 there are notes payable with stockholders
totaling $75,593 and $439,450 and accrued interest payable of $19,276
and $47,643, respectively.

At December 31, 1997 the Company has a liability to several
stockholders of the Company for funds that they have advanced to the
Company or are allowing the Company to utilize. Stockholders advanced
$250,000 to the Company in order that the Company could complete the
Montana oil and gas property purchase. In addition, a stockholder is
allowing the Company to utilize a $100,000 certificate of deposit to
satisfy a bonding requirement in conjunction with the purchase. These
amounts are secured by liens on the Texas oil and gas properties,
assignment of 40% of the Company's net production revenue from the
Montana property until the stockholders have been repaid their
investment plus 25%, and assignment of a carried working interest of
2.65% in the Montana property.

At December 31, 1997 the Company owed its President $80,759 for amounts
advanced to the Company. The amount is unsecured and non interest
bearing. In addition, the Company has issued notes payable totaling
$908,126 to certain officers and key employees in order to fund
salaries due under employment agreements. The notes are unsecured and
bear interest at 8.25% and are due December 31, 1998. The Company
anticipates issuing common stock to liquidate this debt, consequently,
the amount is not included in current liabilities.

NOTE 12: PROPERTIES AND EQUIPMENT

At December 31, 1997 and 1996, properties and equipment consisted of
the following:

<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Oil and gas properties $ 4,770,807 $ 1,609,739
Office equipment 70,224 8,319
Vehicles 34,503
Land 10,000
Buildings 53,500
Equipment 880,861 20,345
----------- -----------

5,819,895 1,638,403

Accumulated depreciation, depletion and amortization (2,819,190) (92,650)
----------- -----------

Net properties and equipment $ 3,000,705 $ 1,545,753
=========== ===========
</TABLE>

14
<PAGE> 49
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12: PROPERTIES AND EQUIPMENT - (continued)

During 1997 the Company acquired certain oil and gas properties, other
assets and related debt from various interest owners (Northridge
Properties) in exchange for 1,100,000 shares of the Company's
restricted common stock. The transaction was recorded based on the
market price of the stock since an independent reserve study was not
available. The Company's acquisition was recorded as follows:

<TABLE>
<S> <C>
Oil and gas properties $ 2,996,000
Buildings 35,000
Vehicles 14,505
Inventory 25,000
Notes payable (45,505)
-----------

Total $ 3,025,000
===========
</TABLE>

NOTE 13: OIL AND GAS PROPERTIES IMPAIRMENT CHARGE

The Company has decided to sell most of the Texas oil and gas
properties. Based on fair market value estimates (the estimated sales
prices that they will receive on the sale of the properties) the
Company has recorded a charge of $2,546,000 to write down the carrying
amounts of the properties. This charge is included in the Company's
results from operations for the year ended December 31, 1997, as oil
and gas properties impairment charge. The Company will not depreciate
or amortize the properties while they are held for disposal. The
Company anticipates completing the sale of the properties during the
second quarter of 1998. These are included in oil and gas properties at
approximately $608,000.

NOTE 14: CONTINGENCIES

At December 31, 1997 there were several potential liabilities due to
pending litigation. Management does not believe that these matters will
result in any liability to the Company, consequently, the Company has
not accrued any liability as a result of these matters. The matters are
summarized below:

On July 18, 1997, Jane Holder filed a Petition for Breach of Contract,
Estoppel and Conversion in the 43rd Judicial District Court of Parker
County, Texas, against the Company and C. E. Justice. Ms. Holder
alleges that she served as a consultant to Mr. Justice and the Company
for a period of time during 1995 and 1996, and that she introduced Mr.
Justice to individuals in California that resulted in the reverse
merger with Quiescent Corporation, and that she assisted in fund
raising for the Company in its initial Regulation D offering. Ms.
Holder contends that Mr. Justice promised that she would be given
250,000 shares of the Company's Common Stock in consideration for her
services, and that the parties had entered into a verbal contract
therefor. Ms. Holder seeks monetary damages for the value of the common
stock that was never issued, together with unpaid commissions on funds
she raised for the Company through its Regulation D offering, plus
reimbursement of expenses incurred in her travel for the Company
between Weatherford and California in assisting with the reverse merger
and Regulation D offering. The Company and Mr. Justice filed a timely
answer denying the allegations contained in the Petition, and the case
is currently in discovery.

15
<PAGE> 50
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 14: CONTINGENCIES - (continued)

In December 1997, Kenneth A. Freeman filed a Petition in the 43rd
Judicial District Court of Parker County, Texas, against the Company
and C.E. Justice alleging Breach of Contract of a Consulting Agreement
entered into between Mr. Freeman and the Company effective January 1,
1997. Mr. Freeman alleges that he entered into a two year consulting
agreement with the Company to provide petroleum engineering services as
requested from time to time by the Company in exchange for 250,000
shares of the Company's common stock to be registered on Form S-8. Mr.
Freeman claims a loss of value of his common stock due to a decline in
share price, alleging that the Company was negligent in not filing the
S-8 Registration sooner than it did. The Company and Mr. Justice have
filed a timely answer to the Petition and deny each and every
allegation contained therein. This case is currently in discovery.

On January 29, 1998, Eugene L. Bonacci, Donna Conley, Penelope Gallo,
Robert Gallo, Robert Maher, Sal Rausa, Randy Rufrano, Charles Stein,
individually and on behalf of Anthony Stein, J. Ralph Stein & Co.
Pension Trust, Roni L. Stein, Musser Enterprises Pension Trust and
Renee Feitelberg, Louis Vaccaro and Judith Vaccaro filed a complaint in
the United States District Court, Southern District of New York against
the Company, C. E. Justice, Brian T. McKee, Scott MacCaughern, Barbara
Matalon, Robert Horrigan and Merit Capital Associates, Inc. alleging
securities fraud and common law fraud in connection with certain
activities relating to the sale of the Company's stock. The Company was
served with this action on February 3, 1998, and is currently reviewing
the allegations with its outside securities and litigation counsel. The
Company will timely file a denial of the plaintiffs' allegations. Mr.
MacCaughern worked with Mr. Novielli in the coordination of the
services of the consultants and Mr. McKee was a stockbroker in New York
who was also introduced to the Company by Mr. Novielli. Merit Capital
Associates, Inc. is an investment firm that was introduced to the
Company by Mr. Novielli, and served as a market maker for the Company
at the request and direction of Mr. Novielli.

16
<PAGE> 51
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 14: CONTINGENCIES - (continued)

During the third quarter of 1997, information began to be received by
the Company from various individuals, including some of the named
Plaintiffs in the most recent complaint, that certain consultants and
possibly others were making improper offers in the market place of the
Company's Common Stock originally issued to the consultants as
compensation and registered by the Company on Form S-8. The Company
began an immediate investigation of these matters, and through its
President, Mr. C. E. Justice, terminated the remaining term of any and
all of the ten consulting agreements still in place. The Company
further terminated its relationship with Mr. Novielli and Dutchess
Capital. The Company has communicated with every party known to the
Company who has alleged that inducements were offered to them to
purchase Company stock in the open market that the Company had no
knowledge of this activity, it did not condone such activity and
believed the same to be a violation of securities laws, and that the
Company would not honor any promise or inducement offer made. As a part
of its investigation, the Company has sought to take sworn statements
from consultants and others, together with depositions and statements
from investors who claim to have been induced to make their investment.
Facts developed thus far through this investigation indicate that the
Company was fraudulently induced to enter into the original ten
consulting agreements and filed a registration statement on Forms-8.
The Company has made demand to the consultants to immediately return
all such S-8 stock to the Company. As noted above, the Company has
filed actions against Mr. Novielli and Mr. Sloan and has additionally
filed a claim in arbitration against Merit Capital and may file
further actions as facts are revealed in the Company's investigation.
The Company is committed to the pursuit of any and all parties who may
have been involved in the inappropriate use of its S-8 stock.

NOTE 15: EMPLOYMENT CONTRACTS

The Company has entered into employment contracts with seven officers,
directors and key employees. The employment contracts began in 1997 and
end January 2002. Five of the contracts provided for the employees to
receive 200,000 shares of the Company's restricted common stock. Those
shares were issued during the year and compensation expense of $180,000
was recorded based on the price of the stock when the agreements were
negotiated. The Company also issued to its president options to
purchase 5,000,000 shares of stock at $.01 per share. The options
expire December 31, 2003. The contracts are automatically renewed
unless either party gives notice with in the time frames specified in
the contracts. The contracts specify certain employee benefits such as
vacations, sick leave, death benefits, health insurance, stock options
and life insurance and provide for increases in compensation if certain
factors are met. The contracts can be terminated for cause or by mutual
consent of the parties involved. The future salaries payable under the
contracts are as follows:

<TABLE>
<S> <C> <C>
1998 $ 1,280,000
1999 1,330,000
2000 1,380,000
2001 1,430,000
2002 --
-----------
Total $ 5,420,000
===========
</TABLE>

17
<PAGE> 52
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 16: RETIREMENT PLAN

During October 1997 the Company instituted a Simple IRA retirement plan
covering substantially all employees. The Plan requires the Company to
match contributions of each participating employee up to three percent
of their salary or a maximum of $6,000. Retirement expense for the year
ended December 31, 1997 was $14,275.

NOTE 17: FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company has a number of financial instruments, none of which are
held for trading purposes. The following methods and assumptions were
used by the Company in determining its fair value disclosures for
financial instruments:

Accounts receivable, cash and accounts and revenue payable - It is
assumed that the amounts will be settled within the next operating
cycle for the recorded amounts. Consequently, the recorded amounts
approximate fair value.

Accounts receivable and advances payable related party - Since the
amounts are not due from (to) third parties, the payment terms are
subject to change. It is not practicable to estimate fair value.

Notes and debentures payable - Notes payable are primarily due to
stockholders. For those notes since the amounts are not payable to an
independent third party, it is not practicable to determine the fair
value. The debentures were issued in the current year to third parties
and are due within two years and are assumed to reflect fair value.
Notes payable to banks are not significant are assumed to be at fair
value.

NOTE 18: BUSINESS SEGMENTS

The Company operates in two business segments: oil and gas production
and commercial energy conservation product manufacturing. Listed below
are sales, operating income, depreciation, identifiable assets and
depreciation for each segment as of and for the year ended December 31,
1997. Identifiable assets include only those assets that are used
exclusively in the business segment.

<TABLE>
<CAPTION>
Oil and Gas Energy Corporate Consolidated
----------- ------ --------- ------------
<S> <C> <C> <C>
Sales $ 599,937 $ 3,203 $ $ 603,140
Operating income (loss) (2,582,065) (813,960) (2,716,966) (6,112,991)
Identifiable assets 2,579,660 1,114,514 1,901,501 5,595,675
Capital expenditures 3,161,068 912,471 107,953 4,181,492
Depreciation, depletion and amortization 147,018 23,736 9,786 180,540
</TABLE>

18
<PAGE> 53
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 19: STOCK OPTIONS

The Company has elected to follow Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees (APB 25) and related
interpretations in accounting for its employee stock options. During
1997 the Company issued options for 5,000,000 shares of the Company's
common stock at $.01 per share to its president as part of this
employment contract. The options expire December 31, 2003. None of the
options were exercised or expired during the current year. Because the
exercise price of the option was below the market price of the
underlying stock on the measurement date, the Company recorded prepaid
compensation of $850,000 and accrued compensation payable of $850,000.
The prepaid compensation is being amortized to expense over the five
year employment contract.

Pro forma information regarding net loss and loss per share is required
by Statement of Financial Accounting Standards No. 123, and has been
determined as if the Company had accounted for its stock options under
the fair value method of that Statement. The fair value for these
options was estimated at the date of the grant using the Black-Scholes
option pricing model with the following weighted-average assumptions
for 1997: risk free interest rate 5.5%, dividend yields of 0%,
volatility factors of the expected market price of the Company's common
stock of 5.182 and a expected life to the option of 5 years.

Option valuation models require the input of highly subjective
assumptions including the expected stock price volatility. Because the
Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value
estimate, in managements opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its
employee stock options.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options vesting period. The
Company's pro forma information for December 31, 1997 follows:

<TABLE>
<S> <C>
Pro forma net loss $(6,521,255)
Pro forma basic loss per share (.3771)
</TABLE>

The fair value of the options issued in 1997 was $.3812 per share
underlying the option.

NOTE 20: SIGNIFICANT CUSTOMERS

Purchasers of 10% or more of the Company's oil and gas production for
the years ended December 31, 1997 and 1996 are Team Energy Marketing
Co. 22% and 29%; Geer Tank Trucks, Inc. 15% and 32%; Atoka Resources
Corp. 27% and 29%; and Warren 14% and 1%, respectively.

19
<PAGE> 54
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 21: GOING CONCERN MATTERS

The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As shown
in the financial statements during the year ended December 31, 1997,
the Company incurred losses of $6,310,091 and had a deficit working
capital of approximately $550,000 and stockholders equity of $131,930.
In addition, the Company recorded an impairment loss of $2,546,000 on
its oil and gas properties and is in the process of selling certain
properties which will reduce future revenues, as well as, future
operating costs, the Company has employment agreements with various
officers and key employees which require annual salaries of $1,280,000
for 1998 although part of the cost may be satisfied with stock, the
Montana property requires expenditures to restore production in order
to increase the revenues of the Company, and Energy Reclaim
Refrigeration, Inc. is still testing its proto types and has not begun
commercial manufacturing. Additional costs will be incurred in order to
begin the commercial manufacturing.

The financial statements do not include any adjustments relating to the
recoverability and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern.
The Company's continuation as a going concern is dependent upon its
ability to raise additional capital, enter into agreements to assist in
funding future development costs on its oil and gas properties or its
manufacturing process, to obtain additional financing or refinancing as
may be required and beginning the manufacture and sale of the "By-Pass
Chiller" and the "Fresh Catch", as well as, other contract
manufacturing work. The Company is in negotiations regarding the
possible sale of a portion of the reserves in Montana for cash and the
secondary development of the property and has been actively seeking
contract manufacturing until commercial manufacturing begins.

NOTE 22: STANDARDS NOT YET IMPLEMENTED

At December 31, 1997, the Company had not yet implemented Financial
Accounting Standards Board Statement No. 130, Reporting Comprehensive
Income which is effective for years beginning after December 15, 1997.
This will be implemented during the first quarter of 1998.

In addition, the Company had not yet implemented Financial Accounting
Standards Board Statement No. 131, Disclosures About Segments of an
Enterprise and Related Information which is effective for years
beginning after December 31, 1997. This will be implemented during the
1998 year.

20
<PAGE> 55
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 23: OIL AND GAS PRODUCING ACTIVITIES

Capitalized Costs

Capitalized cost associated with oil and gas producing activities are
as follows at December 31, 1997 and 1996:

<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Proved properties $ 4,769,523 $ 1,608,455
Unproved properties 1,284 1,284
Accumulated depreciation, depletion and amortization (2,774,462) (81,444)
----------- -----------

Net capitalized costs $ 1,996,345 $ 1,528,295
=========== ===========
</TABLE>

Costs Incurred

Information relating to the Company's costs incurred in its oil and gas
operations is summarized as follows for the years ended December 31,
1997 and 1996:

<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Property acquisition $3,034,500 $ 1,284

Development 126,568 388
</TABLE>

Acquisition of Oil and Gas Properties

In April 1997 the Company purchased working interests in several oil
and gas properties and other assets and related liabilities (see Note
12) in exchange for 1,100,000 shares of restricted common stock valued
at $3,025,000. The values utilized to record this transaction were
based on share price when the agreement was signed since a reserve
evaluation by an independent petroleum engineer was not available. In
addition, the Company acquired additional interests in existing leases
from a stockholder for the stockholder's cost in the properties
($100,000), and acquired another lease for $38,500.

As discussed in Note 5, the Company had entered into an agreement to
acquire a producing property in Montana. The Company had advanced funds
to cover the down payment and work over costs on the property, however,
the acquisition did not close until January 7, 1998. The deposits on
the property acquisition are not included in the amounts above.

All of the Company's oil and gas properties were acquired in September
1995 and 1997 as described above. There were no sales of oil and gas
properties in 1996 and no allowance for impairment was deemed
necessary. Several of the properties acquired were plugged during 1996;
however, no loss was recognized for these retirements. As discussed in
Note 13, during 1997 the Company determined that an allowance for
impairment was necessary and a charge for impairment of $2,546,000 was
recorded. The Company anticipates selling a number of the properties
during 1998.

21
<PAGE> 56
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 23: OIL AND GAS PRODUCING ACTIVITIES - (continued)

Results of Operations

Results of operations for oil and gas producing activities are as
follows for the years ended December 31, 1997 and 1996:

<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Revenues $ 449,612 $ 244,540

Production costs (484,898) (244,030)

Depreciation and depletion (147,018) (62,206)
--------- ---------

(182,304) (61,696)
Net income tax
--------- ---------

Results of operations (excluding corporate overhead
and interest costs) $(182,304) $ (61,696)
========= =========
</TABLE>

Depreciation and depletion per dollar of production was $.33 and $.25
in 1997 and 1996, respectively.

Unaudited Oil and Gas Reserve Quantities

The following unaudited reserve estimates presented as of December 31,
1997 were prepared by management while the December 31, 1996 reserve
estimates were prepared by Harper & Associates, Inc., an independent
petroleum engineer. There are many uncertainties inherent in estimating
proved reserve quantities and in projecting future production rates and
the timing of development expenditures. In addition, reserve estimates
of new discoveries that have little production history are more
imprecise than those of properties with more production history.
Accordingly, these estimates are expected to change as future
information becomes available.

Proved oil and gas reserves are the estimated quantities of crude oil,
condensate, natural gas and natural gas liquids which geological and
engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing
economic and operating conditions.

Proved developed oil and gas reserves are those reserves expected to be
recovered through existing wells with existing equipment and operating
methods.

22
<PAGE> 57
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 23: OIL AND GAS PRODUCING ACTIVITIES - (continued)

Unaudited net quantities of proved reserves and proved developed
reserves of crude oil (including condensate) and natural gas (all of
which are located within the state of Texas) are as follows:

<TABLE>
<CAPTION>
Changes in Proved Reserves (Bbls) (MCF)
-------------------------- ---------- ----------
<S> <C> <C>
Estimated quantity, December 31, 1995 110,075 3,796,350

Production (3,823) (97,642)

Revisions of previous estimates 9,941 82,446
---------- ----------

Estimated quantity, December 31, 1996 116,193 3,781,154

Purchase of reserves 178,479 2,537,102

Production (8,389) (198,855)

Revisions of previous estimates (211,283) (2,964,804)
---------- ----------

Estimated quantity, December 31, 1997 75,000 3,154,597
========== ==========
</TABLE>

Unaudited Standardized Measure

The following table presents a standardized measure of the discounted
future net cash flows attributable to the Company's proved oil and gas
reserves. Future cash inflows were computed by applying year end prices
of proved oil and gas reserves. The future production and development
costs represent the estimated future expenditures (based on current
costs) to be incurred in developing and producing the proved reserves,
assuming continuation of existing economic conditions. Future income
tax expenses were computed by applying statutory income tax rates to
the difference between pre-tax net cash flows relating to the Company's
proved oil and gas reserves and the tax basis of proved oil and gas
properties and available net operating loss carry forwards. Discounting
the future net cash inflows at an arbitrary 10% is a method to measure
the impact of the time value of money.

<TABLE>
<CAPTION>
1997 1996
--------- ---------
(In thousands)
<S> <C> <C>
Future cash inflows $ 5,789 $ 8,645
Future production costs (1,683) (2,987)
Future development costs (1,005) (1,329)
Future income tax expense (1,054) (1,472)
--------- ---------

Future net cash flows 2,047 2,857
10% annual discount for estimated timing of cash flows (555) (971)
--------- ---------

Standardized measure of discounted future net cash flows $ 1,492 $ 1,886
========= =========
</TABLE>

23
<PAGE> 58
LONE STAR INTERNATIONAL ENERGY, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 23: OIL AND GAS PRODUCING ACTIVITIES - (continued)

The following presents the principal sources of the changes in the
standardized measure of discounted future net cash flows for the years
ended December 31, 1997 and 1996:

<TABLE>
<CAPTION>
1997 1996
---------- ----------
(In Thousands)
<S> <C> <C>
Standardized measure of discounted future net cash
flows, beginning of year $ 1,886 $ 1,687

Purchase of reserves in place 2,565

Sales and transfers of oil and gas produced, net of
production costs 35 (2)

Net changes in prices, production and development costs (146) 105

Net change in income taxes 1,523 (118)
Accretion of discount 381 169

Revisions of previous quantity estimates (4,171) 39

Other (581) 6
---------- ----------

Standardized measure of discounted future net cash
flows, end of year $ 1,492 $ 1,886
========== ==========
</TABLE>

24
<PAGE> 59

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- -----------
<C> <C>
2.1 Agreement dated as of April 10, 1995 between Cumberland Petroleum, Inc.
and Quiescent Corporation. (Previously filed as Exhibit 2.1 to the
Company's Report on Form 8-K dated May 19, 1995.) *

3.2 Bylaws of the Company. (Previously filed as the same exhibit number
with the Company's Annual Report on Form 10-KSB dated December 31,
1995.) *

* Incorporated herein by reference.

<PAGE> 60
<TABLE>
<C> <C>
10.13 Purchase and Sale Agreement Between Northridge Oil Company and Lone
Star International Energy, Inc. (Previously filed as the exhibit
number 10.1 with the Company's report on Form 8-K dated April 23,
1997.)*

10.16 Agreement of Acquisition (Previously filed as the exhibit
number 10.1 with the Company's report on Form 8-K dated April 7,
1997.)*

10.17 Employment Contract (Previously filed as the exhibit number 10.2
with the Company's report on Form 8-K dated April 7, 1997.)*

<PAGE> 61

21 List of Subsidiaries

27 Financial Data Schedule

<PAGE> 1

Exhibit 21

List of Subsidiaries

Cumberland Petroleum, Inc. a Texas corporation

Energy Reclaim Refrigeration, Inc., a Texas Corporation

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 15,230
<SECURITIES> 0
<RECEIVABLES> 444,112
<ALLOWANCES> 229,837
<INVENTORY> 0
<CURRENT-ASSETS> 1,323,398
<PP&E> 5,819,895
<DEPRECIATION> 2,819,190
<TOTAL-ASSETS> 6,275,678
<CURRENT-LIABILITIES> 1,872,354
<BONDS> 2,513,255
0
0
<COMMON> 19,805
<OTHER-SE> 112,155
<TOTAL-LIABILITY-AND-EQUITY> 6,275,678
<SALES> 449,612
<TOTAL-REVENUES> 603,140
<CGS> 0
<TOTAL-COSTS> 484,898
<OTHER-EXPENSES> 6,231,233
<LOSS-PROVISION> 229,837
<INTEREST-EXPENSE> 202,135
<INCOME-PRETAX> (6,310,091)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,310,091)
<EPS-PRIMARY> (0.365)
<EPS-DILUTED> (0.365)

</TABLE>