** **

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D. C. 20549**

** **

**FORM 10-K**

** **

**ý**   Annual Report Pursuant to Section 13 or15(d)

**of the Securities Exchange Act of 1934**

** **

**o**  Transition Report Pursuant toSection 13 or 15(d)

**of the Securities Exchange Act of 1934**

** **

**FOR THE FISCAL YEAR ENDED DECEMBER 31,2005**

** **

**COMMISSION FILE NUMBER**

**0-32667**

** **

**CAP ROCK ENERGY CORPORATION**

** **
| **Texas**                     | ** ** | **75-2794300**                            |
|-------------------------------|------------|-------------------------------------------|
| **(State of  Incorporation)** | ** ** | **(I.R.S. Employer  Identification No.)** |

** **
| **500 West Wall Street, Suite 400**                          | ** ** | ** **       |
|--------------------------------------------------------------|------------|------------------|
| **Midland, Texas**                                           | ** ** | **79701**        |
| **(Address of principal  executive office)**                 | ** ** | **(Zip Code)**   |
| ** **                                                   | ** ** | ** **       |
| **Registrant’s  telephone number, including area code** | ** ** | **432-683-5422** |

** **

**Securities registered pursuant to Section 12(b)of the Act:**

** **
| **Title of Each Class**     | ** ** | **Name of each exchange on which  registered** |
|-----------------------------|------------|------------------------------------------------|
| ** **                  | ** ** | ** **                                     |
| **COMMON STOCK, PAR VALUE** | ** ** | **AMERICAN STOCK EXCHANGE**                    |
| **$.01 PER SHARE**          | ** ** | ** **                                     |

** **

**Securities registered pursuant to Section 12(g)of the Act:**          NONE

** **

**Indicate by check mark if the registrant is a well-known seasonedissuer, as defined in Rule 405 of the Securities Act.**
| **Yes** | **o** | **No** | ** ** | **ý** |
|---------|-------|--------|------------|------------|

** **

**Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section15(d) of the Act.**
| **Yes** | **o** | **No** | ** ** | **ý** |
|---------|-------|--------|------------|------------|

** **

**Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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** | **o** | **No** | ** ** | **ý** |
|---------|-------|--------|------------|------------|

** **

**Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form10-K. **ý

** **

**Indicate by check mark whetherthe registrant is a large accelerated filer, an accelerated filer, or annon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct.  (Check one):**

** **
| **Large accelerated filer         **o | ** ** | **Accelerated filer          **o | ** ** | **Non-accelerated filer          **ý |
|-------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|

** **

**Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of the Act).**
| **Yes** | **o** | **No** | ** ** | **ý** |
|---------|-------|--------|------------|------------|

 

**THE AGGREGATE MARKETVALUE OF THE COMMON STOCK HELD BY NON-AFFILIATES OF THE REGISTRANT AS OF JUNE30, 2005, WAS APPROXIMATELY $17,551,000 BASED ON THE CLOSING PRICE OF $18.35FOR THE COMMON STOCK ON THE AMERICAN STOCK EXCHANGE AS REPORTED BY THE WALLSTREET JOURNAL.**

** **

**THENUMBER OF SHARES OF COMMON STOCK OUTSTANDING ON MARCH 28, 2006, WAS 1,647,844.**

**DOCUMENTSINCORPORATED BY REFERENCE**

** **

**Portions of theRegistrant’s definitive Proxy Statement for the 2006 annual meeting of itsshareholders to be filed with the Commission are incorporated by reference intoPart III of this report.  However, if thedefinitive proxy statement for the 2006 Annual Meeting has not been filed withthe Commission by April 30, 2006 (including as a result of or in anticipationof the consummation of the transactions contemplated by the LGB Agreement (asdefined below)), the Company will amend this annual report on Form 10-K toinclude such information if required at such time.**

 

 

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**PART I**

** **

**ITEM 1. BUSINESS**

** **

**The Company**

** **

**Cap Rock Energy Corporation and its subsidiaries (the “Company”) areengaged in the distribution and transmission of electricity in variousnoncontiguous areas in the State of Texas. The Company serves approximately34,000 active meters in 28 counties covering approximately 13,000 square milesin Texas.  The Company had approximately$188 million of assets at December 31, 2005, and generated revenues ofapproximately $87 million in 2005.  TheCompany’s distribution operations are regulated by the Public Utility Commissionof Texas (“PUCT”) and the transmission operations are under the oversightauthority of the Federal Energy Regulatory Commission (“FERC”).**

** **

**The Company’s predecessor, Cap Rock Electric Cooperative, Inc. (the “Cooperative”or the “Predecessor”), was incorporated as an electric cooperative in the Stateof Texas in 1939.  In 1998, members ofthe Cooperative adopted a plan for changing the corporate structure from amember owned cooperative to a shareholder owned corporation, and Cap RockEnergy Corporation (“Energy”) was formed. The transfer of the assets, liabilities and issuance of stock wascompleted by early 2002.   Transfer ofthe Cooperative’s Certificate of Convenience and Necessity (“CCN”), whichallows a company to provide electric utility services within a certifiedterritory in Texas, to the Company was approved by the PUCT effective September1, 2003.**

** **

**In November 2005, upon the unanimous recommendation of a specialcommittee of the Board of Directors of the Company, a definitive agreement andplan of share exchange (“the LGB Agreement”) with a newly formed entity, CapRock Holding Corporation (“the Holding Company”), owned by Lindsay Goldberg& Bessemer L. P. and its affiliates (“LGB”) was signed.  The LGB Agreement provides for the acquisitionof all the outstanding stock of the Company (other than certain shares owned byManagement that will be rolled over into shares of the Holding Companyimmediately prior to closing, and shares held by shareholders who properlyexercise their appraisal rights under Texas law) by the Holding Company inexchange for $21.75 in cash per share. As a result of the proposed transaction, the Company will cease to haveits shares publicly traded.  Theshareholders approved the LGB Agreement at a special meeting held on March 10,2006.  Approval of the transaction by thePUCT and FERC is also a condition for the LGB Agreement to be consummated, andsuch approvals are currently pending at those agencies.  In addition, the transaction is subject toother closing conditions customary for this type of transaction.  A full description of the terms of the LGBAgreement can be found in the definitive proxy statement of the Company filedwith the SEC on January 30, 2006.**

** **

**2**

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** **

**David W. Pruitt, who retired as Chief Executive Officer on March 10,2006, signed a retainer agreement pursuant to which he will serve as aconsultant and advisor to the Company after the closing of the LGB Agreement.**

** **

**The LGB Agreement is anticipated to close in the second quarter of2006, assuming satisfaction or waiver of all conditions of the agreement.**

** **

**Electric Market**

** **

**The electric industry is currently undergoing many changes, both inTexas and nationwide.  Total revenuesfrom sales of electricity to ultimate consumers in the United States total over$250 billion per year.  While the Companyis not currently subject to competition, it has operated in multiplycertificated areas since its existence. Because the Company is regulated by the Public Utility Commission ofTexas, it will be subject to competition in the future.  See State and Federal Regulation – StateRegulation.**

** **

**The Company has experience serving customers in more sparsely populatedareas, a majority of which are dually certificated with another utility.  This experience in a competitive market placegives the Company an advantage over other similar sized utilities.  The Company expects that as competition becomesmore intense and operations become more complicated, more utilities will wantto divest themselves of customers in these sparsely populated areas.  See also Business Strategy.**

** **

**Business Strategy**

** **

**The Company’s objective is to become a national electric distributioncompany, with community focused local operating divisions.  The strategy is to grow by acquiring small tomedium sized electric distribution businesses in rural areas that havesignificant potential for growth.  Thismay include acquiring smaller utilities or pieces of larger utilities in thesetypes of rural areas.**

 

3

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**Distribution Operating Statistics**

** **
| ** **             | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **             | ** ** | **(Thousands of dollars)** | ** ** |
| **Revenue:**           |       |                       |       |     |       |     |       |
| Residential            |       | $                          | 32,248     |     | $          | 29,636   |       | $ | 30,754 |   |
| Large  commercial      |       | 22,105                     |       | 20,242   |       | 19,345   |       |
| Small commercial       |       | 23,765                     |       | 22,247   |       | 20,979   |       |
| Irrigation             |       | 4,666                      |       | 6,078    |       | 5,683    |       |
| Other                  |       | 340                        |       | 546      |       | 2,317    |       |
| Farmersville  contract |       | 3,408                      |       | 2,400    |       | 2,324    |       |
| Total Electric Sales   |       | $                          | 86,532     |     | $          | 81,149   |       | $ | 81,402 |   |

 
|                               |   | **2005** | ** ** | **2004** | ** ** | **2003** |   |
|------------------------------------|--------|----------|------------|----------|------------|----------|--------|
| **Meters  (active and inactive):** |   |     |       |     |       |     |   |
| Residential                        |   | 28,326   |       | 27,900   |       | 28,753   |   |
| Large  commercial                  |   | 1,587    |       | 1,560    |       | 1,553    |   |
| Small  commercial                  |   | 11,655   |       | 11,356   |       | 11,398   |   |
| Irrigation                         |   | 3,153    |       | 3,138    |       | 3,131    |   |
| Farmersville  contract             |   | 1,594    |       | 1,556    |       | 1,535    |   |
| Total Meters                       |   | 46,315   |       | 45,510   |       | 46,370   |   |

 
|                   |   | **2005**   | ** ** | **2004**   | ** ** | **2003**   |   |
|------------------------|--------|------------|------------|------------|------------|------------|--------|
| **Deliveries  (mWh):** |   | ** ** | ** ** | ** ** | ** ** | ** ** |   |
| Residential            |   | 264,448    |       | 252,935    |       | 276,133    |   |
| Large  commercial      |   | 231,672    |       | 219,629    |       | 216,675    |   |
| Small  commercial      |   | 205,825    |       | 195,889    |       | 192,499    |   |
| Irrigation             |   | 38,526     |       | 44,741     |       | 44,612     |   |
| Other                  |   | 52         |       | 54         |       | 63         |   |
| Farmersville  contract |   | 30,447     |       | 27,674     |       | 28,560     |   |
| Total Deliveries       |   | 770,970    |       | 740,922    |       | 758,542    |   |

 

** **

**Revenues and Customers**

** **

**The Company’s operating revenues come from electric or electric relatedsales. Annual sales for 2005 to the Company’s commercial/industrial, residentialand irrigation customers accounted for approximately 55%, 39%, and 6%,respectively, of total electric sales. This trend has remained fairly constant.**

** **

**Commercial and industrial revenues, derived primarily from electricpowered oilfield equipment, are generally not subject to seasonalfluctuation.  Electric power requirementscan, however, be affected by a dramatic change in the price of oil, whichaffects the overall market for oil.  Oiland gas prices have risen over the past few years.  Oilfield activity, and thus electric demandand consumption, may increase because of new drilling programs and theresulting new production.**

** **

**Residential sales vary with temperature fluctuations, primarily duringthe summer months, as the Company’s residential customers use more electricpower for cooling during the hot summer months. Historically, approximately 30%of the Company’s annual residential sales occur during the period July 1 toSeptember 30.**

** **

**Irrigation revenues, derived primarily from cotton farmers withelectric powered irrigation equipment, are subject to temperature and rainfallfluctuations during the cotton planting and growing seasons. Although**

** **

**4**

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** **

**irrigation sales are only 6% of all electric sales for 2005,approximately 80% of those irrigation sales occurred during the period April 1to September 30.**

** **

**Nonutility Investments and Property**

** **

**As of December 31, 2005, the Company’s only non-electric businessinvestment is an office building and the related land that serves as itsgeneral corporate headquarters in Midland, Texas.**

** **

**The Company had a 15% interest in United Fuel and Energy Company (“UnitedFuel”), which is engaged in the petroleum distribution business.   The Company also had a note receivable fromUnited Fuel which was extinguished by United Fuel taking the Company’s positionas borrower on a cross-collateralized note payable.  The Company was a secondary guarantor onUnited Fuel’s note of $3,500,000, which United Fuel repaid in November 2004,and the Company was released from the guaranty.**

** **

**In March 2004, the Company signed an agreement with a shareholder ofUnited Fuel to sell the Company’s shares of stock in United Fuel for a$1,300,000 note receivable from that shareholder.  Pursuant to the terms of the agreement, thefirst installment of $500,000 was received in May 2005, with the remainingbalance of $800,000 due in three equal annual installments.  See Note 6 to the consolidated financialstatements.**

** **

**In February 2004, the Company sold limited partner interests it had inreal estate partnerships at book value to an unrelated third party in exchangefor a note receivable of $286,000, collateralized by the partnershipinterests.  In prior years, the Companyhad guaranteed debt of some of the partnerships.  In 2005, the Company obtained a release ofthose guarantees in exchange for a $50,000 payment to the general partner andforgiveness of the note of $286,000 and associated interest.  See Note 6 to the consolidated financialstatements.**

** **

**Employees**

** **

**As of December 31, 2005, the Company had 120 full-time and eightpart-time employees, none of which were members of any labor unions.**

** **

**State and Federal Regulation**

** **

***State Regulation***

 

Asa Texas electric utility, the Company is subject to the jurisdiction of thePublic Utility Commission of Texas, which has general regulatory authority overrates, certificated territory, and the sale of certain facilities.  At the time of the Company’s conversionfrom an electric cooperative to an investor owned electric utility, the TexasPublic Utility Regulatory Act (“PURA”) provided that a successor to an electriccooperative, such as the Company, would be treated as a cooperative forregulatory purposes. This would have allowed the Board of Directors of the Companyto continue to set the rates that it charges its customers and to decide whenand if to enter into competition. However, during the 2003 Texas legislativesession, SB 1280 was adopted which amended the PURA so that the Company wouldbe treated as an investor owned utility subject to regulation by the PUCT.  The Company’s rates are now subject toregulation and approval by the PUCT, rather than the Company’s Board ofDirectors, and the PUCT will determine how and when the Company will enter intocompetition. See also Note 21, “Commitments and Contingencies,” to theconsolidated financial statements.

 

***Federal Regulation***

** **

Asubsidiary of the Company, NewCorp Resources Electric Cooperative, Inc. (“NewCorp”)owns the transmission system that serves the west Texas divisions and issubject to the jurisdiction of the Federal Energy Regulatory Commission.  FERC has authority over wholesale sales ofelectricity, the interstate transmission of electric power, maintenance ofaccounting records in accordance with the uniform system of accounts and theissuance of certain securities.

 

5

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**Competition and Restructuring in theUtility Industry**

** **

**For many years the Company and its Predecessor have faced competitionin providing electric distribution services. A large percentage of its service territory is dually certified withother utilities.  Therefore even thoughthe Company is not currently subject to competition pursuant to the legislationthat was passed in Texas in 1999, it competes with other utilities in much ofits service territory.  Many of theCompany’s competitors are much larger than the Company and have financialresources that are much greater than the Company’s.  The Company competes with other utilities onthe basis of price and service.  TheCompany’s retail rates are comparable to those of other retail electricproviders in the state.**

** **

**Legislation passed in Texas in 1999, which became effective January2002, will significantly modify the industry and potentially introduce morecompetition into the Texas retail market. In the future, the Company’s customers may be able to purchaseelectricity from other providers, not just those certificated to serve in theservice territory.  However, the Companywill continue to provide distribution services and receive a wires charge.**

** **

**The National Energy Policy Act empowers the Federal Energy RegulatoryCommission to require utilities to provide transmission facilities for thedelivery of wholesale power from other power producers to qualified resellers,such as municipalities, cooperatives and other utilities.  The Company’s transmission facilities in itswest Texas divisions, which are in the Southwest Power Pool (“SPP”), aresubject to regulation by the Federal Energy Regulatory Commission, and theCompany’s transmission facilities in its central Texas division, which are partof the Electric Reliability Council of Texas, Inc., are subject to regulationby the PUCT.  See Note 18 to theconsolidated financial statements.**

** **

**Power Requirements**

** **

**The Company purchases power for resale to its retail customers fromwholesale suppliers and distributes that power to its customers throughapproximately 305 miles of transmission lines and approximately 11,000 miles ofdistribution lines.  The Company’stransmission system interconnects with the systems of power suppliers and otherutilities, to permit bulk power transactions with other electricity suppliers.The Company owns and operates the transmission system that supplies wholesalepower to the Company’s west Texas divisions,  which is a part of the Southwest Power Pool. The SPP coordinatestransmission services among its members. In 2005, the Company purchased all electric power pursuant to wholesaleelectric power contracts with Southwestern Public Service Company (“SPS”),Lower Colorado River Authority (“LCRA”) and Garland Power and Light (“Garland”),which accounted for approximately 72%, 12%, and 16%, respectively, of theelectric power purchases of the Company. Generally, the wholesale electricpower supply contracts are based on fixed charges for kWh usage, transportationand auxiliary services and a variable charge for fuel based on kWh usage. TheCompany’s purchased power costs fluctuate primarily with the price of naturalgas. The contracts with SPS, LCRA and Garland expire in 2013, 2016 and 2007,respectively.    Because the market priceof gas has increased in recent years, Management expects the price to continueto remain high.  We cannot predict whateffect, if any, renegotiation of future expiring contracts may have on theCompany’s financial condition and results of operations. However, there isadequate supply of power and generation within the region should the Companyneed alternative power supplies.  Allcosts associated with purchased power are passed through to the retailcustomer.**

** **

**Environmental Matters**

** **

**The Company is subject to federal and state regulations with respect tocertain environmental matters.  TheCompany is unaware of any material or potential environmental issues andbelieves it is in compliance with all environmental regulations.  The laws applicable to environmental concernscan change rapidly and are difficult to predict. Substantial expenditures maybe required to comply with these ever changing regulations. The Companyanalyzes the potential costs arising from environmental matters on an ongoingbasis.**

 

6

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**Construction and Capital Requirements**

** **

**The Company has no major construction projects planned at the presenttime. Utility construction expenditures for 2006 will consist primarily ofcosts to maintain the Company’s distribution and transmission systems. Totalnet property additions, including construction work in progress, for the yearsended December 31, 2005, 2004 and 2003, were $6,364,000, $4,583,000 and$5,209,000, respectively.  Management’splanned capital expenditures for 2006 are $6,679,000.**

** **

**Company Website**

** **

**The Company’s website address is www.caprockenergy.com.  The Company’s reports on Form 10-K andquarterly reports on Form 10-Q are available free of charge at thiswebsite.  These reports are madeavailable on the website as soon as practicable after electronically filingwith, or furnishing to, the Securities and Exchange Commission.  The information contained on the website isnot part of, nor incorporated by reference into, this document.**

** **

**ITEM 1A. RISK FACTORS**

** **

**Regulation**

** **

**The Company is subject to comprehensive regulation by federal and stateregulatory agencies which significantly influences the operating environment,and thus the Company’s ability to recover costs from retail customers.  The PUCT regulates many aspects of theCompany’s retail distribution operations. Profitability of the Company is dependent on the ability to recovercosts related to providing services to customers.  The Company provides service at ratesapproved by the PUCT, and these rates are generally regulated based on theCompany’s expenses incurred in a test year. Thus, the rates the Company is allowed to charge may or may not matchits expenses at any given period of time. While rate regulation is premised on providing a reasonable opportunityto earn a reasonable rate of return on invested capital, there can be noassurance that the PUCT will judge all costs to have been prudently incurred orthat the regulatory process in which rates are determined will always result inrates that will produce full recovery of costs. It is possible there could be changes in the regulatory environment orreinterpretations of existing laws or regulations that would impair the Company’sability to recover costs historically collected from customers, as well asimpose additional costs or change the method in which the Company conductsbusiness.**

** **

**FERC has jurisdiction over wholesale rates for electric transmissionservice and certain other activities of our transmission subsidiary.  Federal, state and local agencies also havejurisdiction over many of the Company’s other activities, including regulationof retail rates and environmental matters.**

** **

**The Company is unable to predict the impact on its operating resultsfrom the future regulatory activities of any of these agencies.  Changes in regulations or the imposition ofnew or additional regulations could have an adverse impact on results ofoperations and therefore could materially affect the Company’s ability to meetits financial obligations.**

** **

**We remain committed to providing superior service and reliability tocustomers.  Meeting this commitmentrequires the expenditure of significant capital and other resources.  The Company’s failure to provide safereliable service and to meet reliability standards could adversely affect theCompany’s operating results as well as cause increased capital and maintenancecosts and the imposition of fines and penalties by regulatory bodies.**

** **

**Rising energy prices**

** **

**The cost of natural gas and coal has risen over recent years.  The direct effect of these higher costs issomewhat mitigated for the Company because such costs of fuel are recoveredfrom customers through its purchased power recovery.  However, higher fuel costs couldsignificantly impact the Company’s cash flows as a result of timing delaysbetween the collection of fuel cost recoveries and expenditures made for fuelpurchases.  Higher fuel costs could alsocause a decline in customer demand or an increase in bad debt expense.  The Company is unable to predict future fuelprices or the ultimate impact of such prices on its results of operations orcash flows.**

** **

**7**

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** **

**Weather conditions**

** **

**Weather conditions directly impact the demand for electric power.  In the Company’s service areas, demand forpower peaks during the summer months, and severe weather such as tornadoes,storms and ice may cause outages and property damage that may require theCompany to incur additional costs that are generally not insured and that maynot be recoverable from customers.  Theeffect of the failure of the Company’s facilities to operate as planned underthese adverse conditions would be arduous during a peak demand period.**

** **

**Economic cycles**

** **

**Declines in demand for electricity generally follow a sustaineddownturn in the economy, and lessen cash flows, especially as industrialcustomers reduce production.  Economicconditions also impact the ability of customers to pay their bills, thusaffecting the rate of delinquent customer accounts receivable.**

** **

**Major suppliers**

** **

**The Company utilizes suppliers for such items as materials warehousing,meter reading and IT support and services. The ability of these suppliers to provide goods and services may dependupon such items as financial stability, economic conditions and a stableworkforce.  In the event these suppliersare unable to fulfill their commitments or the contracts should not be renewed,the Company could incur additional costs to secure new suppliers at competitiverates and in a timely manner so as to prevent operations from being severelyaffected.   See also Note 21, Commitmentsand Contingencies.**

** **

**LGB Agreement**

** **

**In November 2005, based in part upon the unanimous recommendation of aspecial committee of the Board of Directors, the Company signed the LGBAgreement with a newly formed entity, Cap Rock Holding Corporation, owned byLGB.  Shareholders approved the LGBAgreement at a special meeting held on March 10, 2006.  The transaction is subject to certainconditions outside the control of the Company, including approvals by the PUCTand FERC.  The Company is expendingconsiderable time and resources in completing the transaction.  Efforts to satisfy the closing conditions maydivert time and attention of Management which would otherwise be focused on theoperations of the Company.  In addition,if the conditions to the transaction were not to be satisfied, the Companywould need to refocus management efforts on its ongoing operations as apublicly-held utility.**

** **

**ITEM 1B. UNRESOLVED SEC STAFF COMMENTS**

** **

**None**

** **

**ITEM 2. PROPERTIES**

** **

**Utility Plant**

** **

**The Company owns and operates a transmission system and distribution systems.  The transmission system carries high voltageelectricity over longer distances.  Substations step the voltage down and distribution lines carry thatpower to the ultimate customers.  TheCompany’s transmission system serves the west Texas divisions and consists of17 substations and 305 miles of single pole transmission line that wasconstructed over a period of several years between 1975 and 1995.  The system provides a looped transmissionline at 138 kV that provides for two electric supply delivery points for powerproviders to tie into and deliver power. The 17 substations supply sixty-seven distribution line circuits, whichserve over 9,800 miles of primary and secondary distribution line in 17countywide areas and supplies approximately 120 MW of peak electricalpower.  Many of the distribution circuitscan also be fed from alternative substations in order to minimize outagetime.  The Company has two othernoncontiguous distribution systems.   TheCompany also owns real estate related to its electric distribution**

** **

**8**

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** **

**and transmission business, including easements, right-of-ways, and landwhere substations, as well as distribution and transmission poles and lines,are located.  Real estate and divisionoffice locations in Stanton, Colorado City, Brady and Celeste, Texas, are alsoowned.  The distribution system ispledged as security under the Company’s mortgage notes.**

** **

**Nonutility Property**

** **

**The Company owns a 45,000 square foot office building and the relatedland that is used as its general corporate headquarters in Midland, Texas. TheCompany occupies approximately 35% of the building and the remainder is leasedto commercial tenants.**

** **

**ITEM 3. LEGAL PROCEEDINGS**

** **

**The Company is involved in legal and administrative proceedings andclaims of various types, which arise in the ordinary course of business.  In the opinion of Management, based uponinformation furnished by counsel and others, the ultimate resolution of theseclaims, except for the proceedings described in Note 21 to the consolidatedfinancial statements, will not have a material impact on the Company’sfinancial position, operating results or liquidity.**

** **

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

** **

**There were no matters submitted to a vote of security holders duringthe fourth quarter of 2005.**

** **

**Executive Officers of the Registrant**

** **

**The executive officers of the Company are as follows:**

** **
| **NAME**               | ** ** | **AGE**    | ** ** | **POSITION**                                                          |
|------------------------|------------|------------|------------|-----------------------------------------------------------------------|
| **William L. West**    | ** ** | **49**     | ** ** | **President and Chief Executive Officer**                             |
| ** **             | ** ** | ** ** | ** ** | ** **                                                            |
| **Ulen A. North. Jr.** | ** ** | **60**     | ** ** | **Executive Vice President**                                          |
| ** **             | ** ** | ** ** | ** ** | ** **                                                            |
| **Sammy C. Prough**    | ** ** | **55**     | ** ** | **Vice President and Chief Operating Officer**                        |
| ** **             | ** ** | ** ** | ** ** | ** **                                                            |
| **Ronald W. Lyon**     | ** ** | **50**     | ** ** | **Vice President, General Counsel, Secretary and Treasurer**          |
| ** **             | ** ** | ** ** | ** ** | ** **                                                            |
| **Celia B. Page**      | ** ** | **57**     | ** ** | **Vice President Special Projects and Assistant Secretary/Treasurer** |
| ** **             | ** ** | ** ** | ** ** | ** **                                                            |
| **Melissa D. Davis**   | ** ** | **48**     | ** ** | **Vice President, Controller and Chief Accounting Officer**           |

** **

***William L. West*** served as a consultant to the Company fromJuly through December 2003 and joined the Company full time in January 2004 asChief Strategic Officer, was appointed Vice-President in July 2004, Presidentin December 2004 and was appointed to serve on the Board of Directors at thesame time.   He became Chief ExecutiveOfficer in March 2006.  Prior to this hewas a Senior Manager with KPMG LLP serving in client service and strategiccorporate tax consulting capacities from 1997 through July 2003.    Mr. West is a certified public accountant.

** **

***Ulen A. North, Jr***. has served as Executive Vice President of theCompany since its inception.  He servedin that same position for the Cooperative from December 1996 until itsdissolution.

** **

***Sammy C. Prough*** has served as Vice President and ChiefOperating Officer of the Company since its inception.  He served in the same position for theCooperative from June 1999 until its dissolution.

** **

**9**

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** **

***Ronald W***. *Lyon*has served as Vice President and General Counsel of the Company since October2001, Secretary since August 2002 and Treasurer since 2005. Prior to that, hewas engaged in the private practice of law and served as full-time generalcounsel to the Cooperative from 1993 until its dissolution.

** **

***Celia B. Page*** joined the Company as Controller in July 2001,and was elected to serve as Assistant Secretary/Treasurer in August 2002, VicePresident in December 2002, Chief Accounting Officer in April 2004, and thenVice President Special Projects in March 2006. She previously served as Senior Vice President and Controller ofCostilla Energy, Inc. from April 1996 until July 2001.  Ms. Page is a certified public accountant.

** **

***Melissa D. Davis*** joined the Company as Controller in December2005, and was elected Vice President, Controller and Chief Accounting Officerin March 2006.  Prior to joining theCompany, she was Vice President-Human Resources of Texas-New Mexico PowerCompany from February 1999 to June 2005, Vice President-Customer Operationsfrom March 1997 to February 1999, and Controller and Chief Accounting Officerprior to that.  She is a certified publicaccountant.

** **

**PART II**

** **

**ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

** **

**Market Information and Holders of CommonStock**

** **

**Our common stock is traded on the American Stock Exchange under thesymbol “RKE.”  The following table setsforth the range of high and low sales prices per share of common stock for theperiods shown, as reported in the consolidated reporting system of the AmericanStock Exchange. **

** **
| ** **      | ** ** | **Sales Price** | ** ** |
|-----------------|------------|-----------------|------------|
| ** **      | ** ** | **High**        | ** ** | **Low** | ** ** |
| **2005**        | ** ** | ** **      | ** ** | ** ** | ** ** |
| First  Quarter  |       | $               | 28.12      |   | $ | 23.80 |   |
| Second  Quarter |       | 24.38           |       | 17.90 |   |
| Third  Quarter  |       | 19.30           |       | 15.02 |   |
| Fourth  Quarter |       | 21.07           |       | 13.00 |   |
|            |       |            |       |   |   |
| **2004**        |       |            |       |   |   |
| First  Quarter  |       | $               | 34.50      |   | $ | 30.52 |   |
| Second  Quarter |       | 32.30           |       | 27.10 |   |
| Third  Quarter  |       | 30.70           |       | 23.40 |   |
| Fourth  Quarter |       | 30.40           |       | 24.60 |   |

** **

**As of March 17, 2006, there were approximately 12,101 holders of recordof the Company’s common stock.**

** **

**Dividend Policy**

** **

**The Company has not declared or paid dividends on its common stock todate, and does not anticipate paying dividends in the foreseeable future.  Any dividends declared would be subject tothe prior rights of holders of any outstanding cumulative preferred stock. **At the present time, the Company has not issued preferredstock.  Certain Company loan documents,as well as the terms of the LGB Agreement, restrict the payment of dividends.

** **

**Equity Compensation Plans**

** **

The followingtable sets forth certain information regarding the Company’s equitycompensation plans as of December 31, 2005:

 

10

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| **Plan Category**                                           | ** ** | **Number of securities to be   issued upon exercise of   outstanding options, warrants   and rights  (a)** | ** ** | **Weighted average  exercise price of outstanding   options, warrants and   rights  (b)** | ** ** | **Number of securities   remaining available for   future issuance under   equity compensation   plans (excluding   securities reflected   in column (a))  (c)** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by  security holders     | ** ** | —                                                                                                     |       | —                                                                                         |       | 945,753                                                                                                                                                          |       |
| Equity compensation plans not approved by  security holders | ** ** | —                                                                                                     |       | —                                                                                         |       | —                                                                                                                                                           |       |
| Total                                                       | ** ** | —                                                                                                     |       | —                                                                                         |       | 945,753                                                                                                                                                          |       |

 

**ITEM 6. SELECTED FINANCIAL DATA**

** **

**SELECTED CONSOLIDATED FINANCIAL DATA**

** **

**The following table sets forth selected consolidated financialstatement information for the years ended December 31, 2005, 2004, 2003 and2002, and the nine months ended December 31, 2001 and 2000.  The following selected consolidated financialdata should be read in conjunction with Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and Item 8, “FinancialStatements and Supplementary Data.”**

** **

**11**

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** **
| ** **                                                       | ** ** | **YEARS ENDED DECEMBER 31,** | ** ** | **NINE MONTHS ENDED  DECEMBER 31,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|-------------------------------------|------------|
| ** **                                                       | ** ** | **2005**                     | ** ** | **2004**                            | ** ** | **2003** | ** ** | **2002** | ** ** | **2001 (1)** | ** ** | **2000 (4)** | ** ** |
| ** **                                                       | ** ** | **(Thousands of dollars)**   | ** ** |
| **CONSOLIDATED STATEMENTS OF**                                   |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
| **OPERATIONS DATA:**                                             |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
| Operating revenues                                               |       | $                            | 86,975     |                                | $          | 82,624 |   | $ | 82,844 |   | $ | 74,637 |   | $ | 53,122 |   | $ | 52,100 |   |
| Operating expenses                                               |       | (86,750                      | )          | (72,405                             | )          | (61,875 | ) | (58,307 | ) | (43,142 | ) | (50,101 | ) |
| Operating income                                                 |       | 225                          |       | 10,219                              |       | 20,969 |   | 16,330 |   | 9,980 |   | 1,999 |   |
| Other income (expense) (2)                                       |       | (5,064                       | )          | (6,926                              | )          | (7,634 | ) | (7,140 | ) | (5,550 | ) | (5,915 | ) |
| Income (loss) before income taxes                                |       | (4,839                       | )          | 3,293                               |       | 13,335 |   | 9,190 |   | 4,430 |   | (3,916 | ) |
| Income tax (expense) benefit (3)                                 |       | 613                          |       | 232                                 |       | (2,137 | ) | (414 | ) | — |   | — |   |
| Net income (loss)                                                |       | $                            | (4,226     | )                                   | $          | 3,525 |   | $ | 11,198 |   | $ | 8,776 |   | $ | 4,430 |   | $ | (3,916 | ) |
|                                                             |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
| **NET INCOME (LOSS) PER COMMON SHARE:**                          |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
|                                                             |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
| Basic                                                            |       | $                            | (2.58      | )                                   | $          | 2.28 |   | $ | 7.69 |   | $ | 6.74 |   |   |   |   |   |
| Diluted                                                          |       | $                            | (2.58      | )                                   | $          | 2.21 |   | $ | 7.41 |   | $ | 6.74 |   |   |   |   |   |
|                                                             |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
| **WEIGHTED AVERAGE NUMBER OF COMMON SHARES  OUTSTANDING:**       |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
|                                                             |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
| Basic                                                            |       | 1,640,276                    |       | 1,546,271                           |       | 1,455,443 |   | 1,302,355 |   |   |   |   |   |
| Diluted                                                          |       | 1,686,613                    |       | 1,596,796                           |       | 1,510,741 |   | 1,302,355 |   |   |   |   |   |
|                                                             |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
| **PRO FORMA BASIC AND DILUTED EARNINGS PER  SHARE (UNAUDITED):** |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
|                                                             |       |                         |       |                                |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                                |       |                         |       |                                |       |   |   |   |   | $ | 3.40 |   |   |   |
| Pro forma shares outstanding                                     |       |                         |       |                                |       |   |   |   |   | 1,302,355 |   |   |   |

 
| ** **                           | ** ** | **DECEMBER 31,**           | ** ** |
|--------------------------------------|------------|----------------------------|------------|
| ** **                           | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001 (2)** | ** ** | **2000 (4)** | ** ** |
| ** **                           | ** ** | **(Thousands of dollars)** | ** ** |
| **CONSOLIDATED BALANCE SHEET DATA:** |       |                       |       |   |   |   |   |   |   |   |   |   |   |
|                                 |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Utility plant                        |       | $                          | 147,827    |   | $ | 149,361 |   | $ | 152,162 |   | $ | 156,517 |   | $ | 164,547 |   | $ | 170,111 |   |
| Total assets                         |       | 187,561                    |       | 199,687 |   | 202,989 |   | 211,294 |   | 214,459 |   | 218,382 |   |
| Long-term debt, net                  |       | 130,696                    |       | 134,032 |   | 143,372 |   | 148,052 |   | 181,732 |   | 184,688 |   |
| Equity and margins                   |       |                       |       |   |   |   |   |   |   | 7,672 |   | 6,012 |   |
| Stockholders’ equity            |       | 31,228                     |       | 33,444 |   | 26,973 |   | 14,738 |   |   |   |   |   |
|                                      |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**(1)**           The Company changed its year-end from March 31 to December31, effective December 31, 2001.

**(2)**           Includes $1,357,000 of impaired costs related to the Lamarcombination for the year ended December 31, 2002.

**(3)**           Upon conversion to a shareholder owned corporation, theactivities and transactions of the parent became taxable.

**(4)**           This selected financial data is provided for informationalpurposes only.  These numbers areun-audited and are provided for a consistent presentation based on (1) above.

** **

**12**

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** **

**ITEM7.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

**Cautionary Statement Regarding Forward-Looking Statements**

** **

**This Annual Report on Form 10-K includes “forward-looking statements”as defined by the Securities and Exchange Commission.  We make these forward-looking statements inreliance on the safe harbor protections provided under the Private SecuritiesLitigation Reform Act of 1995.  Allstatements, other than statements of historical fact, included in this Form10-K that address activities, events or developments that we expect, believe oranticipate will or may occur in the future are forward-looking statements.  These forward-looking statements are based onassumptions which we believe are reasonable based on current expectations andprojections about future events and industry conditions and trends affectingour business.  However, whether actualresults and developments will conform to our expectations and predictions issubject to a number of risks and uncertainties that, among other things, couldcause actual results to differ materially from those contained in theforward-looking statements, including the risk factors described in Item 1 ofthis Form 10-K and the following:**

** **

**•**                  Weather conditions could affect  electricity sales and revenues;

**•**                  Change in rate structure and ability to earn a fair returnon the Company’s rate base and recover the costs of operations;

**•**                  Federal and state regulatory actions, and associated legaland administrative proceedings, especially as they relate to the oversightauthority of the Public Utility Commission of Texas, could affect revenues andearnings and could cause the Company to lose customers through increasedcompetition in the electric utility industry;

**•**                  Demands for electric power and the associated costs,including changes in the costs of power plant fuels such as natural gas andcoal could cause purchased power cost to increase, which could in turn affectcustomers’ usage and our revenues;

**•**                  Changes in the Company’s cash position and availability ofcapital resources;

**•**                  The effect of accounting pronouncements issued periodicallyby applicable standard — setting bodies;

**•**                  General economic and political conditions, including tax lawsand rates, inflation rates and interest rates;

**•**                  Unexpected changes in operating expenses and capitalexpenditures;

**•**                  Ability and timing of closure of the LGB Agreement.

** **

**New factors that could cause actual results to differ materially fromthose described in forward-looking statements emerge from time to time, and itis not possible for us to predict all such factors, or the extent to which anysuch factor or combination of factors may cause actual results to differ fromthose contained in any forward-looking statement.  We assume no obligation to update publiclyany such forward-looking statements, whether as a result of new information,future events, or otherwise.**

** **

**The following discussion and analysis of the Company’s  financial condition and results of operationsfor the years ended December 31, 2005, 2004 and 2003, should be read inconjunction with the Company’s audited consolidated financial statements andrelated notes to financial statements included elsewhere in this document.  Unless otherwise indicated, all references tothe Company will include any and all activities of its Predecessor.**

** **

**Overview**

** **

**General**

** **

**Cap Rock Energy Corporation is an electric distribution companyoperating in various noncontiguous areas in the State of Texas. The Companyprovides service to over 34,000 active meters in 28 counties coveringapproximately 13,000 square miles in Texas. This includes 23,200 meters withintwo operating divisions in the Midland-Stanton area of west Texas, 6,300 metersin the central Texas area around Brady, and over 4,500 meters in northeastTexas in Hunt, Collin and Fannin Counties. The Company also provides managementservices to the Farmersville Municipal Electric System which services nearly1,600 meters in Farmersville, Texas.**

** **

**13**

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** **

**The Company purchases power from wholesale suppliers and distributesthat power to its retail customers over transmission lines covering over 305miles and then over 11,000 miles of distribution lines. The Company’s primaryfocus is on the distribution of electricity to its customers, and therefore ithas not and does not plan to engage in the generation of electricity.  In 2005, the Company purchased all electricpower pursuant to wholesale electric power contracts with three suppliers.  Generally, the wholesale electric powersupply contracts are based on fixed charges for kWh usage, transportation andauxiliary services and a variable charge for fuel based on kWh usage. TheCompany’s purchased power costs fluctuate primarily with the price of fuel usedto generate that electricity, which is primarily natural gas and coal. However,all costs associated with purchased power are passed through to the retailcustomer.**

** **

**RateProceeding**

** **

**Effective September 1, 2003, theCompany became subject to the oversight authority of the PUCT, and the ratesand fees charged to customers by the Company are now subject to PUCTapproval.  The rate making process hasincluded rate hearings and proceedings over a period of two years.  The Company has not yet received approvalfrom the PUCT of its compliance tariff detailing the new rate plan, but itexpects such approval in the second quarter of 2006.  The final order concerning the Company’srates adopted a decrease of approximately 2%, which amounts to an annualrevenue decrease of approximately $2 million based on test year kWh sales.**

** **

**As of December 31, 2005, a totalof $4,335,000 in third party costs had been incurred related to this rateproceeding.  The PUCT ruled that$3,217,000 of these costs would be permitted to be recovered by the Companyover a period of three years effective when the new rates go into effect.  Approximately $111,000 of costs were deemedto be not recoverable; therefore these costs were expensed in 2005.  Additional rate case costs of $1,007,000incurred after the PUCT made its determination been deferred for futurerecovery as permitted by the Order.**

** **

**Notices of Violation**

** **

The Company received twoNotices of Violation (“NOVs”) from the PUCT in October 2004, which citedthe Company for charging late fees to residential customers who did not paytheir bills on time, and for charging a regulatory surcharge to customers torecover costs incurred in a prior PUCT proceeding.  The Company contendedthat both of these charges were made in accordance with the Company’s tariffwhich had been adopted by its Board of Directors in accordance with Texas lawat the time.  The PUCT Staff claimed that the Company misapplied itstariff and that, following September 1, 2003, the Company could not chargea rate that, even if authorized by its tariff, violated PUCT rules.

 

**On November 10, 2005, theAdministrative Law Judges (“ALJ’s”) issued a Proposal for Decision (“PFD”)recommending that the Company be found to have violated state law and PUCTrules, and recommending that the Company be ordered to pay total refunds andpenalties in the amount of $1,567,687 as of July 2005.  The PFDrecommended that the refunds be made over a thirteen month period instead ofthe Staff’s requested one-time credit.  The Company filed exceptions tothe PFD on December 6, 2005, which were heard at an open meeting of thePUCT in February 2006.**

** **

**At an open meeting of the PUCTCommissioners held on February 21, 2006, the PUCT Commissioners votedunanimously to adopt the PFD.  A finalorder was entered on March 3, 2006.  TheCompany has recognized a liability for $1,832,000, which represents the amountsrequired to be refunded to customers plus penalties and interest throughDecember 31, 2005.  See Regulatory Accountingin Note 1 to the consolidated financial statements.  The Company has twenty days from the date ofreceipt of the final order to file a motion for rehearing and if that isoverruled, it can appeal to district court. The Company filed a motion for rehearing on March 27, 2006.**

** **

**LGB Agreement**

** **

**In November 2005, the Company signed a definitive agreement and plan ofshare exchange with a newly-formed entity owned by LGB.  The shareholders approved the LGB Agreementat a special meeting held on**

** **

**14**

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** **

**March 10, 2006.  Approval of the transactionby the PUCT and FERC is also a condition for the LGB Agreement to beconsummated.  The LGB Agreement generallyprovides for payment by the Holding Company of $21.75 per share to the Company’sshareholders.  Following the completionof the transaction, the Company will have no publicly held securities.**

** **

**Taxes**

** **

**In connection with the restatement of the Company’s consolidatedfinancial statements for the year ended December 31, 2004, the Audit Committeeof the Board of Directors made a decision to amend applicable tax returns forNewCorp to reflect its status as taxable. Recoverability of the additional tax expense from ratepayers isuncertain.**

** **

**Other**

** **

**In March 2004, the Company signed an agreement with a shareholder ofUnited Fuel to sell the Company’s shares of stock in United Fuel in exchangefor a note receivable of $1,300,000 from that shareholder.    Pursuant to the agreement, the firstinstallment of $500,000 was received in May 2005, with the balance of $800,000plus interest due in equal annual installments over the next three years.  Recognition of the gain was deferred untilreceipt of principal payments.  In 2005,$140,000 of gain was recognized, with $267,000 of gain recognized with eachannual installment.**

** **

**CriticalAccounting Policies and Estimates**

 

The Company’s significant accounting policiesare described in Note 1 to the consolidated financial statements.  Certain of the Company’s accounting policiesrequire the application of judgment by Management in selecting the appropriateassumptions for calculating significant financial estimates.  By their nature, these judgments andestimates are subject to an inherent degree of uncertainty.  These judgments and estimates are based onhistorical experience, terms of existing contracts, observance of trends in theindustry, information provided by customers, and information available fromother outside sources as appropriate. Different estimates reasonably could have been used in the currentperiod, or changes in the accounting estimates are reasonably likely to occurfrom period to period, that could have a material impact on the presentation ofthe Company’s financial condition, changes in financial condition or results ofoperations.  Management believes that thefollowing financial estimates are both important to the portrayal of theCompany’s financial condition and results of operations and require subjectivejudgment.  Further, it is believed thatthe items discussed below are properly recorded in the financial statements forall periods presented.  Management hasdiscussed the development, selection and disclosure of the most criticalfinancial estimates with the Audit Committee of the Board of Directors.

 

***Rate Regulation****. *The Company’s mostcritical accounting policy involves rate regulation.  The Company is subject to the provisions ofStatement of Financial Accounting Standards (“SFAS”) Statement No. 71, “Accountingfor the Effects of Certain Types of Regulation.”  In certain circumstances, SFAS No. 71requires that certain costs and/or obligations be deferred on the balance sheetuntil matching revenues are recognized, subject to regulatory approval.  It is the Company’s policy to assess therecoverability of costs recognized as regulatory assets in accordance with SFASNo. 71, based on each regulatory action and the criteria set forth in SFAS No.71.  Any disallowance of these deferredcosts would be charged immediately against income upon that disallowance.

 

***Power Cost Recovery Factor.***** **The power costrecovery factor is the difference between the cost of power purchased and thecost of power recovered from customers, divided by the number of kilowatt hoursbilled during the period.  Powerpurchased includes transmission costs and wheeling charges.  This factor is estimated each month torecover actual power costs and is added as a surcharge to the base rate.  The factor is based on estimates of powercost increases or decreases due to changes in fuel cost, usage and other costfluctuations.  The estimate is adjustedin the subsequent month as compared to actual activity.  The Company currently defers the differencebetween actual purchased cost and billed cost as a regulatory asset orliability.  The regulatory asset orliability, as well as the deferral, are adjusted accordingly by either receiptfrom, or refund to, the customer of the net deferred amount.

 

15

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***Revenue Recognition Policy.****  *The Company records revenue based on amounts billed to customers aswell as unbilled amounts based upon an estimate of the revenues for energy andservice delivered from the latest billing through the end of the period.

** **

***Stock Based Compensation.*** Effective January 1, 2003, the Company adoptedthe fair value method of accounting for its employee stock incentive plan inaccordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” asamended by SFAS No. 148, “Accounting for Stock-Based Compensation, Transitionand Disclosure.”

** **

***Tax Liabilities and Valuation of Deferred Tax Assets.****  *The Company is required to assess the ultimaterealization of deferred tax assets generated from net operating losses, andcapital losses incurred on the sale of assets. This assessment takes into consideration tax planning strategies withinthe Company’s control, including assumptions regarding the availability andcharacter of future taxable income.

** **

***Impairment of Long-lived Assets.****  *Management reviews the carrying value oflong-lived assets whenever events or changes in circumstances indicate thatsuch carrying values may not be recoverable in accordance with Statement ofFinancial Accounting Standards No. 144, “Accounting for the Impairment orDisposal of Long-lived Assets.” Unforeseen events and changes in conditions could indicate that thesecarrying values may not be recoverable and may therefore result in impairmentcharges.  An impairment loss isrecognized only if the carrying amount of the long-lived asset is notrecoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if itexceeds its future undiscounted cash flows, and if required, fair value oflong-lived asset is written down to its fair value.  The determination of future cash flows, andif required, fair value of long-lived asset is by its nature a highlysubjective judgment.  Fair value isdetermined by calculating the discounted future cash flows using a discountrate, third party contracted bids or appraisals performed by a qualifiedparty.  Significant judgments andassumptions are required in the forecast of future operating results used inthe preparation of the long-term estimated cash flows, including long-termforecasts of the amounts and timing of overall market growth.  Changes in these estimates could have amaterial effect on the assessment of our long-lived assets.

** **

***Postretirement Healthcare Benefits.**** *The Company provides certain postretirement healthcarebenefits to employees and retirees. Determining the costs associated with such benefit is dependent onvarious actuarial assumptions including demographics (age, sex, mortalityrates, discount rates) used in determining the projected benefit obligations,and current and projected health care cost trend rates.  Independent actuaries perform the requiredcalculations, in accordance with accounting principles generally accepted inthe United States.  Actual results thatdiffer from the actuarial assumptions are generally accumulated and amortizedover future periods.

** **

**Results ofOperations**

 
| ** **               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------|------------|-----------------------------|------------|
| ** **               | ** ** | **2005**                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **               | ** ** | **(Thousands of dollars)**  | ** ** |
| **Operating  Revenues:** |       |                        |       |   |   |   |   |
| Electric revenues        |       | $                           | 86,532     |   | $ | 81,149 |   | $ | 81,402 |   |
| Other                    |       | 443                         |       | 1,475 |   | 1,442 |   |
| Total operating revenues |       | $                           | 86,975     |   | $ | 82,624 |   | $ | 82,844 |   |

 

The consumption and demand for electricitywithin the Company’s service areas is greatly impacted by weather conditionsand temperatures.  The hot temperaturesduring the summer months, or the third quarter, require residential customersto use more electricity in cooling their homes. Rural customers who irrigate crops use more electricity in the summermonths for the irrigation process, and if the spring season didn’t bring muchrain, these customers may irrigate sooner and longer.  Portions of the Company’s service areas hadbeen experiencing a severe long-term drought, but these conditions are muchless severe than in the past.

 

Electric revenues increased $5,383,000between 2004 and 2005, which relates to:

 

16

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•                  Increases in power cost recovery of$6,002,000, which is related to the increases in fuel expenses from suppliers,which are passed through to customers;

•                  Increase in kWh sales of $6,234,000;  offset by

•                  Refund of over collection of prior periodpurchased power and disallowed costs of $4,373,000;

•                  Reduction of $2,955,000 in revenues collectedfor the recovery of transmission service.

 

The $4,373,000 was established as aregulatory liability in 2004 and was refunded to customers from January throughSeptember of 2005.

 

A final order from the PUCT concerning theCompany’s rates adopted a decrease of approximately 2%, which amounts to anannual revenue decrease of approximately $2 million based on test year kWhsales, commencing when the final order is approved.  This rate decrease will negatively impact theCompany’s future revenues.

 

Other revenues decreased as the Company’sability to charge late payment fees was limited by the tariff.

 

Electric revenues decreased $253,000 between2003 and 2004, the aggregate components were:

 

•                  An increase in power cost recovery of$2,702,000;

•                  Increase in wholesale sales and kWh sales of$801,000;

•                  A decrease in 2004 of $3,755,000 as a resultof the 2003 change in accounting principle.

 

The increase in power cost recovery iscomprised of the increase of the pass through of fuel costs to customers of$4,150,000, and a decrease in the amount of revenue recognition related to aregulatory surcharge authorized by the Board of Directors of $1,448,000.  It was intended to recover some of the expenseincurred in connection with the Company’s response to Opposing Intervenersactions in the CCN case.  A total of$2,354,000 was billed to customers from June 2003 through February 2004;$92,000 was recognized as revenue in 2004, $1,539,000 was recognized as revenuein 2003, and the remainder of $723,000 was shown as a regulatory liability onthe balance sheet at December 31, 2004.

 

The Company had been realizing deferredrevenue of $4,364,000 equally over a 24 month period from January 2002 toDecember 2003.  This revenue wasrecognized equally in both the 2003 and 2002 periods, and was billed throughthe power cost recovery factor, and is not being reflected in any futureperiods.  This item related to purchasedpower that was expensed in prior years.

** **
| ** **                    | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                    | ** ** | **(Thousands of dollars)** | ** ** |
| **Operating  Expenses:**      |       |                       |       |     |       |     |       |
| Purchased power               |       | $                          | 48,046     |     | $          | 40,032   |       | $ | 36,578 |   |
| Operations and maintenance    |       | 12,995                     |       | 10,331   |       | 10,135   |       |
| General and administrative    |       | 10,736                     |       | 7,518    |       | 4,639    |       |
| Stock compensation            |       | 4,389                      |       | 4,925    |       | 2,133    |       |
| Depreciation and amortization |       | 8,120                      |       | 7,416    |       | 6,719    |       |
| Property taxes                |       | 1,819                      |       | 1,925    |       | 1,345    |       |
| Other                         |       | 645                        |       | 258      |       | 326      |       |
| Total operating expenses      |       | $                          | 86,750     |     | $          | 72,405   |       | $ | 61,875 |   |

** **

Purchased power expense normally moves inrelation to electric demand and consumption.   Contract terms with wholesale power suppliers provide for pricing basedupon the price of fuel, demand and usage.   All costs of power are passed through to the Company’s retail customers.

 

Purchased power increased $8,014,000 from2004 to 2005 because of an increase in the price of fuel from suppliers ofapproximately $6,002,000 and increased kWh sales of $2,012,000.

 

17

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Purchased power increased $3,454,000 from2003 to 2004.  The net changes relatedto:

 

•                  Disallowed power cost of $3,074,000 becauseof an increase in fuel cost related to the regulatory liability because of overcollection of power cost recovery;

•                  Increase in power costs of $4,754,000; offsetby

•                  Decrease of $4,412,000 in 2004 because of theconclusion in 2003 of the rate making treatment of the capital lease paymentsassociated with the transmission system.

 

Rate-making treatment required the Company toclassify the amortization of property and equipment under the capital leaserelated to the Company’s transmission system, as well as the associatedinterest expense, as purchased power. Because the lease was extinguished in September 2003, the treatment isno longer applicable, and the remaining net book value of the transmissionsystem is being depreciated over its remaining life, and that expense isreflected in Depreciation and Amortization expense.

 

Operations and maintenance increased$2,664,000 from 2004 to 2005 because of the following:

•                  Increase in salaries and benefits of$872,000;

•                  Increase in allocated overhead from generaland administrative of $598,000;

•                  Increase of $593,000 in 2005 in costs relatedto vehicles such as maintenance and repairs, fuel and lease costs;

•                  Increase of $329,000 for outsourced andprofessional services.

 

Operations and maintenance increased $196,000between 2004 and 2003.  The majority ofthe change is related to an increased need in maintenance for the distributionand transmission systems which resulted in current expense, as opposed toengaging in construction activities that would have resulted in capitalizedcosts.

 

General and administrative expenses increasedby $3,218,000 from 2004 to 2005 because of the following:

•                  Increased legal and settlement costs of$1,890,000 in 2005, the majority of which related to costs incurred withrespect to the LGB Agreement;

•                  Increase of $457,000 in penalties related tothe PUCT’s decision on certain Notice of Violations;

•                  Increase in 2005 of $524,000 for Board ofDirectors’ fees as they related to the additional meetings in connection withthe LGB Agreement;

•                  Increase in 2005 of $564,000 in professionalservices;

•                  Increase in 2005 of $329,000 for bad debtexpense, the majority of which is the result of forgiveness of the notereceivable related to the real estate partnerships;

•                  Increased costs of $443,000 in 2005 relatedto IT support and outsourced IT functions;

•                  Decrease from 2004 to 2005 as a result ofallocations to utility plant and operations and maintenance of $1,509,000.

 

General and administrative expenses increasedby $2,879,000 from 2003 to 2004, because of the following:

 

•                  Increased costs in 2004 of $1,610,000 relatedto IT support and outsourced IT functions;

•                  Increased expenditures of $218,000 associatedwith public relations;

•                  Decreased overhead allocation from 2003 to2004 to utility plant and operations and maintenance of $890,000 resulted inhigher costs remaining in general and administrative.

 

In December 2002, the shareholders approvedthe Stock Incentive Plan which authorized a total of 800,000 shares under thatplan.  See “Equity Compensation Plans”under Item 5.  In April 2003, eachemployee was granted a noncash stock award, with vesting over 5 years.  Officers, directors and certain retireddirectors were also granted noncash stock awards in July 2003, with vestingperiods ranging from 1 to 5 years.  Bothawards are being amortized to expense over periods of 2 to 5 years, with theexpense reflecting the fair value of the award.

 

**In late April 2005, an award of stock was granted to employees,officers and directors in order to compensate them for the effects ofwithholding shares for taxes on a previous award.  This award, of 134,098 shares, was immediatelyvested, and the fair value of the award of $3,060,000 was expensed.**

 

18

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In December 2004, an additional award ofstock was granted to employees, officers and directors.  Employee awards vest over two years, andofficers’ and directors’ awards vested immediately.  The fair value of this award is beingamortized to expense over the applicable vesting period.  Expected noncash compensation expense by yearfor all awards is as follows: 2006 - $324,000, 2007 - $316,000 and 2008 -$108,000.

** **

Depreciation and amortization increased$704,000 from 2004 to 2005 largely because of the amortization for a full yearof the capitalized costs of the IT system.

 

Depreciation and amortization increased$697,000 from 2003 to 2004 because of the following factors:

 

•                  Conclusion in 2003 of the rate makingtreatment of the amortization of property and equipment associated with thetransmission system capital lease caused an increase of $412,000 because thetreatment is no longer applicable;

•                  Amortization in 2004 of $367,000 relative tothe capitalized costs of the IT system.

 

In connection with the original ten yearcapital lease associated with the transmission system, generally acceptedaccounting principles required the Company to amortize the asset over a periodconsistent with the lease payments.  Thisperiod was much shorter than the estimated life of the asset, and theamortization was charged to purchased power. Because the capital lease was extinguished in September 2003, and therate-making treatment is no longer applicable, the method of depreciation andlife of the transmission system assets was changed to a straight-line method in2003.

 

In its efforts to be able to adapt to achanging regulatory environment, enhance efficiency and automate certainprocesses, management recognized the need for a more sophisticated andresponsive IT system and associated applications.  The Company engaged an outside third party toassess the Company’s current and future IT needs, assist in the selectionprocess of software and related applications, implement the chosen products andprocesses and provide ongoing support.

 

Certain IT costs associated with the changein the operating environment, the software applications and implementationprocess have been capitalized.  TheCompany began a 5 year amortization period beginning March 2004, which was theend of the planned implementation.  Inaddition, the ongoing costs for maintenance and IT support are based on thenumber of meters per respective month and, based on the number of meters as ofDecember 31, 2005, will approximate $1,615,000 per year through the term of thecontract, which is December 2007.  Allapplications are anticipated to be operational by mid 2006.

 

Historically, property tax expense hadremained relatively constant.  In 2004,such expenses increased $580,000 because of current appraisal methodologiesused in the ad valorem taxation of investor owned utilities in Texas, as wellas the Company’s revenue-generating ability, as compared to its former statusas a cooperative.

 

Other expense for 2005 includes the write offof rate case costs of $111,000 that we determined were not recoverable fromcustomers.

 
| ** **                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|
| ** **                                          | ** ** | **2005**                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                          | ** ** | **(Thousands of dollars)**  | ** ** |
| **Other  Income (Expense):**                        |       |                        |       |   |   |   |   |
| Allocation of income from associated  organizations |       | $                           | 573        |   | $ | 540 |   | $ | 530 |   |
| Interest expense, net of capitalized  interest      |       | (6,230                      | )          | (7,983 | ) | (8,047 | ) |
| Interest and other income                           |       | 528                         |       | 646 |   | 795 |   |
| Other                                               |       | 65                          |       | (129 | ) | (912 | ) |
| Total other income (expense)                        |       | $                           | (5,064     | ) | $ | (6,926 | ) | $ | (7,634 | ) |

 

19

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Interest expense decreased $1,753,000 between2005 and 2004 because of the following;

•                  Decrease in 2005 of $2,151,000 due tointerest expense in 2004 on the Beal Bank loan which was repaid in 2004, andthe expensing of related fees and costs;

•                  Increase in 2005 interest expense related tothe CFC mortgage debt because of an increase in interest rates.

 

Interest expense decreased $64,000 between2003 and 2004 because of the following:

 

•                  Amortization of all remaining fees and costsincurred with respect to the Beal Bank loan caused an increase of $787,000 from2003 to 2004;

•                  The initial Beal Bank advance was drawn on inSeptember 2003 and repaid in November 2004, with a resulting net increase of$795,000;

•                  The cross-collateralized note payable to abank was extinguished in September 2003 causing a decrease of $566,000 betweenthe periods;

•                  Interest expense on mortgage debt reflects adecrease of $126,000 because of the declining balance on the debt.

•                  In 2004, there was no amortization of thefees and costs associated with the original transmission system capital leasebecause the lease was extinguished in September 2003.  This caused a decrease of $984,000.

 
| ** **                    | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                    | ** ** | **(Thousands of dollars)** | ** ** |
| **Income  Tax Expense:**      |       |                       |       |     |       |     |       |
| Income tax  expense (benefit) |       | $                          | (613       | )        | $          | (232     | )          | $ | 2,137 |   |
|                               |            |                            |            |          |            |          |            |  |  |  |

 

Income tax expense decreased $681,000 and$2,369,000 between 2004 and 2005, and 2003 and 2004, respectively.  As of December 31, 2005, the Company has netoperating loss carryforwards of approximately $19,005,000 which are scheduledto expire in 2011 through 2025.  As ofDecember 31, 2005, there was a net deferred tax asset of $312,000, but avaluation allowance had been recorded against it.  The decrease in the net deferred taxliability is due largely to the increase in the net operating losscarryforwards.

 

The large change in the effective tax rate of(7.1)% in 2004 and (12.7)% in 2005 as compared to the statutory rate is duelargely to the valuation allowance and expired capital loss in 2004, andnondeductible compensation in 2005.

 

In early 2004, the IRS notified the Companythat it intended to examine the federal income tax return of the Cooperativefor the year 2001.   The IRS completedits examination in 2005, and there was no impact on the Company’s financialposition or results of operations.

 

**The Company was notified in December 2005 that the Texas StateComptroller’s Office intended to examine the state franchise tax returns ofEnergy for the preceding four years. Management believes there will be no material impact on the Company’sfinancial position or results of operations.**

** **

**Contractual Obligations and Other Commitments**

** **

**The following table summarizes the Company’s obligations andcommitments to make future payments under certain contractual obligations:**

** **

**20**

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** **
| ** **                             | ** ** | **2006**                   | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| ** **                             | ** ** | **(Thousands of dollars)** | ** ** |
|                                   |       |                       |       |     |       |     |       |     |       |     |       |           |       |      |       |
| Debt obligations                       |       | $                          | 3,433      |     | $          | 29,822   |       | $        | 3,178      |     | $          | 3,333          |       | $         | 3,469      |   | $ | 90,807 |   | $ | 134,042 |   |
| Capital lease obligations              |       | 73                         |       | 31       |       | 17       |       | 17       |       | 18       |       | 4              |       | 160       |       |
| Operating lease obligations            |       | 695                        |       | 557      |       | 228      |       | 147      |       | 101      |       | —         |       | 1,728     |       |
| Purchase obligations (1)               |       | 4,216                      |       | 2,359    |       | 630      |       | 630      |       | 630      |       | 2,456          |       | 10,921    |       |
| Other long term liabilities  (2)(3)(4) |       | 1,183                      |       | 617      |       | 579      |       | 580      |       | 569      |       | 35,226         |       | 38,754    |       |
|                                        |            |                            |            |          |            |          |            |          |            |          |            |                |            |           |            |  |  |  |  |  |  |  |

 

----

(1)          All ofthe Company’s power contracts are firm, full requirements contracts.  These types of contracts require the Companyto purchase all of its power needs from the seller, but do not mandate aminimum purchase amount.  Therefore,amounts included for each year are basic required transmission charges.  Also included are commitments for IT servicesand certain professional services.

(2)          Includesactuarially calculated amounts for post retirement healthcare costs of$480,000, $552,000, $547,000, $559,000, and $568,000 for the years ended 2006,2007, 2008, 2009 and 2010, respectively, as well as $35,226,000 for the years2011 through 2050.

(3)          TheCompany has a contract with the City of Farmersville, Texas, to act as an agentto provide power and related billing and collection functions, and is obligatedto the City to make payments on a revenue sharing type basis.  The 2006, and estimated 2007, annual paymentsaggregate $630,000.

(4)          Paymentsto or benefits to be provided to advisory council members are included.

 

**Liquidity and Capital Resources**

 

Asof December 31, 2005, the Company had:

 

•                  Cash of $9,857,000;

•                  Working capital of $4,609,000; and

•                  Long-term indebtedness of $130,696,000, netof current portion.

 

**The Company requires capital tofund utility plant additions, working capital and other utility expenditureswhich are recovered in subsequent and future periods through rates.  Capital necessary to meet these cashrequirements is derived primarily from internally generated funds.**

** **

**The decrease in cash of$11,111,000 from 2004 to 2005 is due largely to the refund of $4,373,000 tocustomers of the over collection of prior period purchased power, the underrecovery of purchased power revenue of $2,147,000, increase in expenditures forutility plant of $1,781,000, and a general increase in Operations, Maintenanceand General and Administrative expenditures.**

** **

**Management feels the Company has adequate resources to meet itsobligations for 2006, including those enumerated in the table under “ContractualObligations and Other Commitments.”**

 

**LGBAgreement: **The consummation of the LGB Agreement isexpected to provide a $15 million line of credit to the Company.  This capital availability will allow theCompany to progress and achieve certain long range goals and objectives, aswell as provide short term cash for operations and maintenance.  Subsequent to the consummation of thetransaction, the Company will be privately held.

 

**DeferredTaxes: **The Company’s identification of a technicaltax issue related to the income tax treatment, for financial reportingpurposes, regarding the tax exempt status of one of the Company’s subsidiariesresulted in additional income tax expense for 2004.  This will not require an immediate cashoutlay because it affects deferred taxes payable.  The Company had generated net operatinglosses in earlier periods that was used to offset the taxable nature of thesubsidiary.  The use of the net operatinglosses earlier than expected may also result in increased taxes payable and acomparable decrease in earnings in future periods to the extent of theunavailable net operating losses.

 

**MortgageDebt:**  Through 2001, one of the Company’s primarysources of capital and liquidity had been borrowings from the Company’s primarylender, National Rural Utilities Cooperative Finance Corporation (“CFC”). 

 

21

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Theseborrowings are collateralized by substantially all of the Company’s utilitydistribution assets. The existing long-term debt consists of a series of loansfrom CFC that impose various restrictive covenants, including the prohibitionof additional secured indebtedness of Energy, or the guaranty of such, andrequires the maintenance of a 1.35 debt service coverage ratio as defined inthe CFC loan agreements. In addition, the Company may not make any cashdistribution or any general cancellation or abatement of charges for electricenergy or services to its customers if the ratio of equity to total assets isless than a stated percentage. At December 31, 2005, the Company was incompliance with its CFC loan agreements and the applicable covenants.   See Note 10 to the consolidated financialstatements for a discussion of CFC’s waivers related to the prior conversionfrom a cooperative to a stock holder owned corporation.

 

**Substantially all of the CFCmortgage notes are subject to interest rate repricing at the end of variousperiods.  The Company anticipatesrefinancing one of the mortgage notes that has a balloon payment of $26,367,000due in 2007, or other options may be available if the LGB Agreement isclosed.  Mortgage notes with CFC as ofDecember 31, 2005, and the applicable interest rates are as follows:**

** **
| **Interest Rate**   | ** ** | **Repricing in January** | ** ** | **Amount**     | ** ** |
|---------------------|------------|--------------------------|------------|----------------|------------|
| ** **          | ** ** | ** **               | ** ** | **(in thous)** | ** ** |
|                |       |                     |       |           |       |
| Fixed               | 5.15       | %                        |       | 2007           |       | $ | 62,822 |   |
| Fixed               | 4.50       | %                        |       | 2007           |       | 5,834 |   |
| Fixed               | 6.45       | %                        |       | 2011           |       | 37,825 |   |
| Fixed               | 4.30       | %                        |       | —         |       | 27,345 |   |
| Fixed               | 6.40       | %                        |       | —         |       | 215 |   |
| Fixed               | 7.00       | %                        |       | —         |       | 1 |   |
| Total mortgage debt |       |                     |       | $              | 134,042    |   |
|                     |            |                          |            |                |            |  |  |  |  |

 

**StockCompensation:**  Stock awards weremade to employees, officers and directors in 2005, 2004 and 2003.  Noncash compensation expense of $4,389,000,$4,925,000 and $2,133,000 was recorded for 2005, 2004 and 2003, because thefair value of the award is being amortized over each of the applicable vestingperiods.  If the LGB Agreement closes,all remaining unvested awards will immediately vest, causing all remainingdeferred expense to be recognized. Deferred compensation at December 31, 2005 is $609,000.  If the LGB Agreement is not closed, expectednoncash compensation expense by year would be as follows:   2006 - $261,000, 2007 - $253,000 and 2008 -$95,000.

** **

**NoteReceivable:**  Pursuant to theterms of the note receivable agreement with the shareholder of United Fuel, thefirst installment of $500,000 was received in May 2005, with the remainingbalance of $800,000 due in three equal annual installments.

** **

**PostretirementHealthcare:**  The Company provides continuedmajor medical coverage to retired employees and their dependents.  The actuarially calculated estimate of costsfor future years is shown in the table under “Contractual Obligations and OtherCommitments.”  A one percentage pointchange in assumed health care cost trend rates would have the following effects(in thousands):

** **
| ** **                                                | ** ** | **One Percentage Point** | ** ** |
|-----------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                | ** ** | **Increase**             | ** ** | **Decrease** | ** ** |
| Effect on  total of service cost and interest cost        |       | $                        | 133        |   | $ | (105 | ) |
| Effect on  accumulated post retirement benefit obligation |       | 1,639                    |       | (1,310 | ) |
|                                                           |            |                          |            |  |  |  |  |

** **

**RegulatoryMatters:**  The Company has not yet received approvalfrom the PUCT of its compliance tariff detailing its new rate plan, but expectssuch approval during the second quarter of 2006.  The PUCT’s final order concerning the Company’srates adopted a decrease of approximately 2%, which amounts to an annualrevenue decrease of approximately $2 million based on test year kWh sales.

** **

**22**

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** **

**Recently Issued Accounting Standards**

** **

**A discussion of recently issued accounting pronouncements is described inNote 1 to the consolidated financial statements and such discussion isincorporated by reference in this Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and made a part hereof.**

** **

**ITEM 7A. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

** **

**Market risk represents the risk of changes in the value of a financialinstrument caused by fluctuations in interest rates, foreign currency exchangerates, prices of commodities and equity price risks.**

** **

**Commodity Price Risk**

** **

**All purchases of electricity are pursuant to long-term wholesaleelectric power contracts based on a fixed price for kWh usage, transportationand auxiliary services, with a variable charge for fuel cost, which isgenerally natural gas. This variable cost is affected by unpredictable factors,including weather and worldwide events, which in turn impact supply and demand.  The Company’s exposure to purchased powerprice risk is substantially mitigated because all actual costs of power areable to be recovered from billings to customers.**

** **

**Credit Risk**

** **

**The Company’s concentrations of credit risk consist primarily of cash,trade accounts receivable, sales concentrations with certain customers, and anote receivable from a third party.**

** **

**Credit risk with financial institutions is considered minimal becauseof the number and various physical locations of different financialinstitutions utilized.  In the past, theCompany has utilized repurchase agreements, and may consider using that vehicleagain in the future to maximize return and minimize credit risk.**

** **

**The Company conducts credit evaluations of new customers and assessesthe need for a deposit by that customer. The deposit amount is normally set as 1/6 of an annual customer billing,with such amounts being refunded or credited to the customer after one year ifthe customer has paid timely at least 10 of the previous 12 billings.  No customer accounted for 10% or more of theoperating revenues of the Company.**

** **

**In February 2004, the Company sold minor limited partner interests ithad in real estate partnerships at book value to an unrelated third party inexchange for a note receivable of $286,000, collateralized by the partnershipinterests.  In prior years, the Companyhad guaranteed debt of some of the partnerships.  In 2005, the Company obtained a release ofthose guarantees in exchange for a $50,000 payment to the general partner andforgiveness of the note of $286,000 and associated interest.**

** **

**In March 2004, the Company signed an agreement with a shareholder ofUnited Fuel to sell the Company’s shares of stock in United Fuel for $1,300,000in exchange for a note receivable from that shareholder.  Pursuant to the terms of the agreement, thefirst installment of $500,000 was received in May 2005, with the remainingbalance of $800,000 due in three equal annual installments.**

** **

**Interest Rate Risk**

** **

**The Company is subject to market risk associated with interest rates onour CFC long-term indebtedness.  TheCompany’s mortgage debt with CFC allows for a change from variable rate tofixed rate with no additional fees. Mortgage notes of $62,822,000 with current interest rates of 5.15% aredue to be repriced in January 2007, mortgage notes of $5,834,000 with currentinterest rates of 4.50% are due to be repriced in January 2007,  $37,825,000 with current interest rates of6.45% are due to be repriced in January 2011. No repricing is scheduled for the following:  $27,345,000 with a fixed rate of 4.3%,$215,000 with a fixed rate of 6.40%, and $1,000 with a fixed rate of 7%.  A 1% change in interest rates would cause achange of $1,340,000 in interest expense. The Company attempts to take advantage of low interest rateenvironments, as well as repricing interest rates over staggered periods.**

 

23

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**ITEM8.  Financial Statements andSupplementary Data**

** **

**The consolidatedfinancial statements are set forth on pages F-1 through F-31 of this Form 10-K.**

** **
| **ITEM 9.** | **CHANGES IN AND DISAGREEMENTS WITH  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE** |
|-------------|-------------------------------------------------------------------------------------------|

** **

**None**

** **

**ITEM9(a).**          CONTROLS AND PROCEDURES

** **

**DisclosureControls and Procedures.**  We maintaindisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in reports under the Securities Exchange Act of 1934,as amended, are recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms, and that such information isaccumulated and communicated to management, including our chief executiveofficer and chief financial officer, as appropriate, to allow timely decisionsregarding required disclosures.  Ourinternal control system is designed to provide reasonable assurance regardingthe preparation and fair presentation of published financial statements.  All internal control systems are designedbased in part upon certain assumptions about the likelihood of future events,and, no matter how well designed, have inherent limitations.  Therefore, even those systems determined tobe effective can provide only reasonable assurance with respect to financialstatement presentation and may not prevent or detect all misstatements.

** **

**During the period covered by this report, the Company’s chief executiveofficer and chief financial officer, after evaluating the effectiveness of theCompany’s “disclosure controls and procedures” (as defined in the SecuritiesExchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of December 31, 2005,(the “Evaluation Date”), had concluded that as of the Evaluation Date, theCompany’s disclosure controls and procedures (as required by paragraph (b) ofthe Securities Exchange Act of 1934 Rules 13a-15 or 15d-15) were effective.**

** **

**Restatement of Previously Issued ConsolidatedFinancial Statements. **For the year ended December 31,2004, it was determined that certaintax positions maintained by the Company through its conversion from an electriccooperative to an investor owned utility, might not be correct.   In connection with that changein corporate status, the Company had independent professional consultantsevaluate the corporate structure of the Company and its subsidiaries.  Based on that review, the Company believedthe subsidiary would continue to qualify as a tax exempt cooperative.  Therefore, the Company treated the subsidiaryas tax exempt for both financial and tax reporting purposes.  However, the tax structure of the subsidiarywas reviewed and issues arose concerning its exempt status.    As a result of the Company’s identificationof the issue, on August 24, 2005, Management and the Audit Committee concluded,after consultation with its independent accountants, that the Company wouldamend and restate its Annual Report on Form 10-K for the year ended December31, 2004, to treat the subsidiary as a taxable entity for financial reportingpurposes.  The Company had generated netoperating losses in earlier periods that would be used to offset the taxablenature of the subsidiary.  The use of thenet operating losses, earlier than expected, may result in taxes payable that aregreater than originally disclosed.

 

After reviewing thecircumstances leading to the issue discussed above, it was determined that there was a material weakness inthe Company’s internal controls over financial reporting for the period endedDecember 31, 2004.  The weaknessconcerned reliance on the opinions of the Company’s outside professionals, andcontrols surrounding procedures associated with issues and positions proposedby outside professional consultants that were adopted by the Company.   The Company’s chief executive officer and chieffinancial officer concluded that the Company’s disclosure controls andprocedures over financial reporting were not effective at December 31, 2004, toenable the Company to record, process, summarize and report informationrequired to be included in the Company’s SEC filings within the required timeperiod, and to ensure that such information was accumulated and communicated tomanagement, including our chief executive officer and chief financial officer,to allow timely decisions regarding required disclosure.

** **

**Changes inInternal Control over Financial Reporting.**  Therewere no changes in the Company’s internal control over financial reporting inconnection with the evaluation required by paragraph (d) of the Securities 

** **

**24**

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** **

**Exchange Act of 1934 Rules 13a-15 or 15d-15, that occurred during thequarter ended December 31, 2005, that materially affected, or that werereasonably likely to materially affect, the Company’s internal control overfinancial reporting.**

** **

**Management is implementing additional procedures for evaluating issuesand positions proposed by independent professional consultants that are adoptedby the Company.  These proceduresincluded formalizing the process for adoption of any outside professionalopinion; if a question arises as to the position taken, notification toexecutive management and the Audit Committee; and seeking further professionalopinions and/or guidance from those experienced in any specific subject matter.  The Company’s management is implementingthese additional controls surrounding procedures associated with issues andpositions proposed by outside professional consultants that are adopted by theCompany, and believe that the controls are adequate to assure that similarerrors will not recur.**

** **

**ITEM9(b).**          OTHER INFORMATION

** **

**None**

** **

**PART III**

** **

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERSOF THE REGISTRANT**

** **

**Directors and Executive Officers**

** **

**The information relating to the Company’s directors required by Item 10is intended to be set forth in the definitive proxy statement to be filed withthe SEC for the 2006 Annual Meeting of Shareholders.  However, if the definitive proxy statementfor the 2006 Annual Meeting of Shareholders has not been filed with the SEC byApril 30, 2006 (including as a result of or in anticipation of the consummationof the transactions contemplated by the LGB Agreement), the Company will amendthis annual report on Form 10-K to include such information if required at suchtime.  If the proxy statement has beenfiled by such time, the information is intended to be incorporated herein byreference to the material appearing under the captions “Election of Directors”and “Section 16(a) Beneficial Ownership Reporting Compliance” in the proxystatement to be filed with the SEC.**

** **

**The information required by this item concerning the Company’s executiveofficers is included in Part I, Item 4, of this Form 10-K.**

** **

**ITEM 11. EXECUTIVE COMPENSATION**

** **

**The information required by Item11 is intended to be set forth in the definitive proxy statement to be filedwith the SEC for the 2006 Annual Meeting of Shareholders.  However, if the definitive proxy statementfor the 2006 Annual Meeting of Shareholders has not been filed with the SEC byApril 30, 2006 (including as a result of or in anticipation of the**consummation of the transactions contemplated by the LGBAgreement), the Company will amend this annual report on Form 10-K to includesuch information if required at such time. If the proxy statement has been filed by such time, the information isintended to be incorporated herein by reference to the material appearing underthe captions “Compensation of Directors,” “Compensation of Named Executive Officers,”  “Performance Graph” and “CompensationCommittee Report” in the proxy statement to be filed with the SEC.

** **

**ITEM 12. SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT**

** **

**The information required by Item 12 is intended to be set forth in thedefinitive proxy statement to be filed with the SEC for the 2006 Annual meetingof Shareholders.  However, if thedefinitive proxy statement for the 2006 Annual Meeting of Shareholders has notbeen filed with the SEC by April 30, 2006 (including as a result of or inanticipation of the consummation of the transactions contemplated by the LGBAgreement), the Company will amend this annual report on Form 10-K to includesuch information if required at such time. If the proxy statement has been filed by such time, the information isintended to be incorporated herein by reference to the material appearing**

** **

**25**

----

** **

**under the caption “Beneficial Ownership of Voting Securities” and “EquityCompensation Plans” in the proxy statement to be filed with the SEC.**

** **

**See Item I in Part I concerning the LGB Agreement and the anticipatedchange in control of the Company.**

** **

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

** **

**The information required by Item 13 is intended to be set forth in thedefinitive proxy statement to be filed with the SEC for the 2006 Annual Meetingof Shareholders.  However, if thedefinitive proxy statement for the 2006 Annual Meeting of Shareholders has notbeen filed with the SEC by April 30, 2006 (including as a result of or in anticipationof the**consummation of the transactions contemplated by the LGBAgreement), the Company will amend this annual report on Form 10-K to includesuch information if required at such time. If the proxy statement has been filed by such time, the information isintended to be incorporated herein by reference to the material appearing underthe caption “Certain Relationships and Related Transactions” in the proxystatement to be filed with the SEC.

** **

**In November 2005, the Company entered into a retainer agreement withDavid W. Pruitt, who was then the Company’s Chief Executive Officer.  The agreement provided that Mr. Pruitt wouldcontinue to serve as Chief Executive Officer until the special meeting ofshareholders on March 10, 2006, after which he retired as CEO. The retaineragreement provided that he would also continue to serve on the Board ofDirectors and be entitled to all benefits generally available to board membersand retirees.  Mr. Pruitt and the HoldingCompany entered into a restricted stock agreement at the same time as the LGBAgreement, which modified Mr. Pruitt’s retainer agreement subject to closing ofthe transactions contemplated by the LGB Agreement.  The restricted stock agreement provides thathe will serve as a non-employee advisor and consultant to the Company with a monthlyretainer of $19,000, continuation of service as a board member withoutadditional compensation, and the granting of 54,438 shares of restricted stockof the Holding Company.  If his servicesare terminated or if he dies or becomes totally disabled, the Holding Companywill cause Mr. Pruitt to be paid a lump sum amount equal to $35,000 times thenumber of months remaining on the term of the retainer agreement.  The restricted shares will vest upon LGBachieving certain performance results on its investment.  Any unvested shares will be forfeited.**

** **

**Pursuant to his amended employment contract, William L. West continuedto serve as President of the Company until the special meeting of shareholdersheld on March 10, 2006, after which he remained President but also succeededMr. Pruitt as Chief Executive Officer. The Holding Company and Mr. West entered into an employment agreementwhich will replace the existing employment agreement upon closing of the LGBAgreement.  The employment agreement withthe Holding Company provides for his employment as president and chiefexecutive officer of the Holding Company, a restricted stock grant of 18,497shares of the Holding Company, and a retention bonus of $938,068 as anincentive to remain through the closing and facilitating the consummation ofthe transactions contemplated by the LGB Agreement.  Vesting of the restricted shares occurs onlywhen Mr. West achieves certain employment goals and LGB meets certainperformance results on its investment in the Holding Company.  Any unvested shares will be forfeited.  Under certain circumstances, if Mr. West’semployment is terminated after the close of the LGB Agreement, the HoldingCompany may be obligated to pay Mr. West a lump sum amount equal to 2.5 timeshis current salary.**

** **

**The Holding Company and certain of the other executive officers enteredinto restricted stock agreements with provisions similar to the restrictedstock grants given to Mr. West.  Inaddition, the Holding Company agreed to pay Ronnie W. Lyon, Vice President andGeneral Counsel, a retention bonus of $690,070 as an incentive to remainthrough the closing and facilitating the consummation of the transactionscontemplated by the LGB Agreement.**

** **

**In connection with the LGB Agreement, the Holding Company and certainexecutive officers entered into rollover agreements, in which a certain numberof Company shares owned by each of them will be “rolled over” into shares ofthe Holding Company.**

** **

**Upon entering into the restricted stock agreements described above,each of these individuals surrendered any right under his or her currentemployment contract to receive any payment to which they may have been entitledas a result of a change of control of the Company.**

** **

**26**

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** **

**A full description of the terms of the LGB Agreement can be found inthe definitive proxy statement of the Company filed with the SEC on January 30,2006.**

** **

**ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

** **

**Information called for by Part III, Item 14, is intended to be setforth in the definitive proxy statement to be filed with the SEC for the 2006Annual Meeting of Shareholders.  However,if the definitive proxy statement for the 2006 Annual Meeting of Shareholdershas not been filed with the SEC by April 30, 2006 (including as a result of orin anticipation of the**consummation of the transactions contemplated by the LGBAgreement), the Company will amend this annual report on Form 10-K to includesuch information if required at such time. If the proxy statement has been filed by such time, the information isintended to be incorporated herein by reference to the material appearing underthe caption, “Principal Accountant Fees and Services.”

** **

**PART IV**

** **

**ITEM 15. EXHIBITS, FINANCIAL STATEMENTSCHEDULES AND REPORTS ON FORM 8K**

** **

**Financial Statements**

** **

**For a list of the consolidated financial statements filed as part ofthis Form 10-K, see the Index to Consolidated Financial Statements on page F-1.**

** **

**Financial Statement Schedule**

** **

**The following financial statement schedule is included in Item 14:Schedule II - Valuation and Qualifying Accounts for the years ended December31, 2005, 2004 and 2003.**

** **

**27**

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** **

**Exhibits**

 
| **Exhibit No.**  | ** ** | **Item**                                                                                                                                                                                                                                                                 |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 2.1**  | ** ** | **Agreement and Plan of Share Exchange, dated as of November 4, 2005,  between Cap Rock Energy Corporation and Cap Rock Holding Corporation  (originally filed with Form 8-K dated November 4, 2005) (1)**                                                               |
| **Exhibit 3.1**  | ** ** | **Articles of Incorporation of the Company and amendments thereto (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                                               |
| **Exhibit 3.2**  | ** ** | **Bylaws of the Company (originally filed with Amendment No. 1 to Form  S-1 dated 3/20/01) (1)**                                                                                                                                                                         |
| **Exhibit 3.2a** | ** ** | **Amended and Restated Bylaws of Cap Rock Energy Corporation (originally  filed with Form 10-K for year ended 12/31/03 dated 4/10/04 (1)**                                                                                                                               |
| **Exhibit 3.3**  | ** ** | **Restated and Amended Articles of Incorporation of the Cooperative  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                                             |
| **Exhibit 3.4**  | ** ** | **Bylaws of the Cooperative (originally filed with Amendment No. 1 to  Form S-1 dated 3/20/01) (1)**                                                                                                                                                                     |
| **Exhibit 3.5**  | ** ** | **Amended and Restated Bylaws of the Company (originally filed with  Amendment No. 4 to Form S-1 dated 6/17/01) (1)**                                                                                                                                                    |
| **Exhibit 3.6**  | ** ** | **Amended and Restated Articles of Incorporation of the Company  (originally filed with Amendment No. 4 to Form S-1 dated 6/17/01) (1)**                                                                                                                                 |
| **Exhibit 3.7**  | ** ** | **Articles of Amendment to the Amended and Restated Articles of  Incorporation of the Company (originally filed with Amendment No. 4 to Form  S-1 dated 6/17/01) (1)**                                                                                                   |
| **Exhibit 3.8**  | ** ** | **Amended and Restated Bylaws of the Company (originally filed with Form  10-Q for the quarter ended 9/30/02, dated 11/14/02) (1)**                                                                                                                                      |
| **Exhibit 3.9**  | ** ** | **Amended and Restated Bylaws of the Company (originally filed with Form  10-Q for the quarter ended 6/30/05) (1)**                                                                                                                                                      |
| **Exhibit 5.1**  | ** ** | **Opinion of Ronald W. Lyon (originally filed with Amendment No. 3 to  Form S-1 dated 5/11/01) (1)**                                                                                                                                                                     |
| **Exhibit 8.1**  | ** ** | **Tax Opinion of Looper Reed & McGraw, a Professional Corporation  (originally filed with Amendment No. 2 to Form S-1 dated 4/25/01) (1)**                                                                                                                           |
| **Exhibit 9.1**  | ** ** | **Principal Shareholder Agreement, dated as of November 4, 2005, among  Cap Rock Holding Corporation and David W. Pruitt, Ulen A. North, Jr., Sam  Prough, Celia B. Page, Ronald W. Lyon and William West (originally filed with  Form 8-K dated November 4, 2005) (1)** |
| **Exhibit 10.1** | ** ** | **Second Amendment to Transaction Documents dated November 9, 1994,  between Southwestern Public Service Company, the Cooperative, et. al.  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                      |
| ** **       | ** ** | ** **                                                                                                                                                                                                                                                               |
| **Exhibit 10.2** | ** ** | **Restated Mortgage and Security Agreement dated September 21, 1988, made  by and between the Cooperative and National Rural Utilities Cooperative  Finance Corporation (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01) (1)**                         |
| **Exhibit 10.3** | ** ** | **Second Restated Mortgage and Security Agreement dated October 24, 1995,  made by and between the Cooperative and National Rural Utilities Cooperative  Finance Corporation (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01) (1)**                    |
| **Exhibit 10.4** | ** ** | **Loan Agreement dated October, 1995, between the Cooperative and  National Rural Utilities Cooperative Finance Corporation (originally filed  with Form S-1 dated July 31, 2001) (1)**                                                                                  |

 

28

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| **Exhibit 10.5**  | ** ** | **First Amendment to Loan Agreement dated as of October 28, 1997, between  the Cooperative and National Rural Utilities Cooperative Finance Corporation  (originally filed with Form S-1 date July 31, 2001) (1)**                                                                                                   |
|-------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 10.6**  | ** ** | **Loan Agreement dated as of June 22, 2000, between the Cooperative and  National Rural Utilities Cooperative Finance Corporation and amendment  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                             |
| **Exhibit 10.7**  | ** ** | **Loan Agreement dated December 13, 1994, between the Cooperative and  National Rural Utilities Cooperative Finance Corporation (originally filed  with Form S-1 date July 31, 2001) (1)**                                                                                                                           |
| **Exhibit 10.8**  | ** ** | **Loan Agreement dated March 30, 1993, between the Cooperative and  National Rural Utilities Cooperative Finance Corporation (originally filed  with Form S-1 date July 31, 2001) (1)**                                                                                                                              |
| **Exhibit 10.9**  | ** ** | **Loan Agreement dated March 10, 1992, TX 107-A-9025, between the  Cooperative and National Rural Utilities Cooperative Finance Corporation  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                 |
| **Exhibit 10.10** | ** ** | **Loan Agreement dated May 17, 1990, between the Cooperative and National  Rural Utilities Cooperative Finance Corporation (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                                  |
| **Exhibit 10.11** | ** ** | **Loan Agreement dated March 22, 1990, between the Cooperative and  National Rural Utilities Cooperative Finance Corporation (originally filed  with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                                |
| **Exhibit 10.12** | ** ** | **Notice of Meeting and Proxy Statement for Special Meeting held October  20, 1998 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)  (1)**                                                                                                                                                          |
| **Exhibit 10.13** | ** ** | **Commitment letter dated as of February 11, 2000, between National  Cooperative Services Corporation and Cap Rock Energy Corporation for credit  facilities associated with the purchase of certain electric assets owned by  Citizens Utilities Company (originally filed with Form S-1 date July 31,  2001) (1)** |
| ** **        | ** ** | ** **                                                                                                                                                                                                                                                                                                           |
| **Exhibit 10.14** | ** ** | **Loan Agreement dated March 10, 1992, TX 107-A-9026, between the Cooperative  and National Rural Utilities Cooperative Finance Corporation (originally  filed with Amendment No. 2 to Form S-1 dated 4/25/01) (1)**                                                                                                 |
| **Exhibit 10.15** | ** ** | **Purchase and Sale Agreement dated as of February 11, 2000, between the  Company, the Cooperative and Citizens Utilities Company regarding Arizona  Electric (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)  (1)**                                                                               |
| **Exhibit 10.16** | ** ** | **Purchase and Sale Agreement dated as of February 11, 2000, between the  Company, the Cooperative and Citizens Utilities Company regarding Vermont  Electric (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)  (1)**                                                                               |
| **Exhibit 10.17** | ** ** | **Power Sale Agreement dated May 1, 1999, between the Cooperative and  Electric Clearinghouse, Inc. (originally filed with Amendment No. 1 to Form  S-1 dated 3/20/01) (1)**                                                                                                                                         |
| **Exhibit 10.18** | ** ** | **Wholesale Power Supply and Services Contract dated April 16, 1997,  between Texas New Mexico Power Company and the Cooperative (originally filed  with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                            |
| **Exhibit 10.19** | ** ** | **Southwestern Public Service Company Wholesale Full Requirements Service  Rate Schedule and related Agreement, as amended, with the Cooperative  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                            |

 

29

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| **Exhibit 10.20**  | ** ** | **Ordinance of the City of Greenville, Texas, granting to the Cooperative  a franchise for the transmission and distribution of electricity (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                         |
|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 10.21**  | ** ** | **Ordinance of the City of Midland, Texas, granting to the Cooperative a  franchise for the transmission and distribution of electricity (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                            |
| **Exhibit 10.22**  | ** ** | **Ordinance of the City of Stanton, Texas, granting to the Cooperative a  franchise for the transmission and distribution of electricity (originally  filed with Form S-1 date July 31, 2001) (1)**                                          |
| **Exhibit 10.23**  | ** ** | **Employment Contract between the Cooperative and Ulen North dated July  21, 1992 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)  (subsequently filed with Form 10-K for year ended 12/31/03 dated 4/10/03) (1)**         |
| **Exhibit 10.23a** | ** ** | **Employment Contract between Cap Rock Energy Corporation and Ulen A.  North, Jr. dated September 12, 2001 (originally filed with Amendment No. 2 to  Form S-1 dated 4/25/01) (1)**                                                          |
| **Exhibit 10.24**  | ** ** | **Employment Contract between the Cooperative and David W. Pruitt dated  August 3, 1992 (originally filed with Amendment No. 2 to Form S-1 dated  4/25/01) (1)**                                                                             |
| **Exhibit 10.24a** | ** ** | **Employment Contract between Cap Rock Energy Corporation and David W.  Pruitt dated September 11, 2001 (originally filed with Form 10-K for year  ended 12/31/03 dated 4/10/04) (1)**                                                       |
| **Exhibit 10.25**  | ** ** | **Achievement Based Compensation Agreement Corporate Asset Non-CFC  Financing Arrangements dated August 28, 1994 (originally filed with Form S-1  date July 31, 2001) (1)**                                                                  |
| **Exhibit 10.26**  | ** ** | **Achievement Based Compensation Agreement Corporate Asset Non-CFC  Financing Arrangements dated October 27, 1992 (originally filed with Form S-1  date July 31, 2001) (1)**                                                                 |
| **Exhibit 10.27**  | ** ** | **The Cooperative’s Supplemental Executive Deferred Compensation  Retirement Plan (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01) (1)**                                                                              |
| **Exhibit 10.28**  | ** ** | **Cap Rock Energy Corporation 2001 Stock Incentive Plan (originally filed  with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                             |
| **Exhibit 10.29**  | ** ** | **Cap Rock Energy Corporation 2001 Employee Stock Purchase Plan  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                     |
| **Exhibit 10.30**  | ** ** | **Form of Equity & Membership Redemption Options (originally filed  with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                                |
| **Exhibit 10.31**  | ** ** | **Form of Equity Redemption Options (originally filed with Amendment No.  1 to Form S-1 dated 3/20/01) (1)**                                                                                                                                 |
| **Exhibit 10.32**  | ** ** | **Agreement for Purchase and Sale dated February 7, 2000, by and among  Walter Mickelson, et al., Multimedia Development Corporation and New West  Resources, Inc. (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01) (1)**  |
| **Exhibit 10.33**  | ** ** | **Stock Acquisition Agreement dated January 1, 2001, between Thomas E.  Kelly, Richard C. Skillern, Johnny D. Grimes, Billy D. Grimes and New West  Resources, Inc. (originally filed with Amendment No. 2 to Form S-1 dated  4/25/01) (1)** |
| **Exhibit 10.34**  | ** ** | **Consolidating Loan Agreement dated March 30, 1993, between Cap Rock  Electric Cooperative, Inc. and National Rural Utilities Cooperative Finance  Corporation (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)  (1)**     |

 

30

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| **Exhibit 10.35** | ** ** | **Integrated Supply Agreement between Cap Rock Electric Cooperative, Inc.  and Temple, Inc. (originally filed with Amendment No. 2 to Form S-1 dated  4/25/01) (1)**                                                         |
|-------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 10.36** | ** ** | **Employment Contract between the Cooperative and Mickey Sims (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                       |
| **Exhibit 10.37** | ** ** | **Amendment to Line of Credit Agreement dated June 27, 1997, between  National Rural Utilities Cooperative Finance Corporation and the Cooperative  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**  |
| **Exhibit 10.38** | ** ** | **Loan Agreement dated March 10, 1992, TX 107-A-9027, between the  Cooperative and National Rural Utilities Cooperative Finance Corporation  (originally filed with Amendment No. 2 to Form S-1 dated 4/25/01) (1)**         |
| **Exhibit 10.39** | ** ** | **Achievement Based Compensation Contract of the Cooperative dated August  22, 2000 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)  (1)**                                                                 |
| **Exhibit 10.40** | ** ** | **Loan Agreement dated March 10, 1992, TX 107-A-9024, between Cooperative  and National Rural Utilities Cooperative Finance Corporation (originally  filed with Amendment No. 2 to Form S-1 dated 4/25/01) (1)**             |
| **Exhibit 10.41** | ** ** | **Wholesale Power Agreement dated June 25, 1977, between Lower Colorado  River Authority and McCulloch Electric Cooperative, Inc. (originally filed  with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                   |
| **Exhibit 10.42** | ** ** | **Amendment to Wholesale Power Agreement dated September 28, 1987,  between Lower Colorado River Authority and McCulloch Electric Cooperative,  Inc. (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)** |
| **Exhibit 10.43** | ** ** | **Director Compensation Plan of the Company (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                         |
| **Exhibit 10.44** | ** ** | **Trust Agreement for the Cooperative Supplemental Executive Deferred  Compensation Retirement Plan (originally filed with Amendment No. 1 to Form  S-1 dated 3/20/01) (1)**                                                 |
| **Exhibit 10.45** | ** ** | **CFC Secured Revolving Line of Credit Agreement dated June 24, 1997  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                |
| **Exhibit 10.46** | ** ** | **Achievement Based Compensation Agreement of the Cooperative dated June  29, 1999 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)  (1)**                                                                  |
| **Exhibit 10.47** | ** ** | **Agreement to Combine McCulloch and Cap Rock Electric Cooperatives dated  June 30, 1999 (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01) (1)**                                                            |
| **Exhibit 10.48** | ** ** | **Management Service Agreement between Cooperative and Lamar Electric  Cooperative Association (originally filed with Amendment No. 1 to Form S-1  dated 3/20/01) (1)**                                                      |
| **Exhibit 10.49** | ** ** | **Notice of Annual Meeting and Proxy Statement for Members of McCulloch  Electric Cooperative held on August 21, 1999 (originally filed with Amendment  No. 1 to Form S-1 dated 3/20/01) (1)**                               |
| **Exhibit 10.50** | ** ** | **Agreement to Combine Lamar and Cap Rock Electric Cooperatives dated  October 28, 1999 (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01) (1)**                                                             |
| **Exhibit 10.51** | ** ** | **Loan Agreement between NewWest Resources, Inc, Cap Rock Electric  Cooperative, Inc. and Bank United Texas FSB dated July 12, 2000 (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                 |

 

31

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| **Exhibit 10.52** | ** ** | **Unconditional Guaranty from Cap Rock Electric Cooperative to Bank  United Texas FSB dated July 12, 2000 (originally filed with Amendment No. 1  to Form S-1 dated 3/20/01) (1)**                                                  |
|-------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 10.53** | ** ** | **Lamar County Electric Cooperative Association Notice of Special Meeting  and Proxy Statement for Special Meeting held December 14, 1999 (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                  |
| **Exhibit 10.54** | ** ** | **Signature Leasing, Inc. Master Lease Agreement dated April 1, 2000  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                       |
| **Exhibit 10.55** | ** ** | **Personal Services Agreement between Leonard S. Herring and the  Cooperative dated December 16, 1999 (originally filed with Amendment No. 1 to  Form S-1 dated 3/20/01) (1)**                                                      |
| **Exhibit 10.56** | ** ** | **Term Loan Agreement between Eddins-Walcher Company, Frank’s Fuels,  United Fuel & Energy Corporation, and NewWest Resources dated July 12,  2000 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)** |
| **Exhibit 10.57** | ** ** | **NewCorp Resources Electric Cooperative Open Access Transmission Tariff  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                   |
| **Exhibit 10.58** | ** ** | **Supplement to the Restated Mortgage and Security Agreement between the  Cooperative and CFC dated May 17, 1990 (originally filed with Amendment No. 1  to Form S-1 dated 3/20/01) (1)**                                           |
| **Exhibit 10.59** | ** ** | **Loan Agreement between Cap Rock Cooperative Finance Corporation and CFC  dated June 22, 1999 (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01) (1)**                                                             |
| **Exhibit 10.60** | ** ** | **Confirmation Letter between Electric Clearinghouse, Inc. and the  Cooperative dated May 27, 1999 (originally filed with Amendment No. 1 to Form  S-1 dated 3/20/01) (1)**                                                         |
| **Exhibit 10.61** | ** ** | **Service Agreement Rate Schedule WP between NewCorp Resources and Cap  Rock Electric Cooperative dated March 31, 1995 (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                     |
| **Exhibit 10.62** | ** ** | **Transaction Agreement dated as of September 9, 1993, between  Southwestern Public Service Company, the Cooperative and OTP, Inc.  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                         |
| **Exhibit 10.63** | ** ** | **Assignment of Certificate of Convenience and Necessity by the  Cooperative to NewCorp Resources dated January 17, 1996 (originally filed  with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                   |
| **Exhibit 10.64** | ** ** | **Supplemental Agreement between NewCorp Resources and the Cooperative  dated April 25, 1995 (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01) (1)**                                                               |
| **Exhibit 10.65** | ** ** | **Third Amendment to Transaction Documents by and among Southwestern  Public Service Company, the Cooperative, NewCorp Resources et al dated March  3, 1995 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)** |
| **Exhibit 10.66** | ** ** | **Assignment of Wholesale Power Contract from the Cooperative to NewCorp  Resources dated March 3, 1995 (originally filed with Amendment No. 1 to Form  S-1 dated 3/20/01) (1)**                                                    |
| **Exhibit 10.67** | ** ** | **QSE and Ancillary Services Agreement between the Cooperative and  Garland Power and Light dated June 1, 2001 (originally filed with Amendment  No. 2 to Form S-1 dated 4/25/01) (1)**                                             |

 

32

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| **Exhibit 10.68**  | ** ** | **Letter of Intent between the Company and Boeing Capital Corporation  dated June 5, 2001(1)**                                                                                                                                                                            |
|--------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 10.69**  | ** ** | **Employment Contract between the Company and Lee D. Atkins dated  September 1, 2001 (originally filed with Post Effective Amendment No. 1 to  Form S-1 dated 12/31/01) (1)**                                                                                             |
| **Exhibit 10.70**  | ** ** | **Employment Contract between the Company and Ronald W. Lyon (originally  filed with Post Effective Amendment No. 1 to Form S-1 dated 12/31/01) (1)**                                                                                                                     |
| **Exhibit 10.70a** | ** ** | **Employment Contract between the Company and Ronald W. Lyon dated  October 24, 2001 (originally filed with Form 10-K for the year ended 12/31/03  dated 4/10/04) (1)**                                                                                                   |
| **Exhibit 10.71**  | ** ** | **Employment Contract between the Company and Sam Prough dated September  14, 2001 (originally filed with Post Effective Amendment No. to Form S-1  dated 12/31/01) (1)**                                                                                                 |
| **Exhibit 10.72**  | ** ** | **Achievement Based Compensation Agreement Corporate Asset Non-CFC  Financing Arrangements dated August 21, 2001 (originally filed with Amendment  No. 1 to Form S-1 dated 12/31/01) (1)**                                                                                |
| **Exhibit 10.73**  | ** ** | **Letter from State Securities Board of the State of Texas dated December  6, 2001 (originally filed with Amendment No. 1 to Form S-1 dated 12/31/01)  (1)**                                                                                                              |
| **Exhibit 10.74**  | ** ** | **Employment Contract between the Company and Celia A. Zinn dated  September 20, 2001 (originally filed with Form 10-K for period ended 12/31/02  dated 4/10/03) (1)**                                                                                                    |
| **Exhibit 10.75**  | ** ** | **Cap Rock Energy Corporation Shareholders’ Trust (originally filed with  Form 10-K for period ended 12/31/02 dated 4/10/03) (1)**                                                                                                                                   |
| **Exhibit 10.76**  | ** ** | **Cap Rock Energy Corporation Trust Share Option Agreement (originally  filed with Form 10-K for period ended 12/31/02 dated 4/10/03) (1)**                                                                                                                               |
| **Exhibit 10.77**  | ** ** | **Cap Rock Energy Corporation Trust Funding Agreement (originally filed  with Form 10-K for period ended 12/31/02 dated 4/10/03) (1)**                                                                                                                                    |
| **Exhibit 10.78**  | ** ** | **Supplemental Executive Deferred Compensation Retirement Plan dated  November 14, 2002 (originally filed with Form 10-K for period ended 12/31/02  dated 4/10/03) (1)**                                                                                                  |
| **Exhibit 10.79**  | ** ** | **Beal Bank Loan Agreements dated September 8, 2003 (originally filed  with Form 10-Q for the period ended 9/30/03 dated 11/13/03) (1)**                                                                                                                                  |
| **Exhibit 10.80**  | ** ** | **Washington Mutual Modification and Extension Agreement dated October 9,  2003 (originally filed with Form 10-Q for the period ended 9/30/03 dated  11/13/03) (1)**                                                                                                      |
| **Exhibit 10.81**  | ** ** | **Achievement Based Compensation Contract, Southwestern Public Service  Company Contract dated October 27, 1992 (originally filed with Form 10-K for  year ended 12/31/03 dated 4/10/03) (1)**                                                                            |
| **Exhibit 10.82**  | ** ** | **Managed Services Agreement with Delinea Corporation dated March 12,  2003 (originally filed with Form 10-K for year ended 12/31/03 dated 4/10/03)  (1)**                                                                                                                |
| **Exhibit 10.83**  | ** ** | **Master Operation, Maintenance and Administrative Services Agreement  dated September 29, 2003, between Cap Rock Energy Corporation and NewCorp  Resources Electric Cooperative, Inc. (originally filed with Form 10-K for the  year ended 12/31/03 dated 4/10/04) (1)** |
| **Exhibit 10.84**  | ** ** | **Stock Acquisition Agreement between NewCorp Resources Electric  Cooperative, Inc. and United Fuel and Energy Corporation dated March 18, 2004  (originally filed with Form 10-K for year ended 12/31/03 dated 4/10/04) (1)**                                            |

 

33

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| **Exhibit 10.85**  | ** ** | **Employment Contract between Cap Rock Energy Corporation and William  West dated December 30, 2003 (originally filed with Form 10-Q for period  ended 6/30/04 dated 8/19/04) (1)**                                        |
|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 10.86**  | ** ** | **Amended Letter between Beal Bank S.S.B. and NewCorp Resources dated  September 9, 2004 (originally filed with Form 8-K dated 10/28/04) (1)**                                                                             |
| **Exhibit 10.87**  | ** ** | **Second Amended Letter between Beal Bank S.S.B. and NewCorp Resources  dated September 24, 2004 (originally filed with Form 8-K dated 10/01/04) (1)**                                                                     |
| **Exhibit 10.88**  | ** ** | **Amended Shareholders’ Trust between Cap Rock Energy Corporation  Shareholders’ Trust and Alfred J. Schwartz and Robert G. Holman dated  December 31, 2004 (originally filed with Form 8-K dated 1/06/05) (1)** |
| **Exhibit 10.89**  | ** ** | **Right of First Refusal Agreement between Cap Rock Energy Corporation  Shareholders’ Trust and Alfred J. Schwartz and Robert G. Holman dated  December 31, 2004 (originally filed with Form 8-K dated 1/6/05) (1)**  |
| **Exhibit 10.90**  | ** ** | **Voting Agreement between Cap Rock Energy Corporation Shareholders’  Trust and Alfred J. Schwartz and Robert G. Holman dated December 31, 2004  (originally filed with Form 8-K dated 1/6/05) (1)**                  |
| **Exhibit 10.91**  | ** ** | **Proposal For Decision, PUC Docket No. 28813 issued March 17, 2005  (originally filed with Form 8-K dated 3/17/05) (1)**                                                                                                  |
| **Exhibit 10.92**  | ** ** | **Employment Agreement between Cap Rock Energy Corporation and William  West dated November 3, 2005 (originally filed with Form 8-K dated November 4,  2005) (1)**                                                         |
| **Exhibit 10.93**  | ** ** | **Amendment to Employment Agreement, dated as of November 4, 2005, by and  between Cap Rock Energy Corporation and William West (originally filed with  Form 8-K dated November 4, 2005) (1)**                             |
| **Exhibit 10.94**  | ** ** | **Retainer Agreement between Cap Rock Energy Corporation and David W.  Pruitt dated November 3, 2005 (originally filed with Form 8-K dated November  4, 2005) (1)**                                                        |
| **Exhibit 10.95**  | ** ** | **Amendment to Retainer Agreement, dated as of November 4, 2005, by and  between Cap Rock Energy Corporation and David. W. Pruitt (originally filed  with Form 8-K dated November 4, 2005) (1)**                           |
| **Exhibit 10.96**  | ** ** | **Director Indemnification Agreements (Form) Dated August 31, 2005  (originally filed with Form 10-Q for period ended September 30, 2005) (1)**                                                                            |
| **Exhibit 10.97**  | ** ** | **Director Compensation Policy (Board Policy #100) dated July 6, 2005  (originally filed with Form 10-Q for period ended September 30, 2005) (1)**                                                                         |
| **Exhibit 10.98**  | ** ** | **Supplemental Executive Deferred Compensation Retirement Plan dated  September 1, 2005 (originally filed with Form 10-Q for period ended September  30, 2005) (1)**                                                       |
| **Exhibit 10.99**  | ** ** | **Supplemental Deferred Earned Income Retirement Plan for Independent  Contractors dated September 1, 2005 (originally filed with Form 10-Q for  period ended September 30, 2005) (1)**                                    |
| **Exhibit 10.100** | ** ** | **NRUCFC Loan Agreement and Consolidated and Restated Mortgage and  Security Agreement dated February 7, 2003 (originally filed with Form 10-Q  for period ended September 30, 2005) (1)**                                 |

 

34

----

 
| **Exhibit 10.101** | ** ** | **Employment Contract between Cap Rock Energy Corporation and Melissa D.  Davis dated December 19, 2005 (originally filed with Form 8-K dated March 1,  2006) (1)** |
|--------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 14.1**   | ** ** | **Cap Rock Energy Corporation Code of Ethics dated December 2, 2003  (originally filed with Form 10-K for year ended 12/31/03 dated 4/10/04) (1)**                  |
| **Exhibit 18.1**   | ** ** | **Change in Accounting Principle Letter from KPMG LLP (originally filed  with Form 10-Q dated 5/15/03) (1)**                                                        |
| **Exhibit 20.1**   | ** ** | **Election Form (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01) (1)**                                                                            |
| **Exhibit 21.1**   | ** ** | **Subsidiaries of the Company (originally filed with Amendment No. 1 to  Form S-1 dated 3/20/01) (1)**                                                              |
| **Exhibit 23.2**   | ** ** | **Consent of Ronald W. Lyon is contained in his opinion filed as Exhibit  5.1 to Amendment No. 3 to Form S-1 dated 5/11/01 (1)**                                    |
| **Exhibit 23.3**   | ** ** | **Consent of Bolinger, Segars, Gilbert & Moss, LLP (originally filed  with Amendment No. 2 to Form S-1 dated 4/25/01) (1)**                                     |
| **Exhibit 23.4**   | ** ** | **Consent of Looper Reed & McGraw (originally filed with Amendment  No. 2 to Form S-1 dated 4/25/01) (1)**                                                      |
| **Exhibit 31.1**   | ** ** | **Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 of William L. West (2)**                  |
| **Exhibit 31.2**   | ** ** | **Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 of Melissa D. Davis (2)**                 |
| **Exhibit 32.1**   | ** ** | **Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 of William L. West (2)**                  |
| **Exhibit 32.2**   | ** ** | **Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 of Melissa D. Davis (2)**                 |

** **

----

**(1)**           Previously filed

** **

**(2)**                                  Filed herewith

 

35

----

 

**SIGNATURES**

** **

**In accordance with the requirements of the Securities Act of 1934, asamended, the Registrant certifies that it has reasonable grounds to believethat it meets all of the requirements for filing Form 10K and authorizes thisForm 10K to be signed on its behalf by the undersigned, thereunto dulyauthorized, in the City of Midland, Texas, on March 29, 2006.**

** **
| ** ** | **CAP ROCK ENERGY CORPORATION** |
|------------|---------------------------------|
| ** ** | ** **                      |
| ** ** | **By:**                         |
| ** ** | **/s/ WILLIAM L. WEST**         |
| ** ** | **William L. West**             |
| ** ** | **President and**               |
| ** ** | **Chief Executive Officer**     |

 

**Pursuant to the requirements of the Securities Exchange Act of 1934this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.**

** **
| **Signature**                 | ** ** | **Title**                                                                                        | ** ** | **Date**                 |
|-------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|--------------------------|
| ** **                    | ** ** | ** **                                                                                       | ** ** | ** **               |
| **/s/ WILLIAM L. WEST**       | ** ** | **Director, President  and**                                                                     | ** ** | **March 29, 2006**       |
| **William L. West**           | ** ** | **Chief Executive  Officer**                                                                     | ** ** | ** **               |
| ** **                    | ** ** | **(Principal Executive  Officer)**                                                               | ** ** | ** **               |
| ** **                    | ** ** | ** **                                                                                       | ** ** | ** **               |
| **/s/ MELISSA D. DAVIS**      | ** ** | **Vice President,  Controller and**                                                              | ** ** | **March 29, 2006**       |
| **Melissa D. Davis**          | ** ** | **Chief Accounting  Officer**

**(Principal Financial  and**

**Principal Accounting  Officer)** | ** ** | ** **               |
| ** **                    | ** ** | ** **                                                                                       | ** ** | ** **               |
| **/s/ DAVID W. PRUITT**       | ** ** | **Director, Co-Chairman  of the Board**                                                          | ** ** | **March 29, 2006**       |
| **David W. Pruitt**           | ** ** | ** **                                                                                       | ** ** | ** **               |
| ** **                    | ** ** | ** **                                                                                       | ** ** | ** **               |
| **/s/ RUSSELL E. JONES**      | ** ** | **Director, Co-Chairman  of the Board**                                                          | ** ** | ** March 29, 2006** |
| **Russell E. Jones**          | ** ** | ** **                                                                                       | ** ** | ** **               |
| ** **                    | ** ** | ** **                                                                                       | ** ** | ** **               |
| **/s/ S. D. BUCHANAN**        | ** ** | **Director**                                                                                     | ** ** | ** March 29, 2006** |
| **S. D. Buchanan**            | ** ** | ** **                                                                                       | ** ** | ** **               |
| ** **                    | ** ** | ** **                                                                                       | ** ** | ** **               |
| **/s/ FLOYD L. RITCHEY**      | ** ** | **Director**                                                                                     | ** ** | ** March 29, 2006** |
| **Floyd L. Ritchey**          | ** ** | ** **                                                                                       | ** ** | ** **               |
| ** **                    | ** ** | ** **                                                                                       | ** ** | ** **               |
| **/s/ MICHAEL D.  SCHAFFNER** | ** ** | **Director**                                                                                     | ** ** | ** March 29, 2006** |
| **Michael D. Schaffner**      | ** ** | ** **                                                                                       | ** ** | ** **               |

** **

**36**

----

 

**CAP ROCK ENERGY CORPORATION**

**SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS**

**ALLOWANCE FOR DOUBTFUL ACCOUNTS**

**(AMOUNTS STATED IN THOUSANDS)**

 
| ** **         | ** ** | **COLUMN B -**   | ** ** | **COLUMN C -** | ** ** | **COLUMN D -** | ** ** | **COLUMN E-**  | ** ** |
|--------------------|------------|------------------|------------|----------------|------------|----------------|------------|----------------|------------|
| ** **         | ** ** | **BALANCE AT**   | ** ** | **CHARGED TO** | ** ** | **DEDUCTION-** | ** ** | **BALANCE AT** | ** ** |
| **COLUMN A -**     | ** ** | **BEGINNING OF** | ** ** | **COSTS AND**  | ** ** | **CHARGED-**   | ** ** | **END OF**     | ** ** |
| **DESCRIPTION**    | ** ** | **PERIOD**       | ** ** | **EXPENSES**   | ** ** | **OFF**        | ** ** | **PERIOD**     | ** ** |
| December 31,  2005 |       | $                | 115        |           | $          | 115            |       | $              | 14         |   | $ | 216 |   |
| December 31,  2004 |       | $                | 78         |           | $          | 151            |       | $              | 114        |   | $ | 115 |   |
| December 31,  2003 |       | $                | 50         |           | $          | 113            |       | $              | 85         |   | $ | 78 |   |

 

37

----

 

**INDEX TO FINANCIAL STATEMENTS**

** **
| **Report of  Independent Registered Public Accounting Firm, KPMG LLP**                  | ** ** |
|-----------------------------------------------------------------------------------------|------------|
| ** **                                                                              | ** ** |
| **Consolidated Statements of  Operations Years ended December 31, 2005, 2004 and 2003** | ** ** |
| ** **                                                                              | ** ** |
| **Consolidated Balance  Sheets December 31, 2005 and 2004**                             | ** ** |
| ** **                                                                              | ** ** |
| **Consolidated  Statements of Equity Years ended December 31, 2005, 2004 and 2003**     | ** ** |
| ** **                                                                              | ** ** |
| **Consolidated Statements of Cash Flows Years  ended December 31, 2005, 2004 and 2003** | ** ** |
| ** **                                                                              | ** ** |
| **Notes to Consolidated Financial Statements**                                          | ** ** |

** **

** **

**F-1**

----

** **

**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

** **

**The Board ofDirectors and StockholdersCap Rock Energy Corporation:**

 

**We haveaudited the accompanying consolidated balance sheets of Cap Rock EnergyCorporation and subsidiaries (the Company) as of December 31, 2005 and 2004,and the related consolidated statements of operations, statement of equity, andcash flows for each of the years in the three-year period ended December 31,2005.  In connection with our audits ofthe consolidated financial statements, we also have audited financial statementschedule II.   These consolidatedfinancial statements and financial statement schedule are the responsibility ofthe Company’s management.  Ourresponsibility is to express an opinion on these consolidated financialstatements and financial statement schedule based on our audits.**

 

**We conductedour audits in accordance with the standards of the Public Company AccountingOversight Board (United States).  Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.**

 

**In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Cap Rock EnergyCorporation and subsidiaries as of December 31, 2005 and 2004, and the resultsof their operations and their cash flows for each of the years in thethree-year period ended December 31, 2005, in conformity with U. S. generallyaccepted account principles.  Also in ouropinion, the related financial statement schedule, when considered in relationto the basic financial statements taken as a whole, presents fairly, in allmaterial respects, the information set forth therein.**

** **

** **
| **KPMG LLP** |
|--------------|

** **

** **

**Dallas, TexasMarch 30, 2006**

** **

**F-2**

----

** **

**CAP ROCK ENERGY CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                          | ** ** | **YEAR ENDED DECEMBER 31,**             | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                          | ** ** | **(Thousands of dollars except shares** | ** ** |
| ** **                                          | ** ** | **and per share amounts)**              | ** ** |
| **Operating  Revenues:**                            |       |                                    |       |   |   |   |   |
| Electric revenues                                   |       | $                                       | 86,532     |   | $ | 81,149 |   | $ | 81,402 |   |
| Other                                               |       | 443                                     |       | 1,475 |   | 1,442 |   |
| Total operating revenues                            |       | 86,975                                  |       | 82,624 |   | 82,844 |   |
|                                                |       |                                    |       |   |   |   |   |
| **Operating  Expenses:**                            |       |                                    |       |   |   |   |   |
| Purchased power                                     |       | 48,046                                  |       | 40,032 |   | 36,578 |   |
| Operations and maintenance                          |       | 12,995                                  |       | 10,331 |   | 10,135 |   |
| General and administrative                          |       | 10,736                                  |       | 7,518 |   | 4,639 |   |
| Stock compensation                                  |       | 4,389                                   |       | 4,925 |   | 2,133 |   |
| Depreciation and amortization                       |       | 8,120                                   |       | 7,416 |   | 6,719 |   |
| Property taxes                                      |       | 1,819                                   |       | 1,925 |   | 1,345 |   |
| Other                                               |       | 645                                     |       | 258 |   | 326 |   |
| Total operating expenses                            |       | 86,750                                  |       | 72,405 |   | 61,875 |   |
|                                                |       |                                    |       |   |   |   |   |
| **Operating  Income**                               |       | 225                                     |       | 10,219 |   | 20,969 |   |
|                                                |       |                                    |       |   |   |   |   |
| **Other  Income (Expense):**                        |       |                                    |       |   |   |   |   |
| Allocation of income from associated  organizations |       | 573                                     |       | 540 |   | 530 |   |
| Interest expense, net of capitalized  interest      |       | (6,230                                  | )          | (7,983 | ) | (8,047 | ) |
| Interest and other income                           |       | 528                                     |       | 646 |   | 795 |   |
| Other                                               |       | 65                                      |       | (129 | ) | (912 | ) |
| Total other income (expense)                        |       | (5,064                                  | )          | (6,926 | ) | (7,634 | ) |
|                                                |       |                                    |       |   |   |   |   |
| **Income  (loss) before income taxes**              |       | (4,839                                  | )          | 3,293 |   | 13,335 |   |
|                                                |       |                                    |       |   |   |   |   |
| **Income  Tax Expense (Benefit):**                  |       |                                    |       |   |   |   |   |
| Current                                             |       | 362                                     |       | (1,507 | ) | 2,137 |   |
| Deferred                                            |       | (975                                    | )          | 1,275 |   | — |   |
| Total income tax expense (benefit)                  |       | (613                                    | )          | (232 | ) | 2,137 |   |
|                                                |       |                                    |       |   |   |   |   |
| **Net  Income (Loss)**                              |       | $                                       | (4,226     | ) | $ | 3,525 |   | $ | 11,198 |   |
|                                                |       |                                    |       |   |   |   |   |
| **Net  Income (Loss) Per Common Share:**            |       |                                    |       |   |   |   |   |
| Basic                                               |       | $                                       | (2.58      | ) | $ | 2.28 |   | $ | 7.69 |   |
| Diluted                                             |       | $                                       | (2.58      | ) | $ | 2.21 |   | $ | 7.41 |   |
|                                                |       |                                    |       |   |   |   |   |
| **Weighted  Average Number of Shares Outstanding:** |       |                                    |       |   |   |   |   |
| Basic                                               |       | 1,640,276                               |       | 1,546,271 |   | 1,455,443 |   |
| Diluted                                             |       | 1,686,613                               |       | 1,596,796 |   | 1,510,741 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

F-3

----

 

**CAP ROCK ENERGY CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                 | ** ** | **2005**                   | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------|------------|
| ** **                                                                                                                                                                                                                                 | ** ** | **(Thousands of dollars)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                 |       |                       |       |     |       |
| **Current  Assets:**                                                                                                                                                                                                                       |       |                       |       |     |       |
| Cash                                                                                                                                                                                                                                       |       | $                          | 9,857      |     | $          | 20,968 |   |
| Accounts receivable:                                                                                                                                                                                                                       |       |                       |       |     |       |
| Electric sales, net                                                                                                                                                                                                                        |       | 9,860                      |       | 7,313    |       |
| Other                                                                                                                                                                                                                                      |       | 308                        |       | 457      |       |
| Current portion note receivable (Note 6)                                                                                                                                                                                                   |       | 267                        |       | —   |       |
| Purchased power subject to recovery                                                                                                                                                                                                        |       | 2,214                      |       | —   |       |
| Other current assets (Note 5)                                                                                                                                                                                                              |       | 1,750                      |       | 5,431    |       |
| **Total current assets**                                                                                                                                                                                                                   |       | 24,256                     |       | 34,169   |       |
|                                                                                                                                                                                                                                       |       |                       |       |     |       |
| **Utility  Plant (Note 7)**                                                                                                                                                                                                                |       | 147,827                    |       | 149,361  |       |
| **Investments  and notes receivable (Note 6)**                                                                                                                                                                                             |       | 9,962                      |       | 11,004   |       |
| **Nonutility  property, net (Note 8)**                                                                                                                                                                                                     |       | 1,204                      |       | 1,227    |       |
| **Regulatory  and other assets (Note 9)**                                                                                                                                                                                                  |       | 4,312                      |       | 3,926    |       |
| **Total Assets**                                                                                                                                                                                                                           |       | $                          | 187,561    |     | $          | 199,687 |   |
|                                                                                                                                                                                                                                       |       |                       |       |     |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                              |       |                       |       |     |       |
|                                                                                                                                                                                                                                       |       |                       |       |     |       |
| **Current  Liabilities:**                                                                                                                                                                                                                  |       |                       |       |     |       |
| Current portion of long-term debt                                                                                                                                                                                                          |       | $                          | 3,506      |     | $          | 10,005 |   |
| Accounts payable:                                                                                                                                                                                                                          |       |                       |       |     |       |
| Purchased power                                                                                                                                                                                                                            |       | 6,745                      |       | 3,823    |       |
| Other                                                                                                                                                                                                                                      |       | 3,690                      |       | 3,603    |       |
| Purchased power cost subject to refund                                                                                                                                                                                                     |       | 66                         |       | 4,376    |       |
| Accrued and other current liabilities (Note  12)                                                                                                                                                                                           |       | 4,646                      |       | 3,202    |       |
| Current income tax payable (Note 16)                                                                                                                                                                                                       |       | 994                        |       | 633      |       |
| **Total current liabilities**                                                                                                                                                                                                              |       | 19,647                     |       | 25,642   |       |
|                                                                                                                                                                                                                                       |       |                       |       |     |       |
| **Long-Term  Debt, Net of Current Portion:**                                                                                                                                                                                               |       |                       |       |     |       |
| Mortgage notes (Note 10)                                                                                                                                                                                                                   |       | 130,609                    |       | 133,873  |       |
| Capital leases (Note 10)                                                                                                                                                                                                                   |       | 87                         |       | 159      |       |
| **Total long-term debt**                                                                                                                                                                                                                   |       | 130,696                    |       | 134,032  |       |
|                                                                                                                                                                                                                                       |       |                       |       |     |       |
| **Deferred  Credits (Note 14)**                                                                                                                                                                                                            |       | 5,990                      |       | 6,569    |       |
|                                                                                                                                                                                                                                       |       |                       |       |     |       |
| **Stockholders’  Equity:**                                                                                                                                                                                                            |       |                       |       |     |       |
| Preferred stock, par value $1 per share, 50,000,000  shares authorized, no shares issued or outstanding                                                                                                                                    |       | —                     |       | —   |       |
| Common stock, par value $.01 per share, 50,000,000  shares authorized, 1,765,235 shares issued and 1,647,844 shares outstanding  at December 31, 2005, and 1,733,835 shares issued and 1,617,640 shares  outstanding at December 31, 2004. |       | 17                         |       | 17       |       |
| Paid in capital                                                                                                                                                                                                                            |       | 13,720                     |       | 11,683   |       |
| Retained earnings                                                                                                                                                                                                                          |       | 19,273                     |       | 23,499   |       |
| Less treasury stock of 117,391 and 116,195  shares at December 31, 2005 and 2004, respectively                                                                                                                                             |       | (1,782                     | )          | (1,755   | )          |
| **Total stockholders’ equity**                                                                                                                                                                                                        |       | 31,228                     |       | 33,444   |       |
| **Total Liabilities and Stockholders’ Equity**                                                                                                                                                                                        |       | $                          | 187,561    |     | $          | 199,687 |   |

 

The accompanying notes are an integral part of these consolidatedfinanacial statements.

 

F-4

----

 

**CAP ROCK ENERGY CORPORATION**

**CONSOLIDATED STATEMENTS OF EQUITY**

** **
| ** **                                                                                                                                                     | ** ** | **(Thousands of dollars except number of shares)** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                                                     | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                                                                                                                                     | ** ** | **Common Stock**                                   | ** ** | **Paid in** | ** ** | **Retained** | ** ** | **Treasury Stock** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                                                                                     | ** ** | **# shares**                                       | ** ** | **Value** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **# of shares** | ** ** | **Value** | ** ** | **Equity** | ** ** |
|                                                                                                                                                           |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Balance December 31, 2002**                                                                                                                                  |       | 1,302,355                                          |       | $ | 13 |   | $ | 5,949 |   | $ | 8,776 |   |   |   |   |   | $ | 14,738 |   |
| Repurchase of shares through tender offer                                                                                                                      |       |                                               |       |   |   |   |   |   |   | (82,140 | ) | $ | (821 | ) | (821 | ) |
| Stock awarded through Stock Incentive Plan,  net of shares withheld for taxes and amortization of deferred compensation amortization  of deferred compensation |       | 348,940                                            |       | 4 |   | 1,902 |   |   |   |   |   |   |   | 1,906 |   |
| Unvested shares forfeited                                                                                                                                      |       | (900                                               | )          |   |   | (17 | ) |   |   |   |   |   |   | (17 | ) |
| Repurchase of common stock                                                                                                                                     |       |                                               |       |   |   |   |   |   |   | (260 | ) | (9 | ) | (9 | ) |
| Adjustment to original converson  distribution                                                                                                                 |       |                                               |       |   |   | (19 | ) |   |   | (270 | ) | (3 | ) | (22 | ) |
| Net income                                                                                                                                                     |       |                                               |       |   |   |   |   | 11,198 |   |   |   |   |   | 11,198 |   |
| **Balance December 31, 2003**                                                                                                                                  |       | 1,650,395                                          |       | 17 |   | 7,815 |   | 19,974 |   | (82,670 | ) | (833 | ) | 26,973 |   |
| Stock awarded through Stock Incentive Plan,  net of shares withheld for taxes and amortization of deferred compensation                                        |       | 81,050                                             |       |   |   | 3,894 |   |   |   | (31,500 | ) | (850 | ) | 3,044 |   |
| Stock awarded through Stock for Compensation  Plan                                                                                                             |       | 5,790                                              |       |   |   | 64 |   |   |   |   |   |   |   | 64 |   |
| Unvested shares forfeited                                                                                                                                      |       | (3,400                                             | )          |   |   | (90 | ) |   |   |   |   |   |   | (90 | ) |
| Repurchase of common stock                                                                                                                                     |       |                                               |       |   |   |   |   |   |   | (2,025 | ) | (72 | ) | (72 | ) |
| Net income                                                                                                                                                     |       |                                               |       |   |   |   |   | 3,525 |   |   |   |   |   | 3,525 |   |
| **Balance December 31, 2004**                                                                                                                                  |       | 1,733,835                                          |       | 17 |   | 11,683 |   | 23,499 |   | (116,195 | ) | (1,755 | ) | 33,444 |   |
| Stock awarded through Stock Incentive Plan,  net of shares withheld for taxes and amortization of deferred compensation                                        |       | 40,996                                             |       |   |   | 2,271 |   |   |   |   |   |   |   | 2,271 |   |
| Stock awarded through Stock for Compensation  Plan                                                                                                             |       | 9,567                                              |       |   |   | 121 |   |   |   |   |   |   |   | 121 |   |
| Unvested shares forfeited                                                                                                                                      |       | (19,163                                            | )          |   |   | (355 | ) |   |   |   |   |   |   | (355 | ) |
| Repurchase of common stock                                                                                                                                     |       |                                               |       |   |   |   |   |   |   | (1,196 | ) | (27 | ) | (27 | ) |
| Net loss                                                                                                                                                       |       |                                               |       |   |   |   |   | (4,226 | ) |   |   |   |   | (4,226 | ) |
| **Balance December 31, 2005**                                                                                                                                  |       | 1,765,235                                          |       | $ | 17 |   | $ | 13,720 |   | $ | 19,273 |   | (117,391 | ) | $ | (1,782 | ) | $ | 31,228 |   |

** **

**The accompanying notesare an integral part of these consolidated financial statements.**

** **

**F-5**

----

** **

**CAP ROCK ENERGY CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **YEAR ENDED DECEMBER 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                         | ** ** | **2005**                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                         | ** ** | **(Thousands of dollars)**  | ** ** |
| **Cash  Flows from Operating Activities:**                                         |       |                        |       |   |   |   |   |
| Net income (loss)                                                                  |       | $                           | (4,226     | ) | $ | 3,525 |   | $ | 11,198 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                        |       |   |   |   |   |
| Depreciation and amortization                                                      |       | 8,120                       |       | 7,416 |   | 9,709 |   |
| Amortization of debt issue costs                                                   |       | 46                          |       | 896 |   | 1,063 |   |
| Noncash compensation expense                                                       |       | 1,916                       |       | 3,804 |   | 2,020 |   |
| Equity earnings in MAP                                                             |       | —                      |       | — |   | (144 | ) |
| Loss on equity method investment value                                             |       | —                      |       | — |   | 1,056 |   |
| Write off of regulatory asset and note  receivable                                 |       | 421                         |       | — |   | — |   |
| Change in:                                                                         |       |                        |       |   |   |   |   |
| Other assets/deferred credits                                                      |       | (1,322                      | )          | 2,892 |   | (1,756 | ) |
| Accounts receivable                                                                |       | (2,398                      | )          | 1,127 |   | (3,811 | ) |
| Income tax receivable/payable                                                      |       | 361                         |       | (3,353 | ) | — |   |
| Purchased power cost subject to  refund/recovery                                   |       | (6,524                      | )          | 4,173 |   | 3,704 |   |
| Other current assets                                                               |       | 3,657                       |       | (446 | ) | (1,059 | ) |
| Accounts payable and accrued expenses                                              |       | 4,574                       |       | 1,314 |   | 1,284 |   |
| Net cash provided by operating activities                                          |       | 4,625                       |       | 21,348 |   | 23,264 |   |
| **Cash Flows from Investing Activities**                                           |       |                        |       |   |   |   |   |
| Utility plant additions                                                            |       | (6,364                      | )          | (4,583 | ) | (5,209 | ) |
| Proceeds from liquidation of investments                                           |       | —                      |       | 913 |   | 1,511 |   |
| Change in nonutility property and  investments                                     |       | (11                         | )          | — |   | — |   |
| Issuance of notes receivable                                                       |       | —                      |       | (1,586 | ) | (1,250 | ) |
| Collection of notes receivable                                                     |       | 500                         |       | 1,250 |   | 12,490 |   |
| Net cash provided by (used in) investing  activities                               |       | (5,875                      | )          | (4,006 | ) | 7,542 |   |
| **Cash Flows from Financing Activities:**                                          |       |                        |       |   |   |   |   |
| Proceeds from other long-term debt and  capital leases                             |       | —                      |       | 113 |   | 14,169 |   |
| Payments on mortgage notes                                                         |       | (9,712                      | )          | (3,966 | ) | (3,704 | ) |
| Payments on other long-term debt and  capital leases                               |       | (123                        | )          | (136 | ) | (30,246 | ) |
| Payment of short-term note payable                                                 |       | —                      |       | (14,169 | ) | — |   |
| Debt issuance costs                                                                |       | —                      |       | (3,632 | ) | (1,208 | ) |
| Restricted cash investment                                                         |       | —                      |       | 14,169 |   | (5,962 | ) |
| Repurchase/acquistion of common stock                                              |       | (26                         | )          | (923 | ) | (852 | ) |
| Retirement of former member equity                                                 |       | —                      |       | — |   | (732 | ) |
| Net cash used in financing activities                                              |       | (9,861                      | )          | (8,544 | ) | (28,535 | ) |
| **Increase (Decrease) in Cash and Cash  Equilvalents:**                            |       | (11,111                     | )          | 8,798 |   | 2,271 |   |
| Cash at beginning of year                                                          |       | 20,968                      |       | 12,170 |   | 9,899 |   |
| Cash at end of year                                                                |       | $                           | 9,857      |   | $ | 20,968 |   | $ | 12,170 |   |
| **Noncash financing activities:**                                                  |       |                        |       |   |   |   |   |
| Deferred compensation related to stock  awards                                     |       | $                           | 121        |   | $ | 471 |   | $ | 3,695 |   |
| **Supplemental Cash Flow Information**                                             |       |                        |       |   |   |   |   |
| Cash paid during the year for interest                                             |       | $                           | 4,609      |   | $ | 7,045 |   | $ | 6,640 |   |
| Cash paid during the year for income taxes                                         |       | $                           | —     |   | $ | 1,450 |   | $ | 1,950 |   |

** **

**The accompanying notesare an integral part of these consolidated financial statements.**

** **

**F-6**

----

** **

**CAP ROCK ENERGY CORPORATION**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2005, 2004 AND 2003**

** **

**1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

** **

**General**

** **

**Cap Rock Energy Corporation (the “Company”) was formed in December 1998in accordance with a conversion plan to reorganize a member owned electriccooperative, Cap Rock Electric Cooperative, Inc. (the “Cooperative”) to ashareholder owned business corporation.  The Cooperative was incorporated as an electric cooperative in the Stateof Texas in 1939 to provide electric distribution services and power to itsmembers.  The Company currently providesservice to approximately 34,000 active meters in 28 counties coveringapproximately 13,000 square miles in Texas. Its customers, which are principally residential, commercial andirrigation, are located in the Midland-Stanton area of west Texas, the centralTexas area around Brady, and in northeast Texas in Hunt, Collin and FanninCounties.  Through its subsidiaries, theCompany is also engaged in the transmission of electricity through a loopedsystem 305 miles in length, and in providing various electric and nonelectricservices to customers.**

** **

**Presentation and Principles ofConsolidation**

** **

**The consolidated financial statements include Cap Rock EnergyCorporation (“Energy”) and its wholly-owned subsidiaries, NewCorp ResourcesElectric Cooperative, Inc. (“NewCorp”) and Cap Rock Cooperative FinanceCorporation (“CRCFC”).  All significantintercompany balances and transactions have been eliminated inconsolidation.  Energy and NewCorpmaintain accounting records in accordance with the uniform system of accounts,as prescribed by the Federal Energy Regulatory Commission (“FERC”).**

** **

**Use of Estimates**

** **

**The preparation of the Company’s consolidated financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the reported amounts of assets andliabilities, disclosure of contingent assets and liabilities and the reportedamounts of revenues and expenses.  Actualresults could differ from those estimates.  Items which may be subject to estimationinclude, but are not limited to, the economic useful lives of assets, fairvalues of assets and liabilities, impairment of goodwill, obligations underemployee benefit plans, valuation allowances for receivables and deferred taxassets, unbilled revenues for distribution services and electricity providedfor which meters have not been read, and various other recorded or disclosedamounts.**

** **

**Regulatory Accounting**

** **

**The Company’s principal business is the transmission and distributionof electricity through NewCorp and Energy, respectively.  NewCorp is subject to regulation by theFederal Energy Regulatory Commission, and Energy is regulated by the PublicUtility Commission of Texas (“PUCT”). Accordingly, the Company follows the provisions of SFAS No. 71, “Accountingfor the Effects of Certain Types of Regulation,” and its financial statementsreflect the effects of the different rate making principles mandated by the twojurisdictions regulating its electric operations.  The rates as approved are designed to recoverthe Company’s cost of providing services. Regulatory assets are expected to be recovered through billings tocustomers.   Regulatory liabilitiesrepresent probable future reductions in revenues associated with amounts thatare expected to be credited to customers through the rate making process.**

 

The significant regulatory assets andliabilities are as follows (in thousands): 

 

F-7

----

 
| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|------------------|------------|
| ** **                           | ** ** | **2005**         | ** ** | **2004** | ** ** |
| **Assets:**                          |       |             |       |   |   |
| Rate case costs                      |       | $                | 4,224      |   | $ | 3,593 |   |
| Purchased power subject to recovery  |       | 2,214            |       | — |   |
|                                 |       |             |       |   |   |
| **Liabilities:**                     |       |             |       |   |   |
| Purchased power subject to refund    |       | 66               |       | 4,376 |   |
| Excess recovery of costs and refunds |       | 1,832            |       | 723 |   |
|                                      |            |                  |            |  |  |  |  |

 

**In August 2005, the PUCT issued a final decision that allowed theCompany to recover all of the rate case costs incurred through October 2004,with the exception of $111,000, over a period of three years.  The costs not allowed for recovery wereexpensed.  An additional $736,000 ofcosts were incurred from November 2004 through December 2005.  These are shown on the balance sheet as aregulatory asset because they have been deferred, and the Company will requestrecovery of them during a future rate case proceeding as permitted under thePUCT final order.  The three yearrecovery period will begin after the Company has received approval of the finalcompliance tariff from the PUCT.**

 

Purchased power subject to recovery or refundare recovered from or refunded to customers within 12 months.

 

The excess recovery of costs is the overrecovery of costs from customers related to the transfer of the Certificate ofConvenience and Necessity (“CCN”).  ThePUCT ruled that the Company shall refund the excess recovery of $885,000, late paymentfees of $454,000 and interest on both of $34,000 to customers over a 13 monthperiod anticipated to begin in April 2006. The penalties of approximately $450,000, associated with the excessrecovery and late payment fees, are to be paid to the State in 2006.

 

**Earnings per Share**

** **

**Basic earnings per common share (“EPS”) is computed by dividing netincome by the weighted average number of common shares outstanding.  The calculation for diluted earnings percommon share is similar to the calculation of basic EPS except that theweighted average number of common shares is increased by the number ofpotential dilutive common shares. Diluted EPS reflects the impact of the issuance of common shares for allpotential dilutive common shares outstanding during the period, including stockoptions, warrants and deferred compensation arrangements.**

** **

**Cash Equivalents**

** **

**The Company considers all unrestricted highly liquid investmentspurchased with original maturities of three months or less to be cashequivalents. The carrying amount of cash equivalents approximates market valuedue to the short-term maturity of these investments.**

** **

**Restricted Cash Investment**

** **

**In connection with the initial advance in 2003 from Beal Bank S.S.B.,the Company was required to maintain a restricted cash investment of$14,169,000 which served as collateral.  The initial advance was repaid in November 2004, with funds from thecollateralized restricted cash investment used to satisfy the debt payment.  See Note 11.**

** **

**Allowance for Doubtful Accounts**

** **

**The Company provides an allowance for doubtful accounts receivable thatare estimated to be uncollectible based on historical trends.  As of December 31, 2005 and 2004, theallowance for doubtful accounts was**

** **

**F-8**

----

** **

**$216,000 and $115,000, respectively. Bad debt expense for the yearsended December 31, 2005, 2004 and 2003, was $115,000, $151,000 and $113,000,respectively.**

** **

**Inventories**

** **

**The Company utilizes an independent third party for its materials warehousingfunction.  Inventories owned and on handare primarily transmission parts and materials which are not normally stockedby the warehousing company, supplies and materials maintained on servicetrucks, and materials at various remote field locations.  Inventories are valued at historical cost, atthe lower of cost or market.**

** **

**Investments and Notes Receivable**

** **

**The Company accounts for its investments under the cost basis method ofaccounting if the investment is less than 20% of the voting stock of theinvestee, or under the equity method of accounting if the investment is greaterthan 20% of the voting stock of the investee.  Investments accounted for under the cost method are recorded at theirinitial cost, and any dividends or distributions received are recorded inincome.   For equity method investments,the Company records its share of earnings or losses of the investee during theperiod.  Recognition of losses will bediscontinued when the Company’s share of losses equals or exceeds its carryingamount of the investee plus any advances made or commitments to provideadditional financial support.**

** **

An investment is considered impaired if thefair value of the investment is less than its cost.  Generally, an impairment is consideredother-than-temporary unless (i) the Company has the ability and intent to holdan investment for a reasonable period of time sufficient for an anticipatedrecovery of fair value up to (or beyond) the cost of the investment; and (ii)evidence indicating that the cost of the investment is recoverable within areasonable period of time outweighs evidence to the contrary.  If impairment is determined to beother-than-temporary, then an impairment loss is recognized equal to thedifference between the investment’s cost and its fair value.

** **

**The Company has investments in associated organizations that relateprimarily to required membership certificates and accumulated capitalallocations, all of which are accounted for using the cost method ofaccounting.  Capital allocations for thetwo primary investees, National Rural Utilities Cooperative Finance Corporation(“CFC”) and Texas Electric Cooperative, Inc. (“TEC”), are determined annuallyby the respective organizations based on their bylaws, operating margins, cashpositions and various other factors.  TheCompany recognizes capital allocations from the respective organization asincome when it is declared by each respective organization.  CFC is the Company’s primary lender and TECprovides various lobby services for electric cooperatives in Texas.**

** **

**Utility Plant**

** **

**Utility plant is stated at the original cost and includes allconstruction related direct labor, materials, contracted services, payrolltaxes and related payroll burdens, and overhead.  Contributions in aid of construction arecredited to the applicable utility plant accounts.  Gains or losses resulting from retirements orother dispositions of utility property in the normal course of business arecredited or charged to the accumulated provision for depreciation.  The cost of maintenance, repairs and minorreplacements are charged to operations as incurred.    The Company does not accrue any cost inadvance for major maintenance or repair projects or the cost of removal.**

** **

**Depreciation is provided on the following annual rates:**

** **
| Transmission plant          |   | 3.1% - 10 | %      |
|-----------------------------|--------|-----------|--------|
| Distribution plant          |   | 3.1       | %      |
| General plant:              |   |      |   |
| Structure and  improvements |   | 2.5% - 10 | %      |
| Transportation              |   | 33        | %      |
| Equipment                   |   | 33        | %      |
| Other                       |   | 1.4% - 2  | %      |
| Software costs              |   | 20        | %      |

** **

**F-9**

----

** **

**Nonutility Property**

** **

**Nonutility property is stated at original cost and is an officebuilding and related leasehold improvements, used primarily as the Company’scorporate headquarters.  Maintenance,repairs and miscellaneous replacements and renewals of this type of nonutilityproperty are charged to operations as incurred.   Depreciation is provided on a straight linebasis over estimated useful lives, which range from 15 to 30 years. Income andexpenses related to the Company’s primary real estate property are recognizedon an accrual basis.**

** **

**Prior to their sale in February 2004, the Company had limited partnerinterests in real estate partnerships which were accounted for under the costbasis method of accounting.  Income fromthe Company’s miscellaneous real estate partnership investments was recognizedas income was received.**

** **

**Impairment of Long-Lived Assets**

** **

**The Company is required to evaluate long-lived assets in accordancewith SFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets,” whereby long-lived assets are reviewed annually for impairment orwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparisonof the carrying amount of an asset to estimated undiscounted future cashinflows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscountedfuture cash flows, an impairment charge is recognized for the amount by whichthe carrying amount exceeds the fair value of the asset.  Regulatory assets are charged to expense inthe period in which they are no longer probable of future recovery.**

** **

**Goodwill and Intangible Assets**

** **

**Goodwill is not amortized but is reviewed annually as of December 31for impairment or whenever events and changes in circumstances occur that mayreduce the fair value below the carrying value.**

** **

**In connection with the conversion in 2002 of the line of credit withCFC into a long term mortgage note, the Company was required to pay aconversion fee.  This is being amortizedon a straight line basis over the life of the converted debt, which is due inNovember 2007.**

** **

**Capitalized Interest**

** **

**The Company capitalizes interest cost to construction work in progresscalculated in accordance with SFAS No. 34, “Capitalization of Interest Cost.”  The Company has capitalized, as a part ofutility plant, the cost of borrowed funds used for financing construction.Capitalized interest for the years ended December 31, 2005, 2004 and 2003, was$70,000, $21,000 and $7,000 respectively. The rate used for interest charged to construction is the Company’seffective borrowing rate.**

** **

**Revenue Recognition**

 

**The Company records revenue basedon amounts billed to customers as well as unbilled amounts based upon anestimate of the revenues for energy and service delivered from the latestbilling through the end of the period.**

** **

**Other operating revenue consists primarily of fees from customers foritems such as late payment penalties and connection services, as well asbuilding rental income which is accrued monthly based on contractual leaseobligations.**

** **

**F-10**

----

** **

**Purchased Power Costs**

** **

**The Company accrues its purchased power cost based on actual usage forthe respective period.**

** **

**The Company’s current tariffs for electric service include power costrecovery clauses under which electric rates charged to retail customers areadjusted monthly to collect actual purchased power costs incurred in providingservice. The over or under collection is reflected in the balance sheet asPurchased power subject to recovery or refund. In connection with its review of the Company’s proposed tariffs forretail service, the PUCT may require the Company to change to a fixed fuelfactor method for billing customers, subject to annual reconciliations ofactual power cost incurred to actual fuel revenues collected.**

** **

**During the rate case proceedings in the fall of 2004, the Companydetermined that power costs of $3,074,000 had been over collected under theCompany’s retail tariffs through the power cost recovery process.  A regulatory liability was recorded for thisover collection, and the over recovery was disclosed to the PUCT.  These monies were returned to customersthrough power cost recovery refunds.**

** **

**Income Taxes**

** **

**The Company uses the liability method in accounting for incometaxes.  Under the liability method,deferred income taxes are recognized, at currently enacted income tax rates, toreflect the tax effect of temporary differences between the financial and taxbasis of assets and liabilities.  Suchtemporary differences are the result of provisions in the income tax law thateither require or permit certain items to be reported on the income tax returnin a different period than they are reported in the financial statements.  The Company classifies deferred tax assetsand liabilities into current and noncurrent amounts based on the classificationof the related assets and liabilities. The Company records a valuation allowance to reduce its deferred taxassets to the extent it is more likely than not that such deferred tax assetswill not be realized.  The effect ondeferred tax assets and liabilities of a change in tax rate is recognized inincome in the period that includes the enactment date.  The Company will file a consolidated federalincome tax return.  For financialstatement purposes, federal income taxes are allocated to the individualcompanies based on amounts calculated on a separate return basis.**

** **

**Stock Based Compensation**

** **

**Effective January 1, 2003, the Company adopted the fair value method ofaccounting for its employee stock incentive plan in accordance with SFAS No.123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accountingfor Stock-Based Compensation, Transition and Disclosure.”  Under the historical or retroactivetransition method allowed by SFAS No. 148, the compensation expense for theyear ended December 31, 2002, would not have been different had the fair valuemethod been originally applied.  Deferredcompensation expense recorded at the date of grant is amortized over thevesting period of the related grant.  Seealso Note 13.**

** **

**Recently Issued Accounting Standards**

 

In December 2004, the Financial Accounting StandardsBoard issued SFAS No. 123R, “Share-Based Payment.”  SFAS No. 123R revises SFAS No. 123, “Accountingfor Stock-Based Compensation.”  This newstandard generally requires the cost associated with employee services receivedin exchange for an award of equity instruments be measured based on thegrant-date fair value of the award and recognized in the financial statementsover the period during which the employee is required to provide services inexchange for the award.  SFAS No. 123Ralso provides guidance on how to determine the grant-date fair value for awardsof equity instruments, as well as alternative methods of adopting its requirements.  SFAS No. 123R is effective as of thebeginning of the first annual reporting period after June 15, 2005, and appliesto all outstanding and unvested share-based payment awards at a company’sadoption date.  The Company changed itsmethod of accounting from the intrinsic method per APB Opinion No. 25, to thefair value method per SFAS No. 148, effective January 1, 2003.  

 

F-11

----

 

Therefore, adoption of SFAS No. 123R will not have asignificant impact on the Company’s consolidated financial statements.

 

In December 2004, the FASB issued SFAS No. 151, “InventoryCosts,” which clarifies the accounting for abnormal amounts of idle facilityexpense, freight, handling costs, and wasted material.  Under this Statement, such items will be recognizedas current period charges.  In addition,the Statement requires that allocation of fixed production overheads to thecosts of conversion be based on the normal capacity of the productionfacilities.  This Statement will beeffective for inventory costs incurred on or after January 1, 2006.  The adoption of this Statement will not havea significant effect on the Company’s financial statements.

 

In December 2004, the FASB issued SFAS No. 153, “Exchangesof Nonmonetary Assets,” which eliminates an exception in APB 29 for recognizingnonmonetary exchanges of similar productive assets at fair value, and replacesit with an exception for recognizing exchanges of nonmonetary assets at fairvalue that do not have commercial substance. This Statement will be effective for the Company for nonmonetaryexchanges occurring on or after January 1, 2006.  The adoption of this Statement will not havea significant effect on the Company’s financial statements.

 

In March 2005, the FASB issued FIN 47, “Accountingfor Conditional Asset Retirement Obligations,” which requires conditional assetretirement obligations to be recognized if a legal obligation exists to performasset retirement activities and a reasonable estimate of the fair value of theobligation can be made.  FIN 47 alsoprovides guidance as to when an entity would have sufficient information toreasonably estimate the fair value of an asset retirement obligation.  The Company adopted the provisions of FIN 47in the fourth quarter of 2005.  Noconditional asset retirement obligations were recognized and, accordingly, theadoption of FIN 47 had no effect on the Company’s financial statements.

 

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections.”  SFAS No.154 establishes, unless impracticable, retrospective application as therequired method for reporting a change in accounting principle in the absenceof explicit transition requirements specific to a newly adopted accountingprinciple.  This statement will beeffective for the Company for all accounting changes and any error correctionsoccurring after January 1, 2006.

 

In September 2005, the EITF issued EITF Issue No.04-13, “Accounting for Purchases and Sales of Inventory with the SameCounterparty.”  EITF 04-13 provides guidanceas to when purchases and sales of inventory with the same counterparty shouldbe accounted for as a single exchange transaction.  EITF 04-13 also provides guidance as to whena nonmonetary exchange of inventory should be accounted for at fair value.  EITF 04-13 will be applied to new arrangementsentered into, and modifications or renewals of existing arrangements occurringas of the beginning of the first interim or annual reporting period after March15, 2006.  The application of EITF 04-13is not expected to have a significant impact on the Company’s financialstatements.

 

**Reclassifications**

** **

**Certain reclassifications have been made to prior periods’ financialstatements to conform to the presentation adopted in the current period.**

** **

**2. LGB AGREEMENT**

** **

**In November 2005, the Company signed a definitive agreement and plan ofshare exchange (“the LGB Agreement”) with a newly formed entity, Cap RockHolding Corporation (“the Holding Company”), owned by Lindsay Goldberg &Bessemer L. P. and its affiliates (“LGB”). The LGB Agreement provides for the acquisition of all the outstandingstock of the Company (other than certain shares owned by management that willbe rolled over into shares of the Holding Company immediately prior to closingand shares held by shareholders who properly exercise their appraisal rightsunder Texas law) by the Holding Company in exchange for $21.75 in cash pershare.  As a result of the proposedtransaction, the Company will cease to have its shares publicly traded.  The shareholders approved the LGB Agreementat a special meeting held on March 10, 2006. **

** **

**F-12**

----

** **

**Approval of the transaction by the PUCT and FERC is also a conditionfor the LGB Agreement to be consummated, and approvals are currently pending atthose agencies.  In addition, thetransaction is subject to other closing conditions customary for this type oftransaction.**

** **

**David W. Pruitt, who retired as Chief Executive Officer on March 10,2006, signed a retainer agreement pursuant to which he will serve as aconsultant and advisor to the Company after the closing of the LGB Agreement.**

** **

**The LGB Agreement is anticipated to close in the summer of 2006,assuming satisfaction or waiver of all conditions of the agreement.**

** **

**3. CORPORATE CONVERSION AND REPURCHASE OFFER**

** **

**In 1998, members of the Cooperative adopted a plan for changing thecorporate structure from a member owned cooperative to a shareholder ownedcorporation, and Energy was formed.  Thetransfer of the assets, liabilities and issuance of stock was completed byearly 2002, as well as approval for listing on the American Stock Exchange.**

** **

**Energy’s Articles of Incorporation provide that any shareholder oraffiliate of a shareholder holding in excess of 5% of Energy’s outstandingcommon stock will have its voting rights for those shares in excess of 5%reduced to 1/100 per share.**

** **

**Pursuant to the conversion plan,the Company made a commitment to purchase shares held continuously by theoriginal owners of record until the first anniversary of the distribution ofthe shares at a price of $10 per share if the Company had sufficient cashavailable to purchase all shares tendered.  The Company’s original purchase commitment was only to thoseshareholders who were the original holders of record, and who had held thoseshares continuously until the first anniversary of the distribution of theshares.  In an effort to be inclusive,rather than exclusive, the Company made the offer to all shareholders andextended the offering period beyond the original 60 days.  The offering period began February 5, 2003,and ended April 30, 2003, with 82,140 shares of common stock tendered to andaccepted by the Company at $10 per share, totaling $821,400.  At December 31, 2003, such amount is shown inTreasury stock on the Consolidated Statements of Equity.**

** **

**4. EARNINGS PER SHARE INFORMATION**

** **

**The following table shows the reconciliation of basic and dilutedearnings per share:**

** **

**F-13**

----

** **
| ** **                                                            | ** ** | **YEAR ENDED DECEMBER 31, 2005** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | ** **                       | ** ** | **Number of** | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **Income**                       | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
|                                                                  |       | **(In  Thousands)**              |       |   |   |   |   |
| Basic loss  per share:                                                |       |                             |       |   |   |   |   |
| Loss from continuing operations available  for common stock           |       | $                                | (4,226     | ) | 1,640,276 |   | $ | (2.58 | ) |
|                                                                  |       |                             |       |   |   |   |   |
| Effect of  diluted securities:                                        |       |                             |       |   |   |   |   |
| Shares that have been deferred under the  Stock for Compensation plan |       |                             |       | 46,337 |   |   | (a) |
| Diluted loss per share:                                               |       | $                                | (4,226     | ) | 1,686,613 |   | $ | (2.58 | ) |

 

----

(a)          Effect would be anti-dilutive; therefore notincluded.

** **
| ** **                                                            | ** ** | **YEAR ENDED DECEMBER 31, 2004** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | ** **                       | ** ** | **Number of** | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **Income**                       | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
|                                                                  |       | **(In  Thousands)**              |       |   |   |   |   |
| Basic  earings per share:                                             |       |                             |       |   |   |   |   |
| Income from continuing operations available  for common stock         |       | $                                | 3,525      |   | 1,546,271 |   | $ | 2.28 |   |
|                                                                  |       |                             |       |   |   |   |   |
| Effect of  diluted securities:                                        |       |                             |       |   |   |   |   |
| Shares that have been deferred under the  Stock for Compensation plan |       |                             |       | 50,525 |   | (0.07 | ) |
| Diluted  earnings per share:                                          |       | $                                | 3,525      |   | 1,596,796 |   | $ | 2.21 |   |

** **
| ** **                                                            | ** ** | **YEAR ENDED DECEMBER 31, 2003** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | ** **                       | ** ** | **Number of** | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **Income**                       | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                            | ** ** | **(In Thousands)**               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic  earings per share:                                             |       |                             |       |   |   |   |   |
| Income from continuing operations available  for common stock         |       | $                                | 11,198     |   | 1,455,443 |   | $ | 7.69 |   |
|                                                                  |       |                             |       |   |   |   |   |
| Effect of  diluted securities:                                        |       |                             |       |   |   |   |   |
| Shares that have been deferred under the  Stock for Compensation plan |       |                             |       | 55,298 |   | (0.28 | ) |
| Diluted  earnings per share:                                          |       | $                                | 11,198     |   | 1,510,741 |   | $ | 7.41 |   |

** **

**5. OTHER CURRENT ASSETS**

** **

**Other current assets as of December 31, 2005 and 2004 consisted of thefollowing (in thousands):**

** **

**F-14**

----

** **
| ** **                 | ** ** | **December 31,** | ** ** |
|----------------------------|------------|------------------|------------|
| ** **                 | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                       |       |             |       |   |   |
| Inventories                |       | $                | 1,361      |   | $ | 1,333 |   |
| Prepaid  income tax        |       | —           |       | 3,398 |   |
| Prepaid  insurance         |       | 348              |       | 363 |   |
| Interest  receivable       |       | 21               |       | 91 |   |
| Other                      |       | 20               |       | 246 |   |
| Total Other Current Assets |       | $                | 1,750      |   | $ | 5,431 |   |

** **

**6. INVESTMENTS AND NOTES RECEIVABLE**

** **

**Investments and notes receivable as of December 31, 2005 and 2004,consisted of the following (in thousands):**

** **
| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|------------------|------------|
| ** **                                           | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                                 |       |             |       |   |   |
| Investments  in associated organizations:            |       |             |       |   |   |
| CFC capital term certificates                        |       | $                | 5,754      |   | $ | 5,905 |   |
| CFC patronage capital                                |       | 2,606            |       | 2,569 |   |
| TEC patronage capital and bonds                      |       | 852              |       | 852 |   |
| Other                                                |       | 29               |       | 41 |   |
| Total investments in associated organizations        |       | 9,241            |       | 9,367 |   |
|                                                 |       |             |       |   |   |
| Note  receivable related to United Fuel stock        |       | 533              |       | 1,300 |   |
| Note  receivable related to real estate partnerships |       | —           |       | 286 |   |
| Other  investments                                   |       | 188              |       | 51 |   |
| Total Investments and Notes Receivable               |       | $                | 9,962      |   | $ | 11,004 |   |

** **

**Allocation of income from all associated organizations was $573,000,$540,000 and $530,000, respectively, for the years ended December 31, 2005,2004 and 2003.**

** **

**In February 2004, the Company sold minor limited partner interests ithad in real estate partnerships at book value to an unrelated third party inexchange for a note receivable of $286,000. The terms of the note provided for interest at 4.5% per annum, paymentof all principal and interest due in 2009, with the partnership interests ascollateral.  In prior years, the Companyhad guaranteed debt of some of the partnerships.  In 2005, the Company obtained a release ofthose guarantees in exchange for a $50,000 payment to the general partner andforgiveness of the note of $286,000 and associated interest.**

** **

**In March 2004, the Company signed an agreement with a shareholder ofUnited Fuel and Energy Corporation (“United Fuel”) to sell its shares of stockin that company for a sales price of $1,300,000 in exchange for an installmentnote receivable with interest at 6% per annum. Pursuant to the terms of the agreement, the first installment of$500,000 was received in May 2005, with the remaining balance of $800,000 duein three equal annual installments.**

** **

**7. UTILITY PLANT**

** **

**Utility plant as of December 31, 2005 and 2004 consisted of thefollowing (in thousands):**

** **

**F-15**

----

** **
| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------|------------|
| ** **                          | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                |       |             |       |   |   |
| Distribution  facilities            |       | $                | 183,400    |   | $ | 184,713 |   |
| Transmission  facilities            |       | 66,243           |       | 65,792 |   |
| General  facilities                 |       | 14,538           |       | 9,816 |   |
| Total utility plant                 |       | 264,181          |       | 260,321 |   |
| Less  accumulated depreciation      |       | (118,374         | )          | (111,466 | ) |
| Total utility plant in service, net |       | 145,807          |       | 148,855 |   |
| Construction  work in progress      |       | 2,020            |       | 506 |   |
| Total Utility Plant, net            |       | $                | 147,827    |   | $ | 149,361 |   |

** **

**As of December 31, 2005 and 2004, all utility plant assets, except thetransmission facilities, are pledged to collateralize debt and capital leaseobligations.**

** **

**8. NONUTILITY PROPERTY**

** **

**Nonutility property as of December 31, 2005 and 2004 consisted of thefollowing (in thousands):**

** **
| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|------------------|------------|
| ** **                     | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                           |       |             |       |   |   |
| Real estate                    |       | $                | 1,992      |   | $ | 1,992 |   |
| Furniture,  fixtures and other |       | 2                |       | 7 |   |
| Total nonutility property      |       | 1,994            |       | 1,999 |   |
| Less  accumulated depreciation |       | (790             | )          | (772 | ) |
| Total Nonutility Property, net |       | $                | 1,204      |   | $ | 1,227 |   |

** **

**The Company owns a 45,000 square foot office building that is used asits general corporate headquarters. The Company currently occupiesapproximately 35% of the building and the remainder is leased to commercialtenants, subject to leasing terms ranging from monthly through 2008. For theyears ended December 31, 2005, 2004 and 2003, building rental revenue was$308,000, $294,000 and $258,000, respectively. Building rental revenues, whichare not material to the Company’s operations, for each of the next five yearsare expected to be approximately $250,000 per year. As of December 31, 2005 and2004, the net book value of the building and related property was $1,089,000and $1,112,000, respectively, which is the majority of the nonutility property.**

** **

**9. REGULATORY AND OTHER ASSETS**

** **

**Other assets as of December 31, 2005 and 2004 consisted of thefollowing (in thousands):**

** **
| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|------------------|------------|
| ** **                               | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                     |       |             |       |   |   |
| McCulloch  goodwill, net of amortization |       | $                | —     |   | $ | 199 |   |
| Bank fees,  net of amortization          |       | 88               |       | 134 |   |
| Rate case  costs                         |       | 4,224            |       | 3,593 |   |
| Total Regulatory and Other Assets        |       | $                | 4,312      |   | $ | 3,926 |   |

** **

**F-16**

----

** **

**The McCulloch goodwill is cost incurred in connection with theacquisition of an electric cooperative in 1999.   These costs were evaluated for impairment asof December 31, 2005, and were found to be fully impaired and charged toamortization expense.**

** **

**Bank fees are costs of $210,000 incurred in connection with theconversion of a former line of credit to a mortgage note.  Accumulated amortization at December 31, 2005and 2004 is $122,000 and $76,000.  Bankfees were also incurred in connection with the refinancing of the transmissionsystem with Beal Bank S.S.B.  These costswere amortized over the period of the loan, which was repaid in November2004.  Amortization of all bank feesaggregated $46,000, $923,000 and $363,000 for 2005, 2004 and 2003,respectively, and are shown as interest expense.**

** **

**Rate case costs are third party costs incurred to prepare the rate filingpackage related to the rate proceeding. These costs are regulatory assets because the amount and period overwhich the Company will be allowed to recover these costs is mandated by thePUCT.  The PUCT ruled that $3,217,000 ofrate case costs would be permitted to be recovered by the Company over a periodof three years beginning when the Company’s new rates go into effect.  Approximately $111,000 of costs was deemed bythe PUCT to be not recoverable and were expensed.  The additional amount of rate case costs of$1,007,000 were incurred after the PUCT made its determination.  They have been deferred for futurerecovery.  See Note 21.**

** **

**10. MORTGAGE NOTES AND CAPITAL LEASES**

** **

**The CFC notes were issued in conjunction with a mortgage and securityagreement (“Loan Agreement”) which collateralizes substantially all of theCompany’s distribution assets,  whichhave maturity dates ranging from 2005 to 2035, with required quarterly paymentsof principal and interest.  Under theLoan Agreement, the Company may elect to pay interest on a fixed or variable interestrate basis, as defined. The existing long-term debt consists of series of loansfrom CFC that impose various restrictive covenants, including, among otherthings, provisions that prohibit the incurrence or guaranty of other securedindebtedness by Energy and requires the maintenance of a 1.35 debt servicecoverage ratio, as defined in the CFC Loan Agreements. In addition, the Companymay not make any cash distribution or any general cancellation or abatement ofcharges for electric energy or services to its customers if the ratio of equityto total assets is less than 20%.  Inconjunction with the conversion from a member owned cooperative to ashareholder owned corporation, CFC notified the Company that all existing CFCindebtedness may remain in place with CFC after the conversion.**

** **

**Substantially all of the CFC mortgage notes are subject to interestrate repricing at the end of various periods, at the Company’s option.  Mortgage notes with CFC as of December 31,2005 and 2004, consisted of the following (in thousands):**

** **
| ** **                                                 | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                                       |       |             |       |   |   |
| Interest at  4.70% with interest repricing in January 2006 |       | $                | —     |   | $ | 33,017 |   |
| Interest at  4.85% with interest repricing in January 2006 |       | —           |       | 6,467 |   |
| Interest at  4.50% with interest repricing in January 2007 |       | 5,834            |       | 5,960 |   |
| Interest at  5.15% with interest repricing in January 2007 |       | 62,822           |       | 64,055 |   |
| Interest at  6.45% with interest repricing in January 2011 |       | 37,825           |       | — |   |
| Interest at  fixed rates:                                  |       |             |       |   |   |
| 4.20%                                                      |       | —           |       | 3,590 |   |
| 4.30%                                                      |       | 27,345           |       | 27,872 |   |
| 6.40%                                                      |       | 215              |       | — |   |
| 7.00%                                                      |       | 1                |       | 2 |   |
| Variable  rate                                             |       | —           |       | 2,791 |   |
|                                                       |       | 134,042          |       | 143,754 |   |
| Less current maturities                                    |       | (3,433           | )          | (9,881 | ) |
| Total Mortgage debt, net of current portion                |       | $                | 130,609    |   | $ | 133,873 |   |

** **

**F-17**

----

** **

**In connection with the LGB Agreement, a subordinated line of credit of$15 million is expected to be made available to the Company upon theconsummation of the transactions contemplated by the LGB Agreement.**

** **

**Annual maturities of the mortgage notes as of December 31, 2005, are asfollows (in thousands):**

** **
| 2006                 |   | $      | 3,433   |   |
|----------------------|--------|--------|---------|--------|
| 2007                 |   | 29,822 |    |
| 2008                 |   | 3,178  |    |
| 2009                 |   | 3,333  |    |
| 2010                 |   | 3,469  |    |
| Thereafter           |   | 90,807 |    |
|                 |   |   |    |
| Total  mortgage debt |   | $      | 134,042 |   |

** **

**The Company has miscellaneous capital leases for certain equipment usedin operations, with such equipment included in utility plant on the balancesheet.  Future minimum lease payments areas follows (in thousands):**

** **
| 2006                             |   | $      | 73     |   |
|----------------------------------|--------|--------|--------|--------|
| 2007                             |   | 31     |   |
| 2008                             |   | 17     |   |
| 2009                             |   | 17     |   |
| 2010                             |   | 18     |   |
| Thereafter                       |   | 4      |   |
|                             |   |   |   |
| Total  capital lease obligations |   | $      | 160    |   |

** **

**11. TRANSMISSION SYSTEM FINANCING**

** **

**In connection with the original financing and construction of itstransmission line, the Company entered into agreements which qualified ascapital lease obligations.  As a result,the transmission line, substation assets and associated capital leaseobligations were recorded on the Company’s consolidated financial statements.**

** **

**The original cost of the transmission facility and costs related toconsummation of the lease agreements were recovered from customers throughpower cost billings over a ten year period. Consistent with this ratemaking treatment, the transmission facilitiesand capital lease obligation were amortized over the same ten year period, withthat period ending September 30, 2003.**

 

The final balloon payment on the initialcapital lease was refinanced through a borrowing from Beal Bank S.S.B. (“BealBank”).  Although the financingarrangement provided for the availability of $31,500,000, the only moniesborrowed were an initial advance of $14,169,000 to repay the aforementionedcapital lease balloon payment. Prepayment of the initial advance was not allowed unless an additionaladvance was funded before the September 2004 due date.  The initial advance was collateralized by arestricted cash investment of the same amount.

 

Interest on the Beal Bank loan was 10.75%,payable monthly.  The financingarrangement provided for a commitment fee and reimbursement of expenses,attorney fees, appraisals and consulting which totaled $1,184,000.   Two amendments to the financing agreementwere executed which extended the due date of 

 

F-18

----

 

the initial advance, and the collateralizedcash investment was then used to repay the initial advance in November 2004.

 

**12. ACCRUED AND OTHER CURRENT LIABILITIES**

** **

**Accrued and other current liabilities at December 31, 2005 and 2004,consisted of the following (in thousands):**

** **
| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|------------------|------------|
| ** **                                       | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                             |       |             |       |   |   |
| Accrued  taxes                                   |       | $                | 22         |   | $ | 18 |   |
| Accrued  interest                                |       | 536              |       | 516 |   |
| Accrued  payroll and employee benefits (Note 13) |       | 1,014            |       | 914 |   |
| Regulatory  liability                            |       | 1,832            |       | 723 |   |
| Customer  deposits and prepayments               |       | 830              |       | 778 |   |
| Accrued  other                                   |       | 412              |       | 253 |   |
| Total Accrued and Other Current Liabilities      |       | $                | 4,646      |   | $ | 3,202 |   |

** **

**13. EMPLOYEE BENEFIT PLANS**

** **

**Executive Deferred Compensation Plans**

** **

**In November 2002, the Board approved an Executive Deferred CompensationRetirement Plan whereby management, members of the Board of Directors andcertain highly compensated employees could defer a portion of theircompensation pursuant to the terms of the plan. The Company may also make contributions to the plan on behalf of theindividuals participating in the plan.  Aparticipant is 100% vested in contributions he may make to the plan, withCompany contributions vesting at 10% per year for the first four years, and 20%per year for the next three years.  TheCompensation Committee of the Board of Directors administers the plan.  For the years ended December 31, 2005 and2004, $24,000 and $18,000 were contributed by the Company to the plan, and suchamounts are shown as a liability on the consolidated balance sheets.**

** **

**Stock Incentive Plan**

** **

**The Company has a Stock Incentive Plan, approved by the shareholders,that provides for the granting of awards of common stock, options to purchasecommon stock, both restricted and unrestricted, and certain related rights toeligible officers, employees and directors of the Company.  The plan will continue in effect untilDecember 31, 2013, unless the transactions contemplated by the LGB Agreementare consummated.  The Stock IncentivePlan provides for a maximum of 800,000 shares of the Company’s common stock tobe used for stock awards and the granting of options.   Shares of common stock used to satisfy suchawards will be acquired by the Plan either through open market purchases orthrough the issuance of additional common stock.  For the years ended December 31, 2005, 2004and 2003, the Company recorded compensation expense of $4,389,000, $4,925,000and $2,133,000, respectively, in connection with the fair value of these awardsof common stock, of which $2,114,000, $934,000 and $132,000, respectively, werein the form of shares withheld by the Company, in order to remit cash paymentsfor employees’ payroll tax withholding.**

** **

**Employee Stock Purchase Plan**

** **

**The Company has an Employee Stock Purchase Plan (“ESPP”), also approvedby the shareholders, that provides its employees with the opportunity topurchase shares of its common stock through payroll deductions.  It was the Company’s intention to have theESPP qualify as an employee Stock Purchase Plan under Section 423 of theInternal Revenue Code of 1986, as amended. The Employee Stock Purchase Plan provides for a maximum of 150,000shares.  As of December 31, 2005, theESPP had not been implemented.**

** **

**F-19**

----

** **

**Stock for Compensation Plan**

** **

**The Company has a Stock for Compensation Plan (“SCP”) that provides ameans for eligible employees and directors to receive shares of the Company’scommon stock or restricted share units in lieu of cash compensation.  This plan was also approved by theshareholders.  The SCP provides for amaximum of 500,000 shares of the Company’s common stock to be used inconjunction with this plan.  For theyears ended December 31, 2005, 2004 and 2003, cash bonuses of $6,000, $6,000and $6,000, respectively, had been earned by individuals, who then were awardedshares of stock in lieu of the cash compensation.**

** **

**Defined Contribution Plan**

** **

**The Company has a 401(k) plan for employees who meet certaineligibility requirements.  The planpermits a specified percentage of an employee’s salary to be voluntarilycontributed on a pre-tax basis, with a Company matching feature.  Participants may contribute from two percentof eligible earnings up to the maximum federal limit to various self-directedinvestment funds.  The plan provides forvarious levels of Company matching contributions depending upon the level ofemployee contributions.  Company contributionsaggregated $587,000, $535,000 and $527,000, for the years ended December 31,2005, 2004 and 2003.**

** **

**Other Postretirement Benefits**

** **

**The Company provides continued major medical coverage to retiredemployees and their dependents.  The costto maintain such benefits for the years ended December 31, 2005, 2004 and 2003,totaled $1,508,000, $1,233,000 and $1,039,000, respectively.**

** **

**The Medicare Reform Act of 2003 allows employers who sponsor apostretirement health care plan that provides a prescription drug benefit toreceive a subsidy for the cost of providing that drug benefit.  In order for employers to receive the subsidypayment under the Medicare Reform Act, the value of the offered prescriptiondrug plan must be at least actuarially equivalent to the standard prescriptiondrug coverage provided under Medicare Part D. The Company’s plan meets the actuarially equivalent test and qualifiesfor the subsidy.  The reduction incurrent period service cost due to the subsidy was $27,000 for the year endedDecember 31, 2005, and the impact on the benefit obligation is $1,644,000.**

** **

**The Company uses December 31 as a measurement date for the plan.**

** **

**Obligationsand Funded Status**

**The following tables set forth the obligations, fair value of planassets and funded status at December 31, 2005 and 2004 (in thousands):**

** **

**F-20**

----

** **
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|------------------|------------|
| ** **                             | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                   |       |             |       |   |   |
| **Change  in Benefit Obligations**     |       |             |       |   |   |
| Benefit  obligation, beginning of year |       | $                | 4,078      |   | $ | 3,508 |   |
| Service cost                           |       | 197              |       | 245 |   |
| Interest  cost                         |       | 514              |       | 598 |   |
| Participant  contributions             |       | —           |       | — |   |
| Actuarial  loss                        |       | 347              |       | 380 |   |
| Benefit paid                           |       | (549             | )          | (653 | ) |
| Benefit  obligation, end of year       |       | $                | 4,587      |   | $ | 4,078 |   |
|                                   |       |             |       |   |   |
| **Funded  Status**                     |       |             |       |   |   |
| Funded  status - under funded          |       | $                | 10,147     |   | $ | 11,349 |   |
| Unrecognized  net loss                 |       | (5,560           | )          | (7,271 | ) |
| Accrued  benefit cost                  |       | $                | 4,587      |   | $ | 4,078 |   |

** **

**Components ofNet Periodic Benefit Cost**

**The following sets forth the components of net periodic benefit costfor the years ended December 31, 2005, 2004 and 2003 (in thousands):**

** **
| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|------------------|------------|
| ** **                       | ** ** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                             |       |             |       |   |   |   |   |
| Service cost                     |       | $                | 197        |   | $ | 245 |   | $ | 206 |   |
| Interest  cost                   |       | 514              |       | 598 |   | 504 |   |
| Amortization  of experience loss |       | 347              |       | 380 |   | 329 |   |
| Net  periodict benefit cost      |       | $                | 1,058      |   | $ | 1,223 |   | $ | 1,039 |   |

** **

**F-21**

----

** **

**ActuarialAssumptions and Cost Trends**

**The following sets forth the assumptions used to determine benefitobligations:**

** **
| ** **    | ** ** | **DECEMBER 31,** | ** ** |
|---------------|------------|------------------|------------|
| ** **    | ** ** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Discount rate |       | 5.50             | %          | 5.75 | % | 6.00 | % |

** **
| ** **                                               | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                     |       |     |       |     |       |
| Health care  cost trend rate assumed for next year       |       | 10       | %          | 10       | %          |
| Rate to  which the cost trend rate is assumed to decline |       | 1        | %          | 1        | %          |
| Year that  the rate reaches the ultimate trend rate      |       | 2011     |       | 2010     |       |

** **

**The assumed health care cost trends significantly affect the amountsreported for the post retirement health care liability.  A one percentage point change in assumedhealth care cost trend rates would have the following effects (in thousands):**

** **
| ** **                                                | ** ** | **Increase** | ** ** | **Decrease** | ** ** |
|-----------------------------------------------------------|------------|--------------|------------|--------------|------------|
| Effect on  total of service cost and interest cost        |       | $            | 133        |         | (105       | ) |
| Effect on  accumulated post retirement benefit obligation |       | 1,639        |       | (1,310       | )          |
|                                                           |            |              |            |              |            |  |

** **

**Plan Assets**

**No return on plan assets was assumed in the calculation as the Companyholds no specified plan assets.**

** **

**Future BenefitPayments**

**The following table provides estimates of future benefit payments,which reflect expected future service, as applicable (in thousands):**

** **
| 2006      |   | $     | 480    |   |
|-----------|--------|-------|--------|--------|
| 2007      |   | 552   |   |
| 2008      |   | 548   |   |
| 2009      |   | 559   |   |
| 2010      |   | 569   |   |
| 2011-2015 |   | 3,423 |   |

** **

**14. DEFERRED CREDITS**

** **

**Deferred credits at December 31, 2005 and 2004 consisted of thefollowing (in thousands):**

** **

**F-22**

----

** **
| ** **                                           | ** ** | **DECEMBER 31,** | ** ** |
|------------------------------------------------------|------------|------------------|------------|
| ** **                                           | ** ** | **2005**         | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | ** **       | ** ** | ** ** | ** ** |
| Post  retirement benefits (Note 13)                  |       | $                | 4,587      |   | $ | 4,078 |   |
| Deferred tax  liability                              |       | 300              |       | 1,275 |   |
| Deferred  gain on sale of United Fuel Stock (Note 6) |       | 800              |       | 940 |   |
| Stockholders’  Trust (Note 20)                  |       | 10               |       | 129 |   |
| Deferred  executive compensation                     |       | 181              |       | 36 |   |
| Unclaimed  member capital credits                    |       | 55               |       | 55 |   |
| Other                                                |       | 57               |       | 56 |   |
|                                                 |       | $                | 5,990      |   | $ | 6,569 |   |

** **

**15. FAIR VALUE OF FINANCIAL INSTRUMENTS**

** **

**The following table presents the carrying amounts and estimated fairvalues of the Company’s financial instruments at December 31, 2005 and2004.  SFAS No. 107 defines the fairvalue of a financial instrument as the amount at which the instrument could beexchanged in a current transaction between willing parties (in thousands):**

** **
| ** **        | ** ** | **DECEMBER 31,** | ** ** |
|-------------------|------------|------------------|------------|
| ** **        | ** ** | **2005**         | ** ** | **2004** | ** ** |
| ** **        | ** ** | **Book**         | ** ** | **Fair** | ** ** | **Book** | ** ** | **Fair** | ** ** |
| ** **        | ** ** | **Value**        | ** ** | **Value** | ** ** | **Value** | ** ** | **Value** | ** ** |
| Cash              |       | $                | 9,857      |   | $ | 9,857 |   | $ | 20,968 |   | $ | 20,968 |   |
| Notes  receivable |       | 800              |       | 800 |   | 1,300 |   | 1,300 |   |
| Mortgage  notes   |       | 134,042          |       | 134,042 |   | 143,754 |   | 143,754 |   |
|                   |            |                  |            |  |  |  |  |  |  |  |  |  |  |

** **

The book value of cash and cash equivalentsapproximated fair value because of the short maturity of those instruments. Thecarrying values of accounts receivable and account payable included in theaccompanying consolidated balance sheets approximated market value at December31, 2005 and 2004. As described in Note 10, the Company has both fixed rate andvariable rate notes.The fair value of these mortgage notes is not able to be readily determinedbecause there is no market for this type of debt.

 

**16. INCOME TAXES**

** **

**The Company accounts for income taxes in accordance with SFAS No. 109 “Accountingfor Income Taxes,” which requires the recognition of a liability or an asset,net of a valuation allowance, for the deferred tax consequence of all temporarydifferences between the tax basis and the reported amounts of assets andliabilities, and for the future benefit of operating loss carryforwards.**

** **

The Company identified a technical tax issuerelated to the income tax treatment, for financial reporting purposes,regarding the tax exempt status of one of the Company’s subsidiaries.  The Company will file amended tax returns forthe applicable years.

** **

**The following is a reconciliation of expected income tax expense toactual expense as well as the reconciliation of the statutory tax rate to theeffective rate for the years ended December 31, 2005 and 2004 (in thousands):**

** **

**F-23**

----

** **
| ** **                                | ** ** | **2005**    | ** ** | **2004**       | ** ** |
|-------------------------------------------|------------|-------------|------------|----------------|------------|
| ** **                                | ** ** | **Dollars** | ** ** | **Percentage** | ** ** | **Dollars** | ** ** | **Percentage** | ** ** |
|                                      |       |        |       |           |       |   |   |   |   |
| Income tax  expense at the statutory rate |       | $           | (1,646     | )              | (34.0      | )% | $ | 1,120 |   | 34.0 | % |
| State tax  expense                        |       | 239         |       | 4.9            |       | 190 |   | 5.8 |   |
| Expired  capital loss                     |       | —      |       | —         |       | 2,540 |   | 77.1 |   |
| Change in  valuation allowance            |       | —      |       | —         |       | (5,240 | ) | (159.1 | ) |
| Nondeductible  compensation and other     |       | 794         |       | 16.4           |       | 1,158 |   | 35.1 |   |
|                                      |       | $           | (613       | )              | (12.7      | )% | $ | (232 | ) | (7.1 | )% |

** **

**The tax effects of significant temporary differences and carryforwards atDecember 31, 2005 and 2004, are as follows (in thousands):**

** **
| ** **                              | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------------|------------|------------|------------|------------|------------|
| ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net deferred  tax assets (liabilities): |       |       |       |       |       |
|                                    |       |       |       |       |       |
| Accrued  expenses                       |       | $          | 133        |       | $          | 1,260 |   |
| Allowance  for doubtful accounts        |       | 73         |       | 38         |       |
| Net  operating loss carryforwards       |       | 5,840      |       | 4,154      |       |
| Post  retirement healthcare             |       | 1,560      |       | 1,320      |       |
| Total deferred tax assets               |       | 7,616      |       | 6,772      |       |
|                                    |       |       |       |       |       |
| Property and  equipment                 |       | (6,453     | )          | (6,799     | )          |
| Other                                   |       | (1,463     | )          | (1,248     | )          |
| Total deferred tax liabilities          |       | (7,916     | )          | (8,047     | )          |
|                                    |       |       |       |       |       |
| Valuation allowance                     |       | —     |       | —     |       |
| Net deferred tax asset (liability)      |       | $          | (300       | )          | $          | (1,275 | ) |

** **

**As of December 31, 2005, the Company has net operating losscarryforwards of approximately $17,205,000. The net operating loss carryforwards are scheduled to expire in 2011through 2025.**

** **

**In connection with the restatement of the Company’s consolidatedfinancial statements for the year ended December 31, 2004, Management made adecision to amend applicable tax returns for NewCorp to reflect its status astaxable.  This would not affect thefinancial statement treatment and presentation, as restated. Recoverability ofthe additional tax expense from ratepayers is uncertain.**

** **

**In early 2004, the IRS notified the Company that it intended to examinethe federal income tax return of its Predecessor for the year 2001.  The IRS completed its examination with noimpact on the Company’s financial position or results of operations.**

** **

**The Company was notified in December 2005 that the Texas StateComptroller’s Office intended to examine the state franchise tax returns ofEnergy for the preceding four years. Management believes there will be no material impact on the Company’sfinancial position or results of operations.**

** **

**F-24**

----

** **

**17. MAJOR CUSTOMERS AND SUPPLIERS**

** **

**For the years ended December 31, 2005, 2004 and 2003, the Company hadno customer that accounted for more than 10% of operating revenues.**

 

**The Company utilizes an independent third party for its materialswarehousing function.  The terms of thecontract provide that the third party maintain an adequate inventory level ofdistribution type components, with after hours staffing in case ofemergencies.  The Company has alsooutsourced its meter reading function. In the event the contract with these third parties should not berenewed, the Company believes its operations would not be severely affectedbecause new contracts could be secured at competitive rates and in a timelymanner.  See also Note 21, Commitmentsand Contingencies.**

** **

**18. ELECTRIC DEREGULATION AND CUSTOMER CHOICE**

** **

**On June 22, 2003, the Governor ofthe State of Texas signed Senate Bill 1280 into law which became effectiveSeptember 1, 2003, and amended the**Texas Public Utility Regulatory Act (“PURA”) to effectively require that the Company’srates become subject to regulation and approval by the PUCT.  Under the new law, the PUCT will establish schedules andprocedures for the Company to comply with the requirements of competition.  Because the Southwest Power Pool (“SPP”) doesnot have adequate infrastructure for customer choice, House Bill 1692 providesthat the utilities in the SPP cannot participate in customer choice until2007.  Since the SPP does not haveadequate infrastructure for customer choice at this time, it is expected thatsuch date will be extended by the legislature. The majority of the Company’s service area is in the SPP, whileapproximately 25% is in the Electric Reliability Council of Texas (“ERCOT”).  The Company believes the PUCT will bereasonable in developing appropriate schedules and procedures for the Companyto enter into customer choice and that such action will not adversely affectthe Company’s customers.

** **

**19. RELATED PARTY ACTIVITY**

** **

**One of the compensation vehicles utilized by the Company was the AchievementBased Contract – Southwestern Public Service Company (“ABC-SPS”).  The ABC-SPS contract, which expired inOctober 2003, provided for total compensation of 2% of the annual savingsderived from the SPS purchased power contract, as compared to the prior TexasUtilities purchased power contract.  Forthe year ended December 31, 2003, compensation attributable to the contract was$126,000 for the two executive officers who were the only remainingparticipants in the ABC-SPS contract.**

** **

**In November 2005, the Company entered into a retainer agreement withDavid W. Pruitt, who was then the Company’s Chief Executive Officer.  The agreement provided that Mr. Pruitt wouldcontinue to serve as Chief Executive Officer until the special meeting ofshareholders on March 10, 2006, after which he retired as CEO. The retaineragreement provided that he would also continue to serve on the Board ofDirectors and be entitled to all benefits generally available to board membersand retirees.  Mr. Pruitt and theHolding Company entered into a restricted stock agreement at the same time asthe LGB Agreement, which modified Mr. Pruitt’s retainer agreement subject toclosing of the transactions contemplated by the LGB Agreement.  The restricted stock agreement provides thathe will serve as a non-employee advisor and consultant to the Company with amonthly retainer of $19,000, continuation of service as a board member withoutadditional compensation, and the granting of 54,438 shares of restricted stockof the Holding Company.  If his servicesare terminated or if he dies or becomes totally disabled, the Holding Companywill cause Mr. Pruitt to be paid a lump sum amount equal to $35,000 timesthe number of months remaining on the term of the retainer agreement.  The restricted shares will vest upon LGBachieving certain performance results on its investment.  Any unvested shares will be forfeited.**

** **

**Pursuant to his amended employment contract, William L. West continuedto serve as President of the Company until the special meeting of shareholdersheld on March 10, 2006, after which he remained President but also succeededMr. Pruitt as Chief Executive Officer. The Holding Company and Mr. West entered into an employment agreementwhich will replace the existing employment agreement upon closing of the LGB**

** **

**F-25**

----

** **

**Agreement.  The employmentagreement with the Holding Company provides for his employment as president andchief executive officer of the Holding Company, a restricted stock grant of18,497 shares of the Holding Company, and a retention bonus of $938,068 as anincentive to remain through the closing and facilitating the consummation ofthe transactions contemplated by the LGB Agreement.  Vesting of the restricted shares occurs onlywhen Mr. West achieves certain employment goals and LGB meets certainperformance results on its investment in the Holding Company.  Any unvested shares will be forfeited.  Under certain circumstances, if Mr. West’semployment is terminated after the close of the LGB Agreement, the HoldingCompany may be obligated to pay Mr. West a lump sum amount equal to 2.5times his current salary.**

** **

**The Holding Company and certain of the other executive officers enteredinto restricted stock agreements with provisions similar to the restrictedstock grants given to Mr. West.  Inaddition, the Holding Company agreed to pay Ronnie W. Lyon, Vice President andGeneral Counsel, a retention bonus of $690,070 as an incentive to remainthrough the closing and facilitating the consummation of the transactionscontemplated by the LGB Agreement.**

** **

**In connection with the LGB Agreement, the Holding Company and certainexecutive officers entered into rollover agreements, in which a certain numberof Company shares owned by each of them will be “rolled over” into shares ofthe Holding Company.**

** **

**Upon entering into the restricted stock agreements described above,each of these individuals surrendered any right under his or her currentemployment contract to receive any payment to which they may have been entitledas a result of a change of control of the Company.**

** **

**20.  OTHER SHAREHOLDER MATTERS**

** **

**The Cap Rock Energy Corporation Shareholders’ Trust (the “Trust”) wasestablished by the Company in October 2002, on behalf of former members of theCooperative whose current addresses were unknown and would have received sharesof common stock in connection with the conversion of the Cooperative into theCompany.  The shared authority of the twoTrustees of the Trust is to make distribution of stock to beneficial ownerswhen they have been located.  As ofDecember 31, 2005 and 2004, there were 323,899 and 325,223 shares of stock,respectively, held beneficially by the Trust. Other powers are limited to those granted in the Trust document, the FundingAgreement and the Share Option Agreement.**

 

**The Trust provides that in the case of a tender offer or otherrepurchase offer by the Company for shares of the capital stock of the Company,the Trustees may, in their sole discretion and acting jointly in the bestinterest of the beneficiaries of the Trust, sell all of the shares held in theTrust to the Company at the highest cash price offered under the tender offeror other repurchase offer.  If the tenderoffer by the Company has a premium of 25% or more, the Trustees shall sell allof the shares at the highest cash price offered.  In addition, the Trustees shall not vote theshares in favor of a sale or pledge of assets of the Company, nor for anychange in the capital structure or powers of the Company or in connection witha merger or dissolution, unless previously approved by the Company’s Board ofDirectors.**

** **

**On December 31, 2004, the Trust and the Company entered into a VotingAgreement whereby the shares that are currently held in the Trust will be votedby the Trustees, but as directed by the Company for so long as the shares areheld in the Trust, or by the State in the event the shares escheat.  As consideration, the Company will pay a 10%premium of the value of the shares as of December 30, 2004, to any owner ofshares currently held in the Trust, at such time as the shares are issued tothe legal owner or his or her heirs.   Aliability of $10,000 and $129,000 based on fair value as of December 31, 2005and 2004 has been recognized and is reflected as a long term liability indeferred credits on the consolidated balance sheet.  See Note 14.**

** **

**The Company is currently in the process of preparing submission reportsin order to surrender to the State of Texas and any other states involved,shares held in the Trust that are deemed abandoned by applicable law.  After these reports have been filed, theTrust will transfer such shares as part of the abandoned property process.**

** **

**F-26**

----

** **

**21. COMMITMENTS AND CONTINGENCIES**

** **

**The Company has various obligations to make future payments undercontractual obligations:**

** **
| ** **                   | ** ** | **2006**                   | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| ** **                   | ** ** | **(Thousands of dollars)** | ** ** |
|                         |       |                       |       |     |       |     |       |     |       |     |       |           |       |      |       |
| Operating  lease obligations |       | $                          | 695        |     | $          | 557      |       | $        | 228        |     | $          | 147            |       | $         | 101        |   | $ | — |   | $ | 1,728 |   |
| Purchase  obligations        |       | 4,216                      |       | 2,359    |       | 630      |       | 630      |       | 630      |       | 2,456          |       | 10,921    |       |
| Other long  term liabilities |       | 1,183                      |       | 617      |       | 579      |       | 580      |       | 569      |       | 35,226         |       | 38,754    |       |
|                              |            |                            |            |          |            |          |            |          |            |          |            |                |            |           |            |  |  |  |  |  |  |  |

 

**Operating leases relate primarily to equipment.  Purchase obligations include IT services andpower contracts.  All of the Company’spower contracts are firm, full requirements contracts.  These types of contracts require the Companyto purchase all of its power needs from the seller, but do not mandate aminimum purchase amount.  The amountsincluded for each year are basic required transmission charges.**

** **

**The Company has entered into an agreement with a third party to providecertain information technology related managed services including assessment ofthe current IT environment and future needs; product selection; implementationof financial and operational IT systems; hosting of the applications in aremote environment; user and application support, as well as desktopsupport.  Beginning March 2004, ongoingmaintenance and support costs is based on the number of meters  per respective month and, based on the numberof meters at December 31, 2005, will approximate $1,615,000 per year through2007.  These amounts are reflected in theabove table under Purchase obligations. If a termination of services occurs before the end of the contract,except for material nonperformance, the Company will be required to pay atermination fee on a decreasing sliding scale over the term of thecontract.  The maximum amount for suchtermination fee as of December 31, 2005, is $965,000.**

** **

**The Company has a contract with the City of Farmersville, Texas, to actas an agent to provide power to its customers and related billing andcollection functions.  Terms provide fora two year written notification for termination by either party.  The Company is obligated to make payments tothe City of Farmersville on a revenue sharing type basis.  The 2006 and estimated 2007 annual paymentsare $630,000 and are reflected in the table under Other long term liabilities.**

** **

**Purchased Power and Transmission Services. *  ***The Company purchases all of its electric powerpursuant to long-term wholesale electric power contracts with SouthwesternPublic Service Company, Lower Colorado River Authority (“LCRA”) and GarlandPower and Light (“Garland”). SPS, LCRA and Garland contracts expire in 2013,2016 and 2007, respectively, and account for approximately 72%, 12% and 16%,respectively, of the Company’s electric power purchases for 2005. The contractsfor power cover kWh usage, kW demand levels, transmission, scheduling andancillary services along with energy and fuel costs. The Company’s purchasedpower costs fluctuate primarily with the price of the fuel and usage.Management believes that in the event the contracts are terminated, the Company’soperations will not be severely affected as new contracts can be secured atcompetitive rates with other electric power providers.  However, all costs associated with purchasedpower are passed through to the retail customer.

** **

The Company’s west Texas divisions aresupplied power through a contract with SPS. The SPS contract has no minimum kWhusage requirements, but does have minimum charges for kW demand andtransmission services. The Company must pay a minimum of 65% of the priortwelve months highest monthly kW demand usage multiplied by a fixed rate alongwith their pro-rata share of the fixed transmission costs based on the Company’sprior twelve months usage as a percentage of all SPS usage.

 

**The SPS contract allows the Company to purchase all power needed.Energy, kW demand, ancillary services and scheduling charges are based on fixedfactors charged against usage. The Company also pays a pro-rata share of SPS’sFERC regulated transmission charges. Fuel costs paid to SPS are based on SPS’sactual cost of fuel used to generate electricity. The SPS contract expires inDecember 2013.**

** **

**F-27**

----

** **

**The LCRA contract covers all power utilized by the central Texasdivision of the Company and permits the Company to purchase 100% of the powerneeded to supply the native load of the division.  LCRA charges the Company fixed factors forenergy, kW demand and scheduling services applied to usage. LCRA’s transmissioncharges are fixed monthly charges regulated by ERCOT.  Fuel costs paid to LCRA are the Company’spro-rata share of the amounts that LCRA actually pays for fuel to generateelectricity. The Company is required to purchase power from LCRA, but has nominimum usage levels and only minimal penalties. The contract between LCRA andthe Company expires in June 2016.**

** **

**Garland provides all power supply requirements, including ancillary andscheduling services, for the division in northeast Texas and the City ofFarmersville.  The Company is notrequired to purchase a minimum amount of capacity.  The base price per kWh is at a fixed rate anddoes not fluctuate with the price of gas or other fuels. Fuel costs paid toGarland are based on Garland’s actual cost of fuel used to generate electricity.  The Garland contract expires in 2007.**

** **

**Various members of ERCOT provide the northeast Texas division of theCompany with transmission services. The PUCT regulates the transmission ratesthat are charged by the ERCOT members. The Company pays a fixed monthly feebased on the estimated usage submitted prior to the beginning of each year.There is no contract with the individual ERCOT members. Taking power over theERCOT network requires the Company to pay fees regulated by the PUCT. Theannual charges to use the ERCOT transmission network cover the period fromJanuary 1 to December 31 of each year. Withdrawing from ERCOT and using othertransmission services relieves the user of further charges. Because the use ofthe network is governed by ERCOT and falls under the jurisdiction of the PUCT,a contract is not required with each ERCOT member.**

** **

**OutsourcedFunctions.* ***The Company utilizes an outside third party forits materials warehousing function.  Theterms of the contract provide that the third party maintain an adequate levelof inventory in order that the Company may meet its needs in a timelymanner.  The exclusive contract was foran initial term of 5 years, and has been extended and modified for another 5years through November 2006.  The termsof the contract also provide for termination at any time by either party with90 days written notice.  Upon any finalcontract termination by either party, the Company is required to purchase andpay for any inventory held by the third party at cost plus 10%.  The estimated inventory value plus 10% isapproximately $1,244,000 at December 31, 2005.

** **

**The Company has also outsourced its meter reading function.  The basic terms of the contract provide for afee per meter read, with the contract extended through 2008, unless eitherparty gives 150 days written notice at any time.**

** **

**PUCT Oversight and Decisions**.******  Because of a change in PURA, as ofSeptember 1, 2003, the Company’s rates became subject to regulation andapproval by the PUCT.  In accordance with this change in the PURA, theCompany filed its electric service tariff with the PUCT inSeptember 2003.  The staff of the PUCT took the position that thetariff filed by the Company was the effective tariff, but the staff did proposemodifications to certain tariff provisions.  In December 2005 aProposal for Decision (“PFD”) was issued by the Administrative Law Judges (“ALJ’s)which recommended that the PUCT Commissioners find that the tariffs filed bythe Company in September 2003, were the Company’s legally adoptedtariffs.  At an open meeting of the PUCT Commissioners on February 9,2006, the PFD was approved.  A signedorder from the PUCT Commissioners was entered on February 28, 2006, and twoparties filed motions for rehearing with the PUCT within 20 days of receipt ofthe order.  The Company filed such motionfor rehearing within the prescribed time.

 

**In October 2004, the PUCTinitiated an inquiry to determine the reasonableness of the Company’s rates andordered the Company to submit a rate filing package.  The Company prepared and filed a rate filingpackage that contained a request for a rate increase for some customer classes,which amounted to $5,021,000.  In August2005, the PUCT issued its order providing for a base rate decrease ofapproximately 2%.  An order on rehearingwas issued in November 2005.  Severalparties filed petitions for judicial review of the order.**

 

**The Company has taken theposition that the order issued in August 2005, became final before the PUCTacted on the motions for rehearing.  Thus, the Company filed a petition forjudicial review of that order in September**

** **

**F-28**

----

** **

**2005.  The PUCT rejected the Company’s position inits Order on Rehearing.  Several otherparties also filed petitions for judicial review of the August 2005 order, butotherwise dispute the Company’s position that the August 2005 order becamefinal before the Commission acted on the motions for rehearing**

 

The Company received twoNotices of Violation (“NOVs”) from the PUCT inOctober 2004.    The NOVs cited the Company for charginglate fees to residential customers who did not pay their bills on time, and forcharging a regulatory surcharge to customers to recover costs incurred in aprior PUCT proceeding.  The Company contended that both of these chargeswere made in accordance with the Company’s tariff which had been adopted by itsBoard of Directors in accordance with Texas law at the time.  The PUCTStaff claimed that the Company misapplied its tariff and that, followingSeptember 1, 2003, the Company could not charge a rate that, even ifauthorized by its tariff, violated PUC rules.

 

**On November 10, 2005, theALJ’s issued a PFD recommending that the Company be found to have violatedstate law and Commission rules, and recommending that the Company be ordered topay total refunds and penalties in the amount of $1,567,687 as of July2005.  The PFD recommended that the refunds be made over a thirteen monthperiod instead of the Staff’s requested one-time credit.**

** **

**At an open meeting of the PUCTCommissioners held on February 21, 2006, the PUCT Commissioners votedunanimously to adopt the PFD.  A finalorder was entered on March 3, 2006, requiring the refund of certain amounts tocustomers and payment of interest and penalties.  See Regulatory Accounting in Note 1.  The Company has twenty days from the date ofreceipt of the final order to file a motion for rehearing and if that isoverruled, it can appeal to district court. The Company filed a motion for rehearing on March 27, 2006.**

** **

ThePUCT has not yet established the procedures and time lines for the Company tocomply with the other provisions of the PURA regarding investor ownedutilities, including offering customer choice for customer power requirements.  The Company anticipates that the PUCT willtake relevant factors into consideration in establishing such procedures andtime lines that are appropriate and such actions will not adversely affect theCompany’s customers.

** **

**LGB Agreement**.  TheCompany filed an *Application of Cap RockEnergy Corporation and Cap Rock Holding Corporation Reporting Acquisition ofStock,* Docket No. 32185, with the PUCT on December 20,2005.  The PUCT issued an order requiring the parties to file a jointprocedural schedule setting forth time frames for discovery and a hearingno later than January 23, 2006.  The deadline for parties tointervene was February 3, 2006, and five parties intervened in the case.  On March 8, 2006, the PUCT Commissioners decided they would conduct thehearing on this case.  The hearing datehas been set for April 19 and 20, 2006.

** **

**Lamar.** Litigation involving the Companyand Lamar Electric Cooperative Association, Inc. (“Lamar”) which arose outof Lamar’s termination of the Combination Agreement between Lamar and the Companyin October 2002 and the Management Services Agreement inNovember 2002.  Lamar filed suit against the Company in the 62nd District Court in Lamar County, Texas, seekinga declaratory judgment that it had a right to terminate both agreements withoutregard to payment of any kind to the Company.  The Company believes thatLamar’s stated reason for termination of the Combination Agreement does notfall within the specific allowable exceptions set forth in the agreement, andtherefore the Company is seeking reimbursement of all costs and expensesincurred with regard to the attempted combination which amount to at least $1.4million as well as a cancellation fee of $300,000 for liquidated damages as setout in the terms of the Management Services Agreement.  The Company isalso seeking damages for the lost opportunity costs due to the failure to closethe Lamar Combination Agreement.

 

In October 2004, theCompany filed counterclaims against Lamar’s Board of Directors and twoindividual directors.  The Company also joined several third partiesalleging fraud, civil conspiracy and tortious interference with businessrelations.  Lamar has also amended its suit against the Company, addingclaims for 

 

F-29

----

 

fraud andmisrepresentation.  Discovery is ongoing with regard to the new claims andone of the new parties requested that the case be transferred to Midland Countywhere Rayburn Country Electric Cooperative, Inc. (“Rayburn”) has a pending suitoriginally filed in December 1999 in the 238th District Court seeking to enjoin thecombination of Lamar and the Company.

 

In December 2005, a partial summaryjudgment was granted in which it was ruled that the claims of the Companyagainst Rayburn should be heard in the current lawsuit in Midland County andthat the Combination Agreement between Lamar Electric Cooperative Associationand the Company’s predecessor could not be consummated due to the impossibilityof performance.  The other claims remain.  The Company plans toappeal this decision.  The matter willmost likely go to trial during 2006.

** **

**Other.*** *The Company’s formerChief Financial Officer has filed suit against the Company in the 238thJudicial District Court, Midland County, Texas.  His employment was terminatedin April 2005.  He alleges a breach of his employment contract andseeks damages resulting from such alleged breach.  The case is still inthe early stages of discovery.

 

Billy Eggemeyer, Wilbert Braden, RandyBraden, Individually and on Behalf of All Others Similarly Situated v. Cap RockEnergy Corporation and NewCorp Resources Electric Cooperative, Inc.; Cause No.05-08-U3896-ANC; in the District Court of Upton County, Texas; 112th Judicial District.  Three former members of the Company’spredecessor filed a lawsuit against the Company alleging fraud, conversion andother claims associated with the Company’s conversion from an electriccooperative to a stockholder owned corporation. The plaintiffs are seeking to certify the suit as a class action.  The Company believes the suit is meritless,that it has a good legal defense to the claims, and that the claims are barredby the applicable statute of limitations, laches and res judicata.

** **

**The Company is involved in various litigation matters, none of which isexpected to have a material impact on the financial condition, operatingresults or liquidity of the Company.**

** **

**22. SEGMENT INFORMATION**

** **

**The Company has adopted SFAS No. 131, “Disclosures about Segments of aBusiness Enterprise and Related Information.” Substantially all of the Company’soperations are conducted in Texas and involve the distribution and sale ofelectricity.**

** **

**Business segment information as of and for the years ended December 31,2005, 2004 and 2003, is as follows (in thousands):**

** **
| ** **                    | ** ** | **TOTAL** | ** ** |
|-------------------------------|------------|-----------|------------|
| Operating revenues            |       |      |       |
| December 31, 2005             |       | $         | 86,975     |   |
| December 31, 2004             |       | 82,624    |       |
| December 31, 2003             |       | 82,844    |       |
| Net income (loss)             |       |      |       |
| December 31, 2005             |       | (4,226    | )          |
| December 31, 2004             |       | 3,525     |       |
| December 31, 2003             |       | 11,198    |       |
| Identifiable assets           |       |      |       |
| December 31, 2005             |       | 187,561   |       |
| December 31, 2004             |       | 199,687   |       |
| December 31, 2003             |       | 202,989   |       |
| Capital expenditures          |       |      |       |
| December 31, 2005             |       | 6,364     |       |
| December 31, 2004             |       | 4,583     |       |
| December 31, 2003             |       | 5,209     |       |
| Depreciation and amortization |       |      |       |
| December 31, 2005             |       | 8,120     |       |
| December 31, 2004             |       | 7,416     |       |
| December 31, 2003             |       | 6,719     |       |
| Interest expense, net         |       |      |       |
| December 31, 2005             |       | 6,230     |       |
| December 31, 2004             |       | 7,983     |       |
| December 31, 2003             |       | 8,047     |       |
|                               |            |           |            |  |

** **

**F-30**

----

** **

**23. QUARTERLY FINANCIAL DATA (UNAUDITED)**

** **

**The following table summarizes results for each of the four quarters inthe years ended December 31, 2005 and 2004 (in thousands, except per sharedata):**

** **
| ** **                            | ** ** | **MARCH 31,**                               | ** ** | **JUNE 30,** | ** ** | **SEPT 30,** | ** ** | **DEC 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|--------------|------------|--------------|------------|-------------|------------|
| ** **                            | ** ** | **(In thousands except per share amounts)** | ** ** |
| **2005**                              |       |                                        |       |         |       |         |       |        |       |
| Total revenues                        |       | $                                           | 18,320     |         | $          | 20,751       |       | $           | 27,136     |   | $ | 20,768 |   |
| Operating income (loss)               |       | 1,790                                       |       | (1,324       | )          | 3,673        |       | (3,914      | )          |
| Net income (loss) before income taxes |       | 234                                         |       | (2,649       | )          | 2,858        |       | (5,282      | )          |
| Income tax expense (benefit)          |       | 146                                         |       | (798         | )          | 997          |       | (958        | )          |
| Basic earnings (loss) per share       |       | 0.05                                        |       | (1.13        | )          | 1.13         |       | (2.60       | )          |
| Diluted earnings (loss) per share     |       | 0.05                                        |       | (1.13        | )          | 1.10         |       | (2.60       | )          |
|                                  |       |                                        |       |         |       |         |       |        |       |
| **2004**                              |       |                                        |       |         |       |         |       |        |       |
| Total revenues                        |       | 20,288                                      |       | 22,831       |       | 22,351       |       | 17,154      |       |
| Operating income                      |       | 4,241                                       |       | 5,966        |       | 1,614        |       | (1,602      | )          |
| Net income before income taxes        |       | 2,249                                       |       | 4,026        |       | 190          |       | (3,172      | )          |
| Income tax expense (benefit)          |       | 474                                         |       | 1,011        |       | 168          |       | (1,885      | )          |
| Basic earnings per share              |       | 1.13                                        |       | 1.93         |       | 0.01         |       | (0.84       | )          |
| Diluted earnings per share            |       | 1.09                                        |       | 1.88         |       | 0.01         |       | (0.84       | )          |
|                                       |            |                                             |            |              |            |              |            |             |            |  |  |  |  |

** **

**F-31**

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