Summary of PANHANDLE OIL & GAS INC

ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
Forward-Looking Statements for fiscal 2009 and later periods are made in this document. Such statements represent estimates by management based on the Company's historical operating trends, its proved oil and natural gas reserves and other information currently available to management. The Company cautions that the Forward-Looking Statements provided herein are subject to all the risks and uncertainties incident to the acquisition, development and marketing of, and exploration for oil and natural gas reserves. Investors should also read the other information in this Form 10-Q and the Company's 2008 Annual Report on Form 10-K where risk factors are presented and further discussed. For all the above reasons, actual results may vary materially from the Forward-Looking Statements and there is no assurance that the assumptions used are necessarily the most likely to occur.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2009, the Company had positive working capital of $4,867,892, as compared to positive working capital of $4,599,004 at September 30, 2008. The increase in working capital resulted from a large decrease in accounts payable, mostly offset by a large decrease in oil and natural gas sales receivables and a decrease in refundable income taxes. Significantly lower oil and natural gas prices in fiscal 2009 have resulted in decreased drilling activity, helping reduce the Company's accounts payable. A substantial amount of the payments made for capital expenditures thus far in 2009 are for wells committed to, or which began drilling in fiscal 2008. Likewise, lower sales prices received have reduced the Company's receivables for oil and natural gas sales. Refundable income taxes declined as the Company's fiscal 2008 refund due was received during the quarter ended March 31, 2009.
Although the Company recorded a loss for the six months ended March 31, 2009, operating cash flow increased by 52% over the comparable period in fiscal 2008. During the first six months of fiscal 2009 as compared to fiscal 2008, collection of oil and natural gas sales receivables increased and after adding back increased non-cash items of depreciation, depletion and amortization and provision for impairment operating cash flow increased to $24,911,686. Additions to properties and equipment for oil and natural gas activities during the 2009 period were $18,281,761 ($13,937,212 in the 2008 period). Additions to properties and equipment are distinct from capital expenditures in that these additions include capital expenditures and net decrease (increase) in accounts payable for properties and equipment additions as reflected on the Statements of Cash Flows; therefore, additions to properties and equipment represent amounts recorded in the period, whereas capital expenditures represent amounts paid in the period. Management expects oil and natural gas prices to remain low throughout the remainder of fiscal 2009, resulting in declines in both operating cash flows and drilling activity, which will also reduce property and equipment additions for oil and natural gas activities. Low oil and natural gas prices are having a negative impact on drilling activity on the Company's mineral and leasehold acreage, and not being the operator of any of its oil and natural gas properties makes it extremely difficult for the Company to predict additions to properties and equipment with certainty. However, based on management's assessment of current conditions, fiscal 2009 additions to property and equipment for oil and natural gas activities are projected to be approximately $30,000,000; whereas fiscal 2008 property and equipment for oil and natural gas activities' additions were approximately $53,000,000.
The industry-wide decline in drilling activity has also created downward pressure on the costs for drilling rigs, well equipment, and well services, which is expected to reduce the overall costs of drilling and completing wells. As lower oil and natural gas prices continue to put downward pressure on drilling activity, and resulting production declines eventually occur, natural gas prices are expected to increase in late calendar 2009 to early 2010.
The Company historically funded capital additions, overhead costs and dividend payments primarily from operating cash flow. However, due to recent sharp decreases in oil and natural gas prices and the increased expenditures for drilling in the last two years, the Company has utilized its revolving line-of-credit facility to help fund these expenditures. The Company's strategy to minimize significant increases in borrowings will be to reduce its working interest participation in certain large ownership wells or by simply taking a no cost royalty interest in certain wells. By doing so, the Company reduces its capital expenditures and thereby limits borrowings, but still receives the benefit of a relatively high net revenue interest in the wells. Even with this strategy, and given current drilling activity, temporary moderate increases in borrowing can occur while the Company awaits the receipt of first revenues (which normally is 4 to 6 months after production begins) on recently completed wells. The Company currently has several wells that have been recently completed which will provide significant cash flow during both the third and fourth quarters of fiscal 2009 as the first payments on these wells are received. Debt levels should remain reasonably stable through the remainder of fiscal 2009 as these first revenues are received and the

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effects of the managed drilling activity reduces cash expenditures. The Company has substantial availability under its restructured revolving credit facility and also is well within compliance on its debt covenants (current ratio, debt to EBITDA, tangible net worth and dividends as a percent of operating cash flow). The Company believes its borrowing availability could be increased by placing more of the Company's properties as security under the revolving credit facility.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2009 - COMPARED TO THREE MONTHS ENDED MARCH 31, 2008
Overview:
The Company recorded a second quarter 2009 net loss of $945,256, or $.11 per share, as compared to a net income of $2,831,281 or $.33 per share in the 2008 quarter. The main contributing factors to the recorded loss for the period are decreased revenue due to depressed oil and natural gas prices and increased depreciation, depletion and amortization expense resulting from decreased oil and natural gas reserves. See Note 8 and discussion under Depreciation, Depletion and Amortization heading on page 12 regarding pricing used to calculate oil and natural gas reserves utilized to determine depreciation, depletion and amortization.
Revenues:
Total revenues decreased $3,873,207 or 30% for the 2009 quarter. The decrease was the result of a $6,469,445 decrease in oil and natural gas sales partially offset by revenue increases of $2,658,858 related to natural gas derivative contracts. Lower revenues from oil and natural gas sales resulted from a decrease of 58% in natural gas sales prices to $3.23 per mcf and a decrease of 57% in oil sales prices to $41.21. Although sales prices steeply declined, the negative effect on revenues was mitigated by increases in both oil and natural gas sales volumes of 7% and 42%, respectively. The Company recorded gains on natural gas derivative contracts in the fiscal 2009 quarter of $290,545 as compared to losses of $2,368,313 during the fiscal 2008 quarter. The table below outlines the Company's sales volumes and average sales prices for oil and natural gas for the three month periods of fiscal 2009 and 2008:

                                  BARRELS           AVERAGE              MCF             AVERAGE             MCFE             AVERAGE
                                    SOLD             PRICE              SOLD              PRICE              SOLD              PRICE
Three months ended 3/31/09         34,744          $ 41.21            2,171,660          $ 3.23            2,380,124          $ 3.55
Three months ended 3/31/08         32,399          $ 95.18            1,533,363          $ 7.71            1,727,757          $ 8.63

                 Quarter ended   Barrels Sold   MCF Sold    MCFE Sold
                    3/31/09         34,744      2,171,660   2,380,124
                   12/31/08         30,260      2,313,739   2,495,299
                    9/30/08         31,375      1,995,333   2,183,583
                    6/30/08         31,907      1,788,462   1,979,904
                    3/31/08         32,399      1,533,363   1,727,757

Gains (Losses) on Natural Gas Derivative Contracts:
The Company's fair value of derivative contracts was $207,745 as of March 31, 2009 and $-0- as of December 31, 2008. The Company had a net gain of $290,545 in the three months ended March 31, 2009 compared to a loss of $2,368,313 for the three months ended March 31, 2008. The Company received cash payments under the contracts of $82,800 and $39,600 (realized gains) for the three months ended March 31, 2009 and March 31, 2008, respectively.

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Lease Operating Expenses (LOE):
LOE increased $473,807 or 33% in the 2009 quarter. LOE per mcfe decreased to $.81 per mcfe in the 2009 quarter, as compared to $.84 per mcfe in the 2008 quarter. The accumulation of new wells which have come on line during the last year has resulted in an overall increase in LOE. The decrease on a per mcfe basis is due to the decrease in natural gas sales prices resulting in lower "value based" fees (primarily gathering and marketing costs) which are charged as a percent of natural gas sales, combined with declining prices for field services and supplies.
Production Taxes:
Production taxes decreased $585,865 or 63% in the 2009 quarter as compared to the 2008 quarter. The decline in production tax expense is the result of a 43% decrease in oil and natural gas sales and production tax credits on horizontal wells drilled in the southeast Oklahoma Woodford Shale. The state of Oklahoma offers a refund on horizontally drilled wells of nearly all production taxes paid for the first four years of production or until well payout occurs, whichever comes first. The result is a decrease in the severance tax rate as a percentage of oil and natural gas sales from 6.2% in the 2008 quarter to 4.0% in the 2009 quarter. Horizontally drilled wells coming on line in the Woodford Shale (all of which qualify for the production tax credits) have become a more significant part of the Company's production, thus production tax expense as a percentage of oil and natural gas sales has continued to decline. Exploration Costs:
Exploration costs decreased $121,707 or 80% in the 2009 quarter as compared to the 2008 quarter. The decrease is primarily related to a $138,641 decrease in leasehold expiration and abandonment costs in the 2009 quarter as compared to the 2008 quarter. One dry hole was recorded in the 2009 quarter at a cost of approximately $12,000.
Depreciation, Depletion and Amortization (DD&A):
DD&A increased $2,638,957 or 59% in the 2009 quarter. DD&A per mcfe in the 2009 quarter was $2.98 as compared to $2.57 in the 2008 quarter. The overall increase is the combined result of increased production in the 2009 quarter over the 2008 quarter and decreased oil and natural gas reserves. New wells that have come on line in the past year (most of which were higher cost horizontally drilled wells in the southeast Oklahoma Woodford Shale and the Arkansas Fayetteville Shale) have significantly increased oil and natural gas sales volumes. Low oil and natural gas prices (non-escalated prices for oil and natural gas of $46.93 and $2.47, respectively) used in the most recent reserve study reduced the economic lives of the Company's properties resulting in marginally lower reserve volumes and accelerated DD&A taken on the properties. The increased DD&A per mcfe is the result of the lower reserve volumes which create a higher DD&A rate per mcfe, and the higher cost horizontally drilled wells which have come on line in the past year. Provision for Impairment:
The provision for impairment decreased $93,676 in the 2009 quarter. In the 2009 quarter two fields were impaired a total of $132,321 as compared to the 2008 quarter which incurred impairment on four fields totaling $225,997. General and Administrative Costs (G&A):
G&A costs increased $97,814 or 8% in the 2009 quarter. The increase is mostly comprised of increased personnel related expenses of approximately $50,000, increased legal fees of approximately $30,000 and increased consulting fees of approximately $9,000.
Income Taxes:
The 2009 quarter incurred a benefit for income taxes of $1,026,000 as a result of a pre-tax loss of $1,971,256 as compared to a provision for income taxes of $1,480,000 in the 2008 quarter as a result of pre-tax income of $4,311,281. The resulting effective tax benefit rate in the 2009 quarter was 52% as compared to an effective tax provision rate of 34% in the 2008 quarter. The Company's utilization of excess percentage depletion (which is a permanent tax benefit) increased the tax benefit in the 2009 quarter, whereas it decreased the provision for income taxes in the 2008 quarter. The effect of this permanent tax benefit is that the effective tax rate is increased when recording a benefit for income taxes as in the fiscal 2009 quarter, while reducing the effective tax rate when recording a provision for income taxes as in the fiscal 2008 quarter. The benefit of excess percentage depletion is not directly related to the amount of a recorded loss or income. Accordingly, in cases where a recorded loss or income is relatively small, the proportional effect of the excess percentage depletion on the effective tax rate may become significant. Further, in the quarter ended March 31, 2009, with the decline in product prices and

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forecasted loss in fiscal 2009, the Company established a valuation allowance on certain state tax net operating loss carryforwards (NOLs) for which the Company no longer believes are more likely than not to be realized prior to expiration. This reduced the benefit recognized during the respective quarter by $278,000.
SIX MONTHS ENDED MARCH 31, 2009 - COMPARED TO SIX MONTHS ENDED MARCH 31, 2008
Overview:
The Company recorded a six month period 2009 net loss of $1,819,885, or $.22 per share, as compared to a net income of $6,311,588 or $.74 per share in the 2008 period.
Revenues:
Total revenues decreased $6,257,308 or 24% for the fiscal 2009 period as compared to the fiscal 2008 period. Lower revenues from oil and natural gas sales resulted from a 49% decrease in natural gas sales prices to $3.58 per mcf and a 49% decrease in oil sales prices to $46.14 per bbl. Although prices steeply declined, an increase in natural gas sales volumes of 43% partially offset the negative effect on revenues. The Company recorded gains on natural gas derivative contracts in the fiscal 2009 period of $683,552 as compared to losses of $2,104,527 during the fiscal 2008 period. The table below outlines the Company's sales volumes and average sales prices for oil and natural gas for the six month periods of fiscal 2009 and 2008:

                                BARRELS           AVERAGE              MCF             AVERAGE             MCFE             AVERAGE
                                  SOLD             PRICE              SOLD              PRICE              SOLD              PRICE
Six months ended 3/31/09         65,004          $ 46.14            4,485,399          $ 3.58            4,875,423          $ 3.91
Six months ended 3/31/08         69,120          $ 90.52            3,144,243          $ 6.96            3,558,963          $ 7.91

The increases in sales volumes are a result of successful drilling in the Company's core areas of the southeast Oklahoma Woodford Shale, the Fayetteville Shale in Arkansas and the Anadarko Basin in western Oklahoma where the Company has multiple plays. Contributing to the increased sales volumes, several new wells came on line during fiscal 2009 in these core areas. However, drilling in all of these areas has declined substantially and expectations are that the Company will see fewer wells coming on line during the remaining six months of fiscal 2009. This will limit the potential for sales volume increases during the last two quarters of fiscal 2009.
Gains (Losses) on Natural Gas Derivative Contracts:
The Company's fair value of derivative contracts was $207,745 as of March 31, 2009 and $646,193 as of September 30, 2008. The Company had a net gain of $683,552 in the six months ended March 31, 2009 compared to a loss of $2,104,527 for the six months ended March 31, 2008. The Company received cash payments of $1,122,000 and $101,000 (realized gains) for the 2009 and 2008 periods, respectively.
Lease Operating Expenses (LOE):
LOE increased $878,049 or 31% in the 2009 period as compared to the 2008 period. LOE per mcfe decreased in the fiscal 2009 period to $.75 per mcfe, as compared to $.79 per mcfe in the 2008 period. The accumulation of new wells which have come on line during the last year has resulted in an overall increase in LOE. The decrease on a per mcfe basis is due to the decrease in natural gas sales prices resulting in lower "value based" fees (primarily gathering and marketing costs) which are charged as a percent of natural gas sales, combined with declining prices for field services and supplies. Production Taxes:
Production taxes decreased $1,008,721 or 57% in the 2009 period as compared to the 2008 period. The decline in production tax expense is the result of a 32% decrease in oil and natural gas sales and production tax credits on horizontal wells drilled in the southeast Oklahoma Woodford Shale. The state of Oklahoma offers a refund on horizontally drilled wells of nearly all production taxes paid for the first four years of production or until well payout occurs, whichever comes first. The result is a decrease in the severance tax rate as a percentage of oil and natural gas sales from 6.2% in the 2008 period to 3.9% in the 2009 period.

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Exploration Costs:
Exploration costs decreased $159,423 or 44% in the 2009 period as compared to the 2008 period. The decrease is primarily related to a decrease in leasehold expiration and abandonment costs in the 2009 period as compared to the 2008 period of approximately $205,000. Two dry holes were recorded in the 2009 period at a cost of approximately $36,000; no dry holes were recorded in the fiscal 2008 period.
Depreciation, Depletion and Amortization (DD&A):
DD&A increased $5,332,439 or 61% in the 2009 period as compared to the 2008 period. DD&A was $2.88 per mcfe in the 2009 period as compared to $2.45 per mcfe in the 2008 period. The overall increase is the result of increased production in the 2009 period over the 2008 period and higher DD&A per mcfe. The increase in the DD&A per mcfe is due to new wells that have come on line during the past year and decreased oil and natural gas reserves. New wells that have come on line in the past year (most of which were higher cost horizontally drilled wells in the southeast Oklahoma Woodford Shale and the Arkansas Fayetteville Shale) have significantly increased oil and natural gas sales volumes on which DD&A is calculated. Low oil and natural gas prices (non-escalated prices for oil and natural gas of $46.93 and $2.47, respectively) used in the most recent reserve study reduced the economic lives of the Company's properties resulting in lower overall reserve volumes and accelerated DD&A taken on the properties. The increased DD&A per mcfe is the result of the lower reserve volumes which create a higher DD&A rate per mcfe, and the higher cost horizontally drilled wells which have come on line in the past year. Provision for Impairment:
The provision for impairment increased $1,660,235 in the 2009 period as compared to the 2008 period. Driven by depressed oil and natural gas prices, impairment was recorded on 18 fields during the 2009 period in the amount of $2,008,241. Two of the fields accounted for $1,729,034 of the impairment, one field in Wheeler County, Texas consisting of one deep well (drilled in 2006 and had mechanical issues during completion which dramatically increased costs) was impaired $1,070,129 and one mature field in Beckham County, Oklahoma principally consisting of wells drilled in 2006 and prior was impaired $658,905. The Company did not incur any impairment in the three primary areas of operation (Woodford Shale area, Fayetteville Shale area and Dill City project). During the 2008 period, six fields were impaired a total of $341,482. General and Administrative Costs (G&A):
G&A costs decreased $280,068 or 10% in the 2009 period as compared to the 2008 period due to decreased personnel related costs of approximately $393,000, which included a decrease in employee bonus costs of approximately $500,000 in the 2009 period (the result of beginning to ratably accrue for estimated 2008 annual employee bonuses during the 2008 fiscal period due to specific bonus performance criteria being established plus recording the full 2007 annual discretionary bonuses approved and paid during the 2008 fiscal period), partially offset by increases in legal fees of approximately $55,000. Income Taxes:
The fiscal 2009 period incurred a benefit for income taxes of $1,205,000 as a result of a pre-tax loss of $3,024,885 as compared to a provision for income taxes of $3,299,000 in the fiscal 2008 period as a result of pre-tax income of $9,610,588. The resulting effective tax benefit rate in the fiscal 2009 period was 40% as compared to an effective tax provision rate of 34% in the fiscal 2008 period. The Company's utilization of excess percentage depletion (which is a permanent tax benefit) increased the tax benefit in the fiscal 2009 period, whereas it decreased the provision for income taxes in the fiscal 2008 period. The effect of this permanent tax benefit is that the effective tax rate is increased when recording a benefit for income taxes as in the fiscal 2009 period, while reducing the effective tax rate when recording a provision for income taxes as in the fiscal 2008 period. The benefit of excess percentage depletion is not directly related to the amount of a recorded loss or income. Accordingly, in cases where a recorded loss or income is relatively small, the proportional effect of the excess percentage depletion on the effective tax rate may become significant. In the six months ended March 31, 2009, with the decline in product prices and forecasted loss in fiscal 2009, the Company established a valuation allowance on certain state tax net operating loss carryforwards (NOLs) for which the Company no longer believes are more likely than not to be realized prior to expiration. This reduced the benefit recognized during the respective period by $278,000.
CRITICAL ACCOUNTING POLICIES
Preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. However, the accounting principles used by the Company generally do not change the Company's reported cash flows or liquidity. Generally, accounting rules do not involve

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a selection among alternatives, but involve a selection of the appropriate policies for applying the basic principles. Interpretation of the existing rules must be done and judgments made on how the specifics of a given rule apply to the Company.
The more significant reporting areas impacted by management's judgments and estimates are crude oil and natural gas reserve estimation, impairment of assets, oil and natural gas sales revenue accruals and provision for income tax. Management's judgments and estimates in these areas are based on information available from both internal and external sources, including engineers, geologists, consultants and historical experience in similar matters. Actual results could differ from the estimates as additional information becomes known. The oil and natural gas sales revenue accrual is particularly subject to estimates due to the Company's status as a non-operator on all of its properties. Production information obtained from well operators is substantially delayed. This causes the estimation of recent production, used in the oil and natural gas revenue accrual, to be subject to some variations. Oil and Natural Gas Reserves
Management considers the estimation of crude oil and natural gas reserves to be the most significant of its judgments and estimates. These estimates affect the unaudited standardized measure disclosures, as well as DD&A and impairment calculations. Changes in crude oil and natural gas reserve estimates affect the Company's calculation of depreciation, depletion and amortization, provision for abandonment and assessment of the need for asset impairments. On an annual basis, with a semi-annual update, the Company's consulting engineer (Pinnacle Energy Services, LLC), with assistance from Company geologists, prepares estimates of crude oil and natural gas reserves based on available geologic and seismic data, reservoir pressure data, core analysis reports, well logs, analogous reservoir performance history, production data and other available sources of engineering, geological and geophysical information. However, when significant oil and natural gas price changes occur between periods in which reserves would normally be calculated, the Company updates the reserve calculations utilizing a price deck current with the period. Both DD&A and impairment were calculated in the 2009 quarter based on these updated reserve calculations. As required by the guidelines and definitions established by the SEC, these estimates are based on current crude oil and natural gas pricing held flat over the life of the properties. However, projected future crude oil and natural gas pricing assumptions are used by management to prepare estimates of crude oil and natural gas reserves used in formulating management's overall operating decisions. Based on the Company's fiscal 2008 DD&A, a 10% change in the DD&A rate per mcfe would result in a corresponding $1,978,466 annual change in DD&A expense. Crude oil and natural gas prices are volatile and largely affected by worldwide production and consumption and are outside the control of management.
Successful Efforts Method of Accounting
The Company has elected to utilize the successful efforts method of . . .