NATIONAL ENERGY GROUP INC, 10-Q, 1999-10-29

NATIONAL ENERGY GROUP INC
10-Q, 1999-10-29
CRUDE PETROLEUM & NATURAL GAS

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<PAGE> 1
================================================================================

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

----------------------

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999

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

Commission File No. 0-19136 (Common Stock)
and 333-9045 (Series B Senior Notes)
and 333-38075 (Series D Senior Notes)

NATIONAL ENERGY GROUP, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 58-1922764
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)

1400 ONE ENERGY SQUARE
4925 GREENVILLE AVENUE
DALLAS, TEXAS 75206
(Address of principal executive offices)

(214) 692-9211
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

40,527,482 shares of the registrant's Common Stock, $0.01 par value,
were outstanding on October 29, 1999.

================================================================================

<PAGE> 2

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
INDEX

<TABLE>
<CAPTION>
PAGE NO.
PART I. FINANCIAL INFORMATION -------
<S> <C> <C>
Item 1. Financial Statements
Consolidated Balance Sheets at December 31, 1998 and September 30, 1999
(Unaudited)..................................................................... 1
Consolidated Statements of Operations for the three and nine months ended
September 30, 1998 and 1999 (Unaudited)......................................... 2
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1998 and 1999 (Unaudited)................................... 3
Consolidated Statement of Stockholders' Equity (Deficit) for the nine months ended
September 30, 1999 (Unaudited).................................................. 4
Notes to Consolidated Financial Statements (Unaudited)............................. 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................................... 11
Item 3. Quantitative and Qualitative Disclosure about Market Risk.......................... 20

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.................................................................. 21
Item 3. Defaults Upon Senior Securities.................................................... 21
Item 5. Other Information.................................................................. 21
Item 6. Exhibits and Reports on Form 8-K................................................... 21
</TABLE>

<PAGE> 3

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS

<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1998 1999
---------------- ---------------
<S> <C> <C>
Current assets:
Cash and cash equivalents.......................................... $ 2,542,235 $ 19,037,894
Marketable securities.............................................. 339,250 387,188
Accounts receivable--oil and natural gas sales..................... 5,030,155 5,527,645
Accounts receivable--joint interest and other...................... 1,918,411 538,234
Other.............................................................. 1,905,050 1,335,645
---------------- ---------------
Total current assets............................................ 11,735,101 26,826,606
Oil and natural gas properties, at cost (full cost method):
Subject to ceiling limitation...................................... 327,459,034 329,341,299
Accumulated depreciation, depletion, and amortization.............. (251,712,879) (263,597,419)
---------------- ---------------
Net oil and natural gas properties.............................. 75,746,155 65,743,880
Other property and equipment........................................... 2,601,163 2,495,606
Accumulated depreciation........................................... (989,905) (1,246,713)
---------------- ---------------
Net other property and equipment................................ 1,611,258 1,248,893
Other assets and deferred charges, net................................. 5,909,344 6,073,037
---------------- ---------------
Total assets....................................................... $ 95,001,858 $ 99,892,416
================ ===============

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Liabilities not subject to compromise:
Current liabilities:
Accounts payable-trade.......................................... $ 2,019,114 $ 1,797,943
Accounts payable-revenue........................................ 4,446,696 2,094,356
Credit facility................................................. 25,000,000 25,000,000
Accrued interest on credit facility............................. 280,160 --
Senior Notes including unamortized issuance premium............. 166,238,513 --
Accrued interest on Senior Notes................................ 10,537,601 --
Current portion of gas prepayments.............................. 485,845 --
Other........................................................... 561,049 --
---------------- ---------------
Total current liabilities.................................... 209,568,978 28,892,299
Long-term liabilities:
Gas balancing and prepayments................................... 2,052,691 --
Other........................................................... 312,957 --
Liabilities subject to compromise:
Accounts payable-trade.......................................... -- 1,956,756
Accounts payable-revenue........................................ -- 3,156,050
Senior Notes including unamortized issuance premium............. -- 166,119,932
Accrued interest on Senior Notes................................ -- 10,537,601
Gas balancing and prepayments................................... -- 2,690,119
Other........................................................... -- 147,844
---------------- --------------
Total liabilities subject to compromise...................... -- 184,608,302
Commitments and contingencies (Note 6)
Stockholders' equity (deficit):
Convertible preferred stock, $1.00 par:
Authorized shares--1,000,000; Issued and outstanding shares--171,187
Aggregate liquidation preference--$17,118,700................... 171,187 171,187
Common stock, $.01 par value:
Authorized shares--100,000,000; Issued and outstanding shares--
40,527,482 at December 31, 1998 and September 30, 1999,
respectively................................................... 405,275 405,275
Additional paid-in capital......................................... 113,089,872 113,089,872
Unrealized loss on marketable securities, net...................... (176,094) (128,157)
Accumulated deficit................................................ (230,423,008) (227,146,362)
---------------- ---------------
Total stockholders' equity (deficit)............................ (116,932,768) (113,608,185)
---------------- ---------------
Total liabilities and stockholders' equity (deficit)............... $ 95,001,858 $ 99,892,416
================ ===============
</TABLE>

See accompanying notes.

1
<PAGE> 4

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- --------------------------------
1998 1999 1998 1999
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues:
Oil and natural gas sales.............................. $ 8,573,214 $ 11,208,832 $ 29,646,157 $ 27,798,898

Cost and expenses:
Lease operating........................................ 2,217,486 1,520,589 6,303,066 4,417,165
Oil and natural gas production taxes................... 700,841 484,002 1,959,587 1,381,007
Depreciation, depletion, and amortization.............. 5,050,793 4,132,029 16,983,673 12,886,651
Write-down of oil and natural gas properties........... 38,650,000 -- 89,950,000 --
Restructuring charges.................................. 274,725 -- 872,971 --
General and administrative............................. 1,369,442 900,985 4,303,401 3,024,045
--------------- --------------- --------------- ---------------
Total costs and expenses.............................. (48,263,287) 7,037,605 120,372,698 21,708,868
--------------- --------------- --------------- ---------------
Operating income (loss)................................... (39,690,073) 4,171,227 (90,726,541) 6,090,030
Other income (expense):
Interest expense....................................... (3,971,558) (482,166) (11,231,026) (1,405,246)
Interest income and other, net......................... 69,552 -- 354,148 --
--------------- --------------- --------------- ---------------
Income (loss) before reorganization items
and income taxes....................................... (43,592,079) 3,689,061 (101,603,419) 4,684,784
Reorganization items:
Professional fees and other............................ -- (709,863) -- (1,853,468)
Interest earned on accumulating cash resulting from
Chapter 11 proceedings................................ -- 187,280 -- 445,330
--------------- --------------- --------------- --------------
Income (loss) before income taxes......................... (43,592,079) 3,166,478 (101,603,419) 3,276,646
Provision for income taxes................................ -- -- -- --
--------------- --------------- --------------- --------------
Net income (loss) ........................................ (43,592,079) 3,166,478 (101,603,419) 3,276,646
Preferred stock dividend requirements..................... (157,095) -- (471,285) --
--------------- --------------- --------------- --------------
Net income (loss) applicable to common shareholders....... $ (43,749,174) $ 3,166,478 $ (102,074,704 $ 3,276,646
=============== =============== =============== ==============

Net income (loss) per common share, basic and diluted..... $ (1.08) $ .08 $ (2.52) $ .08
=============== ============== =============== ==============
Weighted average number of common shares outstanding...... 40,509,419 40,527,482 40,490,585 40,527,482
=============== =============== =============== ==============
</TABLE>

See accompanying notes.

2
<PAGE> 5

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
1998 1999
------------- -------------

<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) .................................................... $(101,603,419) $ 3,276,646
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation, depletion, and amortization ......................... 16,983,673 12,886,651
Write-down of oil and natural gas properties ..................... 89,950,000 --
Amortization of issuance premium .................................. (118,582) (118,582)
Amortization of deferred compensation ............................. 31,457 34,078
Common stock, options, and warrants issued for services ........... 32,811 11,248
Other ............................................................. 256,242 (109,903)
Changes in operating assets and liabilities:
Accounts receivable ............................................ 8,225,627 874,449
Other current assets ........................................... 696,294 717,637
Accounts payable and accrued liabilities ....................... (11,779,193) 1,887,685
------------- -------------
Net cash provided by operating activities .................... 2,674,910 19,459,909
------------- -------------

INVESTING ACTIVITIES
Purchases of other property and equipment ............................ (511,954) --
Oil and gas acquisition, exploration, and development expenditures.... (46,881,351) (3,036,672)
Proceeds from sales of oil and gas properties ........................ -- 597,907
Purchases of other long-term assets .................................. (594,476) (529,295)
Other ................................................................ 15,020 3,810
------------- -------------
Net cash used in investing activities ........................ (47,972,761) (2,964,250)
------------- -------------

FINANCING ACTIVITIES
Proceeds from credit facility ........................................ 30,000,000 --
Repayments of credit facility ........................................ (5,000,000) --
Repayments of other long-term liabilities ............................ (26,918) --
Proceeds from exercise of stock options and warrants ................. 93,750 --
Proceeds from employee stock purchase plan ........................... 56,420 --
Preferred stock dividends ............................................ (314,185) --
------------- -------------
Net cash provided by financing activities .................... 24,809,067 --
------------- -------------
Increase (decrease) in cash and cash equivalents ..................... (20,488,784) 16,495,659
Cash and cash equivalents and beginning of period .................... 25,954,479 2,542,235
------------- -------------
Cash and cash equivalents at end of period ........................... $ 5,465,695 $ 19,037,894
============= =============

SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid in cash ................................................ $ 9,534,005 $ 1,788,761
============= =============

</TABLE>

See accompanying notes.

3
<PAGE> 6

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)

CONVERTIBLE UNREALIZED
PREFERRED STOCK COMMON STOCK ADDITIONAL LOSS
------------------------- --------------------------- PAID-IN ON MARKETABLE
SHARES AMOUNT SHARES AMOUNT CAPITAL SECURITIES
----------- ----------- ------------- ------------ -------------- ---------------

<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1998..... 171,187 $ 171,187 40,527,482 $ 405,275 $ 113,089,872 $ (176,094)
Unrealized gain on marketable
securities................. -- -- -- -- -- 47,937
Net income.................... -- -- -- -- -- --
----------- ---------- ------------- ------------ ------------- ----------
Balance at September 30, 1999.... 171,187 $ 171,187 40,527,482 $ 405,275 $ 113,089,872 $ (128,157)
=========== =========== ============= ============ ============== ==========
</TABLE>

<TABLE>
<CAPTION>
TOTAL
STOCKHOLDERS'
ACCUMULATED EQUITY
DEFICIT (DEFICIT)
--------------- ----------------

<S> <C> <C>
Balance at December 31, 1998..... $ (230,423,008) $ (116,932,768)
Unrealized gain on marketable
securities................. -- 47,937
Net income.................... 3,276,646 3,276,646
-------------- ----------------
Balance at September 30, 1999.... $ (227,146,362) $ (113,608,185)
============== ================
</TABLE>

See accompanying notes.

<PAGE> 7

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1999

1. PETITION FOR RELIEF UNDER CHAPTER 11

On December 4, 1998, certain of the holders of the Senior Notes (see Note 5)
of National Energy Group, Inc. (the "Company") filed an Involuntary Petition for
an Order for Relief under Chapter 11 of Title 11 of the United States Bankruptcy
Code in the United States Bankruptcy Court for the Northern District of Texas,
Dallas Division, due to non-payment of interest due December 2, 1998, after
expiration of a 30-day grace period. On December 23, 1998, the Company filed, in
the Bankruptcy Court, an Answer to and Motion to Dismiss the pending Involuntary
Petition. The Company's Motion affirmed that it (i) was meeting its obligations
and generally paying its debts as they become due, unless such debts were the
basis of a bona fide dispute and (ii) had arranged with the lender under its
credit facility to borrow additional funds sufficient to pay the interest due on
the Senior Notes, conditioned upon the Court's dismissal of the Involuntary
Petition. However, on February 8, 1999, the Bankruptcy Court denied the
Company's Motion to Dismiss the Involuntary Petition. An Order for Relief was
entered by the Bankruptcy Court on February 11, 1999. The Order for Relief
places the Company under the protection of the Court and precludes payment of
the interest on the Senior Notes at this time. Additionally, payment of
liabilities existing as of February 11, 1999 to certain unsecured creditors and
dividends in arrears to holders of the Company's preferred stock and any pending
litigation are stayed during the Bankruptcy proceeding. The Company shall act as
debtor-in-possession and will continue to operate its business and manage its
properties in the ordinary course of business during its Chapter 11 proceeding.
As a result of the Chapter 11 filing, the Company discontinued the accrual of
interest on the unsecured Senior Notes and discontinued the accrual of dividends
on the unsecured preferred stock. Approximately $13.3 million additional
interest expense would have been recognized by the Company for the first nine
months of 1999 if not for the discontinuation of the interest accrual on the
Senior Notes.

On August 4, 1999, the Company and the unsecured creditors' committee (the
"Committee") appeared before the Bankruptcy Court and announced agreement on the
process for marketing the Company and/or its assets. The Court entered an order
which provided that the Company and the Committee would employ CIBC World
Markets Corp. ("CIBC") to solicit bids for sale of the Company and/or its
assets. The Company will assist CIBC in assembling a data room for potential
bidders to view information regarding the Company's assets. CIBC will market the
Company's assets pursuant to procedures approved by the Company, the Committee
and the Court. The marketing process will culminate in an auction to be
conducted by the Bankruptcy Court on November 1, 1999. The Committee will have
the sole right to select the highest and best bid and only the Committee's
selected bid will be presented to the Court for approval. Alternatively, the
Committee, at its discretion, may reject all bids. The Court also extended the
Company's period of exclusivity (the statutory period during which only the
Company may file a plan of reorganization) through the marketing process and
auction of the Company's assets. During this period of exclusivity, the Company
has agreed not to file a plan of reorganization. If a proposal to purchase the
Company's assets is selected by the Committee and approved by the Court, then
either the Committee or the Company may propose a plan of reorganization. If the
Committee rejects all bids, or if the Court does not approve a sale of the
Company's assets, then the Company may file a plan or reorganization and the
Committee may seek to terminate exclusivity and file a plan of reorganization.
However, if the Committee requests a hearing to terminate exclusivity, the
Company has agreed not to file a plan of reorganization prior to the Court's
ruling on the Committee's motion. In addition, the Court approved the retention
of Netherland, Sewell & Associates, Inc. to (i) complete its reserve evaluation
of the Company's oil and natural gas properties as of December 31, 1998, (ii)
update the reserve evaluation as of July 1, 1999 and (iii) provide assistance to
the Company, CIBC and prospective buyers during the marketing process. On July
9, 1999, the Court approved Neligan & Averch, L.L.P., as bankruptcy counsel for
the Company. Pursuant to an agreed order between the Company and the Committee,
the Court entered an order on September 7, 1999 approving a severance program
for the Company's employees which provides for certain payments in the event of
a closing of the sale of substantially all the Company's assets or confirmation
of a plan of reorganization; provided such employee is not terminated for cause
or does not voluntarily resign prior to such event. The order also provides that
Mr. Alexander, CEO, and Mr. Devlin, Vice President and General Counsel, shall
not be entitled to any such payments until the earlier of (i) confirmation of a
plan of reorganization, (ii) conversion to a Chapter 7 proceeding, or (iii)
termination by a trustee. Payments under this program could be approximately $2
million if both the stay bonus and severance portions are paid in full.

5
<PAGE> 8

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1999

1. PETITION FOR RELIEF UNDER CHAPTER 11 (CON'T)

The accompanying consolidated financial statements have been prepared on a
going concern basis of accounting and do not reflect any adjustments that might
result should the Company be unable to continue as a going concern. The
Company's prior losses from operations and the related Chapter 11 proceeding
raise concern about its ability to continue as a going concern. The
appropriateness of using the going concern basis is dependent upon, among other
things, (i) confirmation of a plan of reorganization under the Bankruptcy Code,
(ii) the ability to achieve profitable operations after such confirmation and
(iii) the ability to generate sufficient cash from operations to meet its
obligations, (iv) the extension of the Company's exclusive right to file a plan
of reorganization through the marketing process and (v) the fact that the
committee, at its discretion, may reject all bids at which time the Company
could put forth a plan of reorganization.

2. BASIS OF PRESENTATION

In management's opinion, the accompanying consolidated financial statements
contain all adjustments (consisting solely of normal recurring accruals)
necessary to present fairly the financial position of the Company as of December
31, 1998 and September 30, 1999, the results of operations for the three and
nine months ended September 30, 1998 and 1999, and the cash flows for the nine
months ended September 30, 1998 and 1999.

The accompanying unaudited consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and disclosures normally included in annual
financial statements prepared in accordance with generally accepted accounting
principles have been omitted pursuant to those rules and regulations, although
the Company believes that the disclosures made are adequate to make the
information presented not misleading. These financial statements should be read
in conjunction with the Company's consolidated financial statements and notes
thereto included in the Company's consolidated Annual Report on Form 10-K for
the year ended December 31, 1998.

Certain previously reported amounts have been reclassified to conform with
the current presentation.

The results of operations for the nine months ended September 30, 1999, are
not necessarily indicative of the results expected for the full year.

The Company capitalizes internal general and administrative costs that can
be directly identified with acquisition, exploration, and development
activities. These costs totaled approximately $582,000 and $186,000,
respectively, for the three months ended September 30, 1998 and 1999. These
costs totaled approximately $1,567,000 and $679,000, respectively, for the nine
months ended September 30, 1998 and 1999. The Company capitalized interest costs
of approximately $905,000 and $2,824,000, respectively, for the three and nine
months ended September 30, 1998. The Company did not capitalize interest costs
during 1999.

Overhead reimbursements received from joint interest partners which are
included as a reduction of general and administrative expense totaled
approximately $204,000 and $271,000 for the three months ended September 30,
1998 and 1999, respectively and totaled $712,000 and $673,000 for the nine
months ended September 30, 1998 and 1999, respectively.

As of January 1, 1998, the Company adopted Financial Accounting Standards
Board Statement No. 130, Reporting Comprehensive Income. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources.
Statement 130 establishes rules for the reporting and display of comprehensive
income and its components. For the three and nine months ended September 30,
1998 and 1999, the differences between net income and total comprehensive income
were not material.

6
<PAGE> 9

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1999

3. ACQUISITIONS

On March 31, 1998, the Company acquired Fortune Natural Resources
Corporation's 12.5% working interest in the East Bayou Sorrel Field for $4.5
million in cash. This acquisition did not have a significant impact on the 1998
results of operations.

4. CREDIT FACILITY

On August 29, 1996, the Company, NEG-OK, Inc. and Boomer Marketing, entered
into a credit facility with Bank One, Texas, N.A. ("Bank One") as Bank and
Administrative Agent, and the Credit Lyonnais New York Branch, as Bank and
Syndication Agent (collectively with Bank One, the "Banks"). The credit facility
consisted of a $100.0 million reducing revolving line of credit, with an initial
borrowing base of $60.0 million and a $5.0 million term loan. Interest under the
reducing revolving line of credit was payable monthly at the Bank One base rate,
as adjusted.

In November 1996, the Company repaid the outstanding borrowings under the
credit facility with a portion of proceeds from the issuance of $100.0 million
principal amount of Series A Senior Notes. See Note 5.

In connection with the issuance of the Series A Notes in 1996, the Company
revised the credit facility. The revised credit facility had a borrowing base of
$25.0 million. The borrowing base may be redetermined at least semiannually and
may require mandated monthly principal reductions from time to time. The
principal amount of any borrowings is due at maturity, August 29, 2000 and
interest is payable monthly.

The Company granted liens to the Banks on substantially all of the Company's
oil and natural gas properties, whether currently owned or hereafter acquired,
and a negative pledge on all other oil and natural gas properties. The credit
facility requires, among other things, semiannual engineering reports covering
oil and natural gas properties, and maintenance of certain financial ratios,
including the maintenance of a minimum interest coverage, a current ratio, and a
minimum tangible net worth.

The credit facility contains other covenants prohibiting cash dividends,
distributions, loans, or advances to third parties, except that cash dividends
on preferred stock will be allowed so long as no event of default exists or
would exist as a result of the payment thereof. In addition, if the Company is
required to purchase or redeem any portion of the Senior Notes, or if any
portion of the Senior Notes become due, the borrowing base is subject to
reduction.

The Company is required to pay a commitment fee on the unused portion of the
borrowing base equal to 1% per annum.

On December 7, 1998, the Banks gave notice to the Company that all
outstanding obligations under the credit facility were accelerated and were
immediately due and payable due to certain unspecified Events of Default as
defined in the loan agreement.

Effective December 22, 1998, the credit facility and all associated liens
were assigned by the Banks to Arnos, Inc., ("Arnos") an affiliated subsidiary of
the Company's Series D preferred stockholder. In a letter dated December 23,
1998, Arnos (1) rescinded the acceleration of the loan, (2) waived all defaults
existing at that time and (3) made sufficient borrowings available to pay the
interest on the Senior Notes that was due on November 2, 1998, conditioned upon
the Bankruptcy Court's dismissal of the Involuntary Petition. The Company is
currently paying interest expense at an 8.5% rate under the Arnos credit
facility. The Company had $25,000,000 outstanding under the Arnos credit
facility as of September 30, 1999. At September 30, 1999, the Company was in
violation of the minimum interest coverage ratio and current ratio covenants
under the Arnos credit facility and as a result has classified the amount
outstanding as a current liability.

7
<PAGE> 10

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1999

4. CREDIT FACILITY (CON'T)

At September 30, 1999, the fair value of borrowings under the Arnos credit
facility approximates the carrying value of the liability. Pursuant to the Order
for Relief dated February 11, 1999, the Company is prohibited from obtaining
further borrowings without Court approval.

On August 4, 1999, the Bankruptcy Court entered an order which provided that
if the Court approves the sale of the Company's assets or if the creditors
committee proposes a plan of reorganization following such a sale, then Arnos
shall be paid in full, from the sales proceeds, the amount outstanding under the
secured loan, including any unpaid interest. If no sale of the Company's assets
is approved and an internal reorganization of the Company's debt structure is
approved, the creditors committee may propose any treatment of the Arnos credit
facility allowed by law, and Arnos shall retain its right to oppose any such
treatment. The order also provided for the immediate payment to Arnos for all
monthly interest on its secured claim at the contractual non-default rate,
retroactive to December 4, 1998. Pursuant to this order, the Company paid
approximately $1.4 million in interest to Arnos on August 10, 1999 and has paid
monthly interest due subsequent to August 10, 1999.

5. 10 3/4% SENIOR NOTES DUE 2006

In November 1996, the Company issued $100 million aggregate principal amount
of unregistered Series A Notes (the "Series A Notes"). The net proceeds of the
Series A Notes of approximately $96.1 million were used to repay approximately
$62.0 million of borrowings under a prior facility and to increase the Company's
working capital. In 1997, the Series A Notes were exchanged for registered
10 3/4% Senior Notes due 2006 (the "Series B Notes") which were substantially
identical to the Series A Notes. Collectively, the Series A Notes and Series B
Notes are referred to as "the Series A/B Notes". In August 1997, the Company
issued $65.0 million aggregate principal amount of its unregistered 10 3/4%
Senior Notes (the "Series C Notes"). The net proceeds of the Series C Notes of
approximately $64.8 million were used to repay approximately $23.0 million of
borrowings under the credit facility and to increase the Company's working
capital. In December 1997, the Company exchanged substantially all of the Series
A/B Notes and all of the Series C Notes for registered 10 3/4% Senior Notes due
2006 (the "Series D Notes"). The Series D Notes are substantially identical to
the Series A/B Notes and the Series C Notes. Collectively, the Series A/B Notes,
the Series C Notes and the Series D Notes are referred to as the "Senior Notes."
The Senior Notes bear interest at an annual rate of 10 3/4%, payable
semiannually in arrears on May 1 and November 1 of each year. The Senior Notes
are senior, unsecured obligations of the Company, ranking pari passu with all
existing and future senior indebtedness of the Company, and senior in right of
payment to all future subordinated indebtedness of the Company.

On December 4, 1998, certain of the holders of the Senior Notes of the
Company filed an Involuntary Petition for an Order for Relief under Chapter 11
of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy
Court for the Northern District of Texas, Dallas Division, due to non-payment of
interest due December 2, 1998, after expiration of a 30-day grace period. On
December 23, 1998, the Company filed, in the Bankruptcy Court, an Answer to and
Motion to Dismiss the pending Involuntary Petition. The Company's Motion
affirmed that it (i) was meeting its obligations and generally paying its debts
as they become due, unless such debts were the basis of a bona fide dispute and
(ii) had arranged with the lender under its credit facility to borrow additional
funds sufficient to pay the interest due on the Senior Notes, conditioned upon
the Court's dismissal of the Involuntary Petition. However, on February 8, 1999,
the Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary
Petition. An Order for Relief was entered by the Bankruptcy Court on February
11, 1999. The Order for Relief places the Company under the protection of the
Court and precludes payment of the interest on the Senior Notes at this time.
Additionally, payment of liabilities existing as of February 11, 1999 to certain
unsecured creditors and dividends in arrears to holders of the Company's
preferred stock and any pending litigation are stayed during the Bankruptcy
proceeding. The Company shall act as debtor-in-possession and will continue to
operate its

8
<PAGE> 11

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1999

5. 10 3/4% SENIOR NOTES DUE 2006 (CON'T)

business and manage its properties in the ordinary course of business during its
Chapter 11 proceeding. As a result of the Chapter 11 filing, the Company
discontinued the accrual of interest on the unsecured Senior Notes and
discontinued the accrual of dividends on the unsecured preferred stock.
Approximately $13.3 million additional interest expense would have been
recognized by the Company for the first nine months of 1999 if not for the
discontinuation of the interest accrual on the Senior Notes.

On August 4, 1999, the Company and the Committee appeared before the
Bankruptcy Court and announced agreement on the process for marketing the
Company and/or its assets. The Court entered an order which provided that the
Company and the Committee would employ CIBC to solicit bids for sale of the
Company and/or its assets. The Company will assist CIBC in assembling a data
room for potential bidders to view information regarding the Company's assets.
CIBC will market the Company's assets pursuant to procedures approved by the
Company, the Committee and the Court. The marketing process will culminate in an
auction to be conducted by the Bankruptcy Court on November 1, 1999. The
Committee will have the sole right to select the highest and best bid and only
the Committee's selected bid will be presented to the Court for approval.
Alternatively, the Committee, at its discretion, may reject all bids. The Court
also extended the Company's period of exclusivity (the statutory period during
which only the Company may file a plan of reorganization) through the marketing
process and auction of the Company's assets. During this period of exclusivity,
the Company has agreed not to file a plan of reorganization. If a proposal to
purchase the Company's assets is selected by the Committee and approved by the
Court, then either the Committee or the Company may propose a plan of
reorganization. If the Committee rejects all bids, or if the Court does not
approve a sale of the Company's assets, then the Company may file a plan or
reorganization and the Committee may seek to terminate exclusivity and file a
plan of reorganization. However, if the Committee requests a hearing to
terminate exclusivity, the Company has agreed not to file a plan of
reorganization prior to the Court's ruling on the Committee's motion. In
addition, the Court approved the retention of Netherland, Sewell & Associates,
Inc. to (i) complete its reserve evaluation of the Company's oil and natural gas
properties as of December 31, 1998, (ii) update the reserve evaluation as of
July 1, 1999 and (iii) provide assistance to the Company, CIBC and prospective
buyers during the marketing process. On July 9, 1999, the Court approved Neligan
& Averch, L.L.P., as bankruptcy counsel for the Company. Pursuant to an agreed
order between the Company and the Committee, the Court entered an order on
September 7, 1999 approving a severance program for the Company's employees
which provides for certain payments in the event of a closing of the sale of
substantially all the Company's assets or confirmation of a plan of
reorganization; provided such employee is not terminated for cause or does not
voluntarily resign prior to such event. The order also provides that Mr.
Alexander, CEO, and Mr. Devlin, Vice President and General Counsel, shall not be
entitled to any such payments until the earlier of (i) confirmation of a plan of
reorganization, (ii) conversion to a Chapter 7 proceeding, or (iii) termination
by a trustee. Payments under this program could be approximately $2 million if
both the stay bonus and severance portions are paid in full.

At September 30, 1998 and 1999, unamortized issuance premiums associated
with the Senior Notes totaled $1,238,513 and $1,119,932, respectively.

The Indenture contains certain covenants limiting the Company and any
Restricted Subsidiaries, with respect to the following: (i) assets sales; (ii)
restricted payments; (iii) the incurrence of additional indebtedness and the
issuance of certain redeemable preferred stock; (iv) liens; (v) sale and
leaseback transactions; (vi) lines of business; (vii) dividend and other payment
restrictions affecting subsidiaries; (viii) mergers and consolidations; and (ix)
transactions with affiliates.

9
<PAGE> 12

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1999

6. COMMITMENTS AND CONTINGENCIES

Other than the Bankruptcy Court proceeding, the Company is not a defendant
in any material pending legal proceedings.

7. CRUDE OIL AND NATURAL GAS PRODUCING ACTIVITIES

The Company follows the full cost method of accounting for oil and natural
gas properties. Under such method, the net book value of such properties, less
related deferred income taxes, may not exceed a calculated "ceiling." The
ceiling is the estimated after-tax future net revenues from proved oil and
natural gas properties, discounted at 10% per year. In calculating future net
revenues, prices and costs in effect at the time of the calculation are held
constant indefinitely, except for charges which are fixed and determinable by
existing contracts.

The net book value is compared to the ceiling on a quarterly and yearly
basis. The excess, if any, of the net book value above the ceiling is required
to be written off as a non-cash expense. At September 30, 1999, the net book
value of the Company's oil and natural gas properties did not exceed the full
cost ceiling based on the weighted average prices of crude oil and natural gas
received by the Company, and therefore no writedown was required. At March 31,
1998, June 30, 1998, and September 30, 1998 the net book value of the Company's
oil and natural gas properties exceeded the full cost ceiling, based on the
weighted average prices of crude oil and natural gas received by the Company,
resulting in non-cash writedowns of $26.5 million, $24.8 million and $38.7
million, respectively. There can be no assurance that there will not be
additional writedowns in future periods under the full cost method of accounting
as a result of sustained decreases in oil and natural gas prices or other
factors.

10
<PAGE> 13

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

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

The information below should not be construed to imply that the results
discussed herein will necessarily continue into the future or that any
conclusion reached herein will necessarily be indicative of actual operating
results in the future. Such discussion only represents the best present
assessment by management of the Company.

On August 4, 1999, the Company and the unsecured creditors' committee (the
"Committee") appeared before the Bankruptcy Court and announced agreement on the
process for marketing the Company and/or its assets. The Court entered an order
which provided that the Company and the Committee would employ CIBC World
Markets Corp. ("CIBC") to solicit bids for the sale of the Company and/or its
assets. The Company will assist CIBC in assembling a data room for potential
bidders to view information regarding the Company's assets. CIBC will market the
Company's assets pursuant to procedures approved by the Company, Committee and
the Court. The marketing process will culminate in an auction to be conducted by
the Bankruptcy Court on November 1, 1999. The Committee will have the sole right
to select the highest and best bid and only the Committee's selected bid will be
presented to the Court for approval. Alternatively, the Committee, at its
discretion, may reject all bids. The Court also extended the Company's period of
exclusivity (the statutory period during which only the Company may file a plan
of reorganization) through the marketing process and auction of the Company's
assets. During this period of exclusivity, the Company has agreed not to file a
plan of reorganization. If a proposal to purchase the Company's assets is
selected by the Committee and approved by the Court, then either the Committee
or the Company may propose a plan of reorganization. If the Committee rejects
all bids, or if the Court does not approve a sale of the Company's assets, then
the Company may file a plan or reorganization and the Committee may seek to
terminate exclusivity and file a plan of reorganization. However, if the
Committee requests a hearing to terminate exclusivity, the Company has agreed
not to file a plan of reorganization prior to the Court's ruling on the
Committee's motion. In addition, the Court approved the retention of Netherland,
Sewell & Associates, Inc. to (i) complete its reserve evaluation of the
Company's oil and natural gas properties as of December 31, 1998, (ii) update
the reserve evaluation as of July 1, 1999 and (iii) provide assistance to the
Company, CIBC and prospective buyers during the marketing process. Pursuant to
an agreed order between the Company and the Committee, the Court entered an
order on September 7, 1999 approving a severance program for the Company's
employees which provides for certain payments in the event of a closing of the
sale of substantially all the Company's assets or confirmation of a

11
<PAGE> 14

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

plan of reorganization; provided such employee is not terminated for cause or
does not voluntarily resign prior to such event. The order also provides that
Mr. Alexander, CEO, and Mr. Devlin, Vice President and General Counsel, shall
not be entitled to any such payments until the earlier of (i) confirmation of a
plan of reorganization, (ii) conversion to a Chapter 7 proceeding, or (iii)
termination by a trustee. Payments under this program could be approximately $2
million if both the stay bonus and severance portions are paid in full.

OVERVIEW

The Company's current financial condition and 1998 and 1999 operating
results have resulted from the depressed oil prices which existed during 1998
and the first quarter of 1999, coupled with unfavorable revisions in estimates
of the Company `s oil and natural gas reserves during 1998. The recovery of oil
prices during the second and third quarters of 1999 has had positive effects on
the Company's revenues, profitability and cash flows.

The Company has made, and will continue to make, ordinary course capital
expenditures for the development and exploitation of oil and natural gas
reserves, subject to economic conditions and in accordance with the rulings and
procedures set forth by the Court. Due to the Chapter 11 proceeding, the Company
has suspended its exploratory drilling program and is prohibited from making
additional acquisitions. Development drilling is anticipated to be limited to
(i) ordinary course nonoperated wells in which we have limited working interests
and in which the failure to participate may result in drainage, depletion or
loss of current reserves and (ii) operated wells deemed to be economical given
current oil and natural gas prices. Large expenditures for developmental
drilling may require court approval and none are planned at this time. The
Company will limit its capital expenditures to ordinary course enhancement of
current production through workovers, recompletions, and other production
enhancing activities deemed to be economical given current oil and natural gas
prices. Future production could be adversely affected by the continued inability
to make acquisitions of producing properties and continue the exploratory and
development of its current asset base due to the Chapter 11 proceedings.

The revenues generated by the Company's operations are highly dependent upon
the prices of, and demand for, oil and natural gas. The price received by the
Company for its oil and natural gas production depends on numerous factors
beyond the Company's control, including seasonal price fluctuation, the
condition of the U.S. economy, foreign imports, political conditions in other
oil and natural gas producing countries, the actions of the Organization of
Petroleum Exporting Countries and domestic governmental regulations, legislation
and policies. Declines during 1998 and the first quarter of 1999 in the prices
of oil and natural gas had a material adverse effect on the carrying value of
the Company's oil and natural gas properties.

RESULTS OF OPERATIONS

OVERVIEW OF PRODUCTION, SALES AND UNIT ECONOMICS

The following table sets forth certain information regarding the production
volumes, oil and natural gas sales, average sales prices, and unit economics per
Mcfe for revenues and expenses related to the Company's oil and natural gas
production for the periods indicated.

12
<PAGE> 15

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------- ---------------------------
1998 1999 1998 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net production:
Oil (Mbbls) ............................... 278 280 906 865
Natural gas (Mmcf) ........................ 2,682 2,291 8,675 7,188
Natural gas equivalent (Mmcfe) ............ 4,350 3,971 14,110 12,380

Oil and natural gas sales (in thousands):
Oil ....................................... $ 3,393 $ 5,734 $ 11,976 $ 13,628
Natural gas ............................... 5,180 5,475 17,670 14,171
---------- ---------- ---------- ----------
Total ..................................... $ 8,573 $ 11,209 $ 29,646 $ 27,799
========== ========== ========== ==========

Average sales price:
Oil (per Bbl) ............................. $ 12.21 $ 20.49 $ 13.22 $ 15.75
Natural gas (per Mcf) ..................... 1.93 2.39 2.04 1.97

Unit economics (per Mcfe):
Average sales price ....................... $ 1.97 $ 2.82 $ 2.10 $ 2.25
Lease operating expenses .................. .51 .38 .45 .36
Oil and natural gas production taxes ...... .16 .12 .14 .11
DD&A (excluding writedowns) ............... 1.16 1.04 1.20 1.04
General and administrative ................ .31 .23 .30 .24
</TABLE>

THREE MONTHS ENDED SEPTEMBER 30, 1999, COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 1998

Revenues. Total revenues increased by $2.6 million (30.2%) to $11.2 million
for 1999 from $8.6 million in 1998. The increase in revenues was due to the
significant oil price increase combined with the increase in natural gas prices
offset by the decrease in production from the same period in 1998. Average
natural gas prices increased $.46 per Mcf to $2.39 per Mcf for 1999 from $1.93
for 1998 while average oil prices increased $8.28 per barrel to $20.49 for 1999
from $12.21 for 1998.

In 1999, the Company produced 280 Mbbls of oil, compared to 278 Mbbls
produced in 1998. The increase in oil production is the result of natural
decline, partially offset by the successful drilling and completion of the State
Lease #2102 well at the Company's East Bayou Sorrel area, which came on line in
October of 1998. In 1999, the Company produced 2,291 Mmcf of natural gas, a
decrease of 14.6% from 2,682 Mmcf produced in 1998. The decline in natural gas
production is primarily due to natural decline as well as flush production
during the third quarter of 1998 at the Company's East Texas and Arkoma
properties since the Company had limited activities in these areas during 1999.

Costs and Expenses. Lease operating expenses decreased $.7 million (31.8%)
to $1.5 million for 1999 from $2.2 million for 1998. The decrease is primarily
the result of the Company's efforts to reduce operating costs. Lease operating
expenses per Mcfe decreased $.13 to $.38 for 1999 from $.51 for 1998.

Oil and natural gas production taxes decreased $.2 million (28.6%) to $.5
million for 1999 from $.7 million for 1998. This decrease is the direct result
of various severance tax refunds received by the Company in the third quarter.

Depreciation, depletion and amortization ("DD&A") decreased $1.0 million
(19.6%) to $4.1 million for 1999 compared to $5.1 million for 1998 due to the
decrease in the average DD&A rate per Mcfe which was $1.04 for 1999 compared to
$1.16 for 1998. The decrease in the DD&A rate was due to the full cost ceiling
writedowns during 1998.

13
<PAGE> 16

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

At September 30, 1998, the net book value of the Company's oil and natural
gas properties exceeded the full cost ceiling, resulting in a non-cash writedown
of the Company's oil and natural gas properties of $38.7 million for the three
months ended September 30, 1998. This writedown resulted primarily from the
decline in natural gas prices combined with revisions of estimated proved
reserves as of September 30, 1998. No ceiling writedown was required for the
three months ended September 30, 1999.

General and administrative costs decreased $.5 million (35.7%) to $.9
million for 1999 compared to $1.4 million for 1998. The decrease in general and
administrative expenses is the direct result of the Company's efforts in
restructuring the management team and other personnel and efforts to control
other expenses. As discussed in Note 2 to the consolidated financial statements,
the Company capitalizes internal general and administrative costs that can be
directly identified with acquisition, exploration and development activities.
These capitalized costs totaled $.6 million and $.2 million for the three months
ended September 30, 1998 and 1999, respectively.

Other Income and Expenses. The $3.5 decrease (87.5%) million in interest
expense to $.5 million for 1999 from $4.0 million for 1998 was due to the
Company's discontinuation of recording interest on the Senior Notes due to the
Chapter 11 proceedings as discussed in Note 1 to the consolidated financial
statements. Approximately $4.4 million additional interest expense would have
been recognized by the Company for the three months ended September 30, 1999, if
not for the discontinuation of the interest accrual on the Senior Notes. The
average balance of debt outstanding during 1999 was $190.0 million as compared
to average debt outstanding of $187.8 million for 1998. The weighted average
interest rate for 1999 was 8.35% (excluding Senior Notes) compared to 10.31% for
1998. The decline in the weighted average interest rate is due to the
discontinued interest on the Senior Notes.

Reorganization Items. In the second quarter of 1999, the Company recorded
charges of approximately $.7 million for professional fees and other
reorganization expenses resulting from the Chapter 11 proceedings.

Net Income (Loss). The Company recorded net income of $3.2 million for 1999,
compared with a net loss of $43.6 million for 1998. Net income for 1999 includes
net reorganization costs of $.5 million and the net loss for 1998 includes a
writedown of oil and natural gas properties of $38.7 million.

NINE MONTHS ENDED SEPTEMBER 30, 1999, COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 1998

Revenues. Total revenues decreased by $1.8 million (6.2%) to $27.8 million
for 1999 from $29.6 million in 1998. The reduction in revenues was due to the
decline in oil and natural gas production combined with the decline in natural
gas prices offset by the increase in oil prices from the same period in 1998.
Average natural gas prices decreased $.07 per Mcf to $1.97 per Mcf for 1999 from
$2.04 for 1998 and average oil prices increased $2.53 per barrel to $15.75 for
1999 from $13.22 for 1998.

In 1999, the Company produced 865 Mbbls of oil, a decrease of 4.5% from the
906 Mbbls produced in 1998. The Company discontinued additional developmental
drilling at Goldsmith Adobe Unit in March 1998 due to the decline of crude oil
prices. The reduction in oil production resulting from natural decline and from
the discontinued drilling at the Goldsmith Adobe Unit was partially offset by
the successful drilling and completion of the State Lease #2102 well at the
Company's East Bayou Sorrel area which came on line in October of 1998. In 1999,
the Company produced 7188 Mmcf of natural gas, a decrease of 17.1% from 8,675
Mmcf produced in 1998. The decline in natural gas production is primarily due to
natural decline as well as flush production during the third quarter of 1998 at
the Company's East Texas and Arkoma properties since the Company had limited
activities in these areas during 1999.

Costs and Expenses. Lease operating expenses decreased $1.9 million (30.0%)
to $4.4 million for 1999 from $6.3 million for 1998. The decrease is primarily
the result of the Company's efforts to reduce operating costs. Lease operating
expenses per Mcfe decreased $.09 to $.36 for 1999 from $.45 for 1998.

14
<PAGE> 17

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

Oil and natural gas production taxes decreased $.6 million (30.0%) to $1.4
million for 1999 from $2.0 million for 1998. This decrease is the direct result
of the Company's reduced revenues combined with severance tax refunds received
by the Company.

Depreciation, depletion and amortization decreased $4.1 million (24.1%) to
$12.9 million for 1999 compared to $17.0 million for 1998 due to the decrease in
the average DD&A rate per Mcfe which was $1.04 for 1999 compared to $1.20 for
1998. The decrease in the DD&A rate was due to the full cost ceiling writedowns
during 1998.

At March 31, 1998, June 30, 1998, and September 30, 1998 the net book value
of the Company's oil and natural gas properties exceeded the full cost ceiling,
resulting in non-cash writedowns of the Company's oil and natural gas properties
of $26.5 million, $24.8 million, and $38.7 million respectively, for the
respective three month periods. These writedowns resulted primarily from the
decline in natural gas prices and costs incurred on unsuccessful exploratory
wells drilled during the period, combined with revisions of estimated proved
reserves as of March 31, 1998, June 30, 1998, and September 30, 1998. No ceiling
writedown was required for the nine months ended September 30, 1999.

General and administrative costs decreased $1.3 million (30.2%) to $3.0
million for 1999 compared to $4.3 million for 1998. The decrease in general and
administrative expenses is the direct result of the Company's efforts in
restructuring the management team and other personnel and efforts to control
other expenses. As discussed in Note 2 to the consolidated financial statements,
the Company capitalizes internal general and administrative costs that can be
directly identified with acquisition, exploration and development activities.
These capitalized costs totaled $1.6 million and $.7 million for the nine months
ended September 30, 1998 and 1999, respectively.

Other Income and Expenses. The $9.8 million (87.5%) decrease in interest
expense to $1.4 million for 1999 from $11.2 million for 1998 is due to the
Company's discontinuation of recording interest on the Senior Notes due to the
Chapter 11 proceedings as discussed in Note 1 to the consolidated financial
statements. Approximately $13.3 million additional interest expense would have
been recognized by the Company for the first nine months of 1999 if not for the
discontinuation of the interest accrual on the Senior Notes. The average balance
of debt outstanding during 1999 was $190.0 million as compared to average debt
outstanding of $177.4 million for 1998. The weighted average interest rate for
1999 was 8.1% (excluding Senior Notes) compared to 10.5% for 1998. The decline
in the weighted average interest rate is due to the discontinued interest on the
Senior Notes.

Reorganization Items. In the first nine months of 1999, the Company recorded
charges of approximately $1.9 million for professional fees and other
reorganization expenses resulting from the Chapter 11 proceedings.

Net Income (Loss). Net income was $3.3 million for 1999, compared with a net
loss of $101.6 million for 1998. Net income for 1999 includes net reorganization
costs of $1.4 million and the net loss for 1998 includes writedowns of oil and
natural gas properties totaling $90.0 million.

LIQUIDITY AND CAPITAL RESOURCES

NINE MONTHS ENDED SEPTEMBER 30, 1999, COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 1998

Net cash provided by operating activities was $19.5 million for 1999,
compared to net cash provided by operating activities of $2.7 million for 1998.
The increase in cash flows from operating activities is due to reduced payments
on trade account payable due to the lack of drilling activity during the period,
the nonpayment of prepetition trade accounts payable and the discontinuation of
recording interest expense on the Senior Notes both due to the Chapter 11
proceedings and reduction of lease operating expenses during 1999.

15
<PAGE> 18

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

Net cash used in investing activities was $3.0 million for 1999 compared
with $48.0 million for 1998. The cash used by investing activities for 1999
included $3.0 million of expenditures related primarily to drilling and
exploration activities compared with $46.9 million for 1998. The Company's
ability to undertake drilling and exploration activities is currently limited
due to the Chapter 11 proceedings.

There was no cash provided by financing activities during 1999 compared with
net cash provided by financing activities of $24.8 million for 1998. The net
cash provided by financing activities during 1998 consisted primarily of
proceeds from borrowings under the revised credit facility. Currently, no
additional borrowings are available under the credit facility.

CREDIT FACILITY

In connection with the issuance of the Series A Notes in 1996 (See Note 5 to
the consolidated financial statements), the Company revised its credit facility.
The revised credit facility had a borrowing base of $25.0 million. The borrowing
base may be redetermined at least semiannually and may require mandated monthly
principal reductions from time to time. The principal amount of any borrowings
is due at maturity, August 29, 2000 and interest is payable monthly.

The Company granted liens to the Banks (See Note 4 to the consolidated
financial statements) on substantially all of the Company's oil and natural gas
properties, whether currently owned or hereafter acquired, and a negative pledge
on all other oil and natural gas properties. The credit facility requires, among
other things, semiannual engineering reports covering oil and natural gas
properties, and maintenance of certain financial ratios, including the
maintenance of a minimum interest coverage, a current ratio, and a minimum
tangible net worth.

16
<PAGE> 19

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

10 3/4% SENIOR NOTES DUE 2006

In November 1996, the Company issued $100 million aggregate principal amount
of unregistered 10 3/4% Senior Notes due 2006 (the "Series A Notes"). The net
proceeds of the Series A Notes of approximately $96.1 million were used to repay
approximately $62.0 million of borrowings under a prior facility and to increase
the Company's working capital. In 1997, the Series A Notes were exchanged for
registered 10 3/4% Senior Notes due 2006 (the "Series B Notes") which were
substantially identical to the Series A Notes. Collectively, the Series A Notes
and Series B Notes are referred to as the "Series A/B Notes". In August 1997,
the Company issued $65.0 million aggregate principal amount of its unregistered
10 3/4% Senior Notes (the "Series C Notes"). The net proceeds of the Series C
Notes of approximately $64.8 million were used to repay approximately $23.0
million of borrowings under the credit facility and to increase the Company's
working capital. In December 1997, the Company exchanged substantially all of
the Series A/B Notes and all of the Series C Notes for registered 10 3/4% Senior
Notes due 2006 (the "Series D Notes"). The Series D Notes are substantially
identical to the Series A/B Notes and the Series C Notes. Collectively, the
Series A/B Notes, the Series C Notes and the Series D Notes are referred to as
the "Notes." The Notes bear interest at an annual rate of 10 3/4%, payable
semiannually in arrears on May 1 and November 1 of each year. The Notes are
senior, unsecured obligations of the Company, ranking pari passu with all
existing and future senior indebtedness of the Company, and senior in right of
payment to all future subordinated indebtedness of the Company.

17
<PAGE> 20

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

10 3/4% SENIOR NOTES DUE 2006 (CON'T)

approve a sale of the Company's assets, then the Company may file a plan or
reorganization and the Committee may seek to terminate exclusivity and file a
plan of reorganization. However, if the Committee requests a hearing to
terminate exclusivity, the Company has agreed not to file a plan of
reorganization prior to the Court's ruling on the Committee's motion. In
addition, the Court approved the retention of Netherland, Sewell & Associates,
Inc. to (i) complete its reserve evaluation of the Company's oil and natural gas
properties as of December 31, 1998, (ii) update the reserve evaluation as of
July 1, 1999 and (iii) provide assistance to the Company, CIBC and prospective
buyers during the marketing process. Pursuant to an agreed order between the
Company and the Committee, the Court entered an order on September 7, 1999
approving a severance program for the Company's employees which provides for
certain payments in the event of a closing of the sale of substantially all the
Company's assets or confirmation of a plan of reorganization; provided such
employee is not terminated for cause or does not voluntarily resign prior to
such event. The order also provides that Mr. Alexander, CEO, and Mr. Devlin,
Vice President and General Counsel, shall not be entitled to any such payments
until the earlier of (i) confirmation of a plan of reorganization, (ii)
conversion to a Chapter 7 proceeding, or (iii) termination by a trustee.
Payments under this program could be approximately $2 million if both the stay
bonus and severance portions are paid in full.

PREFERRED STOCK

Under the terms of the Series D preferred stock, a change in control of the
Company may occur if any of certain events occur that trigger the Series D
preferred stock Contingent Voting Rights (as defined in the Series D Certificate
of Designations) to elect one-half of the Board of Directors plus one member.
Pursuant to the Order for Relief dated February 11, 1999, the Company was placed
into a Title 11, Chapter 11 of the United States Code bankruptcy reorganization
proceeding. Such proceeding allows the Series D preferred stockholder to
exercise its right to control the Company's Board of Directors. To date, the
Series D preferred stockholder has not exercised such right.

FUTURE CAPITAL AND FINANCING REQUIREMENTS

The Company has made, and will continue to make, ordinary course capital
expenditures for the development and exploitation of oil and natural gas
reserves, subject to economic conditions and in accordance with the rulings and
procedures set forth by the Court. Due to the Chapter 11 proceeding, the Company
has suspended its exploratory drilling program. The Company will limit its
capital expenditures to ordinary course enhancement of current production
through workovers, recompletions, and other production enhancing activities
deemed to be economical given current oil and natural gas prices. Development
drilling is anticipated to be limited to (i) ordinary course nonoperated wells
in which we have limited working interests and in which the failure to
participate may result in drainage, depletion or loss of current reserves and
(ii) operated wells deemed to be economical given current oil and natural gas
prices. Large expenditures for developmental drilling may require court approval
and none are planned at this time.

The Company budgeted approximately $7.8 million for capital expenditures
related to its oil and natural gas properties for 1999, of which approximately
$6.0 million would be for ordinary course development and exploitation
activities, and approximately $1.8 million would be for delay rentals, lease
bonuses, geological and geophysical costs. Actual amounts to be expended by the
Company for these activities will be dependent upon a number of factors,
including Court approval, if necessary, oil and natural gas prices, the
availability of capital, seismic and contract service costs, availability of
drilling rigs and future drilling results. The Company is not contractually
committed to expend the budgeted funds.

The Company currently expects that existing cash and cash flows from
operations will be sufficient to fund planned capital expenditures for its
existing properties through 1999. However, the Company would require additional
capital to fund any acquisitions, and access to these markets could be limited
due to the Chapter 11 proceeding.

18
<PAGE> 21

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

Subject to Court approval, the Company may seek additional capital, if
required, from traditional reserve base borrowings, equity, and debt offerings
or joint ventures to further develop and explore its properties and to acquire
additional properties. There is no assurance, even if approved by the Court,
that the Company would be able to access additional capital or that, if
available, it will be at prices or on terms acceptable to the Company. In
addition, the Chapter 11 proceeding and restrictions from the Bankruptcy Court
could limit the Company's ability to access additional capital markets.

Should the Company be unable to access the capital markets or should
sufficient capital not be available, the development and exploration of the
Company's properties could be delayed or reduced and, accordingly, oil and
natural gas revenues and operating results may be adversely affected.

FINANCIAL REPORTING IMPACT OF FULL COST METHOD OF ACCOUNTING

The net book value is compared to the ceiling on a quarterly and yearly
basis. The excess, if any, of the net book value above the ceiling is required
to be written off as a non-cash expense. At September 30, 1999, the net book
value of the Company's oil and natural gas properties did not exceed the full
cost ceiling based on the weighted average prices of crude oil and natural gas
received by the Company, and therefore no writedown was required. At March 31,
1998, June 30, 1998, and September 30, 1998, the net book value of the Company's
oil and natural gas properties exceeded the full cost ceiling, based on the
weighted average prices of crude oil and natural gas received by the Company,
resulting in non-cash writedowns aggregating $26.5 million, $24.8 million and
$38.7 million, respectively. There can be no assurance that there will not be
additional writedowns in future periods under the full cost method of accounting
as a result of sustained decreases in oil and natural gas prices or other
factors.

CHANGES IN PRICES AND INFLATION

The prices received by the Company for its oil and natural gas production
declined dramatically during 1998 and the first quarter of 1999. The recovery of
oil prices during the second and third quarters of 1999 has had positive effects
on the Company's revenues, profitability and cash flows. Oil and natural gas
prices are subject to seasonal and other fluctuations that are beyond the
Company's ability to control or predict.

From time to time, the Company may hedge oil and natural gas prices, and
while the use of hedging arrangements limits the downside risk of adverse price
movements, it may also limit future gains from favorable movements. All hedging
had previously been accomplished pursuant to swap agreements based upon standard
forms. The Company addressed market risk by selecting instruments whose value
fluctuations correlate strongly with the underlying commodity being hedged.
Credit risk related to hedging activities is managed by requiring minimum credit
standards for counter parties, periodic settlements, and market to market
valuations. The Company has not been required to provide collateral relating to
hedging activities. At September 30, 1999, the Company had no hedging or basis
swap agreements outstanding.

At September 30, 1999, the Company had entered into forward sales contracts
with two purchasers covering the future production of natural gas. Deliveries
under these contracts are priced based on NYMEX prices less a differential
whereby the Company may fix the price for deliveries under these contracts at
any time three days prior to the close of the then current contract based on the
NYMEX prices at that time. The Company pays the cost of transportation of the
natural gas to the delivery point specified in the contracts. Currently, the
Company has not fixed the sales price of natural gas to be delivered under these
contracts.

19
<PAGE> 22

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

Although certain of the Company's costs and expenses are affected by the
level of inflation, inflation has not had a significant effect on the Company's
results of operations during the three and nine months ended September 30, 1998
and 1999.

YEAR 2000

The year 2000 ("Y2K") problem arises because of computer programs which use
two digits rather than four digits to define a year. This may result in
miscalculations or complete system failures in processing data with programs
using date sensitive information.

The Company currently uses commercially available software for its
management information systems, including accounting, engineering, and word
processing applications. This software has either already been warranted by the
suppliers or publishers to be Y2K compliant or the suppliers and publishers have
represented such software will be compliant in upgrades the Company will receive
in 1999 at minimal or no cost to the Company.

The Company has completed its review of its internal computer systems and
considers it to be Y2K compliant. The costs of compliance were not material
since its management information systems were warranted to be compliant or were
represented to be compliant in upgrades the Company received in 1999.
Furthermore, the Company replaced its former oil and natural gas system in 1996
with a Y2K compliant oil and natural gas package.

Management is in the final stages of obtaining confirmation from its major
suppliers and purchasers that they also are or will be Y2K compliant. The costs
of seeking such confirmation has been minimal. Management believes that it will
not be practical to independently verify the responses because it does not
believe that the Company would be given access to carry out such verification or
that the costs of doing so would be affordable. Management believes the cost to
replace non-compliant suppliers and purchasers will not be material. However,
based on current data, management does not expect to have to replace any of its
current suppliers or purchasers. Any Y2K problems that do occur will likely
manifest themselves in reduced production through equipment shut downs or
impaired liquidity through inability of customers to take delivery of production
or process payments. The Company is establishing contingency plans for mission
critical items.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

None.

20
<PAGE> 23

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Other than the Bankruptcy Court proceedings, the Company is not a defendant
in any material pending legal proceedings.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

At September 30, 1999, the Company was in violation of the minimum interest
coverage ratio and current ratio covenants under the Arnos credit facility and
has classified borrowings under the facility as current liabilities and as a
result has classified the amount outstanding as a current liability.

On December 4, 1998, certain of the holders of the Senior Notes (see Note 5
to the consolidated financial statements) the Company filed an Involuntary
Petition for an Order for Relief under Chapter 11 of Title 11 of the United
States Bankruptcy Code in the United States Bankruptcy Court for the Northern
District of Texas, Dallas Division, due to non-payment of interest due December
2, 1998, after expiration of a 30-day grace period. On December 23, 1998, the
Company filed, in the Bankruptcy Court, an Answer to and Motion to Dismiss the
pending Involuntary Petition. The Company's Motion affirmed that it (i) was
meeting its obligations and generally paying its debts as they become due,
unless such debts were the basis of a bona fide dispute and (ii) had arranged
with the lender under its credit facility to borrow additional funds sufficient
to pay the interest due on the Senior Notes, conditioned upon the Court's
dismissal of the Involuntary Petition. However, on February 8, 1999, the
Bankruptcy Court denied the Company's Motion to Dismiss the Involuntary
Petition. An Order for Relief was entered by the Bankruptcy Court on February
11, 1999. The Order for Relief places the Company under the protection of the
Court and precludes payment of the interest on the Senior Notes at this time.
Additionally, payment of liabilities existing as of February 11, 1999 to certain
unsecured creditors and dividends in arrears to holders of the Company's
preferred stock and any pending litigation are stayed during the Bankruptcy
proceeding. The Company shall act as debtor-in-possession and will continue to
operate its business and manage its properties in the ordinary course of
business during its Chapter 11 proceeding. As a result of the Chapter 11 filing,
the Company discontinued the accrual of interest on the unsecured Senior Notes
and discontinued the accrual of dividends on the unsecured preferred stock.
Approximately $13.3 million additional interest expense would have been
recognized by the Company for the first nine months of 1999 if not for the
discontinuation of the interest accrual on the Senior Notes.

ITEM 5. OTHER INFORMATION

The Company's common stock traded on the Nasdaq National Market since
September 1, 1995 under the symbol "NEGX". On November 9, 1998, Nasdaq notified
the Company that its common stock would be delisted effective at the close of
business that day for failing to meet the net tangible asset test and minimum
bid price requirements set forth in NASD Marketplace Rules 4450(a)(3) and
4450(a)(5). Nasdaq also advised the Company that its common stock was
immediately eligible for trading on the OTC Bulletin Board through authorized
broker-dealers who had been market makers in the Company's stock during the last
30-days prior to the Company's delisting on Nasdaq. The Company contacted its
OTC Market Makers to notify them of Nasdaq's action and to facilitate future
trading activity. The Company's common stock currently trades on the OTC
Bulletin Board under the symbol "NEGXQ".

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

The list of exhibits required by Item 601 of Regulation S-K and filed as
part of this report is set forth in the Index to Exhibits.

(b) Reports on Form 8-K

None.

21
<PAGE> 24

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

NATIONAL ENERGY GROUP, INC.

By: /s/ Bob G. Alexander October 29, 1999
-----------------------------------------
Bob G. Alexander
President and Chief Executive Officer

By: /s/ Melissa H. Rutledge October 29, 1999
-----------------------------------------
Melissa H. Rutledge
Vice President, Controller and
Chief Accounting Officer

22
<PAGE> 25

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

INDEX TO EXHIBITS

2.1 Agreement and Plan of Merger, dated June 6, 1996, among the Company,
NEG-OK, Inc. ("NEG-OK"), and Alexander Energy Corporation
("Alexander") (1)
2.2 First Amendment to Agreement and Plan of Merger, dated as of June
20, 1996, among the Company, NEG-OK, and Alexander (2)
2.3 Mutual Waiver Agreement dated as of August 29, 1996 by and among the
Company, NEG-OK and Alexander (3)
3.1 Certificate of Incorporation of the Company, which includes the
Certificate of Incorporation of the Company filed with the Secretary
of State of Delaware on November 20, 1990 (4), the Certificate of
Elimination of the Redeemable Convertible Preferred Stock, Series A
of the Company, filed with the office of the Secretary of State of
the State of Delaware on June 2, 1994 (3), the Certificate of
Amendment of Certificate of Incorporation of the Company, filed with
the office of the Secretary of State of the State of Delaware on
August 29, 1996 (3), the Certificate of Designations of the Company
of 10% Cumulative Convertible Preferred Stock, Series B (5), the
Certificate of Designations of the Company of 10 1/2% Cumulative
Convertible Preferred Stock, Series (6), the Certificate of
Designations of the Company of Convertible Preferred Stock, Series D
(3), and the Certificate of Designations of the Company of
Convertible Preferred Stock, Series E (3)
3.2 By-laws of the Company (4)
4.1 Certificate of Designations of the Company of 10% Cumulative
Convertible Preferred Stock, Series B (5)
4.2 Certificate of Designations of the Company of 10 1/2 % Cumulative
Convertible Preferred Stock, Series C (6)
4.3 Certificate of Designations of the Company of Convertible Preferred
Stock, Series D (3)
4.4 Certificate of Designations of the Company of Convertible Preferred
Stock, Series E (3)
4.5 Indenture dated as of November 1, 1996, among the Company, National
Energy Group of Oklahoma, Inc., formerly NEG-OK, and BankOne,
Columbus, N.A. (7)
4.6 Indenture dated August 21, 1997, among the Company and Bank One,
N.A. (8)
4.7 Instrument of Resignation, Appointment and Acceptance, dated October
23, 1998, between the Company, Bank One, Texas, N.A. and Norwest
Bank Minnesota, N.A. (9)
27.1 Financial Data Schedule (10)
99.1 Order of Bankruptcy Court Granting Relief on Involuntary Petition
(11)

- -----------

(1) Incorporated by reference to the Company's Registration Statement on
Form S-4 (No. 333-9045), dated July 29, 1996.

(2) Incorporated by reference to Amendment No. 1 to the Company's
Registration Statement on Form S-4 (No. 333-9045), dated August 7,
1996.

(3) Incorporated by reference to the Company's Current Report on Form
8-K, dated August 29, 1996.

(4) Incorporated by reference to the Company's Registration Statement on
Form S-4 (No. 33-38331), dated April 23, 1991.

(5) Incorporated by reference to the Company's Current Report on Form
8-K, dated June 17, 1994.

(6) Incorporated by reference to the Company's Current Report on Form
8-K, dated July 18, 1995.

(7) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1996.

<PAGE> 26

NATIONAL ENERGY GROUP, INC.
DEBTOR-IN-POSSESSION

INDEX TO EXHIBITS (CON'T)

(8) Incorporated by reference to the Company's Form S-4 (No. 333-38075),
filed October 16, 1997.

(9) Incorporated by reference to the Company's annual report on Form
10-K for the year ended December 31, 1998.

(10) The Financial Data Schedule is filed herewith for EDGAR filings
only.

(11) Incorporated by reference to the Company's Current Report on Form
8-K, dated February 8, 1999.

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