UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB [X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2006 [   ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from __________________ to ______________________. Commission file number 0-25951 CONSOLIDATED ENERGY, INC. (Exact Name of Small Business Issuer as Specified in its Charter) Wyoming 86-0852222 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 76 George Road
Betsy Layne, KY 41605 (Address of Principal Executive Offices) (606) 478-1333 (Issuers Telephone Number, Including Area Code) Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Common Stock, par value $0.001 per share  Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d)
of the Exchange Act during the past 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes  X No ___  (i) As of December 1, 2006, the issuer had 24,564,003 shares of common stock, par value $0.001 per share, issued and outstanding.  (ii) Transitional Small Business Disclosure Format (check one):  Yes  No  X (iii) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes __  No  X   CONSOLIDATED ENERGY, INC.  INDEX TO FORM 10-QSB Page PART I FINANCIAL INFORMATION 3 Item 1. Financial Statements 3 Condensed Consolidated Balance Sheets as of December 31, 2005 and September 30, 2006 (unaudited) 3 Condensed Consolidated Statements of Operations (unaudited) for the three and nine
months ended September 30, 2005 and September 30, 2006 4 Condensed Consolidated Statement of Cash Flows (unaudited) for the nine
months ended September 30, 2005 and September 30, 2006 5 Notes to Condensed Consolidated Financial Statements 7 Item 2. Managements Discussion and Analysis or Plan of Operation 21 Item 3. Controls and Procedures 46 PART II OTHER INFORMATION 48 Item 4. Submission of Matters to a Vote of Security Holders 48 Item 5. Other Information 48 Item 6. Exhibits 49  2  PART I
FINANCIAL INFORMATION Item 1. Financial Statements CONSOLIDATED ENERGY, INC. CONDENSED CONSOLIDATED BALANCE SHEETS September 30,
2006December 31,
2005(unaudited)ASSETSCURRENT ASSETSCash$
775$              1,031Accounts receivable671,6671,754Accounts receivable - other71,41771,417Prepaid and other24,2717,754Total current assets768,13081,956BUILDING, EQUIPMENT AND COAL LEASESBuilding and equipment, net of $1,329,254 and $791,027 Depreciation12,976,14911,073,058Coal Leases, net of $64,025 and $17,829 Amortization15,693,86115,157,721Total building, equipment and coal leases, net28,670,01026,230,779OTHER ASSETSRestricted cash753,13570,800Prepaid royalty143,15870,857Other assets25,00055,800Total other assets921,293197,457Total Assets$
30,359,433$    26,510,192LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)CURRENT LIABILITIESCash overdrafts$                98,151$            23,532Convertible debentures--707,959Accounts payable2,445,0631,453,350Accrued liabilities2,036,8646,917,796Royalties payable555,026476,638Current portion of capital lease--1,295,322Notes payable3,130,3542,172,191Derivative liability - warrants5,604,8113,551,471Derivative liability - convertible shares12,674,9617,602,941Payable to related parties670,659590,659Total current liabilities27,215,88924,791,859Deferred royalties payable147,599157,541Asset retirement obligations53,44134,629Notes payable  long term portion3,906,6141,478,931Total long-term liabilities4,107,6541,671,101Total Liabilities31,323,54326,462,960STOCKHOLDERS EQUITY (DEFICIT)Common stock, $0.001 per value; 100 million shares authorized;
24,564,003  and 14,823,246 shares issued and outstanding24,56414,824Additional paid-in capital25,305,36714,266,314Accumulated deficit(26,294,041)(14,233,906)Total Stockholders Equity (Deficit)$
(964,110)$            47,232Total Liabilities and Stockholders Equity (Deficit)$
30,359,433$     26,510,192 See Notes to Condensed Consolidated Financial Statements.  3  CONSOLIDATED ENERGY, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) Nine Months
Ended
September 30,Three Months
Ended
September 30,2005200620052006REVENUESCoal Sales$     1,816,305$     4,950,722$    920,739$    1,702,406Other revenue--3,000----Total revenue1,816,3054,953,722920,7391,702,406EXPENSESCost of sales, excluding depreciation of mine equipment of $415,347and $684,339, and amortization of coal leases of $2,829and $46,196 for the nine months ended September 30, 2005 and 2006, respectively1,959,5065,207,5961,082,9422,045,462Operating expenses2,897,7784,102,1911,248,3791,858,607Liquidated damages--69,167----Depreciation and amortization418,175730,536158,677280,040Total costs and expenses5,275,45910,109,4902,489,9984,184,109LOSS FROM OPERATIONS(3,459,154)(5,155,768)(1,569,259)(2,481,703)OTHER INCOME (EXPENSE)Interest income--21,036--17,288Loss on sale of assets(72,833)(511,635)----Change in fair value of warrant liability(1,909,557)11,882,1752,151,470(629,917)Change in fair value of conv. share liability2,950,001(853,388)404,412(843,450)Interest expense, net of $1,228,987 and $130,119 capitalized interest for the nine and three months ended September 30, 2005, respectively(110,095)(17,442,555)(88,310)(793,095)Total other income (expense)857,516(6,904,367)2,467,572(2,249,174)NET INCOME (LOSS)$    (2,601,638)$   (12,060,135)$  898,313$  (4,730,877)BASIC AND DILUTED
NET (LOSS) PER COMMON SHARE$            (0.21)$             (0.63)$           0.07$           (0.21)WEIGHTED AVERAGE NUMBER OF
COMMON SHARES12,686,93919,132,20712,686,93922,966,846 See Notes to Condensed Consolidated Financial Statements.   4  CONSOLIDATED ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited) For the nine months ended September 30,20052006CASH FLOWS FROM OPERATING ACTIVITIESNet Loss$      (2,601,638)$      (12,060,135)Adjustments to reconcile net loss to net cash provided by operating activitiesDepreciation and Amortization418,175730,536Stock Issued for Services244,776633,169Stock Issued for Interest Payments--368,032Amortization of debt discount23,51815,692,800Loss on Sale of Assets72,833511,635Change in fair value of convertible share liability(2,950,001)853,388Change in fair value of warrant liability1,909,557(11,882,175)Changes in Operating assets and LiabilitiesPrepaid Expenses(3,611)(16,517)Accounts Receivable2,033(669,913)Prepaid Royalties(39,500)(72,301)Other Assets(32,408)30,800Cash Overdrafts(400,623)74,619Accounts Payable1,272,719628,460Accrued Liabilities--1,205,311Royalties Payable(42,972)78,388Deferred Royalties Payable(7,380)(9,942)Deferred Revenue226,254--Purchase of Restricted Cash(1,300)(682,335)Asset Retirement Obligations--2,301NET CASH USED BY OPERATING ACTIVITIES(1,909,568)(4,583,879)CASH FLOWS FROM INVESTING ACTIVITIESPurchase of Equipment(6,002,315)(4,019,124)Interest Capitalized(4,471,036)--Lease Cost Capitalized--(582,336)Proceeds from disposal of equipment18,0004,500NET CASH USED BY INVESTING ACTIVITIES(10,455,351)(4,596,960)CASH FLOWS FROM FINANCING ACTIVITIESProceeds from Secured Notes-9,693,022Proceeds from note payable907,410-Proceeds From Convertible Debentures12,765,000-Advances from (Payment) to Related Parties(497,528)80,000Payments on Capital Leases(346,834)-Payments on Notes Payable(403,910)(592,439)Proceeds From Stock Sales--NET CASH PROVIDED BY FINANCING ACTIVITIES12,424,1389,180,583NET (DECREASE) INCREASE IN CASH59,219(256)CASH BALANCE, BEGINNING OF YEAR4,3921,031CASH BALANCE, END OF YEAR$           63,611$                775 See Notes to Condensed Consolidated Financial Statements.  5  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and with the instructions to Form 10-QSB and Item 310 of Regulation S-B.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements.  The accompanying unaudited condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are considered necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented.  The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period.  The accompanying financial statements should be read in conjunction with the audited consolidated financial statements of Consolidated Energy, Inc. and consolidated subsidiaries (the Company) included in the Companys Form 10-KSB for the fiscal year ended December 31, 2005. The discussion and analysis of the Companys financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, the Company evaluates its estimates, including those related to reserves for bad debts and those related to the possible impairment of long-lived assets.  The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates. The Company was incorporated in Nevada on December 18, 1996, under the name Barbeque Capital Corp., and engages principally in the business of mining coal in Eastern Kentucky.  The Companys main business focus is the operation of profitable coal mines and its main customer is American Electric Power, Co. The Companys financial statements have been presented on the basis that it is a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.  The Company has not established revenues sufficient to cover its operating costs, has incurred significant outstanding current obligations and has incurred substantial net losses, thereby raising substantial doubts about its ability to continue as a going concern.  The Company has recently completed raising additional funds which it anticipates to be adequate to complete mine development projects and cover its overhead costs until such time as enough revenue is generated to cover all operating costs.  If these funds are not adequate and additional funds are raised through the issuance of equity securities, the current stockholders may experience dilution.  Furthermore, there can be no assurance that additional financings will be available when needed or that if available, such financings will include terms favorable to the Companys stockholders.  If such financings are not available when required or are not available on acceptable terms, the Company may be unable to take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on its business, financial condition and results of operations. 2. Notes Payable The January 2005 Bridge Notes  6  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)   On January 11, 2005, the Company closed a financing transaction for $2,500,000 in bridge financing to be used exclusively for the purchase of equipment and to fund expenditures for the consummation of mining activities at its Warfield Mine operations. The financing consisted of a senior secured promissory note for the face amount of $2,500,000 with an interest rate of 9% per annum and a payment date (principal and interest) of March 31, 2005. Gryphon Master Fund, LP and GSSF Master Fund, LP, both Bermuda limited partnerships, were collectively the payees on the note.  The note was repaid with the proceeds from the Companys February 2005 financing - see below.  In consideration for the above note, the Company paid a commitment fee of $50,000 to the Gryphon Master Fund and GSSF Master Fund, and a flat fee of $10,000 as reimbursement for fees and expenses incurred in connection with the negotiation, preparation and delivery of the note, all deducted from the proceeds of funding the note.  As additional consideration, the Company issued to Gryphon Master Fund and GSSF Master Fund a warrant for the purchase of an aggregate of 514,706 shares of the Companys common stock at an exercise price of $1.70 per share, exercisable for five years.  The warrant also contains so-called "piggyback" registration provisions under which the warrant holder may request that the shares underlying the warrant be included in a registration with respect to an offering of the Companys securities.  In addition to the above bridge note fees and warrants, the Company paid Stonegate Securities, Inc., a Texas corporation, which the Company refer to as Stonegate, a placement agent fee for a total of $200,000 cash and issued warrants for the purchase of an aggregate of 51,470 shares of the Companys common stock on the same terms as the warrants issued to Gryphon Master Fund and GSSF Master Fund.  The warrant issuances were in the form of a warrant issued to Scott R. Griffith and a warrant issued to Jesse B. Shelmire IV, each for the purchase of 25,735 shares.  The cash paid and warrants issued were per the terms of a non-exclusive Placement Agency Agreement between the Company and Stonegate.  6% Senior Secured Convertible Notes On February 24, 2005, the Company entered into a financing transaction for aggregate gross proceeds of $7,000,000, with additional investment rights of up to an additional $7,000,000 (hereinafter, the 6% Notes), such financing to be used for the purchase of equipment and to fund expenditures for the consummation of mining activities at the Companys Warfield Mine.  The financing is in the form of 6% senior secured convertible notes for an aggregate total face amount of $7,000,000 and a term of three years.  The 6% senior secured notes may be converted to common stock at a conversion price of $1.70 per share.  Holders of such notes are Gryphon Master Fund, L.P., GSSF Master Fund, LP, Lonestar Partners, L.P., WS Opportunity International Fund, Ltd., WS Opportunity Fund (QP), L.P., WS Opportunity Fund, L.P., Renaissance US Growth Investment Trust PLC, and BFS US Special Opportunities Trust PLC (collectively, the Holders).  As additional consideration, the Company issued to each of such holders warrants for the purchase of an aggregate of 2,058,824 shares of the Companys common stock at an exercise price of $1.70 per share, exercisable for five years.  The conversion price of such notes, and the exercise price of such warrants, are subject to certain normal and customary anti-dilution adjustment provisions and also include a one-time reset date provision with a floor price of $0.90 per share.  In February 2005, simultaneous with the closing of the 6% Note offering, the Company used approximately $2,527,000 of the proceeds of the above offering to repay the January 2005 bridge loan (principal and interest) from Gryphon Master Fund and GSSF Master Fund.  The Company also paid a flat fee of $30,000 to Gryphon Master Fund and GSSF Master Fund as reimbursement for fees and expenses incurred in connection with the negotiation, preparation and delivery of the 6% Notes and related investment documents. In addition to the above fees related to the issuance of the 6% Notes, the  7  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  Company paid Stonegate a total of $340,000 cash and issued warrants for the purchase of an aggregate of 617,647 shares of the Companys common stock on the same terms as the warrants issued to the Holders.  During March 2005, two investors in the Companys February 2005 private placement exercised their additional investment rights for an aggregate of $750,000 in the same 6% senior secured convertible notes that may be convertible into 441,176 shares of the Companys common stock at an exercise price of $1.70 upon the occurrence of certain events.  In connection with the additional investment, the Company issued warrants for the purchase of 44,116 shares of the Companys common stock at an exercise price of $1.70 to Stonegate.  In April 2005, Stonegate exercised all of the 713,223 warrants issued through a cashless exercise provision in exchange for the issuance of 485,850 shares of the Companys common stock.  During June 2005, seven investors exercised their additional investment rights for an aggregate of $6,000,000 in the same 6% senior secured convertible notes that may be convertible into 3,529,411 shares of the Companys common stock at an exercise price of $1.70 upon the occurrence of certain events.  In July, placement agent warrants issued to Stonegate for the purchase of 352,994 shares issued in connection with the exercise of the additional investment rights were exercised pursuant to cashless exercise provisions for the issuance of 166,290 shares.  In connection with the above transactions, the Company executed a security agreement (the "Security Agreement") giving the Holders a security interest in and to any and all of the Companys assets and properties ("Collateral" as defined in the Security Agreement).  Each of the Companys subsidiaries has also executed a Guaranty for the Companys obligations under the 6% Notes.  On July 1, 2005, the Company failed to pay interest as required pursuant the terms of certain 6% senior secured convertible notes and Additional Investment Rights first executed on February 24, 2005 for an aggregate total face amount of $13,750,000, and thereby caused a default under the terms of the notes.  The September and November 2005 Bridge Notes Subsequently, and in order to secure additional financing for continuing operations, on September 23, 2005, the Company executed a promissory note (the "September Bridge Note") payable to Cordillera Fund L.P. for an aggregate principal amount of up to $1,500,000.  On November 24, 2005 the existing September Bridge Note holders and the Company agreed to increase the amount of debt by $300,000 to a total of $1,800,000.The September Bridge Note was subsequently cancelled on January 13, 2006 and exchanged for an investment in the Companys 8% senior secured convertible notes and warrants. See below for a description of the material terms of this transaction.  In connection with the September Bridge Note, the Company entered into a Consent and Waiver with the holders of the 6% Notes, whereby they consented to the September Bridge Note transactions and waived, until resolution of the September Bridge Note transactions, the application of any of the provisions of the 6% Notes and related transaction documents.  The Company also entered into a Subordination Agreement in connection with the September Bridge Note, whereby Cordillera Fund L.P. agreed to subordinate the September Bridge Note to the prior payment in full in cash of the 6% Notes.  In addition, the holders of the 6% Notes entered into a Bridge Forbearance with the Company whereby they agreed to forebear from exercising any of their rights or remedies under the 6% Notes and the related securities purchase agreement, security agreement and any other related transaction documents for a period of ten business days.  On October 6, 2005, the holders of the 6% Notes signed an extension to the Bridge Forbearance until the earliest to occur of the following: (i) November 18, 2005, (ii) the expiration and termination of  8  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  the September Bridge Note, or (iii) the completion by the Company of a new financing.  On January 13, 2006, the 6% Note holders signed another forbearance agreement pursuant to which, among other things, they agreed to waive the Companys prior defaults on the 6% Notes, and the holders of the $1.8 million bridge notes agreed to cancelled their notes in exchange for the 8% notes issued in January 2006  See January 13, 2006 Private Placement below.  January 13, 2006 Private Placement  On January 13, 2006, the Company sold approximately $6.24 million principal amount of 8% senior secured convertible notes due June 30, 2008 to 18 accredited investors (the 8% Notes).  In connection with the sale of the 8% Notes, the Company issued investors warrants to purchase an aggregate of approximately 3.3 million shares of common stock, calculated as 50% of each investors subscription amount divided by $0.90.  Of the $6.24 million principal amount of 8% Notes, the Company received gross proceeds of $3.3 million.  The remaining approximate $2.94 million principal amount was paid by investors as follows: (a) $1.8 million was paid by the cancellation of the September Bridge Notes; (b) $102,000 represents a management fee owed to the lead investor, Gryphon Master Fund, L.P.; (c) $586,000 represents interest accrued on the Companys 6% Notes and pursuant to certain Additional Investment Rights sold February 24, 2005 and $452,000 as placement agent fees.  The 8% Notes have a final maturity date of June 30, 2008, accrue interest at the rate of 8% per annum, are secured by all of the Companys properties and assets and the properties and assets of each of the Companys subsidiaries, and are guaranteed by each of the Companys subsidiaries.  The 8% Notes rank pari passu with the Companys outstanding 6% Notes.  Interest may be paid either in cash or with shares of common stock in the Companys sole discretion.  Holders of the 8% Notes have the right to convert the outstanding principal amount into shares of the Companys common stock from time to time based on a conversion price of $0.90, subject to adjustment.  Beginning July 1, 2006, on the first day of each month the Company is required to redeem 1/24th of the outstanding principal of the 8% Notes (the Monthly Redemption Amount).  If the transaction is registered on an effective registration statement and certain other conditions are satisfied, the Company may pay the Monthly Redemption Amount with shares of common stock based on a conversion price equal to the lesser of (a) the then conversion price and (b) 80% of the daily volume weighted average price of the common stock for the 10 consecutive trading days prior to the applicable monthly redemption date.  In the event the Companys annualized EBITDA for the two fiscal quarters ending December 31, 2006 (the Annualized EBITDA) is less than $17 million, the conversion price of the 8% Notes will be reset to equal the greater of (a) $0.30 or (b) a price determined by the following formula: [3 * X/Y], where X equals the Annualized EBITDA and Y equals the number of shares of common stock outstanding on a fully diluted basis on December 31, 2006.  In addition, if the Company issues or commits to issue or distribute new securities at a price per share less than the current market price or the current conversion price, then the conversion price will be adjusted to reflect such lower price.  The conversion price is also subject to adjustment for stock dividends, stock splits, stock combinations and similar dilutive transactions.  The warrants issued in connection with the 8% Notes have an exercise price of $0.90 per share and are exercisable until January 14, 2011.  Holders may exercise the warrants on a cashless basis after the first anniversary of the initial issuance date and then only in the event that a registration statement covering the resale of the warrant shares is not then effective.  In the event the Companys annualized EBITDA for the two fiscal quarters ending December 31, 2006 (the Annualized EBITDA) is less than $17 million, the exercise price of the warrants will be reset to equal the greater of (a) $0.30 or (b) a price determined by the following formula: [3 * X/Y], where X equals the Annualized EBITDA and Y equals the number of shares of common stock outstanding on a fully diluted basis on December 31, 2006.  In addition, if the Company issues or commits to issue or distribute new securities at a price per share less  9  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  than the current market price or the current exercise price, then the exercise price will be adjusted to reflect such lower price.  The exercise price is also subject to adjustment for stock dividends, stock splits, stock combinations and similar dilutive transactions.  The investors have agreed to restrict their ability to convert the 8% Notes and exercise the warrants such that the number of shares of common stock held by them in the aggregate and their affiliates after such conversion or exercise does not exceed 4.99% of the Companys then issued and outstanding shares of common stock. The Company agreed to file a registration statement with the SEC registering the resale of the shares of common stock issuable upon conversion of the 6% Notes and the 8% Notes and related warrants on or before February 12, 2006 and cause such registration statement to be declared effective no later than May 31, 2006.  The Company has filed such registration statement, as amended, on Form SB-2 but has not yet been informed by the SEC regarding its effectiveness.  Forbearance Agreement  On January 13, 2006, the Company entered into a forbearance agreement with the holders of the Companys 6% Notes.  In connection with the January 13, 2006 private placement described above, holders of the 6% Notes waived certain events of default (the Existing Defaults) by the Company including: (a) the Companys failure to pay accrued but unpaid interest on the 6% Notes when due; (2) the Companys failure to comply with certain negative and financial covenants of the securities purchase agreement dated February 22, 2005; (3) the Companys failure to comply with certain registration requirements of the registration rights agreement dated February 24, 2005; and (4) the Companys failure to comply with certain other provisions of the 6% Notes, the February 22, 2005 securities purchase agreement and the February 24, 2005 registration rights agreement to the extent that completion of the January 13, 2006 private placement may cause any processing delay of the Companys prior registration statement (SEC File No. 333-127261) with the SEC.  In connection with the forbearance agreement, the Company agreed to release and discharge each of the parties thereto and each of their affiliates from any and all claims that the Company has or ever had against such parties through January 13, 2006.  Solely for the purpose of completing the January 13, 2006 private placement, the parties waived the anti-dilution provisions of the 6% Notes and the related warrants, any existing rights associated with Additional Investment Rights and the right to liquidated damages and other remedies under the February 24, 2005 registration rights agreement.  The parties also agreed to forbear from enforcing certain remedies as a result of the Existing Defaults through December 30, 2005.  Pursuant to the terms of the forbearance agreement, the following substantive amendments were made to the February 22, 2005 securities purchase agreement; the 6% Notes, the related warrants and the February 24, 2005 registration rights agreement:  · The minimum EBITDA financial covenants required by the February 22, 2005 securities purchase agreement through March 31, 2006 were deleted; · The maximum capital expenditures required by the February 22, 2005 securities purchase agreement were deleted in their entirety; · The minimum cash level requirements of the February 22, 2005 securities purchase agreement through June 30, 3006 were deleted; · The minimum cash level requirement of the February 22, 2005 securities purchase  10  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  agreement for the period from July 1, 2006 through September 30, 2006 was changed from $2 million to $1 million; · The definition of Conversion Price in the 6% Notes and Exercise Price in the related warrants was changed from $1.70 to $0.90; · The interest requirement of the 6% Notes was changed to require interest payments beginning July 1, 2006; · A provision was added to the 6% Notes and the related warrants requiring an adjustment to the conversion price and exercise price in the event the Companys annualized EBITDA for the two fiscal quarters ending December 31, 2006 (the Annualized EBITDA) is less than $17 million.  In such event, the conversion price and exercise price will be reset to equal the greater of (a) $0.30 or (b) a price determined by the following formula: [3 * X/Y], where X equals the Annualized EBITDA and Y equals the number of shares of common stock outstanding on a fully diluted basis on December 31, 2006; · A provision was added to the 6% Notes and the related warrants requiring an adjustment to the conversion price and exercise price in the event the Company issue or commits to issue or distribute new securities at a price per share less than the current conversion or exercise price; · The Events of Default provision of the 6% Notes was amended replacing the event of default for failure to have an effective registration statement within 270 days of the closing date with an event of default for failure to have an effective registration statement within 270 days of the closing date for the January 13, 2006 private placement; · An event of default was added to the 6% Notes for a breach of any of the Companys representations, warranties or covenants contained in any agreement or document executed in connection with the January 13, 2006 private placement; and · The required filing date and earliest required effectiveness date of the February 24, 2005 registration rights agreement was changed to February 12, 2006 and May 31, 2006, respectively.  Notwithstanding the availability of Rule 144, each investor agreed not to sell, offer or otherwise transfer any shares of the Companys common stock beneficially owned by them until the earlier of: (a) May 31, 2006, or (b) the date the required registration statement is declared effective by the SEC.  The parties also entered into an amended and restated security agreement reflecting the pari passu nature of the 6% Notes with the 8% Notes.  In lieu of cash payment of accrued but unpaid interest due pursuant to the 6% Notes, the Company issued holders notes and warrants pursuant to the terms of the January 13, 2006 private placement.  In addition, the Company issued non-convertible promissory notes to holders of the 6% Notes in the aggregate principal amount of $2,640,000 which represents liquidated damages which had accrued and is payable pursuant to the February 24, 2005 registration rights agreement.  The promissory notes bear interest at the rate of 3% per annum, compounded annually.  The full amount of principal and interest is due on June 30, 2008.  The Companys obligations pursuant to the promissory notes are secured by all of the Companys properties and assets and the properties and assets of each of the Companys subsidiaries pari passu with the 6% Notes and 8% Notes.  As additional incentive to enter into the forbearance agreement, the Company issued to all 6%  11  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  Note holders additional warrants to purchase an aggregate of 5,580,065 shares of common stock calculated pursuant to the following formula: X = [(Y/$0.90) * (0.50  Z)], where: X = the number of shares of common stock underlying the warrant certificate; Y = the stated aggregate principal amount of all 6% Notes; and Z = the number of shares of common stock underlying all warrants previously issued to such party in connection with the 6% Notes.  The additional warrants issued have identical terms to the warrants sold by the Company pursuant to the January 13, 2006 private placement.  Other Agreements Executed in Connection with the January 13, 2006 Private Placement  Also in connection with the January 13, 2006 private placement:  (a) the Company secured a directors and officers liability insurance policy which provides $10,000,000 of total coverage;  (b) each of the Companys then-current officers and directors entered into an agreement to vote all shares of common stock owned by them to increase the Companys authorized shares of common stock from 50 million shares to 100 million shares;  (c) each of the Companys then-current officers and directors entered into an agreement to vote for Timothy M. Stobaugh, Robert Chmiel, Jesse Shelmire and Scott Griffith as additional directors and for a fifth additional director designated by Gryphon Master Fund, L.P. within 60 days of closing;  (d) each of the Companys officers and directors entered into lock-up agreements agreeing not to offer, sell, contract to sell, pledge or otherwise dispose of any shares of common stock or other of the Companys equity securities for the period ending on January 13, 2007;  (e) the Companys subsidiary, Eastern Consolidated Energy, Inc., entered into an agreement with Kentucky Energy Consultants, Inc. whereby Kentucky Energy Consultants, Inc. agreed to: (i) change its coal sales commission to 2.5% of the gross sales price received by Eastern Consolidated Energy, Inc. on any purchase orders and/or contracts on either spot or contract arrangements, and (ii) forfeit its coal sales commission of 2.5% of gross revenues less trucking costs until such time that the Company reach $20 million in aggregate EBITDA production;  (f) the Companys subsidiary, Eastern Consolidated Energy, Inc., entered into an agreement with New River Energy Sales Company, Inc. whereby, among other things, New River Energy Sales Company, Inc. agreed to reduce its coal sales commission from 5% to 2.5% of gross coal sales until such time that the Company reach $20 million in aggregate EBITDA production;  (g) together with the Companys subsidiary CEI Holdings, Inc., the Company entered into an agreement with Saudi American Minerals, Inc. whereby, among other things: (i) the parties terminated that certain Agreement and Plan of Acquisition and Merger dated May 30, 2003 and all subsequent amendments to such agreement; and (ii) the Company agreed to pay $750,000 cash and issue 3,000,000 shares of common stock to Saudi American Minerals, Inc. in exchange for the assignment by Saudi American Minerals, Inc. of a 25% interest in its patented clean coal technology (Patent No. 6,447,559) including any subsequent improvements thereto; and  (h) the Company entered into a consulting agreement with RC Financial Group, LLC, pursuant to which Robert Chmiel was retained as a non-exclusive financial advisor for a term of 24 months in exchange for the following compensation: (i) $17,500 each month from January 1, 2006 through June 30,  12  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  2006; (ii) $12,500 each month thereafter; and (iii) issuance of a warrant to purchase 150,000 shares of common stock with an exercise price of $0.90 per share and an expiration date of December 31, 2011. July 12, 2006 Financing  On July 12, 2006 (the "Closing Date), the Company completed the transactions contemplated by a Securities Purchase Agreement, effective as of June 30, 2006 (the Purchase Agreement).  Under the terms of the Purchase Agreement, the Company issued to four institutional investors (the Senior Investors) $4,444,444 in face amount of Variable Rate Original Issue Discount Convertible Secured Debentures (the Secured Debentures) due June 2008.  The Company realized gross proceeds of $4,000,000 from the issuance. The Secured Debentures bear interest at the annual rate of the higher of 12% or prime rate plus 4%, and may be convertible into common stock of the Company at a fixed conversion price of $1.36.  The Secured Debentures are secured by a first priority security interest in equipment that was purchased with the proceeds from the Secured Debentures (the Equipment) and a subordinated security interest in all assets of the Company as well as certain of the Companys real estate located in Martin County, Kentucky.  In addition, the Secured Debentures are guaranteed by the Companys subsidiaries.  Of the amount raised, $3,750,000 was deposited into a blocked account and was used to purchase the Equipment.  The balance of the funds ($250,000) was deposited into a control account and will be released when the Company issues one or more widely disseminated press releases reporting that it has produced and sold at least 70,000 tons of coal during each of three consecutive calendar months. On the same date, pursuant to an Unsecured Debt Securities Purchase Agreement, effective as of June 30, 2006 (the Unsecured Purchase Agreement, together with the Purchase Agreement, the Agreements), the Company also issued to six institutional investors (the Junior Investors, together with the Senior Investors, the Investors) unsecured convertible debentures in the principal amount of $1,750,000 (the Unsecured Debentures).  The Unsecured Debentures are due in July 2008, accrue interest at the annual rate of 15% and may be converted into shares of common stock at a fixed conversion price of $0.90.  Under the terms of the Agreements, the Company also issued to the Investors an aggregate of 4,000,000 shares of common stock (the Investor Shares) and five-year warrants to purchase up to 5,875,000 shares of the Companys common stock at $0.01 per share (the Warrants).  The sale and issuance of all securities pursuant to the Agreements was exempt from registration requirements pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder.  Pursuant to the terms of a registration rights agreement, the Company agreed to file a registration statement with the Securities and Exchange Commission (the Commission) registering the resale of (i) the shares of common stock issuable upon conversion of the Secured Debentures and the Unsecured Debentures, (ii) the Investor Shares, and (iii) the shares of common stock issuable upon the exercise of the Warrants on the earlier of (a) the 60th calendar day following the Closing Date, or (b) the 20th calendar day following the date on which the Companys registration statement currently on file with the Commission is declared effective and cause such registration statement to be declared effective no later than 60 days after the filing thereof.  The Company has not yet filed a registration agreement and as such is currently in non compliance with this registration rights agreement.  The Company however has not triggered an Event of Default pursuant to the Secured Debentures.  The Company would trigger an Event of Default if a registration statement shall not have been declared effective by the Commission on or prior to the 210th calendar day after the Closing Date.   13  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  In connection with the execution of the Agreements and as a condition to the completion thereof, the holders of (i) an aggregate of $7,000,000 in principal amount of the Companys 6% Senior Secured Convertible Notes due 2008 dated February 24, 2005, (ii) an aggregate of $6,750,000 in principal amount of the Companys 6% Senior Secured Convertible Notes due 2008 dated March 18, 2005, June 8, 2005 and June 30, 2005, and (iii) an aggregate of $6,239,930 in principal amount of the Companys 8% Senior Secured Convertible Notes due 2008 dated January 13, 2006 have agreed to subordinate their security interests in the Companys assets to liens granted to the holders of the Secured Debentures in the Equipment.  They also agreed to waive, until November 30, 2006, certain penalties due to them and agreed to allow the Company to pay some of the accrued interest on their existing notes in shares of common stock.  As a further condition to the completion of the Agreements, approximately $708,000 of outstanding debentures and approximately $497,000 of accrued salaries were converted into shares of common stock at a $0.90 conversion price.  In connection with the transactions contemplated under the Agreement, the Company paid (i) a placement agent fee of $140,000 in cash and issued five-year warrants to purchase 400,000 shares of common stock at $0.01 per share to Ascendiant Securities, LLC, and (ii) a placement agent fee of $262,500 in cash and issued five-year warrants to purchase 100,000 shares of common stock at $0.01 per share to Stonegate Securities and its principals Jesse Shelmire and Scott Griffith, each a director of the Company.  As an inducement to one of the Junior Investors to purchase the Unsecured Debentures, Messrs. Shelmire and Griffith sold to that Junior Investor Company securities owned by them, consisting of $300,000 face amount of promissory notes issued by the Company, warrants to purchase 150,000 of the Companys common stock, and 300,000 shares of the Companys common stock for a total purchase price of $300,000.  Bank Notes  On October 27, 2005, the Company borrowed $329,190 from Community Trust Bank, Pikeville, KY to purchase mining equipment.  The note had a maturity date of January 27, 2006 and an annual interest rate of the Prime Rate plus one percent (1%), calculated on the basis of an assumed 360-day year for the actual number of days elapsed.  The note plus all accrued interest was paid in full on January 20, 2006.  Convertible Debentures  The Company had issued a total of $707,959 in convertible debentures, which were convertible into shares of the Companys common stock at 60% to 70% of the asking price quoted on the OTCBB on the date of conversion.  These debentures were converted into shares of common stock as part of the July 12, 2006 transaction  see above.  Accounts Receivable Leveraging Agreement  On April 24, 2006, the Company signed an agreement for a Line of Credit with Community Trust Bank, Inc., Pikeville, KY pursuant to which the Company may borrow 80% of its accounts receivable, up to $5 million.  The Company will be required to make monthly payments of interest-only, calculated by multiplying the then principal balance outstanding by an interest rate determined to be Prime Rate plus 1%.  14  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)   The Companys notes payable at September 30, 2006 consisted of the following: Promissory NotesAmount Due at
September 30,
2006Senior secured convertible Note dated February 14, 2005; interest rate of 6% per annum from original issue.  Interest due semi-annually with six month anniversary date.  Principal and interest can be converted into shares of the Companys common stock at $0.90 per share.  Principal due 36 months from the date of issue.$    7,000,000Senior secured convertible Note dated June 30, 2005; interest rate of 6% per annum from original issue.  Interest due semi-annually with six month anniversary date.  Principal and interest can be converted into shares of the Companys common stock at $0.90per share.  Principal due 36 months from the date of issue.6,750,000Senior secured convertible note dated January 13, 2006; interest rate of 8%.  Principal and interest are due monthly commencing with June 30, 2006.   Principal and interest can be converted into shares of the companys common stock at $0.90 per share.6,239,930Senior secured non-convertible promissory note dated January 13, 2006; interest rate of 3% per annum compounded annually with principal and interest due upon final maturity date of June 30, 2008.2,640,000Senior secured convertible note dated July 12, 2006; interest at the annual rate of the higher of 12% or prime rate plus 4%.  Interest is due monthly and principal is due commencing with the 1st of the month following 120 days from July 12, 2006.   Principal and interest can be converted into shares of the companys common stock at $1.36 per share.  Principal due upon final maturity date of June 30, 2008.4,444,444Junior unsecured convertible promissory note dated July 12, 2006; interest rate of 15% per annum; accrues monthly; payable upon certain cash flow conditions. Principal due upon final maturity date of June 30, 2008.1,750,000Bank Note Dated June 25, 2005; Interest rate 5.99% payable monthly11,138Bank Note Dated July 15, 2005; Interest rate 5.0%, payable monthly21,796Bank Note Dated June 25, 2005; Interest rate of 5.99%, payable monthly21,593Bank Note Dated June 25, 2005; Interest rate of 5.99%, payable monthly22,421Bank Line of Credit Note, Interest rate prime plus 1%, interest only due through September 30, 2006413,406TOTAL PROMISSORY NOTES$  29,314,728Less: debt discount(22,277,760)Less: current portion of notes payable(3,130,354)TOTAL LONG-TERM PORTION  OF PROMISSORY NOTES$  3,906,614   15  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  3. Equity Transactions Issuance of Stock upon the Conversion of Notes Payable and Accrued Interest  During the first quarter of 2005, the Company issued 29,348 shares of common stock upon the conversion debt principal and interest totaling $53,884.  During the second quarter of 2005, the Company issued 29,330 shares of common stock upon the conversion of debt principal and interest totaling $52,529.  In July 2006, the Company issued 952,239 shares of common stock upon the conversion debt principal and interest totaling $857,015.  Issuance of Stock in lieu of Cash for Accrued Interest  During the third quarter 2006, the Company issued 534,801 shares of common stock in lieu of cash as payment of interest totaling $414,792 to the holders of the 6% Notes for interest which accrued for the six months ended July 1, 2006.  The accrued interest was converted into shares of common stock at a $0.7756 conversion price, which was the 10-day volume weighted average price (VWAP) of the stock for the 10 trading days prior to July 1, 2006 as quoted in the Over The Counter Electronic Bulletin Board trading exchange.  Issuance of Stock Pursuant to the Exercise of Warrants In January 2005, the Company issued warrants for the purchase of an aggregate of 51,470 shares of the Companys common stock with a term of five years and an exercise price of $1.70 per share to Stonegate Securities, Inc., as additional placement agent compensation related to the January 2005 bridge financing.  In February 2005, the Company issued to Stonegate warrants to purchase 1,110,290 shares of common stock with term of five years and an exercise price of $1.70 per share as additional compensation for the placement of the Companys sale of 6% senior secured convertible notes and related warrants in February 2005 and the exercise of Additional Investment Rights during 2005.  These warrants were exercised on a cashless basis at $4.09, the price of the stock on the date the holders exercised the warrants, and the Company thereby issued an aggregate of 652,144 and cancelled warrants to purchase 509,616 shares. In February and March 2006, the Company issued 2,093,306 shares of common stock and cancelled warrants to purchase 1,208,000 shares of common stock pursuant to the cashless exercise of warrants.  The warrants had an exercise price between $0.90 and $1.70 per share and were cashlessly exercised between $2.35 and $3.20, the price of the stock on the date the holders exercised the warrants.  In August 2006, the Company issued 349,553 shares of common stock and cancelled warrants to purchase 3,847 shares of common stock pursuant to the cashless exercise of warrants.  The warrants had an exercise price of $0.01 and were cashlessly exercised at $1.01, the price of the stock on the date the holder exercised the warrants. Issuance of Stock for Services On March 23, 2005, the Company authorized the issuance of 200,000 shares of its common stock for services, which were performed during the year that ended December 31, 2002.  The value of the stock issued was $1,010,000, which was the fair market value quoted in the Over The Counter Electronic Bulletin Board trading exchange (OTCBB), and has been recorded as an expense in the year that ended December 31, 2004, with a corresponding increase in accrued liabilities.  16  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  During 2005, the Company issued 110,000 shares of common stock in exchange for consulting services valued at $269,976, the fair market value on the OTCBB on the date the stock was issued. In June 2006, the Company issued 200,000 shares to RC Financial Group, LLC for consulting services rendered.  As a result, the Company recognized a $202,000 consulting expense.  Robert Chmiel is the sole owner of RC Financial Group and is the Companys current interim chief financial officer. Issuance of Stock for Mining Lease In February 2005, the Company issued 2,500,000 shares of its common stock to Eastern Land Development Company, Inc. and acquired the lease right to mine an additional approximately 13.0 million tons of recoverable coal in the Alma, Pond Creek, Coalburg, Taylor, Richardson, and Broas seams.   The acquisition was booked at $4,875,000, the fair market value of the stock on the date issued. Issuance of Stock for Compensation On January 3, 2005, the Company issued 550,000 shares of its common stock to the Officers and Directors for services rendered during the year that ended December 31, 2004.  The Company recognized a $1,072,500 compensation expense during 2004, which represents the fair market value of the stock on the OTCBB on the date the stock was issued.  Issuance of Stock for Accrued Salaries On July 12, 2006, the Company issued 552,036 shares of its common stock to Mr. Tackett and Mr. Jacobs, both officers and directors of the Company, for $496,834 of accrued salaries as a further condition to the completion of the July 2006 financing.  The accrued salaries were converted into shares of common stock at a $0.90 conversion price.  Issuance of Stock Pursuant to Financing Agreement On July 12, 2006, the Company issued 4,000,000 shares of its common stock to certain investors pursuant to the terms of the certain financing transaction described in detail above.  See Note 2.  Registration Statement  The Company entered into a Registration Rights Agreement with the investors in the Companys 6% Senior Secured Convertible Notes described in Note 2.  The Company was required to file a registration statement  by April 10, 2005, registering the resale of the shares of common stock issuable upon conversion of the 6% Senior Secured Convertible Notes and the common stock issuable upon exercise of the warrants attached to such 6% Senior Secured Convertible Notes.  The Company also was required to cause such registration statement to be declared effective by June 24, 2005 (or July 24, 2005 if reviewed by the SEC).  The Company is required to pay the investors liquidated damages equal to 2% of the purchase price of the securities for each 30 day period (prorated for any period less than 30 days) that such deadlines are not met.  The Company filed the initial registration statement on May 16, 2005 and the registration statement has not yet been declared effective.  As of January 13, 2006, the Company incurred $2.64 million in liquidated damages, and the Company paid such damages by issuing 3% notes on January 13, 2006.  As part of the Companys January 13, 2006 private placement described under Note 2, the Company will not incur further liquidated damages if the registration statement is declared effective by May 31, 2006.  On July 12, 2006, the Company closed an additional financing pursuant to which the Company  17  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  entered into a Registration Rights Agreement with the new investors wherein the Company agreed to file a registration statement with the SEC on the earlier of (a) the 60th calendar day following the closing date, or (b) the 20th calendar day following the date on which the Companys registration statement currently on file with the SEC is declared effective and cause such registration statement to be declared effective no later than 60 days after the filing thereof.  In connection with the execution of the July 2006 financing, the existing investors agreed to waive, until November 30, 2006, certain liquidated damage penalties due to them since the Company did not cause the registration statement to be declared effective by May 31, 2006.  The Company has not yet filed a registration agreement and as such is currently in non compliance with this registration rights agreement.  The Company however has not triggered an Event of Default pursuant to the Secured Debentures.  The Company would trigger an Event of Default if a registration statement shall not have been declared effective by the Commission on or prior to the 210th calendar day after the Closing Date.  On June 29, 2006, the Company received comments from the SEC and on August 14, 2006 the Company filed an amended Registration Statement on Form SB-2, amending the registration statement pursuant to the June 29, 2006 comments.  The Company has been informed that it must file an additional amendment, updated with its most recently filed quarterly financial statement.  4. Related Party Transactions Barry Tackett, appointed as a director and CFO in February 2004, was paid a total of $10,610 for accounting services in fiscal 2005.  In January 2005, Mr. Tackett also received a total of 225,000 shares for consulting services in fiscal 2004 valued at $438,750.  In January 2006, Mr. Tackett resigned as CFO and agreed to serve as the Companys Controller.  The Company currently has an oral agreement with Mr. Tackett.  Mr. Tackett provides services relating to all aspects of the Companys accounting needs, including payroll services and general day to day accounting functions.  Jacobs Risk Management, a risk management consulting company operated as a sole proprietorship by one of the Companys directors and the Companys Secretary, Joseph G. Jacobs, provides preventative and ongoing compliance support to help insure that the Company remains in compliance with all state and federal regulatory coal mining matters.  Through Jacobs Risk Management, Mr. Jacobs was paid a total of $7,146 in fiscal 2005.  In January 2005, Mr. Jacobs also received 225,000 shares for consulting services in fiscal 2004 valued at $438,750.  The Company currently has an oral agreement with Mr. Jacobs in connection with Jacobs Risk Managements services.  Additionally, the Company leases its executive offices at 76 George Rd. Betsy Layne, KY from Jacobs Risk Management.  The office is leased for $2,000 per month plus utilities, which approximates market rates.  During the calendar fourth quarter 2005 and the calendar first quarter of 2006, the Company issued 20,000 shares to RC Financial Group, LLC for consulting services rendered.  As a result, the Company recognized a $25,200 consulting expense in 2005 and has booked a $10,500 consulting expense in 2006.  In June 2006, the Company issued 200,000 shares to RC Financial for consulting services rendered.  As a result, the Company recognized a $202,000 consulting expense.  Robert Chmiel is the sole owner of RC Financial Group, LLC and is the Companys current interim chief financial officer.  On July 12, 2006, the Company issued 193,518 shares of its common stock to Mr. Tackett and issued 358,518 shares of its common stock to Mr. Jacobs, both officers and directors of the Company, for a combined $496,834 of accrued salaries as a further condition to the completion of the July 2006 financing.  The accrued salaries were converted into shares of common stock at a $0.90 conversion price.   18  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)  5. Events Subsequent to September 30, 2006 Resignation of Officer and Director On October 25, 2006, the Board of Directors of the Company accepted the resignation of David Guthrie as President, Chief Executive Officer and Director pursuant to the terms of Mr. Guthries resignation letter dated October 25, 2006.  Mr. Guthrie is resigning in order to pursue other opportunities.  In accordance with the Boards approval, Mr. Guthrie shall continue to receive his salary in the normal course of business through November 15, 2006, and the Company shall also transfer ownership to Mr. Guthrie of an automobile previously purchased by the Company for Mr. Guthries use while he was employed.  The Company has not appointed any replacement for Mr. Guthrie, and all existing officers of the Company shall continue to be employed in their current positions. Restatement of September 30, 2005 Balances  On January 3, 2005, the Company issued 2,500,000 shares of its common stock for additional coal seams on the Dempsey Lease, to certain shareholders who at the time were deemed to be controlling shareholders.  The 2,500,000 shares of stock were valued and originally booked at par value of $2,500 which approximated the cost basis of the Lease in the hands of the controlling shareholders.  In November 2005, the Company discovered the error and the correction is reflected in the financial statements for the fiscal year ended December 31, 2005 which reflect the 2,500,000 shares of stock valued at fair market of $4,875,000 which represents the closing quoted market value of our stock on the date of the acquisition of the additional seams.  As summarized below, the restatements only affected the value of certain balance sheet items and accordingly, did not result in a change to earnings.  The following sets forth the balance sheet items affected by these changes:  AsAsReportedRestatementRestated9/30/05Adjustment9/30/05Coal Leases, Net of Amortization$  6,020,708$  5,956,800$  11,977,508Additional Paid-in-Capital$10,571,052$  5,956,800$  16,527,852  In July 2006, the Company determined that the warrants issued in conjunction with the senior secured notes and the shares into which the senior secured notes can be converted into, should have been accounted for as derivatives,with the initial fair value of the derivatives being recorded as a liability and the corresponding debit being recorded as a reduction in the related senior secured note payable as debt discount.  Changes in the fair value of the derivative from the initial fair value calculation to the balance sheet date are recorded in earnings.  The following table sets forth the financial statement items affected by changes to the financial statements caused by recording the warrants issued in conjunction with the senior secured notes and the shares into which the senior secured notes can be converted into, as derivatives.  19  CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)   As Reported and RestatedJuly 2006 RestatementAs Restated9/30/05Adjustments9/30/05Coal leases, net of amortization11,977,508385,557(5)12,363,065Derivative liability warrants(3,383,309)(1)969,336(6)(1,909,557)(3)(4,323,530)Derivative liability conversion shares(10,067,648)(2)2,950,001(4)(7,117,647)Long term notes payable(10,669,221)10,067,648(2)(385,557)(5)(987,130)Additional Paid-in-Capital(16,527,852)3,383,309(1)(969,336)(6)(14,113,879)Retained deficit11,457,704(1,909,557)(3)2,950,001(4)10,417,260Changes in fair value derivative liability warrants(1,909,557)(3)(1,909,557)Changes in fair value derivative liability conversion shares2,950,001(4)2,950,001Net Loss(3,642,082)(1,040,444)(2,601,638)  (1) Represents the initial fair value of the warrant liability.  The fair value was calculated using the Binomial Lattice pricing model with the following assumptions:  (i) risk free interest rate of 3.91%; (ii) expected life of 5.0 years; (iii) expected volatility of 83.24%; (iv) expected dividend yield of 0.00%; and (v) stock valuation of $4.00. (2) Represents the initial fair value of the conversion share liability.  The fair value was calculated using the Binomial Lattice pricing model with the following assumptions:  (i) risk free interest rate of 3.67%; (ii) expected life of 3.0 years; (iii) expected volatility of 83.24%; (iv) expected dividend yield of 0.00%; and (v) stock valuation of $1.70. (3) Represents the change in the fair of the warrant derivative liability between the initial commitment date and September 30, 2005. The fair value was calculated using the Binomial Lattice pricing model with the following assumptions:  (i) risk free interest rate of 4.18%; (ii) expected life of 4.42 years; (iii) expected volatility of 84.56%; (iv) expected dividend yield of 0.00%; and (v) stock valuation of $2.35. (4) Represents the change in the fair of the conversion share derivative liability between the initial commitment date and September 30, 2005. The fair value was calculated using the Binomial Lattice pricing model with the following assumptions:  (i) risk free interest rate of 4.18%; (ii) expected life of 2.42 years; (iii) expected volatility of 84.56%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $1.70. (5) Represents the change in the amortization of the debt discount.  During this period the Company was capitalizing all interest charges. (6) Represents the value associated with the settlement of 1,066,176 warrants through a cashless exercise.   20    Item 2. Managements Discussion and Analysis or Plan of Operation The information contained in this Form 10-QSB is intended to update the information contained in our Annual Report on Form 10-KSB for the year ended December 31, 2005 and presumes that readers have access to, and will have read, the Managements Discussion and Analysis or Plan of Operation and other information contained in such Form 10-KSB previously filed.  The following discussion and analysis also should be read together with our condensed consolidated financial statements and the notes to the condensed consolidated financial statements included elsewhere in this Form 10-QSB. This discussion summarizes the significant factors affecting the consolidated operating results, financial condition and liquidity and cash flows of Consolidated Energy, Inc. for the three and nine months ended September 30, 2006 and September 30, 2005 respectively.  Except for historical information, the matters discussed in this Managements Discussion and Analysis or Plan of Operation are forward looking statements that involve risks and uncertainties and are based upon judgments concerning various factors that are beyond our control.  Actual results could differ materially from those projected in the forward-looking statements as a result of, among other things, the factors described below under the caption Cautionary Statements and Risk Factors. Overview Consolidated Energy, Inc. engages principally in the business of mining coal in Eastern Kentucky.  Our business focus is the operation of profitable coal mines conducted through our wholly-owned coal mining subsidiary, Eastern Consolidated Energy, Inc.  We have the right to mine an estimated 20.2 million tons of recoverable coal pursuant to multiple lease agreements.  We do not own any coal mineral rights.  We are a producer and marketer of Appalachian coal, which is supplied to domestic electric utilities.  After obtaining permits from the U.S. Department of the Interior, we mine properties for the extraction of coal minerals.  We obtain reclamation bonds for each of our producing properties.  These bonds typically take the form of cash deposits with the U.S. Department of the Interior, Office of Surface Mining, or OSM.  At September 30, 2006, $121,700 was on deposit with OSM for reclamation bonds related to our Warfield mining operations.  Coal sales are made through the spot market and through long-term supply contracts.  Over the next 6-12 months, we expect all coal production to be sold solely through existing long-term contracts.  If no other long-term contracts are executed, we anticipate selling any coal not covered by the existing contracts in the spot market.  We have committed nearly 100% of our current anticipated overall run-rate to American Electric Power, Co. (AEP).  We have two contracts with AEP, one of which is a 36 month coal supply contract for 40,000 tons per month beginning April 2006.  The second contract is a 12-month contract for approximately 50,000 tons per month, with a 24-month option.  If AEP exercises its option on the second contract, the two contracts combined will account for nearly 100% of our production capacity over the next three years and account for approximately 15% of our current recoverable tonnage.  If AEP does not exercise its option on this second contract, AEP will account for approximately 70% of our production capacity for the first 12 months and approximately 9% of our current recoverable tonnage.  The coal industry has been highly competitive with very low margins in the past several years.  Recently, the surge in prices for natural gas has made coal more competitive with that alternative energy source, which has enabled coal fired power plants, using the latest clean air compliant scrubber technology, to be price competitive with natural gas fired plants.  We believe this has and will continue to cause increased demand for coal for the foreseeable future, resulting in higher prices and improved margins for our product.   However, the price of coal is very volatile, and there can be no assurances that  21    the price of coal will not drop below current levels.  We do not generate sufficient cash from operations to fund new mine development, and our expansion into new mines therefore depends on our ability to raise the required funds through debt or equity offering.  If we are not able to raise additional financing or if such financing is not available on acceptable terms, we may be unable to expand our mining operations beyond current production levels. We were incorporated in Nevada on December 18, 1996, under the name Barbeque Capital Corp.  In early October 2002, we entered into an agreement and plan of reincorporation and merger with Consolidated Energy, Inc., a privately-held Wyoming corporation which was incorporated for the sole purpose of merging with Barbeque Capital Corp.  On October 4, 2002 the secretary of state Wyoming issued a certificate of merger acknowledging that Barbeque Capital Corp. (Nevada) had merged into Consolidated Energy Inc. (Wyoming), which became the surviving entity.  On October 14, 2002, the reincorporation was deemed effective and we affected a change in its domicile from Nevada to Wyoming and changed its name from Barbeque Capital Corp. to Consolidated Energy, Inc.  In August 2003, we entered the coal mining business by issuing 3,000,000 shares of our common stock in exchange for all of the issued and outstanding stock of Eastern Consolidated Energy, Inc., a privately-held Kentucky coal mining corporation.  Critical Accounting Policies, Judgments and Estimates  The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, we evaluate our estimates, including those related to computing depreciation, amortization, reclamation liability, asset impairment, valuation of non-cash transactions, and recovery of receivables.  Estimates are then based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates. We believe our most critical accounting policies include revenue recognition, the corresponding accounts receivable, the methods of estimating reclamation expenses of actual mining operations in relation to estimated total mineable tonnage on our leased properties, and valuation of embedded derivatives.  We believe the following accounting policies affect our more significant judgments and estimates used in preparation of our consolidated financial statements. Revenue Recognition.  Under SEC Staff Accounting Bulletin No. 104, Revenue Recognition, we recognize revenue when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the sellers price to the buyer is fixed or determinable, and (4) collectibility is reasonably assured. Mined Coal.  In the case of mined coal which is sold, we negotiate a specific sales contract with each customer, which includes a fixed price per ton, a delivery schedule, and terms for payment.  We recognize revenue from sales made pursuant to these contracts at the time of delivery. Accounts Receivable.  Accounts receivable balances are evaluated on a continual basis and allowances, if any, are provided for potentially uncollectible accounts based on our estimate of the collectibility of customer accounts.  If the financial condition of a customer were to deteriorate, resulting in an impairment of its ability to make payments, an additional allowance may be required.  Allowance  22    adjustments, if any, are charged to operations in the period in which the facts that give rise to the adjustments become known.  To date, we have not had any customer whose payment was considered past due, and as such, have not recorded any reserves for doubtful collectibility. Asset Retirement Obligation.  The Surface Mining Control and Reclamation Act of 1977 and similar state statutes require that mine properties be restored in accordance with specified standards and an approved reclamation plan.  Significant reclamation activities include reclaiming refuse and slurry ponds, reclaiming the pit and support acreage atsurface mines, and sealing portals at deep mines.  Reclamation activities that are performed outside of the normal mining process are accounted for as asset retirement obligations in accordance with the provisions of Statement of Financial Accounting Standards, or SFAS, No. 143, Accounting For Asset Retirement Obligations.  We record our reclamation obligations on a mine-by-mine basis based upon current permit requirements and estimated reclamation obligations for such mines as determined by the Office of Surface Mining when we post a predetermined amount of reclamation bonds prior to commencing mining operations.  OSMs estimates of disturbed acreage are determined based on approved mining plans and related engineering data.  Cost estimates are based upon estimates approved by OSM based on historical costs.  In accordance with SFAS No. 143, we determine the fair value of our asset retirement obligations using a discounted cash flow methodology based on a discount rate related to the rates of US treasury bonds with maturities similar to the expected life of a mine, adjusted for our credit standing. On at least an annual basis, we review our entire reclamation liability and make necessary adjustments for permit changes granted by state authorities, additional costs resulting from accelerated mine closures, and revisions to cost estimates and productivity assumptions, to reflect current experience.  At September 30, 2006, we had recorded asset retirement obligation liabilities of $53,441.  While the precise amount of these future costs cannot be determined with certainty, as of September 30, 2006, we estimate that the aggregate undiscounted cost of final mine closure is approximately $121,700. Convertible Debt Issued with Warrants Accounted for as Derivative Financial Instruments.In accordance with Emerging Issues Task Force No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock, we recognize the value of convertible debt issued with warrants as a derivative financial instrument.  Our senior secured convertible debt was accounted for as an embedded derivative and valued on the transaction date using a Binomial Lattice pricing model.  The warrants were accounted for separately and also as a derivative and were valued on the transaction date using a Binomial Lattice pricing model as well as per EITF 00-19.  At every reporting balance sheet date, the values of the derivatives are evaluated and any change to fair market value is recorded as a gain or loss in our statement of operations.  The notice conversion feature and the warrants may be exercised at any time and, therefore, have been reported as current liabilities. Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123R Share-Based Payment, a revision to FASB No. 123.  SFAS No. 123R replaces existing requirements under SFAS No. 123 and APB Opinion No. 25, and requires public companies to recognize the cost of employee services received in exchange for equity instruments, based on the grant-date fair value of those instruments, with limited exceptions.  SFAS No. 123R also affects the pattern in which compensation cost is recognized, the accounting for employee share purchase plans, and the accounting for income tax effects of share-based payment transactions.  For small-business filers, SFAS No. 123R will be effective for interim periods beginning after December 15, 2005.  We do not have any current exposure to SFAS No. 123R however we will apply this accounting principle if in the future we issue stock options to employees.   23    In December 2004, the FASB issued FASB Statement No. 153.  This Statement addresses the measurement of exchanges of nonmonetary assets.  The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged.  The guidance in that Opinion, however, included certain exceptions to that principle.  This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance.  A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange.  This Statement is effective for financial statements for fiscal years beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges incurred during fiscal years beginning after the date of this Statement is issued.  We do not believe this Statement will have any impact on our financial statements once adopted.  Results of Operations  Revenues increased for the nine month period ended September 30, 2006 compared to the same nine month period in the prior year period because operations were limited in the previous period as we transitioned back into a producing entity, having suspended operations during most of 2005 to complete the wash plant facility and complete the ventilation and slope projects.  For the nine months ended September 30, 2006, we had revenues of $4,953,722, of which $4,950,722 was derived from coal sales and $3,000 was derived from oil and gas sales.  One regional coal producer accounted for all coal sales.  Costs and expenses totaled $17,013,858, which included other expenses of approximately $6.90 million related to the change in value of the convertible debt and warrant liabilities and interest expense of approximately $17.44 million, for a net loss of $12,060,135, or $0.63 per share.  For the nine months ended September 30, 2005, we had had coal sales of $1,816,305 and did not have any sales from oil and gas.  Costs and expenses totaled $4,417,943, which included other expense of approximately $1.0 million related to the change in value of the convertible debt and warrant liabilities and interest expense of approximately $110,000, for a net loss of $2,601,638 or $0.21 per share.  The approximate $3.14 million increase in revenue for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005 was attributable to the fact, in the previous year, we had limited production as we completed our construction projects.  For the three months ended September 30, 2006, we had revenues of $1,702,406, of which $1,702,406 was derived from coal sales and did not have any sales from oil and gas sales. One regional coal producer accounted for all coal sales.  Costs and expenses totaled $6,433,283, which included other expenses of approximately $1.47 million related to the change in value of the convertible debt and warrant liabilities and a decrease in interest expense of approximately $.79 million, for a net loss of $2,249,174 or $0.21 per share.  For the three months ended September 30, 2005, we had had coal sales of $920,739 and did not have any sales from oil and gas. Costs and expenses totaled $22,426, which included other income of approximately $2.56 million related to the change in value of the convertible debt and warrant liabilities and interest expense of approximately $88,000, for a net income of $898,313 or $.07per share.  The approximate $782,000 increase in revenue for the three months ended September 30, 2006 compared to the three months ended September 30, 2005 was attributable to the fact, in the previous year, we had limited production as we completed our construction projects.  For the nine months ended September 30, 2006, the cost of revenue was approximately $5.21 million and consisted primarily of salary, benefits, workers compensation and other compensation costs directly attributable to the employment of miners of approximately $2.21 million, and direct costs paid to third party vendors whose goods and services were directly used in producing coal, which primarily included equipment leases and maintenance expenses of $285,000, parts and supplies used in the process  24    of coal production of approximately $1.88 million, transportation costs of approximately $385,000, royalties and taxes of approximately $465,000 and approximately $55,000 for the cost of purchased coal.  For the nine months ended September 30, 2005, the cost of revenue was approximately $1.96 million and consisted primarily of salary, benefits, workers compensation and other compensation costs directly attributable to the employment of miners of approximately $536,000, and direct costs paid to third party vendors whose goods and services were directly used in producing coal, which primarily included equipment leases and maintenance expenses of approximately $95,000, parts and supplies used in the process of coal production of approximately $266,000, transportation costs of approximately $199,000, royalties and taxes of approximately $215,000, and approximately $403,000 for the cost of purchased coal.  For the three months ended September 30, 2006, the cost of revenue was approximately $2.05 million and consisted primarily of salary, benefits, workers compensation and other compensation costs directly attributable to the employment of miners of approximately $0.93 million, and direct costs paid to third party vendors whose goods and services were directly used in producing coal, which primarily included equipment leases and maintenance expenses of $165,000, parts and supplies used in the process of coal production of approximately $712,500, transportation costs of approximately $90,000, and royalties and taxes of approximately $150,000.  For the three months ended September 30, 2005, the cost of revenue was approximately $1.08 million and consisted primarily of salary, benefits, workers compensation and other compensation costs directly attributable to the employment of miners of approximately $142,000, and direct costs paid to third party vendors whose goods and services were directly used in producing coal, which primarily included equipment leases and maintenance expenses of approximately $16,000, parts and supplies used in the process of coal production of approximately $173,000, transportation costs of approximately $128,000, cost of purchased coal of approximately 403,000 and royalties and taxes of approximately $218,000.  Operating expenses for the nine months ended September 30, 2006 were approximately $4.10 million compared to operating expense of approximately $2.90 million for the nine months ended September 30, 2005.  This approximately $1.20 million increase was mainly attributable to an increase of approximately $695,000 in consulting and professional fees from $975,000 for the nine month period in 2005 compared to $1.67 million for the same nine month period in 2006.   Officer salaries and related expenses increased from $243,000 for the nine month period ended September 30, 2005 to approximately $645,000 for the nine month period ended September 30, 2006 due to additional officers being added to our payroll as we improved our management team.  Operating expenses for the three months ended September 30, 2006 were approximately $1.86 million compared to operating expenses of approximately $1.08 million for the three months ended September 30, 2005.  This approximately $0.78 million increase was mainly attributable to an increase of approximately $670,000 in consulting and professional fees from $350,000 for the three month period in 2005 compared to $1.02 million for the same three month period in 2006.  Officer salaries and related expenses increased from approximately $201,000 for the three month period ended September 30, 2005 to approximately $441,000 for the three month period ended September 30, 2006 due to additional officers being added to our payroll as we improved our management team.  Restatement of September 30, 2005 Balances  On January 3, 2005, we issued 2,500,000 shares of our common stock for additional coal seams on the Dempsey Lease, to certain shareholders who at the time were deemed to be controlling shareholders.  The 2,500,000 shares of stock were valued and originally booked at par value of $2,500 which approximated the cost basis of the Lease in the hands of the controlling shareholders.  In November 2005, we discovered the error and the correction is reflected in our financial statements for the fiscal year  25    ended December 31, 2005 which reflect the 2,500,000 shares of stock valued at fair market of $4,875,000 which represents the closing quoted market value of our stock on the date of the acquisition of the additional seams.  As summarized below, the restatements only affected the value of certain balance sheet items and accordingly, did not result in a change to earnings.  The following sets forth the balance sheet items affected by these changes:  AsAsReportedRestatementRestated9/30/05Adjustment9/30/05Coal Leases, Net of Amortization$  6,020,708$  5,956,800$  11,977,508Additional Paid-in-Capital$10,571,052$  5,956,800$  16,527,852  In July 2006, the Company determined that the warrants issued in conjunction with the senior secured notes and the shares into which the senior secured notes can be converted into, should have been accounted for as derivatives,with the initial fair value of the derivatives being recorded as a liability and the corresponding debit being recorded as a reduction in the related senior secured note payable as debt discount.  Changes in the fair value of the derivative from the initial fair value calculation to the balance sheet date are recorded in earnings.  The following table sets forth the financial statement items affected by changes to the financial statements caused by recording the warrants issued in conjunction with the senior secured notes and the shares into which the senior secured notes can be converted into, as derivatives.  As Reported and RestatedJuly 2006 RestatementAs Restated9/30/05Adjustments9/30/05Coal leases, net of amortization11,977,508385,557(5)12,363,065Derivative liability warrants(3,383,309)(1)969,336(6)(1,909,557)(3)(4,323,530)Derivative liability conversion shares(10,067,648)(2)2,950,001(4)(7,117,647)Long term notes payable(10,669,221)10,067,648(2)(385,557)(5)(987,130)Additional Paid-in-Capital(16,527,852)3,383,309(1)(969,336)(6)(14,113,879)Retained deficit11,457,704(1,909,557)(3)2,950,001(4)10,417,260Changes in fair value derivative liability warrants(1,909,557)(3)(1,909,557)Changes in fair value derivative liability conversion shares2,950,001(4)2,950,001Net Loss(3,642,082)(1,040,444)(2,601,638)  (1) Represents the initial fair value of the warrant liability.  The fair value was calculated using the Binomial Lattice pricing model with the following assumptions:  (i) risk free interest rate of  26    3.91%; (ii) expected life of 5.0 years; (iii) expected volatility of 83.24%; (iv) expected dividend yield of 0.00%; and (v) stock valuation of $4.00. (2) Represents the initial fair value of the conversion share liability.  The fair value was calculated using the Binomial Lattice pricing model with the following assumptions:  (i) risk free interest rate of 3.67%; (ii) expected life of 3.0 years; (iii) expected volatility of 83.24%; (iv) expected dividend yield of 0.00%; and (v) stock valuation of $1.70. (3) Represents the change in the fair of the warrant derivative liability between the initial commitment date and September 30, 2005. The fair value was calculated using the Binomial Lattice pricing model with the following assumptions:  (i) risk free interest rate of 4.18%; (ii) expected life of 4.42 years; (iii) expected volatility of 84.56%; (iv) expected dividend yield of 0.00%; and (v) stock valuation of $2.35. (4) Represents the change in the fair of the conversion share derivative liability between the initial commitment date and September 30, 2005. The fair value was calculated using the Binomial Lattice pricing model with the following assumptions:  (i) risk free interest rate of 4.18%; (ii) expected life of 2.42 years; (iii) expected volatility of 84.56%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $1.70. (5) Represents the change in the amortization of the debt discount.  During this period the Company was capitalizing all interest charges. (6) Represents the value associated with the settlement of 1,066,176 warrants through a cashless exercise.  Related Party Transactions Barry Tackett, appointed as a director and CFO in February 2004, was paid a total of $10,610 for accounting services in fiscal 2005.  In January 2005, Mr. Tackett also received a total of 225,000 shares for consulting services in fiscal 2004 valued at $438,750.  In January 2006, Mr. Tackett resigned as CFO and agreed to serve as our Controller.  We currently have an oral agreement with Mr. Tackett.  Mr. Tackett provides services relating to all aspects of our accounting needs, including payroll services and general day to day accounting functions.  Jacobs Risk Management, a risk management consulting company operated as a sole proprietorship by one of our directors and our corporate Secretary, Joseph G. Jacobs, provides preventative and ongoing compliance support to help insure that we remain in compliance with all state and federal regulatory coal mining matters.  Through Jacobs Risk Management, Mr. Jacobs was paid a total of $7,146 in fiscal 2005.  In January 2005, Mr. Jacobs also received 225,000 shares for consulting services in fiscal 2004 valued at $438,750.  We currently have an oral agreement with Mr. Jacobs in connection with Jacobs Risk Managements services.  Additionally, we lease our executive offices at 76 George Rd. Betsy Layne, KY from Jacobs Risk Management.  The office is leased for $2,000 per month plus utilities, which approximates market rates.  During the calendar fourth quarter 2005 and the calendar first quarter of 2006, we issued 20,000 shares to RC Financial Group, LLC for consulting services rendered.  As a result, we recognized a $25,200 consulting expense in 2005 and have booked a $10,500 consulting expense in 2006.  In June 2006, we issued 200,000 shares to RC Financial for consulting services rendered.  As a result, we recognized a $202,000 consulting expense.  Robert Chmiel is the sole owner of RC Financial Group, LLC and is our current interim chief financial officer. On July 12, 2006, we issued 193,518 shares of our common stock to Mr. Tackett and issued 358,518 shares of our common stock to Mr. Jacobs, both officers and directors of the Company, for a combined $496,834 of accrued salaries as a further condition to the completion of the July 2006 financing.  The accrued salaries were converted into shares of common stock at a $0.90 conversion price.  27    Liquidity and Capital Resources  As of September 30, 2006, we had cash and cash equivalents of approximately $754,000, of which approximately $753,000 was restricted cash.  As of September 30, 2006, we had negative working capital of approximately $14.23 million.  We expect a significant use of cash during the remaining calendar quarter of 2006, as we continue to expand our coal mining operations.  We anticipate the need to acquire additional assets and/or mining operations, and may be required to raise additional funds by issuing additional equity or debt securities, the amount and timing of which will depend in large part on our spending program.  In March 2006, we entered into a Memorandum of Understanding for a Line of Credit with Community Trust Bank, Inc., Pikeville, KY pursuant to which we may borrow 80% of our accounts receivable, up to $5 million.  We are required to make monthly payments of interest-only, calculated by multiplying the then principal balance outstanding by an interest rate determined to be the Prime Rate plus 1%.  We received approval from greater than 60% of our outstanding note holders, as required by our January 2006 agreement prior to incurring any additional indebtedness, and subsequently signed the Line of Credit Agreement on April 24, 2006.  As of September 30, 2006, we had total accounts receivable of approximately $671,667.  Pursuant to the terms of the line of credit agreement with Community Trust Bank, as of September 30, 2006 we received cash of approximately $537,300 (80% of $671,667) based on accounts receivable at September 30, 2006.  To date, we have funded operations primarily through the issuance of notes payable and convertible debentures.  We have also issued stock for services in lieu of cash.  In September and November 2005, we obtained a $1.8 million bridge loan.  This allowed us to continue operating through the middle of January 2006.  Subsequently in January 2006, we were able to secure additional financing with terms agreeable to the Bridge Note holders which transferred the bridge note into the additional funding, the material terms of which are described above in the section titled Recent Developments.  In April 2006, we entered into the Line of Credit Agreement described above with Community Trust Bank, Inc.  In July 2006, we closed an additional financing transaction, the material terms of which are also described below in the section titled Recent Developments.  Now that (i) the wash plant is operational,  (ii) we have re-commenced coal production in the Pond Creek seam, generating approximately 20,000 tons per month, (iii) we have commenced selling coal pursuant to our sales contract with American Electric Power, and (iv) have completed the July 2006 financing, the proceeds of which will be used to purchase additional equipment and provide working capital which we believe will allow us to a monthly production level in excess of 60,000 tons within 45 days, management believes we now have enough cash, and the availability of cash pursuant to this Line of Credit, to continue operations with no further influx of cash.  However, we estimate that our monthly production must exceed 55,000 tons per month in order for us to generate cash flow from operations sufficient enough for to service our debt and conduct operations without any additional outside sources of capital.  We may seek additional capital in order to expand our operations, with a goal to raise an additional approximately $1 to $3 million, which would allow us to produce approximately 80,000 to 100,000 tons per month, subject to the availability of capital at terms favorable to us.  If we are unable to produce in excess of 55,000 tons per month, then we will scale back operations to reduce operating expenditures.  No assurances, however, can be made that we will reduce costs enough to continue operations and we may be forced to suspend or completely cease operations, the results of which may be detrimental to the investment of our shareholders and existing note holders. As of September 30, 2006, we had not established revenues sufficient to cover our operating costs, and there remains substantial doubt about our ability to continue as a going concern consistent with the report of our auditor at December 31, 2005.  At this filing date, we believe we have sufficient capital to complete mine development, operate the wash plant, and upgrade and/or maintain the equipment necessary to increase the production capability of the Alma and Pond Creek seams, however, we may seek additional financing to increase operations until the planned production is fully implemented.  If  28    additional funds are raised through the issuance of equity securities, the current stockholders may experience dilution.  Furthermore, there can be no assurance that additional financings will be available when needed or that if available, such financings will include terms favorable to us and our stockholders.  If such financings are not available when required or are not available on acceptable terms, we may be unable to take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and results of operations.  If such funding is received and we successfully complete the planned increase in production, management believes we will have adequate resources for operations without any additional outside infusion of capital. However, if such operations are substantially delayed or impaired, we may be forced to suspend or cease operations.  Cash Flows We currently satisfy our working capital requirements through cash flows generated from the sale of coal as well as the sale of notes payable and convertible debentures.  For the nine months ended September 30, 2006, we had a net decrease in unrestricted cash of approximately $256.  Cash flows from operating, financing and investing activities for the nine months ended September 30, 2005 and September 30, 2006 are summarized in the following table: ActivityNine Months
Ended
September 30,
2005Nine Months
Ended
September 30,
2006Operating activities$   (1,909,568)$ (4,583,879)Investing activities:(10,455,351)(4,596,960)Financing activities12,424,1389,180,583Net increase (decrease) in cash$    59,219$             (256 320,639)  Operating Activities  The net cash used in operating activities of approximately $4.58 million during the nine months ended September 30, 2006 was primarily the result of the net loss of approximately $12.06 million and increases in accounts receivable of approximately $669,000 offset by an increase in accrued liabilities of approximately $1.21 million as we completed our slope construction and wash plant projects and commenced coal sales, an increase in accounts payable and royalties payable of approximately $707,000 and non-cash expenses of approximately $6.54 million.  The non-cash expenses recorded during the period primarily included approximately $731,000 for depreciation and amortization and $633,000 of non-cash consulting and compensation expenses related to the issuance of common stock for services rendered, accretion of debt discount of $15.69 million and $511,635 of loss on sale of capital assets, offset by change in fair value of warrant liability of $11.88 million and change in fair value of convertible shares of $0.85 million. The net cash used in operating activities of approximately $1.91 million during the nine months ended September 30, 2005 was primarily the result of the net loss of approximately $2.6 million partially offset by an increase in accounts payable and accrued liabilities of approximately $1.2 million and non-cash expenses of approximately $281,000 of which $418,175 was for depreciation and amortization and $1.91 million in change in fair value of warrant liability offset by approximately $2.96 million in change in fair value of convertible share liability. Investing Activities  29     Approximately $4.60 million of the cash used in investing activities during the nine months ended September 30, 2006 was due primarily to the addition of approximately $4.02 million of property, plant and equipment, and $582,000 pursuant to the capitalization of lease costs.  To the extent that we make additional asset acquisitions in the remaining quarter of 2006 similar to our investing activities in the past year, we will need to raise additional cash from outside sources.  If additional funds are raised through the issuance of equity securities, the current stockholders may experience dilution.  Furthermore, there can be no assurance that additional financings will be available when needed or that if available, such financings will include terms favorable to us or our stockholders.  If such financings are not available when required or are not available on acceptable terms, we may be unable to take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and results of operations. For the nine months ended September 30, 2005, $10.46 million of cash was used in investing activities resulted primarily from the purchase of equipment of approximately $6.0 million, and approximately $4.47 million of capitalized interest. Financing Activities  On January 11, 2005, we closed a financing transaction for $2,500,000 in bridge financing to be used exclusively for the purchase of equipment and to fund expenditures for the consummation of mining activities at our Warfield Mine operations. The financing consisted of a senior secured promissory note for the face amount of $2,500,000 with an interest rate of 9% per annum and a payment date (principal and interest) of March 31, 2005. Gryphon Master Fund, LP and GSSF Master Fund, LP, both Bermuda limited partnerships, were collectively the payees on the note.  The note was repaid with the proceeds from our February 2005 financing - see below.  In consideration for the above note, we paid a commitment fee of $50,000 to the Gryphon Master Fund and GSSF Master Fund, and a flat fee of $10,000 as reimbursement for fees and expenses incurred in connection with the negotiation, preparation and delivery of the note, all deducted from the proceeds of funding the note.  As additional consideration, we issued to Gryphon Master Fund and GSSF Master Fund a warrant for the purchase of an aggregate of 514,706 shares of our common stock at an exercise price of $1.70 per share, exercisable for five years.  The warrant also contains so-called "piggyback" registration provisions under which the warrant holder may request that the shares underlying the warrant be included in a registration with respect to an offering of our securities.  In addition to the above bridge note fees and warrants, we paid Stonegate Securities, Inc., a Texas corporation, which we refer to as Stonegate, a placement agent fee for a total of $200,000 cash and issued warrants for the purchase of an aggregate of 51,470 shares of our common stock on the same terms as the warrants issued to Gryphon Master Fund and GSSF Master Fund.  The warrant issuances were in the form of a warrant issued to Scott R. Griffith and a warrant issued to Jesse B. Shelmire IV, each for the purchase of 25,735 shares.  The cash paid and warrants issued were per the terms of a non-exclusive Placement Agency Agreement between us and Stonegate.  On February 24, 2005, we entered into a financing transaction for aggregate gross proceeds of $7,000,000, with additional investment rights of up to an additional $7,000,000 (hereinafter, the 6% Notes), such financing to be used for the purchase of equipment and to fund expenditures for the consummation of mining activities at our Warfield Mine.  The financing is in the form of 6% senior secured convertible notes for an aggregate total face amount of $7,000,000 and a term of three years.  The 6% senior secured notes may be converted to common stock at a conversion price of $1.70 per share.  Holders of such notes are Gryphon Master Fund, L.P., GSSF Master Fund, LP, Lonestar Partners, L.P.,  30    WS Opportunity International Fund, Ltd., WS Opportunity Fund (QP), L.P., WS Opportunity Fund, L.P., Renaissance US Growth Investment Trust PLC, and BFS US Special Opportunities Trust PLC (collectively, the Holders).  As additional consideration, we issued to each of such holders warrants for the purchase of an aggregate of 2,058,824 shares of our common stock at an exercise price of $1.70 per share, exercisable for five years.  The conversion price of such notes, and the exercise price of such warrants, are subject to certain normal and customary anti-dilution adjustment provisions and also include a one-time reset date provision with a floor price of $1.00 per share.  In February 2005, simultaneous with the closing of the 6% Note offering, we used approximately $2,527,000 of the proceeds of the above offering to repay the January 2005 bridge loan (principal and interest) from Gryphon Master Fund and GSSF Master Fund.  We also paid a flat fee of $30,000 to Gryphon Master Fund and GSSF Master Fund as reimbursement for fees and expenses incurred in connection with the negotiation, preparation and delivery of the 6% Notes and related investment documents. In addition to the above fees related to the issuance of the 6% Notes, we paid Stonegate a total of $340,000 cash and issued warrants for the purchase of an aggregate of 617,647 shares of our common stock on the same terms as the warrants issued to the Holders.  During March 2005, two investors in our February 2005 private placement exercised their additional investment rights for an aggregate of $750,000 in the same 6% senior secured convertible notes that may be convertible into 441,176 shares of our common stock at an exercise price of $1.70 upon the occurrence of certain events.  In connection with the additional investment, we issued warrants for the purchase of 44,116 shares of our common stock at an exercise price of $1.70 to Stonegate.  In April 2005, Stonegate exercised all of the 713,223 warrants issued through a cashless exercise provision in exchange for the issuance of 485,850 shares of our common stock.  During June 2005, seven investors exercised their additional investment rights for an aggregate of $6,000,000 in the same 6% senior secured convertible notes that may be convertible into 3,529,411 shares of our common stock at an exercise price of $1.70 upon the occurrence of certain events.  In July, placement agent warrants issued to Stonegate for the purchase of 352,994 shares issued in connection with the exercise of the additional investment rights were exercised pursuant to cashless exercise provisions for the issuance of 166,290 shares.  In connection with the above transactions, we executed a security agreement (the "Security Agreement") giving the Holders a security interest in and to any and all of our assets and properties ("Collateral" as defined in the Security Agreement).  Each of our subsidiaries has also executed a Guaranty for our obligations under the 6% Notes.  The proceeds received from the financing described above were budgeted to allow us to:  · access the Pond Creek coal seam at Warfield; · acquire the equipment necessary to mine the Pond Creek seam; · prepare to construct a coal washing facility at Warfield; and · begin engineering and permitting of other coal seams at Warfield.  A portion of the proceeds received from the transactions were used to provide working capital and materials necessary to construct three slopes and the ancillary ventilation necessary to allow us to access the Pond Creek coal seam.  This construction project was originally scheduled to be near completion by the end of the third quarter 2005.  The schedule to complete this project was adjusted for the end of January 2006.  The slope construction project did conclude in February, 2006, and we experienced additional costs related to equipment repairs and additional costs associated with the substantial time required to handle the thousands of cubic yards of material associated with a geological fault encounter.  31     A portion of the net proceeds were used to prepare the site and to secure the equipment associated with the planned coal washing facility.  The wash plant construction project was initiated in mid March 2005.  The initial plan provided for a certain location and equipment type.  However, during the rework of the Pond Creek project, management was able to negotiate to have a significant amount of Alma coal washed by third parties.  Management sought to have this product washed in order to verify the laboratory reports obtained earlier.  Information obtained during this process indicated that we could potentially realize greater profits from the washed coal if some adjustments were made to the initial wash plant plans.  In early June 2005, management determined to change the design, final location, and overall size of the proposed wash plant to accommodate this new information.  As a result of these changes, the overall budgeted cost of the wash plant was increased by approximately 12.5% (from $4 million to $4.5 million) and completion was delayed.  The wash plant became operational in late March 2006 at a total cost of approximately $6.4 million.  Recent Financing Developments  6% Senior Secured Convertible Notes On July 1, 2005, we failed to pay interest as required pursuant the terms of the 6% Notes including the Additional Investment Rights first executed on February 24, 2005 for an aggregate total face amount of $13,750,000, and thereby caused a default under the terms of the notes.  Subsequently, and in order to secure additional financing for continuing operations, on September 23, 2005, we executed a promissory note (the "September Bridge Note") payable to Cordillera Fund L.P. for an aggregate principal amount of up to $1,500,000.  On November 24, 2005 the existing September Bridge Note holders and we agreed to increase the amount of debt by $300,000 to a total of $1,800,000.The September Bridge Note was subsequently cancelled on January 13, 2006 and exchanged for an investment in our 8% senior secured convertible notes and warrants. See below for a description of the material terms of this 8% transaction.  In connection with the September Bridge Note, we entered into a Consent and Waiver with the Holders of the 6% Notes, whereby they consented to the September Bridge Note transactions and waived, until resolution of the September Bridge Note transactions, the application of any of the provisions of the 6% Notes and related transaction documents.  We also entered into a Subordination Agreement in connection with the September Bridge Note, whereby Cordillera Fund L.P. agreed to subordinate the September Bridge Note to the prior payment in full in cash of the 6% Notes.  In addition, the Holders of the 6% Notes entered into a Bridge Forbearance with us whereby they agreed to forebear from exercising any of their rights or remedies under the 6% Notes and the related securities purchase agreement, security agreement and any other related transaction documents for a period of ten business days.  On October 6, 2005, the holders of the 6% Notes signed an extension to the Bridge Forbearance until the earliest to occur of the following: (i) November 18, 2005, (ii) the expiration and termination of the September Bridge Note, or (iii) the completion by us of a new financing.  As described below, on January 13, 2006, the 6% Note holders signed another forbearance agreement pursuant to which, among other things, they agreed to waive our prior defaults on the 6% Notes.  January 13, 2006 Private Placement  On January 13, 2006, we sold approximately $6.24 million principal amount of 8% senior secured convertible notes due June 30, 2008 to 18 accredited investors (the 8% Notes).  In connection with the sale of the 8% Notes, we issued investors warrants to purchase an aggregate of approximately 3.3  32    million shares of common stock, calculated as 50% of each investors subscription amount divided by $0.90.  Of the $6.24 million principal amount of 8% Notes, we received gross proceeds of $3.4 million.  The remaining approximate $2.94 million principal amount was paid by investors as follows: (a) $1.8 million was paid by the cancellation of the September Bridge Notes; (b) $102,000 represents a management fee owed to the lead investor, Gryphon Master Fund, L.P.; (c) $586,000 represents interest accrued on our 6% Notes, and $452,000 as placement agent fees.  The 8% Notes have a final maturity date of June 30, 2008, accrue interest at the rate of 8% per annum, are secured by all of our properties and assets and the properties and assets of each of our subsidiaries, and are guaranteed by each of our subsidiaries.  The 8% Notes rank pari passu with our outstanding 6% Notes.  Interest may be paid either in cash or with shares of our common stock in our sole discretion.  Holders of the 8% Notes have the right to convert the outstanding principal amount into shares of our common stock from time to time based on a conversion price of $0.90, subject to adjustment.  Beginning July 1, 2006, on the first day of each month we are required to redeem 1/24th of the outstanding principal of the 8% Notes (the Monthly Redemption Amount).  If the transaction is registered on an effective registration statement and certain other conditions are satisfied, we may pay the Monthly Redemption Amount with shares of common stock based on a conversion price equal to the lesser of (a) the then conversion price and (b) 80% of the daily volume weighted average price of the common stock for the 10 consecutive trading days prior to the applicable monthly redemption date.  In the event our annualized EBITDA for the two fiscal quarters ending December 31, 2006 (the Annualized EBITDA) is less than $17 million, the conversion price of the 8% Notes will be reset to equal the greater of (a) $0.30 or (b) a price determined by the following formula: [3 * X/Y], where X equals the Annualized EBITDA and Y equals the number of shares of common stock outstanding on a fully diluted basis on December 31, 2006.  In addition, if we issue or commit to issue or distribute new securities at a price per share less than the current market price or the current conversion price, then the conversion price will be adjusted to reflect such lower price.  The conversion price is also subject to adjustment for stock dividends, stock splits, stock combinations and similar dilutive transactions.  The warrants issued in connection with the 8% Notes have an exercise price of $0.90 per share and are exercisable until January 14, 2011.  Holders may exercise the warrants on a cashless basis after the first anniversary of the initial issuance date and then only in the event that a registration statement covering the resale of the warrant shares is not then effective.  In the event our annualized EBITDA for the two fiscal quarters ending December 31, 2006 (the Annualized EBITDA) is less than $17 million, the exercise price of the warrants will be reset to equal the greater of (a) $0.30 or (b) a price determined by the following formula: [3 * X/Y], where X equals the Annualized EBITDA and Y equals the number of shares of common stock outstanding on a fully diluted basis on December 31, 2006.  In addition, if we issue or commit to issue or distribute new securities at a price per share less than the current market price or the current exercise price, then the exercise price will be adjusted to reflect such lower price.  The exercise price is also subject to adjustment for stock dividends, stock splits, stock combinations and similar dilutive transactions.  The investors have agreed to restrict their ability to convert the 8% Notes and exercise the warrants such that the number of shares of common stock held by them in the aggregate and their affiliates after such conversion or exercise does not exceed 4.99% of our then issued and outstanding shares of common stock. We agreed to file a registration statement with the SEC registering the resale of the shares of common stock issuable upon conversion of the 6% Notes and the 8% Notes and related warrants on or before February 12, 2006 and cause such registration statement to be declared effective no later than May 31, 2006.  We have filed such registration statement, as amended, on Form SB-2 but have not yet been informed by the SEC regarding its effectiveness.  33     Notwithstanding the availability of Rule 144, each investor agreed not to sell, offer or otherwise transfer any shares of our common stock beneficially owned by them until the earlier of: (a) May 31, 2006 or (b) the date the required registration statement is declared effective by the SEC.  The parties also entered into an amended and restated security agreement reflecting the pari passu nature of the 6% Notes with the 8% Notes.  In lieu of cash payment of accrued but unpaid interest due pursuant to the 6% Notes, we issued holders notes and warrants pursuant to the terms of the January 13, 2006 private placement.  In addition, we issued non-convertible promissory notes to Holders of the 6% Notes in the aggregate principal amount of $2,640,000 which represents liquidated damages which had accrued and is payable pursuant to the February 24, 2005 registration rights agreement.  The promissory notes bear interest at the rate of 3% per annum, compounded annually.  The full amount of principal and interest is due on June 30, 2008.  Our obligations pursuant to the promissory notes are secured by all of our properties and assets and the properties and assets of each of our subsidiaries pari passu with the 6% Notes and 8% Notes.  On October 27, 2005, we borrowed $329,190 from Community Trust Bank, Pikeville, KY to purchase mining equipment.  The note had a maturity date of January 27, 2006 and an annual interest rate of the Prime Rate plus one percent (1%), calculated on the basis of an assumed 360-day year for the actual number of days elapsed.  The note plus all accrued interest was paid in full on January 20, 2006.  July 12, 2006 Private Placement  On July 12, 2006 (the "Closing Date), we completed the transactions contemplated by a Securities Purchase Agreement, effective as of June 30, 2006 (the Purchase Agreement).  Under the terms of the Purchase Agreement, we issued to four institutional investors (the Senior Investors) $4,444,444 in face amount of Variable Rate Original Issue Discount Convertible Secured Debentures (the Secured Debentures) due June 2008.  We realized gross proceeds of $4,000,000 from the issuance.  The Secured Debentures bear interest at the annual rate of the higher of 12% or prime rate plus 4%, and may be convertible into shares of our common stock at a fixed conversion price of $1.36.  The Secured Debentures are secured by a first priority security interest in equipment to be purchased with the proceeds from the Secured Debentures (the Equipment) and a subordinated security interest in all our assets as well as certain of our real estate located in Martin County, Kentucky.  In addition, the Secured Debentures are guaranteed by our subsidiaries.  Of the amount raised, $3,750,000 was deposited into a blocked account and will be released upon the purchase of the Equipment.  The balance of the funds was deposited into a control account and will be released when we issue one or more widely disseminated press releases reporting that we have produced and sold at least 70,000 tons of coal during each of three consecutive calendar months. On the same date, pursuant to an Unsecured Debt Securities Purchase Agreement, effective as of June 30, 2006 (the Unsecured Purchase Agreement, together with the Purchase Agreement, the Agreements), we also issued to six institutional investors (the Junior Investors, together with the Senior Investors, the Investors) unsecured convertible debentures in the principal amount of $1,750,000 (the Unsecured Debentures).  The Unsecured Debentures are due in July 2008, accrue interest at the annual rate of 15% and may be converted into shares of our common stock at a fixed conversion price of $0.90.   34    Under the terms of the Agreements, we also issued to the Investors an aggregate of 4,000,000 shares of common stock (the Investor Shares) and five-year warrants to purchase up to 5,875,000 shares of our common stock at $0.01 per share (the Warrants).  The sale and issuance of all securities pursuant to the Agreements was exempt from registration requirements pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder.  Pursuant to the terms of a registration rights agreement, we agreed to file a registration statement with the Securities and Exchange Commission (the Commission) registering the resale of (i) the shares of common stock issuable upon conversion of the Secured Debentures and the Unsecured Debentures, (ii) the Investor Shares, and (iii) the shares of common stock issuable upon the exercise of the Warrants on the earlier of (a) the 60th calendar day following the Closing Date, or (b) the 20th calendar day following the date on which the Companys registration statement currently on file with the Commission is declared effective and cause such registration statement to be declared effective no later than 60 days after the filing thereof.  We have not yet filed a registration agreement and as such we are currently in non compliance with this registration rights agreement.  We however have not triggered an Event of Default pursuant to the Secured Debentures.  We would trigger an Event of Default if a registration statement shall not have been declared effective by the Commission on or prior to the 210th calendar day after the Closing Date.  In connection with the execution of the Agreements and as a condition to the completion thereof, the holders of (i) an aggregate of $7,000,000 in principal amount of our 6% Senior Secured Convertible Notes due 2008 dated February 24, 2005, (ii) an aggregate of $6,750,000 in principal amount of our 6% Senior Secured Convertible Notes due 2008 dated March 18, 2005, June 8, 2005 and June 30, 2005, and (iii) an aggregate of $6,239,930 in principal amount of our 8% Senior Secured Convertible Notes due 2008 dated January 13, 2006 have agreed to subordinate their security interests in our assets to liens granted to the holders of the Secured Debentures in the Equipment.  They also agreed to waive, until November 30, 2006, certain penalties due to them and agreed to allow us to pay some of the accrued interest on their existing notes in shares of common stock.  As a further condition to the completion of the Agreements, approximately $708,000 of outstanding debentures and approximately $497,000 of accrued salaries were converted into shares of common stock at a $0.90 conversion price.  In connection with the transactions contemplated under the Agreement, we paid (i) a placement agent fee of $140,000 in cash and issued five-year warrants to purchase 400,000 shares of common stock at $0.01 per share to Ascendiant Securities, LLC, and (ii) a placement agent fee of $262,500 in cash and issued five-year warrants to purchase 100,000 shares of common stock at $0.01 per share to Stonegate Securities and its principals Jesse Shelmire and Scott Griffith, each a director of the Company.  As an inducement to one of the Junior Investors to purchase the Unsecured Debentures, Messrs. Shelmire and Griffith sold to that Junior Investor Company securities owned by them, consisting of $300,000 face amount of promissory notes, warrants to purchase 150,000 of common stock, and 300,000 shares of common stock for a total purchase price of $300,000.  Issuance of Stock  In February 2005, we issued 2,500,000 shares of our common stock to Eastern Land Development Company, Inc. and acquired the right to mine an additional approximately 13.0 million tons recoverable coal in the Alma, Pond Creek, Coalburg, Taylor, Richardson, and Broas seams.  The acquisition was booked at $4,875,000, the fair market value of the stock on the date issued.   35    In June 2006, we issued 200,000 shares to RC Financial Group, LLC for consulting services rendered.  As a result, we recognized a $202,000 consulting expense.  Robert Chmiel is the sole owner of RC Financial Group, LLC and is our current interim chief financial officer.  In July 2006, we issued 952,239 shares of common stock upon the conversion debt principal and interest totaling $857,015.  On July 12, 2006, we issued 552,036 shares of our common stock to Mr. Tackett and Mr. Jacobs, both officers and directors of the Company, for $496,834 of accrued salaries.  The accrued salaries were converted into shares of common stock at a $0.90 conversion price.  During the third quarter 2006, we issued 534,801 shares of common stock in lieu of cash as payment of interest totaling $414,792 to the holders of the 6% Notes for interest which accrued for the six months ended July 1, 2006.  The accrued interest was converted into shares of common stock at a $0.7756 conversion price, which was the 10-day volume weighted average price (VWAP) of the stock for the 10 trading days prior to July 1, 2006 as quoted in the Over The Counter Electronic Bulletin Board trading exchange.  Contractual Obligations  The following summarizes our contractual obligations at September 30, 2006 and the effects such obligations are expected to have on liquidity and cash flow in future periods.  TotalLess than 1 yearAfter 1 yearNotes payable$29,314,728$  458,742$28,835,986Operating leases79,64865,80313,845Employment obligations312,667312,667-Total contractual obligations$29,707,043$ 837,212$28,849,831  Our notes payable at September 30, 2006 consisted of the following:  36     Promissory NotesAmount Due at
September 30,
2006Senior secured convertible Note dated February 14, 2005; interest rate of 6% per annum from original issue.  Interest due semi-annually with six month anniversary date.  Principal and interest can be converted into shares of the Companys common stock at $0.90 per share.  Principal due 36 months from the date of issue.$    7,000,000Senior secured convertible Note dated June 30, 2005; interest rate of 6% per annum from original issue.  Interest due semi-annually with six month anniversary date.  Principal and interest can be converted into shares of the Companys common stock at $0.90per share.  Principal due 36 months from the date of issue.6,750,000Senior secured convertible note dated January 13, 2006; interest rate of 8%.  Principal and interest are due monthly commencing with June 30, 2006   Principal and interest can be converted into shares of the companys common stock at $0.90 per share.6,239,930Senior secured non-convertible promissory note dated January 13, 2006; Interest rate of 3% per annum compounded annually with principal and interest due upon final maturity date of June 30, 2008.2,640,000Senior secured convertible note dated July 12, 2006; interest at the annual rate of the higher of 12% or prime rate plus 4%.  Interest is due monthly and principal is due commencing with the 1st of the month following 120 days from July 12, 2006.   Principal and interest can be converted into shares of the companys common stock at $1.36 per share.  Principal due upon final maturity date of June 30, 2008.4,444,444Junior unsecured convertible promissory note dated July 12, 2006; interest rate of 15% per annum; accrues monthly; payable upon certain cash flow conditions. Principal due upon final maturity date of June 30, 2008.1,750,000Bank Note Dated June 25, 2005; Interest rate 5.99% payable monthly11,138Bank Note Dated July 15, 2005; Interest rate 5.0%, payable monthly21,796Bank Note Dated June 25, 2005; Interest rate of 5.99%, payable monthly21,593Bank Note Dated June 25, 2005; Interest rate of 5.99%, payable monthly22,421Bank Line of Credit Note, Interest rate prime plus 1%, interest only due through June 30, 2006413,406TOTAL PROMISSORY NOTES$  29,314,728Less: debt discount(22,277,760)Less: current portion of notes payable(3,130,354)TOTAL LONG-TERM PORTION  OF PROMISSORY NOTES$  3,906,614  We rent mining equipment pursuant to an operating lease agreement, and made lease payments totaling $57,000 during the nine months ended September 30, 2006.  Off-Balance Sheet Arrangements At September 30, 2005 and September 30, 2006, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, variable interest or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.  As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.  37    Cautionary Statements and Risk Factors Several of the matters discussed in this document contain forward-looking statements that involve risks and uncertainties.  Factors associated with the forward-looking statements that could cause actual results to differ materially from those projected or forecast are included in the statements below.  In addition to other information contained in this report, readers should carefully consider the following cautionary statements. Risks Related To Our Business Our mining operations are relatively new and we have no extensive history of operating coal mines.  Our mining operations began in September 2003 when we acquired our current mining operation in Kentucky.  Since that time, we have had nominal production and development operations.  Since inception of our current business in September 2003 through September 30, 2006 we have had only $10,401,858 in revenue.  Accordingly, our success is dependent on our ability to manage further mine development, increase production levels and achieve profitable sales with the resources we have available or can secure. In addition, we will have to adjust our planning to changing conditions in the highly competitive coal industry. None of these requirements for success can be demonstrated by our performance to date and there is no assurance we will be able to accomplish them in order to sustain our operations.  Our financial status creates substantial doubt whether we will continue as a going concern.  If we do not continue as a going concern, investors will lose their entire investment.  We have suffered recurring losses from operations and we have limited capital resources.  We reported net losses totaling $12,060,136 and $6,418,284 for the nine months ended September 30, 2006 and the fiscal year ended December 31, 2005, respectively.  Because of these factors, the accompanying financial statements are prepared using generally accepted accounting principles applicable to a going concern, which contemplates realization of assets and the liquidation of liabilities in the normal course of business.  There are no assurances that we will be able to achieve a level of revenues adequate to generate sufficient cash flow from operations or obtain additional financing through private placements, public offerings and/or bank financing necessary to support our working capital requirements.  To the extent that funds generated from any private placements, public offerings and/or bank financing are insufficient, we will have to raise additional working capital.  No assurance can be given that additional financing will be available, or if available, will be on acceptable terms.  If adequate working capital is not available we will be forced to discontinue operations, which would cause investors to lose the entire amount of their investment.  We have a significant amount of debt, which limits our flexibility and imposes restrictions on us.  We were in default of interest payments on our outstanding 6% senior secured convertible notes from July 1, 2005 through January 13, 2006.  While the note holders waived the prior defaults, if we default again on any of our outstanding senior secured convertible notes, the note holders will be able to take immediate possession of all of our assets.  As of September 30, 2006, we had current liabilities totaling $27,215,889 and long-term liabilities totaling $4,107,654.  We also have significant lease and royalty obligations.  On July 1, 2005, we failed to pay interest as required pursuant the terms of our 6% senior secured convertible notes (the 6% Notes) executed on February 24, 2005 for an aggregate total face amount of $7,000,000, and thereby caused a default under the terms of such notes.  As a result of the event of default, the holders of the notes could have declared the entire outstanding principal amount immediately due and payable along  38    with any interest accrued thereon. On September 23, 2005, we entered into a Consent and Waiver Agreement with the 6% note holders, pursuant to which they consented to a bridge note financing resulting in $1,800,000 in total gross proceeds and waived the application of default provision under the 6% Notes for a period of ten business days. The waiver was extended to November 18, 2005.  On January 13, 2006, the 6% note holders waived the prior defaults in connection with a private placement of 8% senior secured convertible notes. If we default again, the note holders will have the right to take immediate possession of all of our assets. Based on past experience with the current lenders, our management believes additional waivers will be granted by the lenders, if necessary.  Our profitability may be adversely affected by the status of our long-term coal supply contracts. We intend to sell a substantial portion of our coal under a long-term coal supply agreement, which is a contract with a term greater than 12 months.  The prices for coal shipped under these contracts may be below the current market price for similar-type coal at any given time.  Due to the substantial volume of our potential sales that are subject to these long-term agreements, we may have less coal available with which to capitalize on higher coal prices if and when they arise.  In addition, because long-term contracts typically allow the customer to elect volume flexibility, our ability to realize the higher prices that may be available in the spot market may be restricted when customers elect to purchase higher volumes under such contracts.  Our exposure to market-based pricing may also be increased should customers elect to purchase fewer tons.  In addition, the absence of price adjustment provisions in such contracts makes make it more likely that we will not be able to recover inflation related increases in mining costs during the contract term.  We Suspended Mining Operations at our Warfield Mine in 2005 and only Recently Re-Activated our Mining Operations.  We Will Not Be Able to Generate Any Significant Revenue from such Mine until Mining Operations Re-commence at Projected Levels.  In January 2005, we suspended production at our Warfield Mine to construct three slopes and the ancillary ventilation necessary to allow us to access the Pond Creek coal seam. As a result, there has been minimal production at the mine since February 2005.  In early January 2006, we restarted production as we anticipated the completion of our coal washing facility.  If we are unable to increase our mining operations at our Warfield Mine such that we can produce greater than 55,000 tons per month, we may not be able to financially sustain our operations without additional outside funds.  Without achieving 55,000 tons produced per month, we may not be able to continue as a going concern.  A small number of customers account for a significant portion of our revenue and if we are unable to maintain our current customer base or attract a new customer base, we will be required to curtail or cease operations.  For the nine months ended September 30, 2006, all of our sales were to three customers: Cinergy accounted for 3% of total coal sales, American Electric Power accounted for 89% of coal sales and New River Energy accounted for 8% of coal sales.  We have a 36 month contract for coal sales to American Electric Power for 40,000 tons per month which began in April 2006. We have an additional 12 month contract with American Electric Power with a 24 month option for 50,000 tons per month. If American Electric Power exercises its option on this contract, the two contracts combined will account for approximately 100% of our production capacity over the next three years and account for approximately 15% of our current recoverable reserves.  If American Electric Power does not exercise its option on this contract, American Electric Power will account for approximately 70% of our production capacity for the first 12 months and approximately 9% of our current recoverable reserves.  We intend to discuss the extension of existing agreements or entering into new long-term agreements with American Electric Power and other customers, but the negotiations may not be successful, and those other customers may  39    not agree to purchase coal from us. If American Electric Power were to significantly reduce their purchases of coal from us, or if we were unable to sell coal to them on terms as favorable to us as the terms under our current agreements, and we were unable to secure agreements with other customers, we will be required to curtail or cease operations.  Our profitability may fluctuate due to unanticipated mine operating conditions and other factors that are not within our control. Our mining operations are inherently subject to changing conditions that can affect levels of production and production costs for varying lengths of time and can result in decreases in our profitability.  We are exposed to commodity price risk related to our purchase of diesel fuel, explosives and steel.  In addition, weather conditions, equipment replacement or repair, fires, variations in thickness of a layer, or seam, of coal, amounts of overburden, rock and other natural materials and other geological conditions have had, and can be expected in the future to have, a significant impact on our operating results.  During January 2006, 16 men died in four coal mining accidents in West Virginia.  As a result, West Virginias Governor ordered a halt in coal mining until safety checks could be conducted.  If a similar significant accident was to occur at our mines or other mines in Kentucky, such an accident would cause a minimum of 30 days of delayed production.  A prolonged disruption of production at our mines would result in a decrease in our revenues and profitability, which could be material.  Other factors affecting the production and sale of our coal that could result in decreases in our profitability include:  · continued high pricing environment for our raw materials, including, among other things, diesel fuel, explosives and steel; · expiration or termination of, or sales price redeterminations or suspension of deliveries under, coal supply agreements; · disruption or increases in the cost of transportation services; · changes in laws or regulations, including permitting requirements; · litigation; · work stoppages or other labor difficulties; · mine worker vacation schedules and related maintenance activities; and · changes in coal market and general economic conditions.  Decreases in our profitability as a result of the factors described above could adversely impact our quarterly or annual results materially.  Agreements to which we are a party contain limitations on our ability to manage our operations exclusively and impose significant potential indemnification obligations on us.  In order to obtain financing to develop and expand operations at our Warfield Mine, we have agreed to limit certain capital expenditures and maintain certain cash reserves subject to anticipated operating revenues and other benchmarks.  Risks Relating to Our Industry  The demand for and pricing of our coal is greatly influenced by consumption patterns of the domestic electric generation industry, and any reduction in the demand for our coal by this industry may cause our profitability to decline.  Demand for our coal and the prices that we may obtain for our coal are closely linked to coal consumption patterns of the domestic electric generation industry, which has accounted for approximately  40    92% of domestic coal consumption in recent years.  These coal consumption patterns are influenced by factors beyond our control, including the demand for electricity, which is significantly dependent upon general economic conditions, summer and winter temperatures in the United States, government regulation, technological developments and the location, availability, quality and price of competing sources of coal, alternative fuels such as natural gas, oil and nuclear and alternative energy sources such as hydroelectric power.  Demand for our low sulfur coal and the prices that we will be able to obtain for it will also be affected by the price and availability of high sulfur coal, which can be marketed in tandem with emissions allowances in order to meet Clean Air Act requirements.  Any reduction in the demand for our coal by the domestic electric generation industry would result in a decline in our revenues and profit, which could be material.  Extensive environmental laws and regulations affect the end-users of coal and could reduce the demand for coal as a fuel source and cause the volume of our sales to decline.  The Clean Air Act and similar state and local laws extensively regulate the amount of sulfur dioxide, particulate matter, nitrogen oxides, and other compounds emitted into the air from electric power plants, which are the largest end-users of our coal.  Such regulations, which can take a variety of forms, may reduce demand for coal as a fuel source because they may require significant emissions control expenditures for coal-fired power plants to attain applicable ambient air quality standards, which may lead these generators to switch to other fuels that generate less of these emissions and may also reduce future demand for the construction of coal-fired power plants.  The U.S. Department of Justice, on behalf of the EPA, has filed lawsuits against several investor-owned electric utilities and brought an administrative action against one government-owned utility for alleged violations of the Clean Air Act.  We supply coal to some of the currently affected utilities, and it is possible that other customers of ours will be sued.  These lawsuits could require the utilities to pay penalties, install pollution control equipment or undertake other emission reduction measures, any of which could adversely impact their demand for our coal, and require that we find alternative customers.  If we could not find alternative customers, our revenues will be significantly impaired and we could be forced to reduce operations.  A regional haze program initiated by the EPA to protect and to improve visibility at and around national parks, national wilderness areas and international parks restricts the construction of new coal-fired power plants whose operation may impair visibility at and around federally protected areas and may require some existing coal-fired power plants to install additional control measures designed to limit haze-causing emissions.  The Clean Air Act also imposes standards on sources of hazardous air pollutants.  For example, the EPA has announced that it would regulate hazardous air pollutants from coal-fired power plants.  Under the Clean Air Act, coal-fired power plants will be required to control hazardous air pollution emissions by no later than 2009, which likely will require significant new investment in controls by power plant operators.  These standards and future standards could adversely affect our business by decreasing demand for coal.  Other proposed initiatives, such as the Bush administration's announced Clear Skies Initiative, may also have an adverse effect upon coal operations.  As proposed, this initiative is designed to further reduce emissions of sulfur dioxide, nitrogen oxides and mercury from power plants.  Other so-called multi-pollutant bills, which could regulate additional air pollutants, have been proposed by various members of Congress.  If such initiatives are enacted into law, power plant operators could choose other fuel sources to meet their requirements, reducing the demand for coal and lowering our revenues.  Because our industry is highly regulated, our ability to conduct mining operations is restricted and our profitability may decline.  41     The coal mining industry is subject to regulation by federal, state and local authorities on matters such as: employee health and safety; permitting and licensing requirements regarding environmental and safety matters; air quality standards; water quality standards; plant and wildlife and wetland protection; blasting operations; the management and disposal of hazardous and non-hazardous materials generated by mining operations; the storage of petroleum products and other hazardous substances; reclamation and restoration of properties after mining operations are completed; discharge of materials into the environment, including air emissions and wastewater discharge; surface subsidence from underground mining; and the effects of mining operations on groundwater quality and availability.  Extensive regulation of these matters could have a significant effect on our costs of production and competitive position.  Further regulations, legislation or orders may also cause our sales or profitability to decline by hindering our ability to continue our mining operations, by increasing our costs or by causing coal to become a less attractive fuel source.  Mining companies must obtain numerous permits that strictly regulate environmental and health and safety matters in connection with coal mining, some of which have significant bonding requirements.  Regulatory authorities exercise considerable discretion in the timing of permit issuance.  Also, private individuals and the public at large possess rights to comment on and otherwise engage in the permitting process, including through intervention in the courts.  Accordingly, the permits we need for our mining operations may not be issued, or, if issued, may not be issued in a timely fashion, or may involve requirements that may be changed or interpreted in a manner which restricts our ability to conduct our mining operations or to do so profitably.  We may not be able to obtain or renew surety bonds on acceptable terms.  Federal and state laws require us to either post cash with OSM or obtain surety bonds to guaranty performance or payment of certain long-term obligations, including mine closure or reclamation costs, federal and state workers' compensation costs, coal leases and other miscellaneous obligations.  Many of these bonds are renewable on a yearly basis.  It may be increasingly difficult for us to secure new surety bonds or retain existing bonds without the posting of collateral, which could limit our available working capital.  In addition, the market terms of such bonds have generally become more unfavorable.  For example, it may become increasingly difficult to obtain adequate coverage limits, and surety bonds increasingly contain additional cancellation provisions in favor of the surety.  Mining in Central Appalachia is complex and involves extensive regulatory constraints.  The geological characteristics of Central Appalachia coal reserves, such as depth of overburden and coal seam thickness, make them complex and costly to mine.  As mines become depleted, replacement reserves may not be available when required or, if available, may not be capable of being mined at costs comparable to those characteristic of the depleting mines.  In addition, as compared to mines in other coal producing regions, permitting and licensing and other environmental and regulatory requirements are more costly and time-consuming to satisfy.  These factors could materially adversely affect the mining operations and cost structures of, and our customers' ability to use coal produced by, operators in Central Appalachia, including us.  Intense competition and excess industry capacity in the coal producing regions in which we operate has adversely affected mining revenues and profitability in past years and may again do so in the future.  The coal industry is intensely competitive, primarily as a result of the existence of numerous  42    producers in the coal producing regions in which we operate.  We compete with a large number of coal producers in the markets that we serve.  Additionally, we are subject to the continuing risk of reduced profitability as a result of excess industry capacity and weak power demand by the industrial sector of the economy, which affected many of our competitors in the years prior to our commencement of operations.  If economic conditions change substantially from the current relatively high demand and low available supply levels, it could require us to reduce the rate of coal production from planned levels which will reduce our revenues.  Deregulation of the electric utility industry may cause our customers to be more price-sensitive in purchasing coal, which could cause our profitability to decline.  Electric utility deregulation is expected to provide incentives to generators of electricity to minimize their fuel costs and is believed to have caused electric generators to be more aggressive in negotiating prices with coal suppliers.  To the extent utility deregulation causes our customers to be more cost-sensitive, deregulation may reduce our profit margins and accordingly have a negative effect on our profitability.  Because our profitability is substantially dependent on the availability of an adequate supply of coal reserves that can be mined at competitive costs, the unavailability of these types of reserves would cause our profitability to decline.  Our profitability depends substantially on our ability to mine coal reserves that have the geological characteristics that enables these reserves to be mined at competitive costs.  Replacement reserves may not be available when required or, if available, may not be capable of being mined at costs comparable to those characteristic of the depleting mines.  If we do not accurately assess the geological characteristics of any reserves that we acquire, we may not be able to mine such properties at competitive costs, which would decrease our margins.  Exhaustion of reserves at existing mines would have a similar adverse effect on our operating results.  Disruption in, or increased costs of, transportation services could adversely affect our profitability.  The coal industry depends on rail, barge and trucking transportation to deliver shipments of coal to customers, and transportation costs are a significant component of the total cost of supplying coal.  Disruptions of these transportation services could temporarily impair our ability to supply coal to our customers and thus reduce our revenues.  In addition, increases in transportation costs associated with our coal, or increases in our transportation costs relative to transportation costs for coal produced by our competitors or of other fuels, could adversely affect our business and profitability by reducing our margins and causing us to lose customers to such competitors.  We face numerous uncertainties in estimating our economically recoverable coal reserves, and inaccuracies in our estimates could result in lower than expected revenues, higher than expected costs or decreased profitability.  We base our reserve information on geological data assembled and analyzed by our staff and outside consultants, which includes various engineers and geologists.  The reserve estimates are periodically updated to reflect production of coal from the reserves and new drilling or other data received.  There are numerous uncertainties inherent in estimating quantities of recoverable reserves, including many factors beyond our control.  Estimates of economically recoverable coal reserves and net cash flows necessarily depend upon a number of variable factors and assumptions, such as geological and mining conditions which may not be fully identified by available exploration data or which may differ from experience in current operations, historical production from the area compared with production from  43    other producing areas, the assumed effects of regulation by governmental agencies and assumptions concerning coal prices, operating costs, severance and excise tax, development costs and reclamation costs, all of which may vary considerably from actual results.  For these reasons, estimates of the economically recoverable quantities attributable to any particular group of properties, classifications of reserves based on risk of recovery and estimates of net cash flows expected from particular reserves prepared by different engineers or by the same engineers at different times may vary substantially.  Actual coal tonnage recovered from identified reserve areas or properties may vary materially from estimates, which could significantly increase our costs and reduce revenues.  Defects in title or loss of any leasehold interests in our properties could limit our ability to mine these properties or result in significant unanticipated costs.  We conduct our mining operations on properties that we lease.  The loss of any lease would cause us to lose revenue related to our ability to mine the associated reserves.  Because title to most of our leased properties and mineral rights is not usually verified until we make a commitment to develop a property, which may not occur until after we have obtained necessary permits and completed exploration of the property, our right to mine some of our reserves has in the past, and may again in the future, be lost if defects in title or boundaries exist.  In order to obtain leases or mining contracts to conduct our mining operations on property where these defects exist, we have had to, and may in the future have to, incur unanticipated costs.  In addition, we may not be able to successfully negotiate new leases or mining contracts for properties containing additional reserves, or maintain our leasehold interests in properties where we have not commenced mining operations during the term of the lease.  Acquisitions that we may undertake would involve a number of inherent risks, any of which could cause us not to realize the benefits anticipated to result.  We continually seek to expand our operations and coal reserves through acquisitions of businesses and assets, including leases of coal reserves.  Acquisition transactions involve various inherent risks, such as:  · uncertainties in assessing the value, strengths, weaknesses, contingent and other liabilities and potential profitability of acquisition or other transaction candidates; · the potential loss of key personnel of an acquired business; · the ability to achieve identified operating and financial synergies anticipated to result from an acquisition or other transaction; · problems that could arise from the integration of the acquired business; · unanticipated changes in business, industry or general economic conditions that affect the assumptions underlying the acquisition or other transaction rationale; and · unexpected development costs that adversely affect our profitability.  Any one or more of these factors could cause us not to realize the benefits anticipated to result from the acquisition of businesses or assets.  Risks Related to Our Common Stock  There is a limited market for our common stock which makes it difficult for investors to engage in transactions in our securities.   44    Our common stock is quoted on the OTC Bulletin Board under the symbol "CEIW.OB".  There is a limited trading market for our common stock.  If public trading of our common stock does not increase, a liquid markets will not develop for our common stock.  The potential effects of this include difficulties for the holders of our common stock to sell our common stock at prices they find attractive.  If liquidity in the market for our common stock does not increase, investors in our business may never realize a profit on their investment.  Our stock price is volatile which may make it difficult for investors to sell our securities for a profit.  The market price of our common stock is likely to be highly volatile and could fluctuate widely in price in response to various factors, many of which are beyond our control, including:  · technological innovations or new products and services by us or our competitors; · additions or departures of key personnel; · sales of our common stock; · our ability to integrate operations, technology, products and services; · our ability to execute our business plan; · operating results below expectations; · loss of any strategic relationship; · industry developments; · economic and other external factors; and · period-to-period fluctuations in our financial results.  Because we have a limited operating history with little revenues to date, you may consider any one of these factors to be material.  Our stock price may fluctuate widely as a result of any of the above.  In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies.  These market fluctuations may also materially and adversely affect the market price of our common stock.  Our common stock is deemed a penny stock under the rules of the SEC, which makes transactions in our stock cumbersome.  Our common stock is currently listed for trading on the OTC Bulletin Board which is generally considered to be a less efficient market than markets such as NASDAQ or other national exchanges, and which may cause difficulty in conducting trades and difficulty in obtaining future financing.  Further, our securities are subject to the "penny stock rules" adopted pursuant to Section 15 (g) of the Securities Exchange Act of 1934, as amended, or Exchange Act.  The penny stock rules apply to non-NASDAQ companies whose common stock trades at less than $5.00 per share or which have tangible net worth of less than $5,000,000 ($2,000,000 if the company has been operating for three or more years).  Such rules require, among other things, that brokers who trade "penny stock" to persons other than "established customers" complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning trading in the security, including a risk disclosure document and quote information under certain circumstances.  Many brokers have decided not to trade "penny stock" because of the requirements of the penny stock rules and, as a result, the number of broker-dealers willing to act as market makers in such securities is limited.  In the event that we remain subject to the "penny stock rules" for any significant period, there may develop an adverse impact on the market, if any, for our securities.  Because our securities are subject to the "penny stock rules," investors will find it more difficult to dispose of our securities.  Further, for companies whose securities are traded in the OTC Bulletin Board, it is more difficult: (i) to obtain accurate quotations, (ii) to obtain coverage for significant  45    news events because major wire services, such as the Dow Jones News Service, generally do not publish press releases about such companies, and (iii) to obtain needed capital.  A sale of a substantial number of shares of our common stock may cause the price of our common stock to decline.  If our shareholders sell substantial amounts of our common stock in the public market, including shares issued upon the exercise of outstanding options or warrants, the market price of our common stock could fall. These sales also may make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate. As of November 7, 2006, approximately 5,686,682 shares of our restricted common stock are eligible for sale pursuant to Rule 144.  We operate in an industry that is subject to significant fluctuations in operating results from quarter to quarter that may result in unexpected reductions in revenue and stock price volatility.  Factors that may influence our quarterly operating results include:  1. the worldwide demand for coal; 2. the price of coal; 3. the supply of coal and other competitive factors; 4. the costs to mine and transport coal; 5. the ability to obtain new mining permits; 6. the costs of reclamation of previously mined properties; and 7. industry competition.  Due to these factors, it is possible that in some quarters our operating results may be below our shareholders expectations and those of public market analysts.  If this occurs, the price of our common stock would likely be adversely affected. Our stock price may decrease, which could adversely affect our business and cause our shareholders to suffer significant losses.  The following factors could cause the market price of our common stock to decrease, perhaps substantially: · the failure of our quarterly operating results to meet expectations of investors or securities analysts; · adverse developments in the financial markets, the coal and energy industries and the worldwide or regional economies; · interest rates; · changes in accounting principles; · sales of common stock by existing security holders; · announcements of key developments by our competitors; and · the reaction of markets and securities analysts to announcements and developments involving our Company. Item 3. Controls and Procedures. We maintain disclosure controls and procedures, which we have designed to ensure that material information related to Consolidated Energy, Inc., including our consolidated subsidiaries, is disclosed in our public filings on a regular basis.  In response to recent legislation and proposed regulations, we reviewed our internal control structure and our disclosure controls and procedures.  We believe our pre-  46    existing disclosure controls and procedures are adequate to enable us to comply with our disclosure obligations. Members of our management, including our Chief Operating Officer, Joseph Jacobs, and Interim Chief Financial Officer, Robert Chmiel, have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2006, the end of the period covered by this report.  Based upon that evaluation, Messrs. Jacobs and Chmiel concluded that our disclosure controls and procedures are effective in causing material information to be recorded, processed, summarized and reported by our management on a timely basis and to ensure that the quality and timeliness of our public disclosures complies with our SEC disclosure obligations. There were no significant changes in our internal control over financial reporting or in other factors that could significantly affect the internal control over financial reporting after the date of our most recent evaluation.  47    PART II OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders The Company held its annual shareholders meeting on May 25, 2006.  At the annual meeting, shareholders considered and acted upon the following matters:  1. Elected nine (9) existing directors; 2. Approved an amendment to the Companys Articles of Incorporation to increase the number of its authorized shares of common stock from 50,000,000 to 100,000,000; 3. Ratified Killman Murrell & Co., P.C. as the Companys auditors; and 4. Approved the 2006 Stock Award Plan pursuant to which the Company can issue up to 2,000,000 shares.  There were 13,667,974 shares represented at the meeting in person or by proxy out of 17,975,375 total shares issued and outstanding at the record date.  All matters were approved by the shareholders, with the voting results as follows:  1. Election of directors: GuthrieFor11,262,011Against2,399,963Withheld6,000ChmielFor13,058,759Against603,215Withheld6,000JacobsFor13,412,700Against250,274Withheld5,000JenningsFor13,417,700Against250,274Withheld0BakerFor13,416,700Against250,274Withheld1,000TackettFor13,421,700Against240,274Withheld6,000StobaughFor13,416,700Against250,274Withheld1,000ShelmireFor12,843,462Against603,215Withheld221,297GriffithFor12,904,347Against603,215Withheld160,412  2. Increase authorized shares: For  13,382,500 Against  900 Withheld  284,574 3. Ratify auditors: For  13,532,480 Against 22,900 Withheld  112,594 4. Approve stock option plan: For  11,327,464 Against  2,186,289 Withheld  154,221 Item 5. Other Information Cancellation of the Agreement between Saudi American Minerals Inc. and the Company  On May 1, 2006, the Company received a letter from Saudi American Minerals Inc. (SAMI) informing it that SAMI was exercising its sole right to immediately terminate the December 30, 2005 agreement between the SAMI and the Company.  The Company accepted SAMIs termination of the agreement, thus completely eliminating all obligations of SAMI to the Company and/or its subsidiaries,  48    and reciprocally eliminating any obligations of the Company and/or its subsidiaries to SAMI.  The cancellation letter is attached as an exhibit to this filing.  Cancellation of the Agreement between Kentucky Energy Consultants Inc. and the Company On May 1, 2006, the Company received a letter from Kentucky Energy Consultants Inc. (KECI) informing it that KECI was canceling the agreement between KECI and the Company dated July 21, 2003.  The Company accepted KECIs cancellation of the agreement thus completely terminating all future obligations of KECI to the Company and its subsidiary, Eastern Consolidated Energy, Inc. (ECEI), and reciprocally terminating all future obligations of the Company and ECEI to KECI. The cancellation letter is attached as an exhibit to this filing. Resignation of Officer and Director On October 25, 2006, the Board of Directors of the Company accepted the resignation of David Guthrie as President, Chief Executive Officer and Director pursuant to the terms of Mr. Guthries resignation letter dated October 25, 2006.  Mr. Guthrie is resigning in order to pursue other opportunities.  In accordance with the Boards approval, Mr. Guthrie shall continue to receive his salary in the normal course of business through November 15, 2006, and the Company shall also transfer ownership to Mr. Guthrie of an automobile previously purchased by the Company for Mr. Guthries use while he was employed.  The Company has not appointed any replacement for Mr. Guthrie, and all existing officers of the Company shall continue to be employed in their current positions. Item 6. Exhibits The following exhibits are filed as part of this report: Exhibit NumberDescription3.1Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company's registration statement on Form SB-2/A (File No. 333-127261), filed with the SEC on December 16, 2005).3.2Certificate of Merger (incorporated by reference to Exhibit 3.2 to the Company's registration statement on Form SB-2/A (File No. 333-127261), filed with the SEC on December 16, 2005).3.3By-Laws of the Company (incorporated by reference to Exhibit 3.3 to the Company's registration statement on Form SB-2/A (File No. 333-127261), filed with the SEC on December 16, 2005).4.1Form of Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company's registration statement on Form SB-2/A (File No. 333-127261), filed with the SEC on December 16, 2005).4.2Form of Warrant (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K, filed with the SEC on February 24, 2005).4.3Form of 6% Senior Secured Convertible Note (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K, filed with the SEC on February 24, 2005).  49     4.4Form of 8% Senior Secured Convertible Note Due June 30, 2008 (incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K, filed with the SEC on January 17, 2006).4.5Form of Warrant Issued January 13, 2006 (incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K, filed with the SEC on January 17, 2006).4.6Form of Secured Promissory Note Issued January 13, 2006 (incorporated by reference to Exhibit 4.3 to the Company's Current Report on Form 8-K, filed with the SEC on January 17, 2006).4.7Form Variable Rate Original Issue Discount Convertible Secured Debentures (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).4.8Form of Unsecured Convertible Debenture (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).4.9Form of Warrant (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).10.1Amendment to Coal Purchase and Sale Agreement (incorporated by reference to Exhibit 10.15a to the Company's Annual Report on form 10-KSB, filed with the SEC on April 15, 2005).10.2Securities Purchase Agreement (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K, filed with the SEC on February 24, 2005).10.3Registration Rights Agreement (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K, filed with the SEC on February 24, 2005).10.4Security Agreement (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K, filed with the SEC on February 24, 2005).10.5Cancellation of the agreement between Saudi American Minerals Inc. and the Company (incorporated by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-QSB, filed with the SEC on May 19, 2006).10.6Cancellation of the agreement between Kentucky Energy Consultants Inc. and the Company (incorporated by reference to Exhibit 10.6 to the Company's Quarterly Report on Form 10-QSB, filed with the SEC on May 19, 2006).10.7Securities Purchase Agreement dated as of June 30, 2006 by and among Consolidated Energy, Inc. and the investors signatory thereto (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).10.8Unsecured Debt Securities Purchase Agreement dated as of June 30, 2006 by and among Consolidated Energy, Inc. and the investors signatory thereto (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).10.9Registration Rights Agreement dated as of June 30, 2006 by and among Consolidated Energy, Inc. and the Purchasers signatory thereto (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006). (Incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).  50     10.10Security Agreement dated as of June 30, 2006 by and among Consolidated Energy, Inc., and the Senior Investors. (Incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).10.11Subsidiary Guaranty dated as of June 30, 2006 by and among Eastern Consolidated Energy, Inc., CEI Holdings, Inc., Morgan Mining, Inc., Warfield Processing, Inc. and Eastern Coal Energies, Inc. (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).10.12Intercreditor Agreement dated as of June 30, 2006, among Consolidated Energy, Inc. and the parties listed on the signature page thereto (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).10.13Subordination Agreement dated as of June 30, 2006, among Consolidated Energy, Inc. and the parties listed on the signature page thereto (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).10.14Blocked Account Agreement dated as of June 30, 2006, by and among Consolidated Energy, Inc. and Community Trust and Investment Company  (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).10.15Control Account Agreement dated as of June 30, 2006, by and among Consolidated Energy, Inc. Atoll Asset Management, LLC, Community Trust and Investment Company and the purchasers set forth on the signature page thereto (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on July 17, 2006).10.16Resignation of David Guthrie as President, Chief Executive Officer and Director (incorporated by reference to the Company's Current Report on Form 8-K, filed with the SEC on October 30, 2006).31.1Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1Certification of CEO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2Certification of CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.   51    SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.  CONSOLIDATED ENERGY, INC.Date: December 5, 2006By:/s/ Joseph JacobsJoseph JacobsChief Operating Officer, PrincipalExecutive Officer and DirectorDate: December 5, 2006By:/s/ Robert ChmielRobert ChmielInterim Chief Financial Officer, PrincipalAccounting Officer and Director  In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.  SignatureTitleDate/s/ Joseph Jacobs
Joseph JacobsChief Operating Officer, Principal
Executive Officer and DirectorDecember 5, 2006/s/ Robert Chmiel
Robert ChmielInterim Chief Financial Officer,
Principal Accounting
Officer and DirectorDecember 5, 2006/s/ Barry Tackett
Barry TackettDirectorDecember 5, 2006/s/ Timothy M. Stobaugh
Timothy M. StobaughDirectorDecember 5, 2006/s/ Jesse Shelmire
Jesse ShelmireDirectorDecember 5, 2006/s/ Scott Griffith
Scott GriffithDirectorDecember 5, 2006  52      53