**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe fiscal year ended December 31, 2005**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from                      to                     **

**Commissionfile number:  001-32471**

**PRB GAS TRANSPORTATION, INC.**

(Exact Name of Registrantas specified in its Charter)

| Nevada                                    | ** ** | **20-0563497**                     |
|-------------------------------------------|------------|------------------------------------|
| (State or other  jurisdiction of          |       | (IRS Employer  Identification No.) |
| incorporation or  organization)           |       |                               |
| ** **                                |       | ** **                         |
| **1875  Lawrence Street, Suite 450** |       |                               |
| **Denver,  Colorado 80202**               |       | **80202**                          |
| (Address of  Principal Executive Offices) |       | (Zip Code)                         |

 

Registrant’s Telephone Number, including area code:**  (303) 308-1330**

(Former name, former address and former fiscal year, ifchanged since last report):**  None**

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

|                                | **Title of Each Class** | ** **               |   |  |  | **Name of Exchange on Which Registered** | ** ** | ** ** |
|--------------------------------|-------------------------|--------------------------|--------|--|--|------------------------------------------|------------|------------|
| Common Stock,  $.001 par value |                    | American Stock  Exchange |

 

**Securitiesregistered pursuant to Section 12(g) of the Act:  None**

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or section 15(d) ofthe Exchange Act.  Yes o  No x

Indicate by check mark whether registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.  o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of accelerated filer and large accelerated filer in Rule 12b-2of the Exchange Act.    Large accelerated filer o    Accelerated filer o    Non-accelerated filer x

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

The aggregate market value of the registrant’s commonstock held by non-affiliates of the registrant as of June 30, 2005 was$52,706,175 computed by reference to the price at which the registrant’s commonstock was last traded on that date.

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

|                                    | **Class** | ** **            |   |  |  | **Outstanding at April 5, 2006** | ** ** | ** ** |
|------------------------------------|-----------|-----------------------|--------|--|--|---------------------------------------|------------|------------|
| **Common  Stock, $.001 par value** |      | **7,461,894  shares** |

 

**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of the registrant’s definitive proxy statementto be delivered to stockholders in connection with the Annual Meeting ofstockholders to be held on June 14, 2006 are incorporated by referenceinto Part III of this Form 10-K.

 

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**TABLE OF CONTENTS**

| Item       | ** ** | **Description**                                                                                 | ** ** | **Page**   | ** ** |
|------------|------------|-------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** ** | ** ** | **PART I**                                                                                 | ** ** | ** ** | ** ** |
| ITEM  1.   |       | Business                                                                                        |       | 3          |       |
| ITEM  1A.  |       | Risk Factors                                                                                    |       | 8          |       |
| ITEM 1B.   |       | Unresolved Staff  Comments                                                                      |       | 13         |       |
| ITEM  2.   |       | Properties                                                                                      |       | 13         |       |
| ITEM  3.   |       | Legal Proceedings                                                                               |       | 16         |       |
| ITEM 4.    |       | Submission of  Matters to a Vote of Security Holders                                            |       | 16         |       |
|       | ** ** | **PART II**                                                                                |       |       |       |
| ITEM 5.    |       | Market for  Registrant’s Common Equity and Related Stockholder Matters                     |       | 17         |       |
| ITEM 6.    |       | Selected Financial  Data                                                                        |       | 18         |       |
| ITEM 7.    |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations     |       | 19         |       |
| ITEM 7A.   |       | Quantitative  and Qualitative Disclosures About Market Risk                                     |       | 28         |       |
| ITEM 8.    |       | Consolidated  Financial Statements and Supplementary Data                                       |       | 29         |       |
| ITEM 9.    |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure           |       | 29         |       |
| ITEM 9A.   |       | Controls and  Procedures                                                                        |       | 29         |       |
| ITEM 9B.   |       | Other Information                                                                               |       | 30         |       |
|       | ** ** | **PART III**                                                                               |       |       |       |
| ITEM 10.   |       | Directors and  Executive Officers of the Registrant                                             |       | 31         |       |
| ITEM 11.   |       | Executive  Compensation                                                                         |       | 31         |       |
| ITEM 12.   |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters |       | 31         |       |
| ITEM 13.   |       | Certain  Relationships and Related Transactions                                                 |       | 31         |       |
| ITEM 14.   |       | Principal  Accountant Fees and Services                                                         |       | 32         |       |
|       | ** ** | **PART IV**                                                                                |       |       |       |
| ITEM 15.   |       | Exhibits and  Financial Statement Schedules                                                     |       | 32         |       |
|       |       | Signatures                                                                                      |       | 35         |       |

 

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**Statement ofForward Looking Statements**

This Annual Report on Form 10-K includesforward-looking statements. All statements other than statements of historicalfacts contained herein, including statements regarding our future financialposition, business strategy and plans and objectives of management for futureoperations, are forward-looking statements. The words “believe,” “may,” “will,”“estimate,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect” andsimilar expressions, as they relate to us, are intended to identifyforward-looking statements. We have based these forward-looking statementslargely on our current expectations and projections about future events andfinancial trends that we believe may affect our financial condition, results ofoperations, business strategy and financial needs. These forward-lookingstatements are subject to a number of risks, uncertainties and assumptions.

We undertake no obligation to update publicly orrevise any forward-looking statements. You should not rely upon forward-lookingstatements as predictions of future events or performance. We cannot assure youthat the events and circumstances reflected in the forward-looking statementswill be achieved or occur. Although we believe that the expectations reflectedin the forward-looking statements are reasonable, we cannot guarantee futureresults, levels of activity, performance or achievements.

You should read thefollowing discussion in conjunction with our audited financial statements, andthe notes thereto, and other financial information appearing elsewhere in thisdocument.

**PART I**

**ITEM 1.**             BUSINESS

**Description ofBusiness**

PRB Gas Transportation, Inc. (the “Company,” “us,”“our” or “we”) is an energy company with both oil and gas exploration anddevelopment and mid-stream operations in the Rocky Mountain states.

The Company was incorporated in December 2003. Wewere capitalized and commenced operations in January 2004 when we acquiredcertain gas gathering and related assets of TOP Gathering, LLC (“TOP”). In August 2004,we acquired certain gas gathering and related assets of Bear Paw Energy, LLC (“BPE”).Both the TOP and BPE gas gathering systems are located in the Powder Riverbasin of Wyoming. The Company utilizes these assets to provide gas gathering, processingand compression services (the Company’s “gathering and processing” segment) tothird parties. See Recent Developments for further discussion on our TOPsystem.

During the third quarter of 2005, the Company expandedthe scope of its operations into a new segment (the Company’s “exploration andproduction” segment) that includes exploring for, developing, producing andmarketing coal-bed methane natural gas. In July 2005, the Company formedPRB Energy, Inc., a 100% wholly-owned subsidiary established to conductthe Company’s exploration and production activities.

During September 2005, the Company entered into aFarm-In and Development Agreement, a Management Services Agreement and anOperating Agreement with Enterra Energy Trust and its wholly-owned subsidiaryRocky Mountain Gas (“Rocky Mountain Gas”). The Farm-In and DevelopmentAgreement provided the Company an opportunity to earn interests in RockyMountain Gas’ undeveloped leaseholds located in an area of mutual interest bymaking acquisition and development expenditures during the term of theagreement. In addition, the Company earned a 50% interest in the wells that itdrilled and/or completed in the area of mutual interest. Through December 31,2005, the Company made $2.070 million in development expenditures and drilledand/or completed 28 wells in the area of mutual interest. As a result, theCompany earned an approximate 4.7% interest in Rocky Mountain Gas’ undevelopedleaseholds in the area of mutual interest and a 50% interest in the 28 wells asof 

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December 31, 2005.Once completed wells become productive, future operations will be controlled bythe Operating Agreement and this agreement will also control future operationsin the case of termination of the Farm-In and Development Agreement.

The Management Services Agreement provided for theCompany to earn management fees by operating certain Rocky Mountain Gasproperties and by providing technical and administrative support on a cost-plusbasis. During the year ended December 31, 2005, the Company earned $270thousand in management fees under the Management Services Agreement.

See Recent Developments for further discussion of thetermination of the agreements with Rocky Mountain Gas.

Currently, the Company isexpanding its operations to include projects located outside of the PowderRiver Basin and to include crude oil projects and projects involvingconventional natural gas and natural gas liquids. These projects are in variousstages of evaluation and or negotiation.

**Business Strategy**

We were originally organized as a mid-stream energycompany providing gathering and processing services to coal-bed methane gasproducers. Recently, we expanded into oil and gas exploration and production.Our strategy is to continue this expansion and, where feasible, also providecomplimentary gathering and processing services. It is our plan to seekopportunities in conventional oil and gas exploration and production activitiesin the Powder River Basin and in other basins in the continental United States.

We also plan toimprove and grow our existing gas gathering and processing operations by:

·       enhancingthe profitability of our gathering systems through system consolidation,improving operating efficiencies as well as through development of oil and gasleases;

·       divestingour assets relating to the TOP gas gathering system;

·       designingand building new gathering systems and acquiring existing gathering systems;and

·       acquiringworking interests in oil and gas producing properties and attempting to expandin areas where there may be opportunities to build new gathering systems oroperate existing systems.

**Recent Developments**

During the first quarter 2006, we raised $21.965million, before expenses, by issuing convertible subordinated notes. We intendto use these funds for our capital and acquisition programs.

During the first quarter of 2006, we acquired two gasgathering systems in the Recluse area of Wyoming. In addition, the TermoCompany (“Termo”) designated the Company as its preferred gatherer for its HomesteadDraw Area and this arrangement included a 9.25% working interest to be owned bythe Company. There are approximately 30,000 undedicated acres in the Reclusearea that offer us the opportunity to expand both our exploration andproduction and gathering and processing segments. In addition, we signed anagreement to farm-in on acreage that is dedicated to our BPE gas gatheringsystem. For additional information see Note 17—Subsequent Events to ourconsolidated financial statements in Item 15 of this report.

On March 20, 2006, the Company elected toterminate the Farm-In and Development Agreement and Management ServicesAgreement (referred to in Description of Business) and agreed to continue tooperate the Rocky Mountain Gas properties and provide management services forat least 60 days from the termination date. We have agreed to continue to drillcertain wells that had previously been approved by the State of Wyoming andRocky Mountain Gas under the terms of the Operating Agreement.

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On March 21, 2006, wenotified our customers served by the TOP system that we were raising our ratesto cover cash costs plus 15% for a 2 month period. We also advised thesecustomers that we were planning to shut down the TOP system after the two monthperiod has elapsed. These customers have the right to purchase the TOP systemfrom us on terms to be negotiated, as per the related gas gathering agreements.

**Employees**

As of December 31,2005, we had 18 full-time employees.

**Competition**

***Gas Gathering and Processing***

Gas gathering systems are generally either acquired ordeveloped pursuant to long-term contracts with gas producers or the shippersthey service. The contracts generally run over a period of time whichapproximates a majority of the economic life of the gas producers’ wells. Webelieve that having such contracts and an existing gathering system in placeprovides a significant barrier to entry to third parties seeking to competewith us upon the expiration of our contracts.

When developing newgathering systems in areas where we do not have the advantage of existingsystems in proximity to the development, we may be competing with othergathering system operators or the producer may elect to construct and own thesystem. In the case of other gathering system operators, many possessfinancial, technical and personnel resources substantially greater than ours.

***Exploration and Production***

The Company’s oil and gasexploration activities take place in a highly competitive and speculativebusiness atmosphere. In seeking suitable oil and gas properties forexploration, development or acquisition, the Company competes with a number ofother companies, including large oil and gas companies and other independentoperators with greater financial resources.

**EnvironmentalRegulation**

All facilities and gathering systems that utilizecompressors fueled by natural gas require Wyoming Oil and Gas CorporationCommission operating permits. All of our systems have these permits.

At the time of construction, storm water dischargepermits are required as well as permits for surface discharging of hydrostatictest water. The Company has obtained all necessary construction permits.

Federal Spill Prevention Control and Countermeasurerequirements apply to our facilities and we have approved plans in place.

County and state roadcrossing permits apply to pipelines and gathering systems crossing county andstate highways. The Company is in compliance with these permittingrequirements.

**IntrastateRegulation**

No regulatory body withinthe state of Wyoming controls the gathering rates we may charge.

**Safety andMaintenance**

***Gas Gathering and Processing***

We contract with thirdparties to perform preventive and normal maintenance on our gathering systemsand make repairs and replacements when necessary or appropriate. On our behalf,third parties 

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alsoconduct routine and required inspections of our gathering and other assets asrequired by applicable code or regulation. External coatings and cathodicprotection systems are used to protect against external corrosion. The systemsare continually monitored and tested, and the results recorded, to ensure theearly identification of any problem that may arise. We have contracted a thirdparty to provide the necessary training to our employees as required by the OccupationalSafety and Health Administration.

***Exploration and Production***

We conduct safety trainingclasses for all of our field employees dealing with oil and gas development andproduction. As of December 31, 2005, all employees have participated inthese classes and are in compliance with safety regulations.

**Access toInformation**

Our website address iswww.prbtrans.com. We make available, free of charge, on the Investor Relationssection of our website, our Annual Report on Form 10-K, QuarterlyReports on Form 10-Q, Current Reports on Form 8-K, andall amendments to those reports, as soon as reasonably practicable after thesereports are electronically filed with or furnished to the Securities andExchange Commission (“SEC”). We also make available through our website otherreports electronically filed with the SEC under the Securities Exchange Act of1934, including our proxy statements and reports filed by officers andDirectors under Section 16(a) of that Act. We do not intend forinformation contained in our website to be part of this Annual Report on Form 10-K.

**Acquisitions andDivestitures**

We did not acquire any properties during the yearended December 31, 2005. During the year ended December 31, 2004 weacquired the TOP and BPE gas gathering systems and paid $2.960 million and$7.646 million, respectively, for these acquisitions during 2004. During theyear ended December 31, 2005, we paid an additional $200 thousand inrespect to accrued TOP system acquisition costs and $25 thousand in respect tothe TOP system compressor disposal liability.

During the quarterended March 31, 2006 the Company entered into the following transactions:

·       Thepurchase of a gas gathering system from Storm Cat Energy Corporation and thesigning of a related gas gathering and compression services agreement withStorm Cat covering 6,600 acres. The agreement guarantees the Company minimumthroughput volumes.

·       Thefarm-in of a 15% working interest in leaseholds underlying the BPE gasgathering system. The leaseholds cover 5 townships and total approximately2,500 net acres.

·       TheCompany was designated as the preferred gas gatherer by Termo and this includeda participation in Termo’s Homestead Draw Coal Bed Natural Gas Project nearRecluse, WY in the Powder River Basin, with a 9.25% working interest in thedevelopment of approximately 3,400 existing net acres and any future leaseacquisitions in or around the existing leases.

·       The acquisition of a highpressure natural gas gathering line from Clear Creek Natural Gas, LLC.

**Major Customers**

***Gathering and Processing***

*Ourgathering and processing systems service several customers in the Powder RiverBasin area of Wyoming. Pennaco Energy, Inc. is our largest gathering andprocessing customer at approximately 54% of total revenue for the year ended December 31,2005.*

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***Exploration and Production***

We sold 100% of our gasproduction on a spot sale basis to Enserco Energy, Inc. during the yearended December 31, 2005. We will be evaluating options to market ourfuture natural gas production during 2006.

**Seasonality**

***Gathering and Processing***

Generally, but not always,the demand and price levels for natural gas increase during the colder wintermonths and decrease during the warmer summer months. In addition, pipelines,utilities, local distribution companies and industrial users utilize naturalgas storage facilities and purchase some of their anticipated winterrequirements during the summer, which can lessen seasonal demand fluctuations.Seasonal anomalies such as mild winters and summers sometimes lessen thesefluctuations.

***Exploration and Production***

In addition to the seasonal demands applicable tonatural gas mentioned above, the demand for crude oil and heating oil are alsoimpacted by generally higher prices in the winter. Seasonal anomalies such asmild winters sometimes lessen these fluctuations. The impact of seasonality hasbeen somewhat mitigated by the overall supply and demand economics related tocrude oil because there is a narrow margin of production capacity in excess ofexisting worldwide demand.

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**ITEM 1A.**        RISKFACTORS

The risks anduncertainties described below are not the only risks facing us. Additionalrisks not presently known to us or which we consider immaterial based oninformation currently available to us may also materially adversely affect us.If any of the following risks or uncertainties actually occurs, our business,financial condition and results of operations could be adversely affected.

***We incurred a net loss of $4.625 million and $651thousand for the years ended December 31, 2005 and December 31, 2004,respectively. Our future performance is difficult to evaluate because we have alimited operating history.***

Our operations commencedwith our acquisition of certain assets of TOP as of January 1, 2004 andexpanded with our acquisition of certain assets of BPE effective August 1,2004. In addition, we have recently expanded into the exploration andproduction business. As a result, we have little historical financial andoperating information available to help you evaluate our performance or aninvestment in our common stock.

***To fund our future growth we will require additionalcapital, which may not be available or may only be available on unfavorableterms.***

During the first quarterof 2006, we raised $21.965 million, before costs, by issuing convertiblesubordinated notes. We anticipate that this capital will be adequate for thecurrent calendar year. Our future capital requirements depend on many factors,including development and acquisition opportunities, the availability of debt financingand the cash flow from our operations. To the extent that the funds availableare insufficient to meet future capital requirements, we may need to reduce ourdevelopment activity. Any equity or debt financing, if available at all, may beon terms that are not favorable to us. If we cannot obtain adequate capital onfavorable terms or at all, our business, operating results and financialcondition could be adversely affected.

***Our convertible subordinated notes include interestaccruing at ten percent per annum.***

Our new debt arrangements,as referenced above, include quarterly interest payments of approximately $550thousand. We may not be able to fully service these interest payments in thefuture.

***Our convertible subordinated notes may not be convertedto our common shares.***

If the recently issuednotes are not converted to our common stock before or at maturity during thethird quarter of 2008, we will have to refinance this debt. We may not be ableto refinance these notes and this could adversely affect our financial positionand future operations.

***Our convertible subordinated notes are secured bycertain gas gathering assets.***

In the event of ourdefault in respect to these notes, we could lose control of these assets.Should this occur, our future operating results, financial condition andperformance could be adversely affected.

***Restrictions in credit agreements may prevent us fromengaging in some beneficial transactions.***

As we expand and requirecapital, we intend to enter into credit agreements with financial institutionsto fund a portion of the capital requirements. To obtain funds under creditagreements we may be required to accept operating restrictions which wouldimpair or prevent us from future transactions we deem to be beneficial for ourfuture growth.

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***We depend on our chief executive and chief operatingofficers for critical management decisions and industry contacts.***

We do not have employmentagreements with our chief executive officer and chief operating officer and donot carry key person insurance on their lives. The loss of the services ofeither of these executive officers, through incapacity or otherwise, could havea material adverse effect on our business and would require us to seek andretain other qualified personnel.

***Competition for experienced technical personnelmay negatively impact our operations.***

Our exploratory anddevelopment drilling success depends, in part, on our ability to attract andretain experienced professional personnel. The loss of any key executives orother key personnel could have a material adverse effect on our operations. Aswe continue to grow our asset base and the scope of our operations, our futureprofitability will depend on our ability to attract and retain qualifiedpersonnel, particularly individuals with a strong background in geology,geophysics, engineering and operations.

***A significant decrease in the supply of natural gasfrom our gas gathering customers could materially affect our results ofoperations and financial condition.***

Investments by our gasgathering customers in the maintenance of existing wells and the furtherdevelopment of their reserves will affect their production rates and the volumeof gas we gather. Drilling activity generally decreases as gas prices decrease.We have no control over our customers’ level of drilling activity, the amountof reserves underlying their wells and the rate at which their production froma well will decline. Drilling activity of our customers is affected by, amongother things, prevailing and projected energy prices, demand for hydrocarbons,geological considerations, governmental regulation and the availability andcost of capital.

***Any material nonpayment or nonperformance by our keycustomers could materially affect our results of operations and financialcondition.***

As of December 31,2005, one of our customers, Pennaco Energy, Inc., accounted forapproximately 54% of our 2005 revenue. No other customers exceed 10% of ourrevenue. Some of our customers may be highly leveraged and subject to their ownoperating and regulatory risks.

***Our operations are subject to operational hazards andunforeseen interruptions for which we may be inadequately insured.***

Our operations, bothgathering and processing and exploration and production, are subject to operationalhazards and unforeseen interruptions such as natural disasters, adverseweather, accidents, fires, explosions, hazardous materials releases, mechanicalfailures and other events beyond our control. These events might result in aloss of equipment or life, injury or extensive property damage, as well as aninterruption in our operations. We may not be able to maintain or obtaininsurance of the type and amount we desire at reasonable rates. In someinstances, certain insurance could become unavailable or available only forreduced amounts of coverage. If we were to incur a significant liability forwhich we were not fully insured, it could have a material adverse effect on ourresults of operations and financial condition.

***Growing our business by constructing new gatheringsystems, or expanding existing ones, subjects us to construction and otherrisks.***

We plan to grow ourbusiness, in part, by constructing new gathering systems and by expandingexisting ones. We have no material significant commitments for new constructionor expansion projects as of the date of this report. The construction of a newgathering system or the expansion of an existing gathering system, byadding  compressor stations or by addinga second gathering line along an existing 

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gatheringline, involves numerous regulatory, environmental, political and legaluncertainties, most of which are beyond our control. These projects may not becompleted on schedule or at all or at the budgeted cost. In addition, ourrevenues may not increase immediately upon the expenditure of funds on aparticular project. For instance, if we build a new gathering system, theconstruction will occur over an extended period of time and we will not receivea material increase in revenue until after completion of the project. Thiscould adversely affect our results of operations and financial condition.

***Our business depends on the level of activity in theoil and gas industry, which is significantly affected by volatile energyprices.***

Our businessdepends on the level of activity in oil and gas exploration, development andproduction in markets worldwide. Oil and gas prices, market expectations ofpotential changes in these prices and a variety of political and economic andweather-related factors significantly affect this level of activity. Oil andgas prices are extremely volatile and are affected by numerous factors,including:

·       worldwidedemand for oil and gas;

·       theability of the Organization of Petroleum Exporting Countries, commonly called “OPEC,”to set and maintain production levels and pricing;

·       thelevel of production in non-OPEC countries;

·       thepolicies of the various governments regarding exploration and development oftheir oil and gas reserves;

·       localweather;

·       fluctuatingpipeline takeaway capacity;

·       advancesin exploration and development technology;

·       thepolitical environment surrounding the production of oil and gas;

·       levelof consumer product demand; and

·       the price and availabilityof alternative fuels.

***Future oil and gas price declines or unsuccessfulexploration efforts may result in write-downs of our exploration and productionasset carrying values.***

We follow the successful efforts method of accountingfor our oil and gas properties. All property acquisition costs and costs ofexploratory and development wells are capitalized when incurred, pending thedetermination of whether proved reserves have been discovered. If provedreserves are not discovered with an exploratory well, the costs of drilling thewell are expensed.

The capitalized costs of our oil and gas properties,on a field basis, cannot exceed the estimated future net cash flows of thatfield. If net capitalized costs exceed future net revenues, we must write downthe costs of each such field to our estimate of fair market value. Unprovedproperties are evaluated at the lower of cost or fair market value.Accordingly, a significant decline in oil or gas prices or unsuccessfulexploration efforts could cause a future write-down of capitalized costs.

We review the carryingvalue of our properties quarterly based on prices in effect as of the end ofeach quarter or as of the time of reporting our results. Once incurred, awrite-down of oil and gas properties cannot be reversed at a later date even ifoil or gas prices increase.

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***Substantial capital is required to find, acquire,develop and replace our reserves.***

We need to make substantial capital expenditures tofind, acquire, develop and replace oil and natural gas reserves. Future cashflows and the availability of financing are subject to a number of factors,such as the level of production from existing wells, our success in locatingand producing new reserves and prices of oil and natural gas. If oil or gasprices decrease or we encounter operating difficulties that result in our cashflows from operations being less than expected, we may have to reduce ourcapital expenditures unless we can raise additional funds through debt orequity financing. Debt or equity financing may not always be available to us insufficient amounts or on acceptable terms.

If our revenues were todecrease due to lower oil or gas prices, decreased production or other reasons,and if we could not obtain capital through debt or equity financingarrangements, our ability to execute our development plans, replace ourreserves or maintain production levels could be greatly limited.

***Future oil and gas price declines may affect ourability to raise capital.***

If oil and gas pricesdecrease there will be a corresponding negative impact on the value of ourreserves. This could negatively affect our ability to borrow funds or raisecapital in the equity markets.

***Exploration and development drilling may not result incommercially productive reserves.***

Oil and gasdrilling and production activities are subject to numerous risks, including therisk that no commercially productive oil or natural gas will be found. The costof drilling and completing wells is often uncertain, and oil and gas drillingand production activities may be shortened, delayed or canceled as a result ofa variety of factors, many of which are beyond our control. These factorsinclude:

·       unexpecteddrilling conditions;

·       titleproblems;

·       pressureor irregularities in formations;

·       equipmentfailures or accidents;

·       adverseweather conditions;

·       compliancewith environmental and other governmental requirements;

·       shortagesor delays in the availability of or increases in the cost of drilling rigs andthe delivery of equipment; and

·       lackof availability of experienced drilling crews.

***Competition in our industry is intense, and many ofour competitors have greater financial and technical resources than we do.***

We face intensecompetition from major oil companies, independent oil and gas exploration andproduction companies, financial buyers and institutional and individualinvestors who are actively seeking oil and gas properties throughout the world,along with the equipment, expertise, labor and materials required to operateoil and gas properties. Many of our competitors have financial and technical resourcesvastly exceeding those available to us, and many oil and gas properties aresold in a competitive bidding process in which our competitors may be able topay more for development prospects and productive properties or in which ourcompetitors have technological information or expertise to evaluate andsuccessfully bid for the properties that is not available to us. In addition,shortages of equipment, labor or materials as a result of intense competitionmay result in increased costs or the inability to obtain those 

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resourcesas needed. We may not be successful in acquiring and developing profitableproperties in the face of this competition.

***The actual quantities and present values of our provedoil and gas reserves may be less than we have estimated.***

This Form 10-K contains estimates of ourproved oil and gas reserves and the estimated future net revenues from thosereserves. Reserve estimates are based on various assumptions, includingassumptions required by the SEC relating to oil and gas prices, drilling andoperating expenses, capital expenditures, taxes and availability of funds. Theprocess of estimating reserves is complex. This process requires significantdecisions and assumptions in the evaluation of available geological,geophysical, engineering and economic data for each reservoir. These estimatesare dependent on many variables and, therefore, changes often occur as thesevariables evolve and commodity prices fluctuate. As a result, these estimatesare inherently imprecise. As of December 31, 2005, all of our estimatedproved reserves (by volume) were proved developed producing.

Management has based theestimated discounted future net cash flows from proved reserves on prices andcosts as of the date of the estimate, in accordance with SEC requirements,whereas actual future prices and costs may be materially higher or lower.

***Our revenue projections include assumptions onde-watering time for our coal-bed methane wells in the Powder River Basin inWyoming. These estimated de-watering times may be longer than we expect.***

Our future period revenueand financial position could be adversely affected if we experience delays inselling natural gas due to longer than expected de-watering times.

***We may be required to rescind the sale of up to $1.233million of stock if our private placement of Series C preferred stock isdeemed to have violated federal and state securities laws.***

In December 2004, we received $1.233 million fromthe sale of 411,000 shares of Series C convertible preferred stock. Wepaid no cash or other commissions or finders’ fees in connection with thisoffering. This placement might not have been eligible for an exemption fromregistration under the Securities Act of 1933. In the absence of such anexemption, investors could bring suit against us to rescind their stockpurchases, in which event we could be liable for rescission payments to theseinvestors of up to $1.233 million exclusive of interest and costs. As of December 31,2005, 371,000 Series C convertible preferred shares converted to commonshares and 40,000 Series C convertible shares remain outstanding. Duringthe first quarter of 2006 an additional 30,000 Series C convertible sharesconverted to common shares.

***Concentration of share ownership among our existingexecutive officers, Directors and principal stockholders may prevent othersfrom influencing significant corporate decisions.***

At December 31, 2005, our executive officers,Directors and principal stockholders beneficially own approximately 25.2% ofour outstanding common stock. As a result, these stockholders, acting together,will have the ability to exert substantial influence over all matters requiringapproval by our stockholders, including the election and removal of Directorsand any proposed merger, consolidation or sale of all or substantially all ofour assets and other corporate transactions. This concentration of ownershipcould be disadvantageous to other stockholders with interests different fromthose of our officers, Directors and principal stockholders.

***In 2005, the Company was advised by its auditor of materialweaknesses in the Company’s internal controls and procedures, the correction ofwhich will result in increased cost to the Company.***

Our independent registeredpublic accounting firm has advised our management and Board of Directors thatthere were material weaknesses in our internal controls and procedures duringthe year ended December 31, 2005. Management believes that until these materialweaknesses are corrected, a 

12

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potential misapplication of generally acceptedaccounting principles or potential accounting error in our financial statementscould occur. Enhancing our internal controls to correct the material weaknesseshas and will result in increased costs to us. The identified materialweaknesses relate to significant deficiencies were identified in our internalcontrol over financial reporting relating to the preparation and review offinancial statements and disclosures, identification and resolution of complexaccounting issues, segregation of duties, accounting policies and procedures,information technology systems, and revenue recognition and billing. Managementand Ehrhardt Keefe Steiner & Hoffman PC have determined that thesesignificant deficiencies, in the aggregate, constitute a material weakness ininternal control over financial reporting. Specifically, our staffing levelswere inadequate to facilitate the design, implementation and maintenance of aneffective system of internal control.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

None.

**ITEM 2.**             PROPERTIES

**Description ofProperties**

***Powder River Basin Geology***

In December 1994, there were approximately 200wells in the Powder River Basin producing coal-bed methane gas. Since 1994,over 15,000 gas wells have been drilled in this area and the State of Wyomingand the Bureau of Land Management (“BLM”) have the authority to grant over15,000 additional drilling permits. Production in 1994 was 2.4 billion cubicfeet, and production in 2003 was 3.46 billion cubic feet (Source: Wyoming Oiland Gas Conservation Commission). The average well-life of a coal-bed methanewell is estimated by the BLM to be eight to ten years.

Gas produced from Powder River Basin coals is almost100% methane. The gas is generated during the coal forming process and istrapped in the coal beds by water. In order to produce the coal gas, theformation must first be dewatered. As the water is removed from the coal, thegas is desorbed from the coal. All of the coal-bed reservoirs are low pressureand require compression in order for the gas to be delivered to a pipelinetransportation system.

Natural gas wells in thePowder River Basin area typically experience sharp declines in productionvolume in the first several years of production. Production then stabilizes anddeclines more ratably over a gas well’s average life of approximately eight toten years. Other factors which influence the initial and long term productivityof the coal-bed methane wells are the depths of the coal fields, the initialgas saturation levels of the coal field and the well spacing.

***TOP Gathering System***

Effective January 1, 2004, we acquired the TOPgathering system located in Campbell County, Wyoming. The TOP system wasconstructed in late 2001 and began operations early in 2002. The systemconsists of 4.5 miles of 8-inch coated steel pipeline. The pipelineservices producers of coal-bed methane in the Powder River Basin and iscurrently gathering from 56 wells operated by 2 independent natural gascompanies, transporting approximately 2 million cubic feet of gas per day.

The gathering system has a current throughput capacityof approximately 4 million cubic feet (“MMcf”) of gas per day and is presentlyaveraging approximately 2 million cubic feet per day or approximately 50% of capacity.Our current fees range from $0.55 to $0.84 per thousand cubic feet (“Mcf”) ofnatural gas from 2 producers. Gathering fees are subject to contracts which arelife of lease or 10-year contracts expiring in 2012.

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As a result of a lack ofdrilling in the areas around our TOP system, we determined the system’scarrying value was higher than its fair market value. Accordingly, we recordeda non-cash impairment charge to adjust the carrying value to the fair marketvalue. We plan on shutting down or selling the TOP system. See Note 17—SubsequentEvents to our consolidated financial statements in Item 8 of this report. Foradditional information on this impairment see Note 5—Property, Equipment andContracts to our consolidated financial statements in Item 15 of this report.

***Bear Paw Gathering Systems***

Effective August 1,2004, we acquired certain gathering systems and related contracts from BPElocated in Campbell County, Wyoming. The systems acquired include thefollowing:

·       GAPgas gathering system;

·       BonePile gas gathering system;

·       SouthKitty delivery line; and

·       AntelopeValley delivery line.

Concurrent with the acquisition, we entered into anoperations agreement with BPE. The agreement requires BPE to operate thesystems for us, including repairs, maintenance and compression services, for amonthly fee of $80,000. We are responsible for any major repair and/ormaintenance expenditure in excess of $5,000 per occurrence. The agreementoriginally was a two-year agreement with two one-year extensions at our option.If we terminate the agreement before the four year period is up, for reasonsother than a change of control at BPE, we will enter into an agreement to leasecompression from BPE for the remainder of the four year period. All otherexpenses associated with ownership of the acquired properties are ourresponsibility, including property taxes, rights of way payments and insurance.

***GAP Gas GatheringSystem.******  ***The system was constructed in 1999 andconsists of approximately 25 miles of 12 to 20-inch steel pipe and 127ditch miles of low pressure poly pipe. The gathering system services nineproducers of coal-bed methane in the Powder River Basin.

The gathering line has a current throughput capacityof approximately 18 million cubic feet of gas per day and is presentlyaveraging approximately 3.5 million cubic feet per day or approximately 19% ofcapacity. This system gathers gas from approximately 300 coal-bed wells. Currentfees average $0.80 per Mcf of methane gas. One producer accounts for approximately60% of our revenues from this system.

All of the gas gathering lines within the GAPgathering system send gas to the South GAP facility where the gas is compressedand dehydrated. This high pressure gas stream is then delivered to our AntelopeValley Delivery Line.

***Bone Pile GasGathering System.******  ***The system was constructed in2000 and consists of approximately 9 miles of 8-inch and 16-inchpipeline and 25 miles of low pressure poly pipe. The system services producersof coal-bed methane in the Powder River Basin and is currently gathering from125 wells owned by 1 producer and approximately 20 wells from other producers.

The system has a current throughput capacity ofapproximately 9 million cubic feet of gas per day and is presently averagingapproximately 0.6 million cubic feet per day or approximately 7% of capacity.The system is scheduled to be reconfigured during 2006 to decrease costs,increase operating efficiency and optimize compression. Current fees average$0.52 per Mcf of methane gas. One customer accounts for 90% of our revenuesfrom this system.

After the gas is gathered, it is compressed,dehydrated and delivered to our Antelope Valley Delivery Line.

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***South KittyDelivery Line.*****  **Thesystem was constructed in 2002 and consists of 6 miles of 12-inchpipeline. The line services the South Kitty coal-bed methane development area. Certainshippers move gas down this line in order to sell gas in the local market. TheSouth Kitty line delivers gas into the Bone Pile gathering system and is thensent to our Antelope Valley Delivery Line.

The line has a current throughput capacity in excessof 10 million cubic feet of gas per day and is presently averagingapproximately 1.9 million cubic feet per day or approximately 19% of capacity.

***Antelope Valley Delivery Line.******  ***The system wasconstructed in 1999 and consists of 14 miles of 10-inch pipeline. Theline had an original capacity of approximately 50 million cubic feet of gas perday and is currently configured for 27 million cubic feet per day. The systemis presently averaging approximately 5.7 million cubic feet per day orapproximately 21% of capacity. The gas received from the Bone Pile and GAPgathering systems is transported down the Antelope Valley line and deliveredinto two major transportation lines.

**Reserves**

We engage Sproule Associates Inc., geological andpetroleum engineering consultants, to estimate our natural gas reserves. Weemphasize that reserve estimates are imprecise by their nature, and thatreserve estimates on new discoveries and developments are less precise thanreserve estimates for existing fields. Accordingly, the Company expects theseestimates to change as time passes and information as to actual wellperformance can be included in those future estimates. The Company also reviewsthe calculations and assumptions that Sproule Associates Inc. uses to calculateour reserves.

Proved oil and gas reserves are estimates ofrecoverable quantities of oil, natural gas and natural gas liquids that aredetermined using engineering and geological data with reasonable certainty. Thereserve estimates are based on existing economic and operating conditions andinclude only existing wells from known reservoirs with existing equipment andtechnology. All of the Company’s proved reserves are located in the PowderRiver Basin area of Wyoming.

Thefollowing table summarizes proved reserves data at December 31, 2005:

| **Year Ended December 31, 2005**                     | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Gas (MMcf)                                                               |       | 396        |       |
| Standardized  measure of discounted future net cash flows (in thousands) |       | $          | 688        |       |
| Proved developed  reserves                                               |       | 100        | %          |
|                                                                          |            |            |            |            |            |  |

 

**Production**

Thefollowing table summarizes the production volumes and realized prices for gassold from our properties during the year ended December 31, 2005.

| **Year Ended  December 31, 2005**  | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------|------------|------------|------------|
| Net gas  production (MMcf)              |       | 6          |       |
| Average net daily  gas production (Mcf) |       | 85         |       |
| Average realized  price of gas per Mcf  |       | $8.50      |       |
| Lease operating  expense per Mcf        |       | $4.22      |       |
| Production taxes  per Mcf               |       | $1.06      |       |
| Transportation expense  per Mcf         |       | $0.38      |       |

 

**Productive Wells**

As of December 31,2005 we had working interests in 10 productive wells (4 wells net). Productivewells are either producing or capable of producing although shut-in orde-watering.

15

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**Drilling Activity**

All ofour drilling activity is performed by independent drilling contractors.****During the year ended December 31,2005, we participated in the drilling of the wells listed in the followingtable:

| ** **         | ** ** | **Year Ended  December 31, 2005** | ** ** |
|--------------------|------------|--------------------------------------------------|------------|
| **Gas Wells** | ** ** | ** **                                       | ** ** | **Gross** | ** ** | **Net** | ** ** |
| Exploratory        |       |                                             | 18         |   |   |   | 7 |   |   |
| Development        |       |                                             | 6          |   |   |   | 3 |   |   |
| Total              |       |                                             | 24         |   |   |   | 10 |   |   |
|                    |            |                                                  |            |  |  |  |  |  |  |  |  |

 

As part of our Farm-In andDevelopment Agreement with Rocky Mountain Gas we also earned a 50% interest in4 gross wells (2 wells net) by completing these wells, although these wells hadbeen drilled prior to the initial date of our agreement.

**Acreage**

Thefollowing table details the gross and net acres of developed and undevelopedproperties that we hold. All of the developed and undeveloped acreage includedherein has been earned as part of the Company’s Farm-In and DevelopmentAgreement with Rocky Mountain Gas.

| ** ** | ** ** | **Developed** | ** ** | **Undeveloped** | ** ** | **Total** | ** ** |
|------------|------------|---------------|------------|-----------------|------------|-----------|------------|
| ** ** | ** ** | **Gross**     | ** ** | **Net**         | ** ** | **Gross** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Net** | ** ** |
| Montana    |       | —        |       | —          |       | 5,893     |       | 2,357 |   | 5,893 |   | 2,357 |   |
| Wyoming    |       | 2,240         |       | 896             |       | 737       |       | 638 |   | 2,977 |   | 1,534 |   |
| Total      |       | 2,240         |       | 896             |       | 6,630     |       | 2,995 |   | 8,870 |   | 3,891 |   |

 

**Office Facilities**

We currently lease officespace for our Corporate Headquarters in Denver, Colorado as well as officespace for our Gillette Wyoming Field Operations office.

**ITEM 3.**                LEGALPROCEEDINGS

None.

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

On October 14, 2005,the Company held a special meeting where the stockholders approved an amendmentto Article Sixth of the Company’s Amended and Restated Articles ofIncorporation to provide that the number of Directors shall be a variablenumber consisting of at least one Director but no more than nine Directors andthat the exact number of Directors shall be established by the Board ofDirectors. Prior to this amendment Article Sixth stipulated that thenumber of Directors would be five. This amendment passed by a vote of 1,453,875for, 1,250 against, 2,838 withheld. There were no abstentions or brokernon-votes.

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**PART II**

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

**Principal Marketand Price Range of Common Stock**

Ourcommon stock began trading on the American Stock Exchange on April 12,2005 under the trading symbol PRB. The following table presents the reportedhigh and low sales prices for periods ended:

| **2005**       | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|------------|------------|----------|------------|---------|------------|
| Second quarter |       | $          | 9.95       |     | $          | 6.21    |       |
| Third quarter  |       | $          | 10.32      |     | $          | 5.38    |       |
| Fourth quarter |       | $          | 7.60       |     | $          | 5.41    |       |

 

As of April 5, 2006,we had approximately 29 holders of record of our common stock. This does notinclude holdings in street or nominee names. On April 5, 2006, the closingprice of our common stock was $5.66 per share.

**Dividend Policy**

We have never paidcash dividends on our common stock and we do not anticipate paying dividends inthe foreseeable future. We expect that we will retain all available earningsgenerated by our operations for the development and growth of our business. Inaddition, under the terms of our convertible subordinated notes that wereissued in the first quarter 2006, we are prohibited from declaring or payingcash dividends on our common stock during the period that any note isoutstanding and unpaid. Payment of any future dividends will be at thediscretion of our Board of Directors after taking into account many factors,including our operating results, financial condition, current and anticipatedcash needs, plans for expansion and the above-noted debt agreement.

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**ITEM 6.**                SELECTEDFINANCIAL DATA

The selected consolidated financial data for each ofthe two years in the period ended December 31, 2005 and the selectedconsolidated balance sheet data as of December 31, 2005 and 2004 arederived from, and qualified by reference to, our audited Consolidated FinancialStatements in Item 15 of this report. The selected financial data for each ofthe periods presented ending December 31, 2003, 2002 and 2001and theselected balance sheet data as of December 31, 2003, 2002 and 2001 arederived from audited financial statements of TOP, our predecessor company.

Thefollowing financial data should be read in conjunction with, and are qualifiedby reference to, our Consolidated Financial Statements and related notesthereto in Item 8 of this report and Management’s Discussion and Analysis ofFinancial Condition and Results of Operations included in Item 7 of thisreport.

| ** **                                           | ** ** | **PRB Gas Transportation, Inc.**                                            | ** ** | **TOP Gathering, LLC (Predecessor)** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **Year Ended December 31,**                                                 | ** ** | **Year Ended December 31,**          | ** ** | **Period from  Inception  through  December 31,** | ** ** |
| ** **                                           | ** ** | **2005**                                                                                   | ** ** | **2004**                                            | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                           | ** ** | ** **                                                                                 | ** ** | **(As restated)**                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **(in thousands, except per share and volume amounts)** | ** ** |
| Statement of operations  data:                       |       |                                                                                       |       |                                                |       |   |   |   |   |   |   |   |   |
| Total revenue                                        |       | $                                                                                          | 3,155      |                                                | $          | 2,532 |   | $ | 1,999 |   | $ | 2,097 |   |   | $ | — |   |   |
| Operating expenses                                   |       | 7,822                                                                                      |       | 3,154                                               |       | 1,900 |   | 2,725 |   |   | 2 |   |   |
| Operating (loss) income                              |       | (4,667                                                                                     | )          | (622                                                | )          | 99 |   | (627 | ) |   | (2 | ) |   |
| Net (loss) income—Note  (1)                     |       | (4,625                                                                                     | )          | (651                                                | )          | 79 |   | (636 | ) |   | (2 | ) |   |
| Net loss per share—basic  and diluted           |       | $                                                                                          | (0.69      | )                                                   | $          | (1.33 | ) | $ | — |   | $ | — |   |   | $ | — |   |   |
| Weighted average shares  of common stock outstanding |       | 6,959,025                                                                                  |       | 1,398,907                                           |       | — |   | — |   |   | — |   |   |
| Balance sheet data (at  year end):                   |       |                                                                                       |       |                                                |       |   |   |   |   |   |   |   |   |
| Cash and equivalents                                 |       | $                                                                                          | 6,434      |                                                | $          | 320 |   | $ | 155 |   | $ | 15 |   |   | $ | 316 |   |   |
| Property and equipment,  net                         |       | 6,024                                                                                      |       | 8,136                                               |       | 618 |   | 1,125 |   |   | 908 |   |   |
| Oil and gas properties                               |       | 1,531                                                                                      |       | —                                              |       | — |   | — |   |   | — |   |   |
| Total assets                                         |       | 17,440                                                                                     |       | 11,399                                              |       | 1,603 |   | 1,899 |   |   | 1,253 |   |   |
| Long term liabilities                                |       | 434                                                                                        |       | 65                                                  |       | 86 |   | 260 |   |   | — |   |   |
| Stockholders’ equity                            |       | 15,257                                                                                     |       | 9,318                                               |       | 820 |   | 1,241 |   |   | 913 |   |   |
| Working capital (deficit)                            |       | 7,014                                                                                      |       | (1,169                                              | )          | 287 |   | 376 |   |   | (24 | ) |   |
| Dividends on preferred  stock                        |       | 204                                                                                        |       | 1,212                                               |       | — |   | — |   |   | — |   |   |
| Cash dividends declared  and paid per common share   |       | 0.00                                                                                       |       | 0.00                                                |       | 0.00 |   | 0.00 |   |   | 0.00 |   |   |
| Cash flow data:                                      |       |                                                                                       |       |                                                |       |   |   |   |   |   |   |   |   |
| Cash (used in) provided  by operating activities     |       | $                                                                                          | (781       | )                                                   | $          | 72 |   | $ | 655 |   | $ | (414 | ) |   | $ | 309 |   |   |
| Cash used in investing  activities                   |       | (2,298                                                                                     | )          | (10,647                                             | )          | (14 | ) | (1,150 | ) |   | (908 | ) |   |
| Cash provided by (used  in) financing activities     |       | 9,193                                                                                      |       | 10,895                                              |       | (500 | ) | 1,262 |   |   | 915 |   |   |
| Reserve data:                                        |       |                                                                                       |       |                                                |       |   |   |   |   |   |   |   |   |
| Gas (MMcf)                                           |       | 396                                                                                        |       | —                                              |       | — |   | — |   |   | — |   |   |

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Note (1) The net loss in 2005 includes a non-cashimpairment charge of $2.487 million ($0.36 per basic and diluted share) and $76thousand for cumulative effect of change in accounting principle ($0.01 perbasic and diluted share). For additional information on these items see Note5—Property, Equipment and Contracts, and Note 7—Asset Retirement Obligations toour consolidated financial statements in Item 8 of this report.

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**ITEM 7.**             MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**General Overview**

We own and operate natural gas gathering systems andcoal-bed methane gas wells in the Powder River Basin of Wyoming. We commencedoperations in January 2004 upon our acquisition of certain gas gatheringand related assets of TOP and increased our gathering and processing activitiesin August 2004 when we acquired certain gas gathering and related assetsof BPE. We were originally organized as a mid-stream energy company providinggathering and processing services to coal-bed methane gas producers. During thethird quarter of 2005, we expanded our operations to include exploring for,developing, producing and marketing natural gas, operating coal-bed methaneproperties and providing management services as contract operator (ourexploration and production segment). These activities are in addition to ourgas gathering and processing segment.

Our strategy is tocontinue this expansion and, where feasible, also provide complimentarygathering and processing services. It is our plan to seek opportunities inconventional oil and gas exploration and production activities in the PowderRiver Basin and in other basins in the continental United States. We also planto improve and grow our existing gas gathering and processing operations.

**Recent Developments**

During September 2005, the Company entered into aFarm-In and Development Agreement, a Management Services Agreement and anOperating Agreement with Enterra Energy Trust and its wholly-owned subsidiaryRocky Mountain Gas (“Rocky Mountain Gas”). The Farm-In and DevelopmentAgreement provided the Company an opportunity to earn interests in RockyMountain Gas’ undeveloped leaseholds located in an area of mutual interest bymaking acquisition and development expenditures during the term of theagreement. In addition, the Company earned a 50% interest in the wells that itdrills and/or completed in the area of mutual interest. Through December 31,2005, the Company made $2.070 million in acquisition and developmentexpenditures and drilled and/or completed 28 wells in the area of mutualinterest. As a result, the Company earned an approximate 4.7% interest in RockyMountain Gas’ undeveloped leaseholds in the area of mutual interest and a 50%interest in the 28 wells as of December 31, 2005. Once completed wells areproductive, future operations are controlled by the Operating Agreement andthis agreement also controls future operations in the case of termination of theFarm-In and Development Agreement.

The Management Services Agreement provided for theCompany to earn management fees by operating certain Rocky Mountain Gasproperties and by providing technical and administrative support on a cost-plusbasis. During the year ended December 31, 2005, the Company earned $270thousand in management fees under the Management Services Agreement.

On March 20, 2006, the Company elected toterminate the Farm-In and Development Agreement and Management ServicesAgreement and agreed to continue to operate the Rocky Mountain Gas propertiesand provide management services for at least 60 days from the termination date.The Company has agreed to continue to drill certain wells that had beenpreviously approved by the State of Wyoming and Rocky Mountain Gas under theterms of the Operating Agreement.

During the year ended December 31, 2006, theCompany expects to incur approximately $150 thousand of general andadministrative expenses subsequent to the termination of the Management ServicesAgreement that will not be billed out as management fees. The Company plans toabsorb these costs as part of its expansion plan in 2006.

During the first quarter 2006, we raised $21.965million, before expenses, by issuing convertible subordinated notes. We intendto use these funds for our capital and acquisition programs.

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During the first quarter of 2006, we acquired two gasgathering systems in the Recluse area of Wyoming. In addition, Termo designatedthe Company as its preferred gatherer for its Homestead Draw Area and thisarrangement included a 9.25% working interest to be owned by the Company. Thereare approximately 30,000 undedicated acres in the Recluse area that offer usthe opportunity to expand both our exploration and production and gathering andprocessing segments. In addition, we acquired a working interest in acreagethat is dedicated to our BPE gas gathering systems. For additional informationsee Note 17—Subsequent Events to our consolidated financial statements in Item 15of this report.

We intend on selling orshutting down our TOP system during the second quarter of 2006. The reductionto our revenue for the year ended December 31, 2006 depends on the datethat the TOP system is sold or shut down. The TOP system operated at a loss forthe year ended December 31, 2005 and we expect the impact of this decisionwill improve our financial results for the year ended December 31, 2006.

**General BusinessTrends and Outlook**

We expect our business tocontinue to be affected by some key trends as discussed below. Our expectationsare based on assumptions made by us and information currently available to us.To the extent our underlying assumptions about or interpretations of availableinformation prove to be incorrect, our expectations may vary materially fromactual results.

***U.S. Gas Supply and Outlook***

We believe that therelatively high levels of demand for natural gas by both the residential andcommercial markets will continue to result in steady or increasing natural gasprices which in turn will drive drilling activity. We believe that an increasein U.S. drilling activity and additional sources of supply such as liquefiednatural gas or imports will be required for the natural gas industry to meetthe expected increased demand for, and compensate for the slowing productionof, natural gas in the United States.

***Rising Interest Rate Environment***

The credit marketsrecently have experienced 50-year record lows in interest rates. Duringthe last several months, we have witnessed increases in interest rates.This could affect our ability to access the debt capital markets. In addition,interest rates on future credit facilities and debt offerings could be higherthan current levels, causing our financing costs to increase accordingly.

**Results ofOperations**

***Overview***

***Revenue.***   Ourgas gathering fees are based on contractual rates with our customers and willvary with system throughput as well as the level of services provided andcustomer mix. Our gas gathering fees are not currently regulated by anygovernmental authority.

Our management services fees were determined inaccordance with our Management Services Agreement with Rocky Mountain Gas andvaried depending on the amount of support services that were required tofulfill our obligations under this contract determined on a cost plus 15%basis. On March 20, 2006, we elected to terminate this contract effective May 19,2006.

Our natural gas revenue will vary based on the priceof natural gas and the quantities and quality of the gas we deliver.

***Gas GatheringExpense.******  ***Gas gathering expense includescompression, operating agreement expense, site supervision costs, maintenanceand operating supplies, property taxes, insurance, land use and surface 

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rights payments andcontract services, all of which are relatively fixed costs. Operating expensesalso include transportation fees paid to others which vary with the throughputon our gathering lines.

***Gas ProductionCosts.***   Gas production costs include productiontaxes, well maintenance, monitoring, utilities, pumping and gauging servicesand supplies required to produce natural gas.

***Asset ImpairmentCharge.******  ***Asset impairment charge represents thedifference between our carrying value of the TOP system and the estimated fairmarket value of the TOP system. See Note 5—Property, Equipment and Contracts toour consolidated financial statements in Item 15 of this report.

***ExplorationExpense.***   Gas exploration expense includesthe costs of drilling unsuccessful exploratory wells. See also our descriptionof exploration expense in our discussion of Critical Accounting Policies andEstimates below.

***Depreciation,Depletion, Amortization and Accretion Expense.******  ***Depreciationexpense relates to our compressor sites, pipelines and other gas gatheringequipment, office furniture, office equipment and computers. Depletion expenserelates to developed and undeveloped leaseholds, capitalized development costsand related equipment. Amortization expense relates to the customer contractsunderlying the gas gathering systems. Accretion expense relates to the changein our asset retirement obligation liability due to the passage of time.Depreciation and amortization expense are based on estimates of the relatedassets’ useful lives. Depletion expense is calculated using theunit-of-production method based on estimated proved or estimated proveddeveloped reserves. Accretion expense is calculated using the effectiveinterest method.

***General andAdministrative Expense.******  ***General andadministrative expense includes the costs associated with our corporate office,including personnel costs, professional fees, office rent and other officesupport costs.

***Interest Expense.******  ***During 2005,we had a note payable to the Bank of Oklahoma under a line of credit in theamount of $1.5 million, secured by our gas gathering assets. Interest waspayable monthly at a fluctuating interest rate at the JPMorgan Chase Bank primerate per annum. The annual interest rate was 5.75% at March 31, 2005.Following the payment of the bank line of credit in full in April 2005,the bank released their security interest in the gathering assets and the$1.0 million certificate of deposit pledged by a preferred stockholder.

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Thefollowing table summarizes the results of operations for the years ended 2005and 2004:

| ** **                                                   | ** ** | **Years Ended  December 31,** | ** ** | **Increase /  (Decrease)** | ** ** | **Percentage  Change**    | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------|------------|---------------------------|------------|
| ** **                                                   | ** ** | **2005**                                | ** ** | **2004**                        | ** ** | **2005 v 2004** | ** ** | **2005 v 2004** | ** ** |
| ** **                                                   | ** ** | **(dollars in thousands)**    | ** ** |
| ** **                                                   | ** ** | ** **                              | ** ** | **(As restated)**          | ** ** | ** **                | ** ** | ** ** | ** ** |
| Gas gathering  revenue                                       |       | $                                       | 2,834      |                            |       | $                         | 2,532      |   |   |   | $ | 302 |   |   |   | 12 | % |   |
| Management fee  revenue                                      |       | 270                                     |       |                            | —     |                      |       |   | 270 |   |   |   | 100 | % |   |
| Natural gas revenue                                          |       | 51                                      |       |                            | —     |                      |       |   | 51 |   |   |   | 100 | % |   |
| Total revenue                                                |       | 3,155                                   |       |                            | 2,532      |                      |       |   | 623 |   |   |   | 25 | % |   |
| Gas gathering  expense                                       |       | 1,755                                   |       |                            | 1,314      |                      |       |   | 441 |   |   |   | 34 | % |   |
| Gas production  costs                                        |       | 34                                      |       |                            | —     |                      |       |   | 34 |   |   |   | 100 | % |   |
| Asset impairment  charge                                     |       | 2,487                                   |       |                            | —     |                      |       |   | 2,487 |   |   |   | 100 | % |   |
| Exploration  expense                                         |       | 450                                     |       |                            | —     |                      |       |   | 450 |   |   |   | 100 | % |   |
| Depreciation,  depletion, amortization and accretion expense |       | 1,067                                   |       |                            | 656        |                      |       |   | 411 |   |   |   | 63 | % |   |
| General and  administrative                                  |       | 2,029                                   |       |                            | 1,184      |                      |       |   | 845 |   |   |   | 71 | % |   |
| Total operating  expenses                                    |       | 7,822                                   |       |                            | 3,154      |                      |       |   | 4,668 |   |   |   | 148 | % |   |
| Operating loss                                               |       | (4,667                                  | )          |                            | (622       | )                         |       |   | (4,045 | ) |   |   | nm |   |   |
| Total other  income (expense)                                |       | 118                                     |       |                            | (29        | )                         |       |   | 147 |   |   |   | nm |   |   |
| Cumulative effect  of change in accounting principle         |       | (76                                     | )          |                            | —     |                      |       |   | (76 | ) |   |   | (100 | )% |   |
| Net loss                                                     |       | $                                       | (4,625     | )                               |       | $                         | (651       | ) |   |   | $ | (3,974 | ) |   |   | nm |   |   |
| Cash (used in) provided by operating activities              |       | $                                       | (781       | )                               |       | $                         | 72         |   |   |   | $ | (853 | ) |   |   | nm |   |   |
| Cash used in  investing activities                           |       | $                                       | (2,298     | )                               |       | $                         | (10,647    | ) |   |   | $ | 8,349 |   |   |   | 78 | % |   |
| Cash provided by  financing activities                       |       | $                                       | 9,193      |                            |       | $                         | 10,895     |   |   |   | $ | (1,702 | ) |   |   | (16 | )% |   |

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nm—percentages greaterthan 200% and comparisons from positive to negative values are considered notmeaningful

***2005 Compared to 2004***

***Revenue.***   Totalrevenue increased $623 thousand, or 25%, primarily due to an acquisition-timingrelated increase of $1.055 million in gas gathering revenue applicable to ourBPE systems which we acquired in August 2004. Revenue from management feesand natural gas sales, activities that were initiated during the year ending December 31,2005, also increased by $270 thousand and $51 thousand, respectively. Theserevenue increases offset a $753 thousand decrease in gas gathering revenuesfrom our TOP system resulting from a decline in volumes and the loss of acustomer. This customer represented 11% of our 2004 revenues. We are currentlyin the process of divesting our assets relating to our TOP gathering system.

***Gas GatheringExpense.****  *Gasgathering expense increased $441 thousand or 34% mainly due to the $721thousand increase in BPE systems operating costs resulting from the timing ofthe acquisition of this system. These costs offset a decrease in gas gatheringexpenses relating to our TOP system as a result of releasing excess compressioncapacity.

***Gas ProductionCosts.***   We incurred gas production costs forthe first time in 2005 as a result of our entry into exploration and productionactivities.

***Asset ImpairmentCharge.****  *In2005, we recorded an asset impairment charge of $2.487 million related toour TOP gas gathering system. As a result of declining volumes and the loss ofa customer, we performed an evaluation of the recoverability of our carryingvalue of this system using undiscounted cash 

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flow projections. Wedetermined that the estimated fair value of these gathering system assets wasless than our carrying value.

The estimated fair value was determined usingdiscounted values of probability weighted expected cash inflows and an independentappraiser’s valuation of our TOP gas gathering system. We also evaluated ourBPE gas gathering system for recoverability of carrying values and wedetermined that no impairment was warranted at December 31, 2005. See alsoNote 5—Property, Equipment and Contracts to our consolidated financialstatements in Item 15 of this report.

***ExplorationExpense.******  ***We incurred $450 thousand ofexploration expense in 2005 relating to the drilling costs of 6 unsuccessfulexploratory wells. Four of these six wells were lost due to mechanical failureand have been subsequently re-drilled.

***Depreciation,Depletion, Amortization and Accretion Expense.***   Depreciation,depletion, amortization and accretion expense increased $411 thousand or 63%primarily due to $491 thousand of additional depreciation and amortizationexpense applicable to the BPE assets which were acquired in August 2004.This increase was offset by lower TOP system depreciation and amortization as aresult of the TOP impairment.

***General and Administrative Expense.****  *General and administrative expenseincreased $845 thousand or 71% mainly due to increases of $381 thousand inprofessional fees, $166 thousand in additional expenses associated with being apublic company and $134 thousand in increased payroll costs. Professional feesincreased due to additional legal, accounting and engineering activitiesassociated with our entering the exploration and production business andexpanding our gas gathering and processing business. All other general andadministrative expense increased $164 thousand, net, during 2005 as compared to2004.

**Liquidity andCapital Resources**

***Cash Flows and Capital Expenditures***

At December 31, 2005, cash and cash equivalentstotaled $6.434 million and we had working capital of $7.014 million.Since our inception, we have financed our operating cash flow needs principallythrough public and private offerings of our equity securities. During the firstquarter of 2006, we raised $21.965 million, before expenses, by issuingconvertible subordinated notes. See Note 17—Subsequent Events to ourconsolidated financial statements in Item 15 of this report. We intend to usethese funds for our capital and acquisition programs.

We believe that our cash and cash equivalents on hand,internally generated cash flows and future financing activities will besufficient to fund our planned operational, drilling and acquisitionexpenditures for the foreseeable future. The amount and allocation of futurecapital and exploration expenditures will depend upon a number of factorsincluding the number and size of available economic acquisitions and drillingopportunities, our cash flows from operating and financing activities and ourability to assimilate acquisitions we make. Also, the impact of oil and gasprices on investment opportunities, the availability of capital and borrowingfacilities and the success of our development and exploratory activities couldlead to changes in funding requirements for future development.

On April 12, 2005, we completed our initialpublic offering of 2,300,000 shares of common stock at $5.50 per share and ourshares commenced trading on the American Stock Exchange under the tradingsymbol “PRB.” On closing the offering on April 15, 2005, we receivedproceeds of $11.273 million net of underwriter’s discounts, commissionsand expenses. Including the additional costs of the offering of $1.104 million,including warrants valued at $583 thousand, our net proceeds were$10.169 million.

We used a portion of the proceeds to retire the$1.550 million balance outstanding under our $1.750 million bank line ofcredit. The bank line of credit was cancelled upon payment in full in April 2005and 

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the security interest inour gathering assets and the $1.0 million certificate of deposit pledgedby a preferred stockholder was released.

***Cash Flow Used inOperating Activities.******  ***In2005, our net loss of $4.625 million was mainly comprised of non-cash chargesincluding $2.487 million of asset impairment expense and $1.067 million ofdepreciation, depletion, amortization and accretion expense. In addition, ournet loss includes $450 thousand of exploration expense resulting from writingoff 6 unsuccessful exploratory wells.

Cash used in operating activities of$781 thousand for the year ended December 31, 2005 was$853 thousand greater than the cash used in operating activities for theyear ended December 31, 2004. This increase was mainly attributable tohigher general and administrative expenses and exploration expense andincreased inventories offset by a larger year-end accounts payable balanceresulting from increased operating activities.

***Cash Flow Used inInvesting Activities.******  ***Cash used in investing activitieswas $2.298 million for the year ended December 31, 2005 representinga decrease of $8.349 million as compared to the year ended December 31,2004. During 2004, we acquired the TOP gas gathering system for$2.960 million and the BPE systems for $7.646 million. During 2005, wemade $2.115 million of capital expenditures, including leasehold acquisitioncosts, primarily for our exploration and production drilling activities.

During 2005, these capital expenditures included $1.531million of exploratory drilling costs. During 2005, we charged $450 thousand ofthese exploratory drilling costs, relating to 6 wells, to exploration expense.At December 31, 2005, $1.081 million of exploratory drilling costs,relating to 12 wells, remained capitalized as wells-in-progress pending thedetermination of proved reserves. None of these wells are in areas requiringmajor capital expenditures before production can begin, nor were any of thesewells completed more than one year ago. These wells are currently undergoingde-watering and we believe that after these wells are de-watered we will beable to determine if we have discovered proved reserves. We estimate that inmid 2006 we will be able to make this determination.

Currently, our 2006 capital expenditure program callsfor investing approximately $30 million in oil and gas exploration, developmentand acquisition projects and gas gathering systems projects. We believe thatcash on hand, cash from operating activities and cash from future financingactives will be sufficient to meet our operating and capital expenditure plansfor the foreseeable future.

***Cash Flow fromFinancing Activities.******  ***Cash provided by financingactivities of $9.193 million for the year ended December 31, 2005represents a decrease of $1.702 million as compared to the year ended December 31,2004. During 2005, we raised $11.007 million, net of costs, from ourinitial public offering and used $1.550 million of those proceeds toretire our bank debt. During 2004, we raised $10.604 million, net of thecosts in respect to our Series A and B preferred private placements, weborrowed $1.5 million and we repurchased 800,000 common shares for$800 thousand. During 2004 and 2005, we paid accrued dividends on our Series Aand B preferred shares, with an increase of $91 thousand during 2005 dueto issuance timing.

During the first quarter of 2006, we raised $21.965million, before expenses, through the issuance of convertible subordinatednotes. It is our current plan to establish new credit facilities, most likelywith financial institutions, to supplement cash on hand and cash generated fromoperating activities for use in our 2006 capital expenditure program.

We do not have any off-balance sheet financingarrangements as of December 31, 2005.

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**ContractualObligations**

Thefollowing table summarizes our future commitments as of December 31, 2005(in thousands):

| ** **           | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|----------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Operating leases     |       | $        | 525        |     | $          | 254      |       | $        | 236        |     | $          | 235            |       | $         | 215        |   |   | $ | 514 |   |   | $ | 1,979 |   |
| Operations contracts |       | 560      |       | —   |       | —   |       | —   |       | —   |       |           | —     |      |       | 560 |   |
| Total commitments    |       | $        | 1,085      |     | $          | 254      |       | $        | 236        |     | $          | 235            |       | $         | 215        |   |   | $ | 514 |   |   | $ | 2,539 |   |

 

The above table does not include asset retirementobligations, debt, accounts payable or other accrued liabilities recorded onour consolidated balance sheet as of December 31, 2005. Asset retirementobligations are not included as the Company cannot determine with accuracy thetiming of such payments. The table does not include any commitments enteredinto after December 31, 2005. See Note 17—Subsequent Events to ourconsolidated financial statements in Item 15 of this report.

The Company has acquiredgas gathering properties and contracts that include operating leases in respectto surface-use rights that are cancelable in the event that gas gatheringactivities cease as a result of declining production. The Company also haspurchase commitments for future field operations and maintenance activitieswith third party providers. In addition, the Company is a party tonon-cancelable operating leases for office space, office equipment and otheritems required for operations, including a compressor for our TOP gas gatheringsystem. The table above includes estimated future purchase commitments relatingto these operations support contracts. With regard to the operating leases,future minimum lease payments are calculated based on the contractual rate andperiod, or if the contract was a surface-use agreement, future minimum leasepayments were calculated based on the estimated lives of the associated gasreserves (through 2014) and the applicable contract rate.

**Preferred StockDividends**

All of our Series A10% preferred stockholders and Series B 5% preferred stockholdersconverted to common stock on April 12, 2005. On April 15, 2005, wepaid $155 thousand in accrued dividends up to the conversion date. Our Series CConvertible Preferred stock does not pay dividends.

**Critical AccountingPolicies and Estimates**

Our discussion andanalysis of our financial condition and results of operations are based upon consolidatedfinancial statements which have been prepared in accordance with accountingprinciples generally accepted in the United States. The preparation of thesefinancial statements requires management to make estimates and judgments thataffect the reported amounts of consolidated assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities as of thedate of the financial statements. Actual results may differ from theseestimates under different assumptions or conditions. We consider the followingpolicies to be the most critical to understanding the judgments that areinvolved and the uncertainties that could impact our results of operations,financial condition and cash flows.

***Revenue Recognition***

We recognize gas gathering revenue in the period thatthe gas gathering and transportation services are provided. Our gas gatheringand transportation contracts specify the rate that can be charged on the basisof cents per thousand cubic feet or Mcf of natural gas. Each contract has aseparately negotiated rate and terms may vary. Certain of our contracts includeseparate charges for compression in addition to a transportation fee. Our gasgathering revenue will increase or decrease in proportion to gas volumedelivered over our system. There are measurement points throughout eachgathering system which enable 

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the gas to be accuratelymeasured and allocated back to either different operators or wells. One of ourgas gathering contracts has a monthly minimum billing clause.

We recognize natural gas revenue when the natural gasis delivered to the purchaser and title of the product has passed.

We recognize managementfee revenue during the period when the services are provided.

***Long-lived Assets***

We calculate depreciationand amortization based on estimated useful lives and salvage values of ourassets. When assets are placed into service, we make estimates with respect totheir useful lives that we believe are reasonable. However, factors such ascompetition, regulation or environmental matters could cause us to change ourestimates, thus impacting the future calculation of depreciation andamortization. We evaluate long-lived assets for potential impairment by identifyingwhether indicators of impairment exist and, if so, assessing whether thelong-lived assets are recoverable from estimated future undiscounted cashflows. The actual amount of impairment loss, if any, to be recorded is equal tothe amount by which a long-lived asset’s carrying value exceeds its fair value.Estimates of future discounted cash flows and fair values of assets requiresubjective assumptions with regard to future operating results and actualresults could differ from those estimates. During the year ended December 31,2005, we recorded a $2.487 million asset impairment charge in respect to ourTOP gas gathering system assets. See Note 5—Property, Equipment and Contractsto our consolidated financial statements in Item 15 of this report. We recordedno impairments of long-lived assets during the year ended December 31,2004.

***Asset Retirement Obligations***

We follow Statement ofFinancial Accounting Standards (“SFAS”) No. 143, “Accounting for AssetRetirement Obligations” and Financial Accounting Standards Board (“FASB”)Interpretation No. 47, “Accounting for Conditional Asset RetirementObligations” (“FIN No. 47”), and related pronouncements. The estimatedfair value of the future costs associated with dismantlement, abandonment andrestoration of facilities was recorded as of the effective date of the TOP andBPE acquisitions. In addition, the estimated fair value of the future costs toplug and abandon gas wells was recorded when the related wells were placed intoservice. The net estimated costs are discounted to present values using a riskadjusted rate over the estimated economic life of the related asset. Such costsare capitalized as part of the cost of the related asset and depreciated. Theassociated liability is classified as a long-term liability and is adjustedwhen circumstances change and for the accretion of expense which is recorded asa component of depreciation and amortization.

***Inventory***

We record inventories atcost and adjust the carrying value of inventory based on the lower of cost ormarket.

***Stock-based Compensation***

We account for employee stock options using theintrinsic value method in accordance with Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees” and relatedinterpretations, and provide pro forma disclosures of net income (loss) as if afair value method had been applied in measuring compensation expense. Stockcompensation expense, which is a non-cash charge, is measured as the excess, ifany, of the fair value of our underlying common stock at the date of grant overthe amount an employee must pay to acquire such stock. This compensation costis amortized over the related vesting periods, generally four years, using anaccelerated method. See also “Recently Issued Accounting Pronouncements” below.

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We determine the fairvalue of our common stock by evaluating a number of factors, including ourfinancial condition and business prospects, our stage of development and thevaluations of similar companies in our industry.

***Contingencies***

In the future, we may besubject to adverse proceedings, lawsuits and other claims related toenvironmental, labor, contractual and other matters. We will be required toassess the likelihood of any adverse judgments or outcomes of these matters as wellas potential ranges of probable losses. A determination of the amount ofreserves required, if any, for these contingencies is made after carefulanalysis of each individual issue. The required reserves may change in thefuture due to developments in each matter or changes in approach such as achange in settlement strategy in dealing with these potential matters.

***Oil and Gas Properties***

We follow the successfulefforts method of accounting for our oil and gas activities. Under this methodwe capitalize the costs of leasehold acquisitions, all successful exploratorywells and the costs of all development wells. We expense the costs associatedwith exploratory wells that are unsuccessful. Also under this method we expensegeological and geophysical costs and the costs of maintaining leaseholdinterests. In the event that the fair market values of our properties declineas a result of lower oil and gas prices, the carrying value of those propertiesis reduced by an impairment charge.

***Exploration Expense***

The Company accounts forexploration and development activities utilizing the successful efforts methodof accounting. Exploration costs, including personnel costs, certain geologicaland geophysical expenses and delay rentals for oil and gas leases, are chargedto expense as incurred. Exploratory drilling costs are initially capitalized,but charged to expense if and when the well is determined not to have foundproved reserves in commercial quantities. The application of the successfulefforts method of accounting requires managerial judgment to determine thatproper classification of wells designated as developmental or exploratory ismade to determine the proper accounting treatment of the costs incurred. Theresults from a drilling operation can take considerable time to analyze and thedetermination that commercial reserves have been discovered requires bothjudgment and industry experience. Wells may be completed that are assumed to beproductive but actually deliver oil and gas in quantities insufficient to beeconomic. This may result in the abandonment of the wells at a later date.Wells are drilled that have targeted geologic structures that are bothdevelopmental and exploratory in nature and an allocation of costs is requiredto properly account for the results. The evaluation of oil and leaseholdacquisition costs requires managerial judgment to estimate the fair value ofthese costs with reference to drilling activity in a given area.

***Recently Adopted Accounting Pronouncements***

We implemented and followFIN No. 47, “Accounting for Conditional Asset Retirement Obligations.” FINNo. 47 clarifies that the term conditional asset retirement obligationrefers to a legal obligation to perform an asset retirement activity in whichthe timing and or method of settlement are conditional on a future event thatmay or may not be within the control of the entity. The obligation to performthe asset retirement activity is unconditional even though uncertainty existsabout the timing and (or) method of settlement. FIN No. 47 was effectivefor us December 31, 2005. We implemented FIN No. 47 on December 31,2005, and accordingly, we recorded a $259 thousand asset retirement obligationassociated with our BPE gas gathering systems in our consolidated balancesheets and also recorded the cumulative 

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effectof adopting this change in accounting principle of $76 thousand in ourconsolidated statements of operations.

***Recently Issued Accounting Pronouncements***

In December 2004, the FASB issued SFAS No. 123R,“Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R requires thatcompensation costs relating to share-based payment transactions be recognizedin financial statements based on the fair value of the equity or liabilityinstruments issued. SFAS No. 123R covers a wide range of share-basedcompensation arrangements including share options, restricted share plans,performance-based awards, share appreciation rights and employee share purchaseplans. Effective April 2005, the Securities and Exchange Commissionextended the implementation date to the beginning of a registrant’s next fiscalyear beginning after June 15, 2005. The provisions of SFAS No. 123Rwere adopted by the Company effective January 1, 2006. As a result of theadoption of SFAS No. 123R, the Company expects to record compensationexpense associated with unvested stock options totaling $432 thousand in futureperiods under the modified-prospective adoption method.

In May 2005, the FASB, as part of an effort toconform to international accounting standards, issued SFAS No. 154, “AccountingChanges and Error Corrections” (“SFAS No. 154”), that is effective for usbeginning on January 1, 2006. SFAS No. 154 requires that allvoluntary changes in accounting principles be retrospectively applied to priorfinancial statements as if that principle had always been used, unless it isimpracticable to do so. When it is impracticable to calculate the effects onall prior periods, SFAS No. 154 requires that the new principle be appliedto the earliest period practicable. The adoption of SFAS No. 154 is notanticipated to have a material effect on our financial position or results ofoperations.

SFAS No. 19, “Financial Accounting and Reportingby Oil and Gas Producing Companies,” specifies that drilling costs forcompleted exploratory wells should be expensed if the related reserves cannotbe classified as proved within one year unless certain criteria are met. In April 2005,the FASB issued FASB Staff Position 19-1, “Accounting for Suspended WellCosts” (“FSP 19-1”). FSP 19-1 provides guidance for evaluatingwhether sufficient progress is being made to determine whether reserves can beclassified as proved. FSP 19-1 is effective for all reporting periodsbeginning after April 4, 2005, and the Company adopted FSP 19-1 uponincurrence of its initial exploratory drilling costs during the fourth quarterof 2005.

We have disclosed ouraccounting policy for capitalization of exploratory drilling costs in theExploration Expense section of Critical Accounting Policies and Estimates discussedabove. We have disclosed capitalized exploratory drilling cost amounts in ourdiscussion of Cash Flow Used in Investing Activities in the Liquidity andCapital Resources section above.

**ITEM 7A.**     QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to certainmarket risks inherent within the intrastate natural gas gathering industry. Weintend to manage our operations in a manner designed to minimize our exposureto such market risks.

***Credit Risk***

Credit risk is the risk ofloss resulting from non-performance of contractual obligations by a customer orjoint venture partner. A substantial portion of our accounts receivable arewith customers in the energy industry and are subject to normal industry creditrisk. We assess the financial strength of our customers through regular creditreviews in order to minimize the risk of non-payment.

***Market Risk***

Market risk is the risk ofloss arising from adverse changes in market rates and prices. Because we sellnatural gas at spot prices our financial results will be affected by changes inthe price of natural gas.

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***Interest Rate Risk***

Interest rate risk willexist with respect to new debt offerings that bear interest at floating rates.At December 31, 2005 we had nobank indebtedness. See Note 17—Subsequent Events to our consolidated financialstatements in Item 15 of this report with respect to our debt offering that weclosed during the first quarter of 2006.

**ITEM 8.**                CONSOLIDATEDFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statementsrequired pursuant to this item are included in Item 15 of this Annual Report onForm 10-K and begin on page F-1.

**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

**Conclusion Regarding theEffectiveness of Disclosure Controls and Procedures**

We maintain disclosure controls and proceduresdesigned to provide reasonable assurance that information required to bedisclosed in our reports under the Securities and Exchange Act of 1934, asamended, is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms, and that such informationis accumulated and communicated to our management, including our ChiefExecutive Officer and Principal Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure. Our management, with theparticipation and oversight of our Chief Executive Officer and Principal FinancialOfficer, evaluated the design and effectiveness of our disclosure controls andprocedures as of December 31, 2005. In conducting this evaluation, severalsignificant deficiencies were identified in our internal control over financialreporting relating to the preparation and review of financial statements anddisclosures, identification and resolution of complex accounting issues,segregation of duties, accounting policies and procedures, informationtechnology systems, and revenue recognition and billing. Management hasdetermined that these significant deficiencies, in the aggregate, constitute amaterial weakness in internal control over financial reporting. Specifically,our staffing levels were inadequate to facilitate the design, implementationand maintenance of an effective system of internal control.

On the basis of thesefindings, our Chief Executive Officer and our Principal Financial Officer haveconcluded that our disclosure controls and procedures were not effective, as ofDecember 31, 2005. In connection with the 2005 audit of our financialstatements, our independent registered public accounting firm issued a draftcommunication letter which noted that we had the significant deficiencies andmaterial weakness, described above, in our internal control over financialreporting.

**Remediation of theMaterial Weaknesses**

In response to thecontrol deficiencies listed above, we have taken (or plan to take during 2006)the following steps to remediate the significant deficiencies identified above:

·       Weplan to increase the accounting staff to provide additional expertise in theareas of SEC reporting and complex accounting issues. Additionally, we haveengaged outside help to assist us with complex accounting and financialreporting matters. Continued training of current staff and the need foradditional resources will be evaluated from time to time.

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·       Weplan to implement disclosure controls and procedures and form a DisclosureCommittee which will provide additional oversight and control over the completenessand accuracy of the Company’s financial statements and disclosures included inperiodic filings with the SEC.

·       Weplan to document our accounting policies and procedures and enhance our monthend close and financial reporting processes to include additional controls toimprove the completeness and accuracy of our periodic financial statements.

·       Weplan to replace our current general ledger software with a more robustaccounting and reporting software package that will enable us to increase ourcontrols over system generated reports.

However, until we have completed a formal review ofour internal controls, and even upon completion of such review, there is noassurance that we will have adequately addressed the identified deficiencies,as has been characteristic of companies that have completed their review ofinternal control and have had to report on the results of such review.Accordingly, our internal control over financial reporting may be subject toadditional material weaknesses and significant deficiencies that we have notidentified.

On September 21,2005, the SEC extended the compliance dates related to Section 404 of theSarbanes-Oxley Act (“Section 404”) for non-accelerated filers. Under thisextension a company that is not required to file its annual and quarterlyreports on an accelerated basis (non-accelerated filer) must begin to complywith the Section 404 internal control over financial reporting evaluationand reporting requirements for its first fiscal year ending on or afterJuly 15, 2007. We anticipate that we may become an accelerated filer incalendar 2006 and therefore we could be required to comply with theserequirements for the year ending December 31, 2006. We are currently inthe process of documenting our internal control structure.

**Changes in InternalControl Over Financial Reporting**

There were no changes inour internal control over financial reporting that occurred during the quarterended December 31, 2005 that materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting.

**ITEM 9B.**       OTHERINFORMATION

None.

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**PART III**

**ITEM 10.**      DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

The required information for this item is incorporatedby reference to our Proxy Statement for the 2006 Annual Meeting ofStockholders, since such Proxy Statement will be filed with the Securities andExchange Commission not later than 120 days after the end of our fiscal yearpursuant to Regulation 14A.

Our Board of Directors hasadopted a Code of Business Conduct & Ethics, included as Exhibit 14.1to this annual report on Form 10-K, that applies to our Directors,executives, officers and employees. Our Code of Business Conduct &Ethics can be found on our website, which is located at www.prbtrans.com. Weintend to make all required disclosures concerning any amendments to, orwaivers from, our Code of Business Conduct & Ethics on our website. Anyperson may request a copy of the Code of Ethics, at no cost, by writing to usat the following address:  PRB Gas Transportation, Inc., 1875Lawrence Street, Suite 450, Denver, Colorado 80202, attention: CorporateSecretary.

**ITEM 11.**      EXECUTIVECOMPENSATION

The required informationfor this item is incorporated by reference to our Proxy Statement for the 2006Annual Meeting of Stockholders, since such Proxy Statement will be filed withthe Securities and Exchange Commission not later than 120 days after the end ofour fiscal year pursuant to Regulation 14A.

**ITEM12.**      SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The required informationfor this item is incorporated by reference to our Proxy Statement for the 2006Annual Meeting of Stockholders, since such Proxy Statement will be filed withthe Securities and Exchange Commission not later than 120 days after the end ofour fiscal year pursuant to Regulation 14A.

**Equity CompensationPlan**

Thefollowing table is a summary of the shares of Common Stock authorized forissuance under the Company’s Equity Compensation Plan as of December 31,2005.

| **Plan category**                                  | ** ** | ** ** | ** ** | **Number of securities to  be issued upon exercise  of outstanding options  and other rights** | ** ** | **Weighted-average  exercise price of   outstanding options  and other rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation plans(1)** | ** ** |
|---------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plan approved by stockholders      |       |       | 463,250    |                                                                                                                                             |       |                                                                                                          | $          | 6.74                                                                                                                                           |       |   |   | 279,939 | ** ** |   |
| Equity  compensation plans not approved by stockholders |       |       | —     |                                                                                                                                             |       |                                                                                                          | —     |                                                                                                                                           |       |   | — | ** ** |   |
| Total                                                   |       |       | 463,250    |                                                                                                                                             |       |                                                                                                          | $          | 6.74                                                                                                                                           |       |   |   | 279,939 | ** ** |   |

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(1)          OurBoard of Directors and stockholders approved our Equity Compensation Plan in May 2004.We have authorized a total of 10% of the number of shares outstanding forissuance under this plan. As of December 31, 2005, a total of 743,189shares of Common Stock are authorized for issuance.

**ITEM 13.**      CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The required informationfor this item is incorporated by reference to our Proxy Statement for the 2006Annual Meeting of Stockholders, since such Proxy Statement will be filed withthe Securities and Exchange Commission not later than 120 days after the end ofour fiscal year pursuant to Regulation 14A.

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**ITEM 14.**      PRINCIPALACCOUNTANT FEES AND SERVICES

The required informationfor this item is incorporated by reference to our Proxy Statement for the 2006Annual Meeting of Stockholders, since such Proxy Statement will be filed withthe Securities and Exchange Commission not later than 120 days after the end ofour fiscal year pursuant to Regulation 14A.

**PART IV**

**ITEM 15.**      EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

**15(a)(1) ConsolidatedFinancial Statements.**

The followingconsolidated financial statements of PRB Gas Transportation, Inc. arefiled as part of this report:

| Report of  Independent Registered Public Accounting Firm        |   | F-1                  |   |
|-----------------------------------------------------------------|--------|----------------------|--------|
| Consolidated  Balance Sheets                                    |   | F-2                  |   |
| Consolidated  Statements of Operations                          |   | F-3                  |   |
| Consolidated  Statement of Changes in Stockholders’ Equity |   | F-4                  |   |
| Consolidated  Statements of Cash Flows                          |   | F-5                  |   |
| Notes to Consolidated  Financial Statements                     |   | F-6 - F-29 |   |

 

**15(a)(2) FinancialStatement Schedules.**

Schedules are omittedbecause they are not required or because the information is provided elsewherein the financial statements.

**15(a)(3) Exhibits.**

| Exhibit  Number | ** ** | **Description**                                                                                                                                                                             |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1.1)           |       | Form of Underwriting Agreement (filed as an exhibit to  Form S-1/A filed on April 12, 2005 and incorporated by  reference herein).                                           |
| (3.1)           |       | Amended Articles of Incorporation of the Registrant  (filed as an exhibit to Form S-1/A filed on January 28, 2005  and incorporated by reference herein).                         |
| (3.2)           |       | Amended By-laws of the Registrant (filed as an exhibit  to Form S-1/A filed on January 28, 2005 and incorporated by  reference herein).                                           |
| (3.3)           |       | Series A Preferred Stock Certificate of  Designation (filed as an exhibit to Form S-1 filed on  November 1, 2004 and incorporated by reference herein).                      |
| (3.4)           |       | Series B Preferred Stock Certificate of  Designation Filed (filed as an exhibit to Form S-1 filed on  November 1, 2004 and incorporated by reference herein).                |
| (3.5)           |       | Series C Preferred Stock Certificate of  Designation Filed (filed as an exhibit to Form S-1/A filed on  January 28, 2005 and incorporated by reference herein).              |
| (4.1)           |       | Form of Lockup Agreement—Officers, Directors  and 5% Stockholders (filed as an exhibit to Form S-1/A filed on  November 1, 2004 and incorporated by reference herein).  |
| (4.2)           |       | Form of Lockup Agreement—Series A and B  Preferred Stockholders (filed as an exhibit to Form S-1 filed on  November 1, 2004 and incorporated by reference herein). |
| (4.3)           |       | Form of Underwriter’s Warrant Agreement (filed  as an exhibit to Form S-1/A filed on January 28, 2005 and  incorporated by reference herein).                           |

32

----

 

| (4.4)   |   | Form of Lockup Agreement—Series C  Preferred Stockholders (filed as an exhibit to Form S-1/A filed on  January 28, 2005 and incorporated by reference herein).                             |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (4.5)   |   | Sample Common Stock Certificate (filed as an exhibit  to Form 8-A filed on April 8, 2005).                                                                                                                |
| 4.6     |   | Form of Senior Subordinated Convertible Note                                                                                                                                                                   |
| 4.7     |   | Form of Regitration Rights Agreement between  the Company and the holders of the Company’s Senior Subordinated Convertible  Notes                                                                         |
| (5.1)   |   | Opinion of Resch Polster Alpert & Berger  LLP (filed as an exhibit to Form S-8 on September 14, 2005  and incorporated by reference herein).                                                     |
| (10.1)* |   | Equity Compensation Plan Filed (filed as an exhibit  to Form S-1 filed on November 1, 2004 and incorporated by  reference herein).                                                                        |
| (10.2)  |   | Form of Amended and Restated Warrant  Certificate (filed as an exhibit to Form S-1/A filed on  March 1, 2005 and incorporated by reference herein).                                                  |
| (10.3)  |   | TOP Gathering, LLC Asset Purchase Agreement (filed  as an exhibit to Form S-1/A filed on January 28, 2005 and  incorporated by reference herein).                                                         |
| (10.4)  |   | Bear Paw Energy, LLC Purchase and Sale Agreement  (filed as an exhibit to Form S-1 filed on November 1, 2004  and incorporated by reference herein).                                                      |
| (10.5)  |   | Bear Paw Energy, LLC Mortgage, Security Agreement,  Assignment of Proceeds, and Financing Statement (filed as an exhibit to  Form S-1/A filed on January 28, 2005 and incorporated by  reference herein). |
| (10.6)  |   | Bear Paw Energy, LLC Promissory Note (filed as an  exhibit to Form S-1/A filed on January 28, 2005 and  incorporated by reference herein).                                                                |
| (10.7)  |   | Bear Paw Energy, LLC Operations Agreement (filed as  an exhibit to Form S-1 filed on November 1, 2004 and  incorporated by reference herein).                                                             |
| (10.8)  |   | Bank of Oklahoma Promissory Note (filed as an exhibit  to Form S-1/A filed on March 1, 2005 and incorporated by  reference herein).                                                                       |
| (10.9)  |   | Bank of Oklahoma Mortgage and Security Agreement  (filed as an exhibit to Form S-1/A filed on March 1, 2005 and  incorporated by reference herein).                                                       |
| (10.10) |   | Gathering Services Agreement—United Energy Trading,  LLC (filed as an exhibit to Form S-1/A filed on March 1, 2005  and incorporated by reference herein).                                           |
| (10.11) |   | Gathering Services Agreement—Pennaco Energy Inc.  (filed as an exhibit to Form S-1/A filed on March 1, 2005 and  incorporated by reference herein).                                                  |
| (10.12) |   | Gathering Services Agreement—Natural Gas Fuel  Company, Inc. (filed as an exhibit to Form S-1/A filed on  March 1, 2005 and incorporated by reference herein).                                  |
| (10.13) |   | Farmout and Development Agreement dated  August 1, 2005 between Rocky Mountain Gas, Inc. and PRB  Energy, Inc. (filed as an exhibit to Form 8-K filed on  September 9, 2005).              |
| (10.14) |   | Management Services Agreement dated August 1,  2005 between Rocky Mountain Gas Inc., Enterra Energy Trust and PRB  Energy, Inc. (filed as an exhibit to Form 8-K filed on  September 9, 2005).  |
| 10.15   |   | Form of Subscription Agreement between the  Company and the subscribers to the Company’s Senior Subordinated Convertible  Notes                                                                           |

33

----

 

| 14.1   |   | Code of Business Conduct and Ethics                                                                                                                       |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
| (23.1) |   | Consent of Resch Polster Alpert & Berger  LLP—see exhibit 5.1                                                                               |
| 23.2   |   | Consent of Ehrhardt Keefe Steiner & Hottman  PC                                                                                                  |
| (23.3) |   | Consent of Brownstein. Hyatt and Farber P.C. (filed  as an exhibit to Form S-1/A filed on March 1, 2005 and  incorporated by reference herein). |
| 24.1   |   | Powers of Attorney, incorporated by reference to  Signature page attached hereto.                                                                    |
| 31.1   |   | Chief Executive Officer Certification pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                    |
| 31.2   |   | Principal Financial Officer Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002.                                                |
| 32.1   |   | Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                       |

 

These exhibits are available upon request. Exhibitsidentified in parentheses below are on file with the SEC and are incorporatedherein by reference. All other exhibits are provided as part of this electronicsubmission.

----

()                 Previously filed.

*                    Managementcontract or compensatory plan or arrangements.

34

----

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, PRB GasTransportation, Inc. has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.

 

|                       |   | **PRB Gas  Transportation, Inc.**(Registrant)      |
|----------------------------|--------|---------------------------------------------------------|
| Date: April 13,  2006 |   | /s/ WILLIAM P. BRAND, JR.                          |
|                       |   | William P. Brand, Jr.*Vice President—Finance* |

 

**POWER OF ATTORNEY**

KNOW ALL PERSONS BY THESE PRESENTS, that each personwhose signature appears below constitutes and appoints William P. Brand, Jr.as his attorney-in-fact, with full power of substitution, for him in any andall capacities to sign any amendments to this Report on Form 10-K,and to file the same, with exhibits thereto and other documents in connectiontherewith, with the Securities and Exchange Commission, hereby ratifying andconfirming all that said attorneys-in-fact, or their substitutes, may do orcause to be done by virtue hereof.

Pursuantto the requirements of the Securities Act of 1934, this report has been signedby the following persons in the capacities and on April 13, 2006.

| ** **                     | **Signature** | ** **                                       | ** ** |  | **Title** | ** ** |
|--------------------------------|---------------|--------------------------------------------------|------------|--|-----------|------------|
| /s/ ROBERT W. WRIGHT           |          | Chairman and  Chief Executive Officer            |
| Robert W. Wright               |          |                                             |
| /s/ WILLIAM F. HAYWORTH        |          | President, Chief  Operating Officer and Director |
| William F. Hayworth            |          |                                             |
| /s/ WILLIAM P. BRAND, JR. |          | Vice President—Finance                      |
| William P.  Brand, Jr.    |          |                                             |
| /s/ THOMAS J. JACOBSEN         |          | Director                                         |
| Thomas J. Jacobsen             |          |                                             |
| /s/ REUBEN SANDLER             |          | Director                                         |
| Reuben Sandler                 |          |                                             |
| /s/ JAMES P. SCHADT            |          | Director                                         |
| James P. Schadt                |          |                                             |
| /s/ JOSEPH W. SKEEHAN          |          | Director                                         |
| Joseph W. Skeehan              |          |                                             |
| /s/ JUSTIN W. YORKE            |          | Director                                         |
| Justin W. Yorke                |          |                                             |

 

 

35

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**REPORT OFINDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

Board of Directors and StockholdersPRB Gas Transportation, Inc. and subsidiaryDenver, Colorado

We have audited the accompanying consolidated balancesheets of PRB Gas Transportation, Inc. and its subsidiary as of December 31,2004 and 2005 and the related consolidated statements of operations, changes instockholders’ equity and cash flows for the years then ended. Theseconsolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

We conducted our audits in accordance with standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances butnot for the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of PRB Gas Transportation, Inc. and its subsidiary as of December 31,2004 and 2005, and the results of their operations and their cash flows for theyears then ended in conformity with accounting principles generally accepted inthe United States of America.

As discussed in Note 3 to the consolidated financialstatements, the Company determined that revenues had been billed incorrectlyunder a certain contract during 2005. Accordingly, the 2004 consolidatedfinancial statements have been restated to correct the error.

As discussed in Note 5 to the consolidated financialstatements, the Company adopted Financial Accounting Standards BoardInterpretation No. 47, “Accounting for Conditional Asset RetirementObligations,” effective December 31, 2005.

/s/Ehrhardt Keefe Steiner &Hottman PC

March 30, 2006Denver, Colorado

F-1

----

**PRB Gas Transportation, Inc.Consolidated Balance Sheets(In thousands except share amounts)**

| ** **                                                                                                                                                                                                                     | ** ** | **December 31, 2005** | ** ** | **December 31, 2004**               | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                                                                                                                     | ** ** | ** **                      | ** ** | **(As restated,  see Note 3)** | ** ** |
| **Assets**                                                                                                                                                                                                                     |       |                            |       |                                          |       |   |   |   |   |
| Current assets                                                                                                                                                                                                                 |       |                            |       |                                          |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                                      |       |                            | $          | 6,434                                         |       |   |   | $ | 320 |   |   |
| Accounts receivable                                                                                                                                                                                                            |       |                            | 789        |                                          |       |   | 424 |   |   |
| Inventory, net                                                                                                                                                                                                                 |       |                            | 1,346      |                                          |       |   | — |   |   |
| Prepaid expenses                                                                                                                                                                                                               |       |                            | 194        |                                          |       |   | 103 |   |   |
| Total current assets                                                                                                                                                                                                           |       |                            | 8,763      |                                          |       |   | 847 |   |   |
| Property and equipment, net                                                                                                                                                                                                    |       |                            | 6,024      |                                          |       |   | 8,136 |   |   |
| Oil and gas properties  accounted for under the successful efforts method of accounting                                                                                                                                        |       |                            |       |                                          |       |   |   |   |   |
| Proved properties, net                                                                                                                                                                                                         |       |                            | 314        |                                          |       |   | — |   |   |
| Unproved leaseholds                                                                                                                                                                                                            |       |                            | 136        |                                          |       |   | — |   |   |
| Wells-in-progress                                                                                                                                                                                                              |       |                            | 1,081      |                                          |       |   | — |   |   |
| Total oil and gas properties                                                                                                                                                                                                   |       |                            | 1,531      |                                          |       |   | — |   |   |
| Other non-current assets                                                                                                                                                                                                       |       |                            |       |                                          |       |   |   |   |   |
| Deferred costs of raising capital                                                                                                                                                                                              |       |                            | —     |                                          |       |   | 267 |   |   |
| Deposits                                                                                                                                                                                                                       |       |                            | 23         |                                          |       |   | 4 |   |   |
| Contracts, net                                                                                                                                                                                                                 |       |                            | 1,099      |                                          |       |   | 2,145 |   |   |
| Total other non-current assets                                                                                                                                                                                                 |       |                            | 1,122      |                                          |       |   | 2,416 |   |   |
| Total assets                                                                                                                                                                                                                   |       |                            | $          | 17,440                                        |       |   |   | $ | 11,399 |   |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                 | ** ** |                            |       |                                          |       |   |   |   |   |
| Current liabilities                                                                                                                                                                                                            |       |                            |       |                                          |       |   |   |   |   |
| Accounts payable                                                                                                                                                                                                               |       |                            | $          | 1,652                                         |       |   |   | $ | 138 |   |   |
| Other accrued expenses and current liabilities                                                                                                                                                                                 |       |                            | 97         |                                          |       |   | 44 |   |   |
| Accrued TOP acquisition costs                                                                                                                                                                                                  |       |                            | —     |                                          |       |   | 200 |   |   |
| Dividends payable                                                                                                                                                                                                              |       |                            | —     |                                          |       |   | 134 |   |   |
| Note payable                                                                                                                                                                                                              |       |                            | —     |                                          |       |   | 1,500 |   |   |
| Total current liabilities                                                                                                                                                                                                      |       |                            | 1,749      |                                          |       |   | 2,016 |   |   |
| Retail installment sale contract                                                                                                                                                                                               |       |                            | 27         |                                          |       |   | — |   |   |
| Deferred rent                                                                                                                                                                                                                  |       |                            | 20         |                                          |       |   | — |   |   |
| Asset retirement obligations                                                                                                                                                                                                   |       |                            | 387        |                                          |       |   | 65 |   |   |
| Total liabilities                                                                                                                                                                                                              |       |                            | 2,183      |                                          |       |   | 2,081 |   |   |
| Commitments and  Contingencies                                                                                                                                                                                                 |       |                            |       |                                          |       |   |   |   |   |
| Stockholders’ equity                                                                                                                                                                                                      |       |                            |       |                                          |       |   |   |   |   |
| Capital, 50,000,000 shares authorized, par value  $0.001, 5,639,000 shares undesignated Series A, B and C Convertible  Preferred, 4,361,000 shares authorized; 40,000 and 4,361,000 issued and  outstanding, respectively |       |                            | *          |                                          |       |   | 4 |   |   |
| Common stock, 40,000,000 shares authorized; 8,231,894  issued; 7,431,894 and 800,000 outstanding, respectively                                                                                                                 |       |                            | 8          |                                          |       |   | 2 |   |   |
| Treasury stock                                                                                                                                                                                                                 |       |                            | (800       | )                                             |       |   | (800 | ) |   |
| Additional paid-in-capital                                                                                                                                                                                                     |       |                            | 21,325     |                                          |       |   | 10,763 |   |   |
| Accumulated deficit                                                                                                                                                                                                            |       |                            | (5,276     | )                                             |       |   | (651 | ) |   |
| Total stockholders’ equity                                                                                                                                                                                                |       |                            | 15,257     |                                          |       |   | 9,318 |   |   |
| Total liabilities  and stockholders’ equity                                                                                                                                                                               |       |                            | $          | 17,440                                        |       |   |   | $ | 11,399 |   |   |

----

****                    *amounts less than one thousand

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

F-2

----

**PRB GasTransportation, Inc.Consolidated Statements of Operations(In thousands except share amounts)**

| ** **                                                                                      | ** ** | **Years Ended  December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                      | ** ** | **2005**                                | ** ** | **2004** | ** ** |
| ** **                                                                                      | ** ** | ** **                              | ** ** | **(As restated,   see Note 3)** | ** ** |
| Gas gathering revenue:                                                                          |       |                                    |       |   |   |   |   |
| Related party                                                                                   |       | $                                       | —     |   |   | $ | 692 |   |   |
| Third party                                                                                     |       | 2,834                                   |       |   | 1,840 |   |   |
| Total gas gathering revenue                                                                     |       | 2,834                                   |       |   | 2,532 |   |   |
| Management fee  revenue                                                                         |       | 270                                     |       |   | — |   |   |
| Natural gas  revenue                                                                            |       | 51                                      |       |   | — |   |   |
| Total revenue                                                                                   |       | 3,155                                   |       |   | 2,532 |   |   |
| Operating expenses:                                                                             |       |                                    |       |   |   |   |   |
| Gas gathering expense                                                                           |       | 1,755                                   |       |   | 1,314 |   |   |
| Gas production costs                                                                            |       | 34                                      |       |   | — |   |   |
| Asset impairment charge                                                                         |       | 2,487                                   |       |   | — |   |   |
| Exploration expense                                                                             |       | 450                                     |       |   | — |   |   |
| Depreciation, depletion, amortization and accretion                                             |       | 1,067                                   |       |   | 656 |   |   |
| General and administrative                                                                      |       | 2,029                                   |       |   | 1,184 |   |   |
| Total operating expenses                                                                        |       | 7,822                                   |       |   | 3,154 |   |   |
| Operating loss                                                                                  |       | (4,667                                  | )          |   | (622 | ) |   |
| Other income (expense):                                                                         |       |                                    |       |   |   |   |   |
| Interest and other income                                                                       |       | 167                                     |       |   | 29 |   |   |
| Interest expense                                                                                |       | (49                                     | )          |   | (58 | ) |   |
| Total other income (expense)                                                                    |       | 118                                     |       |   | (29 | ) |   |
| Net loss before  cumulative effect of change in accounting principle                            |       | (4,549                                  | )          |   | (651 | ) |   |
| Cumulative effect  of change in accounting principle                                            |       | (76                                     | )          |   | — |   |   |
| Net loss                                                                                        |       | (4,625                                  | )          |   | (651 | ) |   |
| Convertible  Preferred stock dividends and deemed dividends                                     |       | (204                                    | )          |   | (1,212 | ) |   |
| Net loss  applicable to common stockholders                                                     |       | $                                       | (4,829     | ) |   | $ | (1,863 | ) |   |
| Net loss per  share of common stock before cumulative effect of change in accounting  principle |       | $                                       | (0.68      | ) |   | $ | (1.33 | ) |   |
| Cumulative effect  of change in accounting principle per share of common stock                  |       | (0.01                                   | )          |   | 0.00 |   |   |
| Net loss per  share—basic and diluted                                                      |       | $                                       | (0.69      | ) |   | $ | (1.33 | ) |   |
| Basic and diluted  weighted average shares outstanding                                          |       | 6,959,025                               |       |   | 1,398,907 |   |   |

 

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

F-3

----

**PRBGas Transportation, Inc.Consolidated Statement of Changes in Stockholders’ Equity(In thousands except share amounts)**

| ** **                                                                                                                                                            | ** ** | **Shares** | ** ** | **Amount**                                          | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                                            | ** ** | ** ** | ** ** | **(As restated,   see Note 3)** | ** ** |
| **Series A 10% Convertible Preferred stock,  2,400,000 shares authorized, 0 and 2,400,000 issued and outstanding,  respectively, at December 31, 2005 and 2004** | ** ** | ** ** | ** ** |                                                | ** ** | ** ** |   |
| Balance, January 1,  2004                                                                                                                                        |       | —     |       |                                                | $          | — |   |   |
| Shares issued for  cash                                                                                                                                               |       | 2,400,000  |       |                                                | 2          |   |   |
| Balance,  December 31, 2004                                                                                                                                      |       | 2,400,000  |       |                                                | 2          |   |   |
| Conversion to  common stock                                                                                                                                           |       | (2,400,000 | )          |                                                | (2         | ) |   |
| Balance,  December 31, 2005                                                                                                                                      |       | —     |       |                                                | —     |   |   |
| **Series B 5% Convertible Preferred stock,  1,550,000 shares authorized, 0 and 1,550,000 issued and outstanding,  respectively, at December 31, 2005 and 2004**  | ** ** | ** ** | ** ** |                                                | ** ** | ** ** |   |
| Balance, January 1,  2004                                                                                                                                        |       | —     |       |                                                | —     |   |   |
| Shares issued for  cash                                                                                                                                               |       | 1,550,000  |       |                                                | 2          |   |   |
| Balance,  December 31, 2004                                                                                                                                      |       | 1,550,000  |       |                                                | 2          |   |   |
| Conversion to  common stock                                                                                                                                           |       | (1,550,000 | )          |                                                | (2         | ) |   |
| Balance,  December 31, 2005                                                                                                                                      |       | —     |       |                                                | —     |   |   |
| **Series C Convertible Preferred stock,  411,000 authorized, 40,000 and 411,000 issued and outstanding, respectively,  at December 31, 2005 and 2004**           | ** ** | ** ** | ** ** |                                                | ** ** | ** ** |   |
| Balance, January 1,  2004                                                                                                                                        |       | —     |       |                                                | —     |   |   |
| Shares issued for  cash                                                                                                                                               |       | 411,000    |       |                                                | *          |   |   |
| Balance,  December 31, 2004                                                                                                                                      |       | 411,000    |       |                                                | *          |   |   |
| Conversion to  common stock                                                                                                                                           |       | (371,000   | )          |                                                | *          |   |   |
| Balance,  December 31, 2005                                                                                                                                      |       | 40,000     |       |                                                | *          |   |   |
| **Common stock, 40,000,000 shares authorized,  8,231,894 issued 7,431,894 and 800,000 outstanding, respectively, at December  31, 2005 and 2004**                     | ** ** | ** ** | ** ** |                                                | ** ** | ** ** |   |
| Balance, January 1,  2004                                                                                                                                        |       | —     |       |                                                | —     |   |   |
| Shares issued for  cash                                                                                                                                               |       | 1,600,000  |       |                                                | 2          |   |   |
| Purchase of common  shares for cash                                                                                                                                   |       | (800,000   | )          |                                                | *          |   |   |
| Balance,  December 31, 2004                                                                                                                                      |       | 800,000    |       |                                                | 2          |   |   |
| Issuance of shares  for initial public offering                                                                                                                       |       | 2,300,000  |       |                                                | 2          |   |   |
| Conversion of  Series A Convertible Preferred stock                                                                                                              |       | 2,400,000  |       |                                                | 2          |   |   |
| Conversion of  Series B Convertible Preferred stock                                                                                                              |       | 1,550,000  |       |                                                | 2          |   |   |
| Conversion of  Series C Convertible Preferred stock                                                                                                              |       | 371,000    |       |                                                | *          |   |   |
| Exercise of warrants  and options                                                                                                                                     |       | 10,894     |       |                                                | *          |   |   |
| Balance,  December 31, 2005                                                                                                                                      |       | 7,431,894  |       |                                                | 8          |   |   |
| **Treasury stock**                                                                                                                                                    | ** ** | ** ** | ** ** |                                                | ** ** | ** ** |   |
| Balance, January 1,  2004                                                                                                                                        |       | —     |       |                                                | —     |   |   |
| Purchase of  Treasury stock                                                                                                                                           |       | 800,000    |       |                                                | (800       | ) |   |
| Balance,  December 31, 2005 and 2004                                                                                                                             |       | 800,000    |       |                                                | (800       | ) |   |
| **Additional paid-in-capital**                                                                                                                                        | ** ** | ** ** | ** ** |                                                | ** ** | ** ** |   |
| Balance, January 1,  2004                                                                                                                                        |       |       |       |                                                | —     |   |   |
| Common stock  issued                                                                                                                                                  |       |       |       |                                                | 18         |   |   |
| Series A  Preferred stock issued, net of offering costs                                                                                                          |       |       |       |                                                | 4,985      |   |   |
| Series B  Preferred stock issued, net of offering costs                                                                                                          |       |       |       |                                                | 4,639      |   |   |
| Series C  Preferred stock issued, net of offering costs                                                                                                          |       |       |       |                                                | 1,231      |   |   |
| Deemed capital  contribution related to Series A dividend                                                                                                        |       |       |       |                                                | 63         |   |   |
| Deemed capital contribution  related to Series C issuance                                                                                                        |       |       |       |                                                | 1,027      |   |   |
| Issuance of  warrants for consulting services                                                                                                                         |       |       |       |                                                | 12         |   |   |
| Series A  dividends                                                                                                                                              |       |       |       |                                                | (375       | ) |   |
| Series B  dividends                                                                                                                                              |       |       |       |                                                | (116       | ) |   |
| Series C  deemed dividend                                                                                                                                        |       |       |       |                                                | (587       | ) |   |
| Accrued dividends  on preferred stock                                                                                                                                 |       |       |       |                                                | (134       | ) |   |
| Balance,  December 31, 2004                                                                                                                                      |       |       |       |                                                | 10,763     |   |   |
| Series A  Preferred stock dividends                                                                                                                              |       |       |       |                                                | (139       | ) |   |
| Series B  Preferred stock dividends                                                                                                                              |       |       |       |                                                | (65        | ) |   |
| Proceeds from  initial public offering, net of offering costs                                                                                                         |       |       |       |                                                | 10,738     |   |   |
| Proceeds from  exercise of warrants and options                                                                                                                       |       |       |       |                                                | 28         |   |   |
| Balance,  December 31, 2005                                                                                                                                      |       |       |       |                                                | 21,325     |   |   |
| **Accumulated deficit**                                                                                                                                               | ** ** | ** ** | ** ** |                                                | ** ** | ** ** |   |
| Balance, January 1,  2004                                                                                                                                        |       |       |       |                                                | —     |   |   |
| Net loss (As  restated, see Note 3)                                                                                                                                   |       |       |       |                                                | (651       | ) |   |
| Balance,  December 31, 2004                                                                                                                                      |       |       |       |                                                | (651       | ) |   |
| Net loss                                                                                                                                                              |       |       |       |                                                | (4,625     | ) |   |
| Balance,  December 31, 2005                                                                                                                                      |       |       |       |                                                | (5,276     | ) |   |
| **Total  stockholders’ equity**                                                                                                                                  |       |       |       |                                                | $          | 15,257 |   |   |

----

****      *amount less than one thousand

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

F-4

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**PRB GasTransportation, Inc.Consolidated Statements of Cash Flows(In thousands except share amounts)**

| ** **                                                                                  | ** ** | **Years Ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                  | ** ** | **2005**                                | ** ** | **2004** | ** ** |
| ** **                                                                                  | ** ** | ** **                              | ** ** | **(As restated,  see Note 3)** | ** ** |
| Cash flows from operating  activities                                                       |       |                                    |       |   |   |   |   |
| Net loss                                                                                    |       | $                                       | (4,625     | ) |   | $ | (651 | ) |   |
| Adjustments  to reconcile net loss to net cash (used in) provided by operating activities:  |       |                                    |       |   |   |   |   |
| Asset impairment charge                                                                     |       | 2,487                                   |       |   | — |   |   |
| Exploration expense                                                                         |       | 450                                     |       |   | — |   |   |
| Depreciation, depletion, amortization and accretion                                         |       | 1,067                                   |       |   | 656 |   |   |
| Inventory write down                                                                        |       | 27                                      |       |   | — |   |   |
| Cumulative effect of change in accounting principle                                         |       | 76                                      |       |   | — |   |   |
| Deemed compensation                                                                         |       | —                                  |       |   | 441 |   |   |
| Gain on sale of assets                                                                      |       | (2                                      | )          |   | — |   |   |
| Changes  in assets and liabilities:                                                         |       |                                    |       |   |   |   |   |
| Accounts receivable                                                                         |       | (366                                    | )          |   | (423 | ) |   |
| Inventory                                                                                   |       | (1,373                                  | )          |   | — |   |   |
| Prepaid expenses                                                                            |       | (90                                     | )          |   | (104 | ) |   |
| Deposits                                                                                    |       | (19                                     | )          |   | (4 | ) |   |
| Accounts payable                                                                            |       | 1,514                                   |       |   | 157 |   |   |
| Accrued expenses and other                                                                  |       | 73                                      |       |   | — |   |   |
| Net cash (used in) provided by operating activities                                         |       | (781                                    | )          |   | 72 |   |   |
| Cash flows from investing  activities                                                       |       |                                    |       |   |   |   |   |
| Capital expenditures                                                                        |       | (1,979                                  | )          |   | (41 | ) |   |
| Purchase of TOP system                                                                      |       | —                                  |       |   | (2,960 | ) |   |
| BPE asset purchase                                                                          |       | —                                  |       |   | (7,646 | ) |   |
| Reduction in accrued TOP acquisition costs                                                  |       | (200                                    | )          |   | — |   |   |
| Leasehold acquisition payments                                                              |       | (136                                    | )          |   | — |   |   |
| Sale of fixed assets                                                                        |       | 17                                      |       |   | — |   |   |
| Net cash used in investing activities                                                       |       | (2,298                                  | )          |   | (10,647 | ) |   |
| Cash flows from financing  activities                                                       |       |                                    |       |   |   |   |   |
| Proceeds from IPO, net of issuance costs                                                    |       | 11,007                                  |       |   | — |   |   |
| Deferred costs of raising capital                                                           |       | —                                  |       |   | (255 | ) |   |
| Proceeds from issuance of Series A Convertible  Preferred stock, net of issuance costs |       | —                                  |       |   | 4,987 |   |   |
| Proceeds from issuance of Series B Convertible  Preferred stock, net of issuance costs |       | —                                  |       |   | 4,641 |   |   |
| Proceeds from issuance of Series C Convertible  Preferred stock, net of issuance costs |       | —                                  |       |   | 1,231 |   |   |
| Repurchase of treasury stock                                                                |       | —                                  |       |   | (800 | ) |   |
| Proceeds from issuance of common stock                                                      |       | 28                                      |       |   | 20 |   |   |
| Borrowings under bank loan and financing agreement                                          |       | 50                                      |       |   | — |   |   |
| (Repayment of) proceeds from bank loan                                                      |       | (1,550                                  | )          |   | 1,500 |   |   |
| Dividends                                                                                   |       | (338                                    | )          |   | (429 | ) |   |
| Repayment of retail installment sale contract                                               |       | (4                                      | )          |   | — |   |   |
| Net cash provided by financing activities                                                   |       | 9,193                                   |       |   | 10,895 |   |   |
| Net increase in cash                                                                        |       | 6,114                                   |       |   | 320 |   |   |
| Cash—beginning of year                                                                 |       | 320                                     |       |   | — |   |   |
| Cash—end of year                                                                       |       | $                                       | 6,434      |   |   | $ | 320 |   |   |
| Supplemental disclosure  of cash flow activity                                              |       |                                    |       |   |   |   |   |
| Cash paid for interest                                                                      |       | 49                                      |       |   | 58 |   |   |
| Supplemental schedule for  non-cash activity                                                |       |                                    |       |   |   |   |   |
| Issuance of warrants in connection with public  offering                                    |       | 571                                     |       |   | — |   |   |
| Conversion of Series A, B and C Convertible  Preferred stock                           |       | 4                                       |       |   | — |   |   |
| Asset retirement obligations                                                                |       | 318                                     |       |   | 60 |   |   |
| Retail installment  sale contract used to purchase vehicle                                  |       | 31                                      |       |   | — |   |   |

 

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

F-5

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**PRB GASTRANSPORTATION, INC.Notes to Consolidated Financial StatementsDecember 31, 2005**

**Note 1—Descriptionof Business and Rocky Mountain Gas Agreements**

***Description of Business***

PRB Gas Transportation, Inc. (the “Company”) isan energy company with both oil and gas exploration and development andmid-stream operations in the Rocky Mountain states.

The Company was incorporated in December 2003.The Company was capitalized and commenced operations in January 2004 whenit acquired certain gas gathering and related assets of TOP Gathering, LLC (“TOP”).In August 2004, the Company acquired certain gas gathering and relatedassets of Bear Paw Energy, LLC (“BPE”). Both the TOP and BPE gas gatheringsystems are located in the Powder River basin of Wyoming. The Company utilizesthese assets to provide gas gathering, processing and compression services (theCompany’s “gathering and processing” segment) to third parties.

During the third quarter of 2005, the Company expandedthe scope of its operations into a new segment (the Company’s “exploration andproduction” segment) that includes exploring for, developing, producing andmarketing coal-bed methane natural gas. In July 2005, the Company formedPRB Energy, Inc. a 100% wholly-owned subsidiary established to conduct theCompany’s exploration and production activities.

During September 2005, the Company entered into aFarm-In and Development Agreement, a Management Services Agreement and anOperating Agreement with Enterra Energy Trust and its wholly-owned subsidiaryRocky Mountain Gas (“Rocky Mountain Gas”). The Farm-In and DevelopmentAgreement provided the Company an opportunity to earn interests in RockyMountain Gas’ undeveloped leaseholds located in an area of mutual interest bymaking acquisition and development expenditures during the term of theagreement. In addition, the Company earned a 50% interest in the wells that it drilledand/or completed in the area of mutual interest. Through December 31,2005, the Company made $2.070 million in acquisition and developmentexpenditures and drilled and/or completed 28 wells in the area of mutualinterest. As a result, the Company earned an approximate 4.7% interest in RockyMountain Gas’ undeveloped leaseholds in the area of mutual interest and a 50%interest in the 28 wells as of December 31, 2005. Once completed wells areproductive, future operations are controlled by the Operating Agreement andthis agreement also controls future operations in the case of termination ofthe Farm-In and Development Agreement.

The Management Services Agreement provided for theCompany to earn management fees by operating certain Rocky Mountain Gasproperties and by providing technical and administrative support on a cost-plusbasis. During the year ended December 31, 2005, the Company earned $270thousand in management fees under the Management Services Agreement.

Currently, the Company is expanding its operations toinclude projects located outside of the Powder River Basin and to include crudeoil projects and projects involving conventional natural gas and natural gasliquids. These projects are in various stages of evaluation and or negotiation.

On March 20, 2006, the Company elected toterminate the Farm-In and Development Agreement and Management ServicesAgreement (referred to above) and agreed to continue to operate the RockyMountain Gas properties and provide management services for at least 60 daysfrom the termination date. The Company agreed to continue to drill certainwells that had previously been approved by the State of Wyoming and RockyMountain Gas under the terms of the Operating Agreement.

F-6

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On March 21, 2006,the Company notified its customers served by the TOP system that it was raisingits rates to cover cash costs plus 15% for a 2-month period. The Companyalso advised these customers that it was planning to shut down the TOP systemafter the two month period has elapsed. These customers have the right topurchase the TOP system from the Company on terms to be negotiated, as per therelated gas gathering agreements.

***Restatement of Results***

During June 2005, theCompany determined that it had incorrectly invoiced a customer for the period August 2004through April 2005. The Company invoiced the customer in June 2005for the difference between the original invoices and the corrected invoices ofapproximately $304 thousand. The customer paid the Company the difference duein December 2005. For further information on this restatement, see Note 3—Restatementof Results.

**Note 2—Summary ofSignificant Accounting Policies**

***Basis of Presentation***

The consolidated financial statements include theaccounts of the Company and its wholly-owned subsidiary PRB Energy, Inc.All material intercompany transactions have been eliminated.

Certain prior periodamounts have been reclassified to conform to the current financial statementpresentation.

***Revenue Recognition***

The Company recognizes gasgathering revenue at the time when the service is rendered. The Companyrecognizes revenue from the sale of natural gas during the period the sale ofthe product occurs and title transfers to the buyer. The Company recognizesmanagement services revenue when the service is provided.

***Property, Equipment and Contracts—Gas Gathering andOther***

Property and equipment is stated at estimated fairvalue for the TOP and BPE assets. The Company periodically reviews carryingvalues of long-lived assets for impairment. For information on the TOPimpairment see Note 5—Property, Equipment and Contracts. Other property andequipment, such as office furniture, computer and related software andequipment, automobiles and leasehold improvements are recorded at cost. Depreciationis calculated using the straight-line method over the estimated usefullives of the assets or underlying leases in respect to leasehold improvements,ranging from 3 to 10 years.

Amortization of contractsis calculated using the straight-line method over the term of the underlyingcontracts or the estimated life of production which ranges from four to tenyears.

***Oil and Gas Producing Properties***

The Company has elected tofollow the successful efforts method of accounting for its oil and gasproperties. Under this method of accounting, all property acquisition costs andcosts of exploratory and development wells are capitalized when incurred. If anexploratory well does not find proved reserves, the costs of drilling theunsuccessful exploratory well are charged to expense. Exploratory dry holecosts are included in cash flows from investing activities as part of capitalexpenditures in the consolidated statements of cash flows. The cost ofdevelopment wells, whether productive or not, is capitalized. Geological andgeophysical costs and the cost of carrying and retaining unproved propertiesare expensed as incurred. Depreciation, depletion and amortization (“DD&A”)of capitalized costs of proved oil and gas properties is determined on afield-by-field basis using the units-of-production method based upon proved 

F-7

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reserves.The computation of DD&A takes into consideration restoration, dismantlementand abandonment costs and the anticipated proceeds from equipment salvage. TheCompany has adopted the provisions of Statement of Financial AccountingStandards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations”(“SFAS No. 143”) which provides guidance on accounting for dismantlementand abandonment costs and FASB Interpretation 47, “Accounting for ConditionalAsset Retirement Obligations” (“FIN No. 47”) which provides guidance indetermining estimated dismantlement and abandonment costs in situations wherethe method and timing of settlement are uncertain. See Note 7—AssetRetirement Obligations.

***Exploration Expense***

The Company accounts forexploration and development activities utilizing the successful efforts methodof accounting. Exploration costs, including personnel costs, certain geologicaland geophysical expenses and delay rentals for oil and gas leases, are chargedto expense as incurred. Exploratory drilling costs are initially capitalized,but charged to expense if and when the well is determined not to have foundproved reserves in commercial quantities. The application of the successfulefforts method of accounting requires managerial judgment to determine thatproper classification of wells designated as developmental or exploratory is madeto determine the proper accounting treatment of the costs incurred. The resultsfrom a drilling operation can take considerable time to analyze and thedetermination that commercial reserves have been discovered requires bothjudgment and industry experience. Wells may be completed that are assumed to beproductive but actually deliver oil and gas in quantities insufficient to beeconomic. This may result in the abandonment of the wells at a later date.Wells are drilled that have targeted geologic structures that are bothdevelopmental and exploratory in nature and an allocation of costs is requiredto properly account for the results. The evaluation of oil and leaseholdacquisition costs requires managerial judgment to estimate the fair value ofthese costs with reference to drilling activity in a given area.

***Impairment of Long-Lived Assets***

The Company reviews itslong-lived assets and other intangible assets with long lives for impairmentwhenever events or changes in circumstances indicate that the carrying amountof the asset may not be recovered. An impairment loss is recognized only if thecarrying value of the asset is not recoverable and exceeds its fair marketvalue. The Company estimates the fair market value of its long-lived assetsusing expected future discounted cash flows. See Note 5—Property, Equipment andContracts in respect to the impairment of the TOP gas gathering system.

***Stock-Based Compensation***

At December 31, 2005, the Company has astock-based employee compensation plan that includes stock options issued toemployees and non-employee Directors as more fully described in Note 12—CompensationPlans. The Company has historically accounted for stock-based compensationusing the intrinsic value recognition and measurement principles detailed inAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” and related interpretations. No stock-based compensation expenserelating to stock options has been reflected in the Company’s statements ofoperations for any period presented as all options granted under the plans hadan exercise price equal to the market value of the underlying common stock onthe date of grant. The Company currently uses the Black-Scholes optionvaluation model to calculate required disclosures under SFAS No. 123, “Accountingfor Stock—Based Compensation” (“SFAS No. 123”). As of January 1,2006, the Company has adopted the provisions of SFAS No. 123R, “Share-BasedPayment” (“SFAS No. 123R”). This statement requires the Company to recordcompensation expense associated with the fair value of stock-based compensation.As a result of the adoption of SFAS No. 123R, the Company expects torecord compensation expense 

F-8

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associated with unvestedstock options totaling $432 thousand in future periods under themodified-prospective adoption method.

Thefollowing table illustrates the pro forma effect on net loss and loss per shareif the Company has applied the fair value recognition provisions of SFAS No. 123to stock-based employee compensation:

| ** **                                                                                                                            | ** ** | **For the Year Ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                                            | ** ** | **2005**                                                 | ** ** | **2004** | ** ** |
| ** **                                                                                                                            | ** ** | ** **                                               | ** ** | **(As restated,  see Note 3)** | ** ** |
| ** **                                                                                                                            | ** ** | **in thousands, except  per share amounts**              | ** ** |
| Net loss applicable to common stockholders:                                                                                           |       |                                                     |       |   |   |   |   |
| As reported                                                                                                                           |       | $                                                        | (4,829     | ) |   | $ | (1,863 | ) |   |
| Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of related tax effects |       | 534                                                      |       |   | 38 |   |   |
| Pro forma net loss                                                                                                                    |       | $                                                        | (5,363     | ) |   | $ | (1,901 | ) |   |
| Net loss per share, basic and diluted:                                                                                                |       |                                                     |       |   |   |   |   |
| As reported:                                                                                                                          |       |                                                     |       |   |   |   |   |
| Net loss per share of  common stock before cumulative effect of change in accounting principle                                        |       | $                                                        | (0.68      | ) |   | $ | (1.33 | ) |   |
| Cumulative effect of  change in accounting principle per share of common stock                                                        |       | (0.01                                                    | )          |   | (0.00 | ) |   |
| Total, as reported                                                                                                                    |       | $                                                        | (0.69      | ) |   | $ | (1.33 | ) |   |
| Pro forma:                                                                                                                            |       |                                                     |       |   |   |   |   |
| Net loss per share of  common stock before cumulative effect of change in accounting principle                                        |       | $                                                        | (0.76      | ) |   | $ | (1.36 | ) |   |
| Cumulative effect of  change in accounting principle per share of common stock                                                        |       | (0.01                                                    | )          |   | (0.00 | ) |   |
| Total, pro forma                                                                                                                      |       | $                                                        | (0.77      | ) |   | $ | (1.36 | ) |   |

 

In respect to the proforma disclosures herein the options are amortized to expense over the options’vesting periods. Future actual amounts may differ from the pro formadisclosures.

***Net Loss Per Share***

The Company accounts for earnings (loss) per share (“EPS”)in accordance with SFAS No. 128, “Earnings per  Share” (“SFAS No. 128”). Under SFAS No. 128,basic EPS is computed by dividing the net loss attributable to commonstockholders by the weighted average common shares outstanding withoutincluding any potentially dilutive securities. Diluted EPS is computed bydividing the net loss for the period by the weighted average common sharesoutstanding plus, when their effect is dilutive, common stock equivalents.

*Potentiallydilutive securities, which have been excluded from the determination of dilutedearnings per share because their effect would be anti-dilutive, are as follows:*

| ** **                                  | ** ** | **For the years ended  December31,** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| Series A  Convertible Preferred        |       | —                                              |       | 2,400,000 |   |
| Series B  Convertible Preferred        |       | —                                              |       | 1,550,000 |   |
| Series C  Convertible Preferred        |       | 40,000                                              |       | 411,000 |   |
| Warrants (See  Note 11)                |       | 230,000                                             |       | 45,000 |   |
| Options                                     |       | 463,250                                             |       | 220,000 |   |
| Total potentially  dilutive shares excluded |       | 733,250                                             |       | 4,626,000 |   |

 

F-9

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Subsequentto December 31, 2005 the Company issued the following dilutive securities,which would have increased the number of potentially dilutive shares excluded(above), if these securities were issued prior to December 31, 2005:

| ** **                                   | ** ** | **Potential  Common Shares** | ** ** |
|----------------------------------------------|------------|-----------------------------------|------------|
| Convertible  subordinated debt (See Note 17) |       |                              | 3,137,857  |   |   |
| Warrants (See  Note 17)                      |       |                              | 40,000     |   |   |
| Options                                      |       |                              | 217,500    |   |   |
| Total                                        |       |                              | 3,395,357  |   |   |

 

***Use of Estimates***

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities,disclosures of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

***Income Taxes***

In accordance with SFAS No. 109,“Accounting for Income Taxes” (“SFAS No. 109”), the Companyrecognizes deferred tax liabilities and assets based on the differences betweenthe tax basis of assets and liabilities and their reported amounts in the consolidatedfinancial statements that will result in taxable or deductible amounts infuture years. In evaluating the realizability of net deferred tax assets, theCompany will take into account a number of factors, primarily relating to theCompany’s ability to generate taxable income. The Company has not recorded adeferred tax asset attributable to the net operating loss for the years ended December 31,2005 and December 31, 2004 as it is not more likely than not that adeferred asset will be realized.

***Cash and Cash Equivalents***

The Company considers allhighly liquid instruments purchased with an original maturity of three monthsor less to be cash equivalents. The Company continually monitors its positionswith, and the credit quality of, the financial institutions with which itinvests. As of the balance sheet date, and periodically throughout the year,the Company has maintained balances in various operating accounts in excess offederally insured limits.

***Concentrations of Credit Risk***

The Company grants credit in the normal course ofbusiness to customers in the United States. The Company periodically performscredit analysis and monitors the financial condition of its customers to reducecredit risk. Management periodically reviews accounts receivable aging reportsto assess credit risks, and if appropriate, also reviews updated creditinformation to assess credit risk. In the event that management assesses thecustomers’ accounts receivable collectibility as less than probable, managementreduces the carrying amount by a valuation allowance that reflects management’sbest estimate of the amount that may not be collectible. Allowances for uncollectibleaccounts receivable are based on information available and historicalexperience. As of December 31, 2005 and December 31, 2004, theCompany had not recorded an allowance for doubtful accounts receivable.

F-10

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Salesto customers which represented 10% or more of the Company’s sales for the yearended December 31, 2004 were as follows (as a percentage of total sales):

| **Customer** | ** ** | ** ** | ** ** | **Percent of total sales** | ** ** |
|--------------|------------|------------|------------|-------------------------------------------|------------|
| A            |       |       | 34.0       | %                                         |       |
| B            |       |       | 32.6       | %                                         |       |
| C            |       |       | 17.5       | %                                         |       |

 

Customer A above represents two contracts. From January 1,2004 through September 30, 2004, these contracts were with a related partywhose president was a stockholder of the Company until September 30, 2004.Revenue under these two contracts while they were with a related party was $692thousand which was 27.3% of total sales for the year ended December 31,2004. See Note 15—Related Party Transactions.

One individual customeraccounted for 53.91% of total sales and no other individual customer accountedfor 10% or more of total sales for the year ended December 31, 2005.

***Inventory***

Inventory is recorded atthe lower of cost or market. The Company periodically reviews the carrying costof its inventories as compared to current market value for those inventoriesand adjusts its carrying value to the lower of cost or market.

***Asset Retirement Obligations***

The Company follows SFAS No. 143and FIN No. 47. Estimated future asset abandonment costs are discounted topresent values using a risk-adjusted rate over the estimated economic life ofthe assets. Such costs are capitalized as part of the cost of the related assetand amortized over the related asset’s estimated useful life. The associatedliability is classified as a long-term liability and is adjusted whencircumstances change and for the accretion of expense which is recorded as acomponent of depreciation, depletion and amortization.

***Off-Balance Sheet Arrangements***

As part of its ongoingbusiness, the Company has not participated in transactions that generaterelationships with unconsolidated entities or financial partnerships, such asentities often referred to as structured finance or special purpose entities (“SPEs”),or SPEs which would have been established for the purpose of facilitatingoff-balance sheet arrangements or other contractually narrow or limitedpurposes. As of December 31, 2005, the Company has not been involved inany unconsolidated SPE transactions.

***Recent Accounting Pronouncements***

In December 2004, the FASB issued SFAS No. 123R.SFAS No. 123R requires that compensation costs relating to share-basedpayment transactions be recognized in financial statements based on the fairvalue of the equity or liability instruments issued. SFAS No. 123R coversa wide range of share-based compensation arrangements including share options,restricted share plans, performance-based awards, share appreciation rights andemployee share purchase plans. Effective April 2005, the Securities andExchange Commission extended the implementation date to the beginning of aregistrant’s next fiscal year beginning after June 15, 2005. Theprovisions of SFAS No. 123R were adopted by the Company effective January 1,2006. As a result of the adoption of SFAS No. 123R, the Company expects torecord compensation expense associated with unvested stock options totaling $432thousand in future periods under the modified-prospective adoption method.

F-11

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In March 2005, the FASB issued FIN No. 47which clarifies that the term “conditional asset retirement obligation” refersto a legal obligation to perform an asset retirement activity in which thetiming and/or method of settlement are conditional on a future event that mayor may not be within the control of the entity. The obligation to perform theasset retirement activity is unconditional even though uncertainty exists aboutthe timing and/or method of settlement. This Interpretation is effective foryears ended December 15, 2005 or later. The Company adopted thisInterpretation effective December 31, 2005. See Note 7—Asset RetirementObligations.

In May 2005, the FASB, as part of an effort toconform to international accounting standards, issued SFAS No. 154, “AccountingChanges and Error Corrections” (“SFAS No. 154”), which is effective forthe Company beginning on January 1, 2006. SFAS No. 154 requires thatall voluntary changes in accounting principles be retrospectively applied toprior financial statements as if that principle had always been used, unless itis impracticable to do so. When it is impracticable to calculate the effects onall prior periods, SFAS No. 154 requires that the new principle be appliedto the earliest period practicable. The adoption of SFAS No. 154 is notanticipated to have a material effect on the Company’s financial position orresults of operations.

SFAS No. 19, “Financial Accounting and Reportingby Oil and Gas Producing Companies,” specifies that drilling costs forcompleted exploratory wells should be expensed if the related reserves cannotbe classified as proved within one year unless certain criteria are met. In April 2005,the FASB issued FASB Staff Position 19-1, “Accounting for Suspended WellCosts” (“FSP 19-1”). FSP 19-1 provides guidance for evaluatingwhether sufficient progress is being made to determine whether reserves can beclassified as proved. FSP 19-1 is effective for all reporting periodsbeginning after April 4, 2005, and the Company adopted FSP 19-1 uponincurrence of its initial exploratory drilling costs during the fourth quarterof 2005.

We have disclosed ouraccounting policy for capitalization of exploratory drilling costs in theExploration Expense accounting policy discussed above. We have disclosedcapitalized exploratory drilling cost amounts in Note 13—Disclosures about Oiland Gas Producing Activities.

**Note 3—Restatementof Results**

The Company acquired a contract effective August 2004.During June 2005, the Company determined that it had incorrectly invoicedthis customer for the period August 2004 through April 2005. Theoriginal invoices for this period did not take into account that the agreementincludes a minimum contract billing provision. The Company invoiced thecustomer for the difference between the original invoices and the correctedinvoices in June 2005. The Company was not able to determine whether thecustomer would pay the difference due and as such did not restate its financialstatements until collection was assured. The customer paid the Company for thedifference due (approximately $304 thousand) during December 2005,including approximately $142 thousand and $162 thousand in respect to the yearsended December 31, 2005 and December 31, 2004, respectively. Accordingly,the Company has restated its financial statements as summarized below.

F-12

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Theeffect of this restatement on the Company’s previously issued financial statementof operations, balance sheet, statement of cash flows and stockholders’ equityfor the year ended December 31, 2004 is as follows:

| **Year ended December 31, 2004** | ** ** | ** **                                                            | ** ** | **As reported** | ** ** | **Adjustment** | ** ** | **As restated** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------|------------|----------------|------------|----------------------|------------|
| ** **                                           | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                              |       |                                                                  | $          | 2,370                |       |           |       | $                    | 162        |   |   |   | $ | 2,532 |   |   |
| Net loss                                             |       |                                                                  | $          | (813                 | )          |           |       | $                    | 162        |   |   |   | $ | (651 | ) |   |
| Net loss  attributable to common stock               |       |                                                                  | $          | (2,025               | )          |           |       | $                    | 162        |   |   |   | $ | (1,863 | ) |   |
| Net loss per  share basic and diluted                |       |                                                                  | $          | (1.45                | )          |           |       | $                    | 0.12       |   |   |   | $ | (1.33 | ) |   |
| Accounts  receivable                                 |       |                                                                  | $          | 262                  |       |           |       | $                    | 162        |   |   |   | $ | 424 |   |   |
| Accumulated deficit                                  |       |                                                                  | $          | (813                 | )          |           |       | $                    | 162        |   |   |   | $ | (651 | ) |   |

 

Other line items in thefinancial statements such as operating loss, total current assets etc. havebeen restated similarly. The aforementioned restatement adjustments do not affectcash flows used in operating activities, net cash flow used in investingactivities and net cash provided by financing activities, although certaincomponents of cash flows from operating activities have been restated.

**Note 4—Acquisitions**

***Top Gas Gathering System***

EffectiveJanuary 1, 2004, the Company purchased the gas gathering assets of TOP,located in Campbell County Wyoming, for $3.185 million, including direct costsof $66 thousand, cash of $2.774 million, a compressor disposal liabilityassumed of $145 thousand (of that amount $120 thousand was paid during 2004)and acquisition costs payable to TOP of $200 thousand. The Company recorded theacquisition using the purchase method of accounting as per SFAS No. 141, “BusinessCombinations” (“SFAS No. 141”). In conjunction with the purchaseaccounting, the Company recorded the fair value of the liability for the assetretirement obligations, estimated at $60 thousand, in accordance with SFAS No. 143.The purchase consideration, including legal fees and other professional feesincurred, was allocated to the following asset categories based on theestimated fair value of the assets acquired:

| **Asset category**       | ** ** | ** ** | ** ** | **In thousands** | ** ** |
|-------------------------------|------------|------------|------------|-----------------------|------------|
| Compressor site               |       |       | $          | 1,240                 |       |   |
| Pipeline and  interconnect    |       |       | 984        |                  |       |
| Gathering  contracts          |       |       | 1,021      |                  |       |
| Asset retirement  obligations |       |       | (60        | )                     |       |
| Total                         |       |       | $          | 3,185                 |       |   |

 

The Company reviewed itscarrying value of the TOP gas gathering system during the year ended December 31,2005 and recorded an impairment charge of $2.487 million in its statement ofoperations. See Note 5—Property, Equipment and Contracts.

F-13

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***Bear Paw Gas Gathering System***

EffectiveAugust 1, 2004, the Company purchased certain gas gathering assets fromBPE, located in Campbell County Wyoming, for $7.646 million, including directcosts of $146 thousand. The Company paid $5.5 million in cash and provided anote payable of $2.0 million. The Company paid the note in full on December 15,2004, see Note 10—Borrowings. The purchase was recorded using the purchasemethod of accounting under SFAS No. 141. The purchase price, includinglegal fees and other professional fees incurred, was allocated to the assetcategories as outlined in the following table based on the estimated fair valueof the assets acquired: 

| **Asset category** | ** ** | ** ** | ** ** | **In thousands** | ** ** |
|-------------------------|------------|------------|------------|-----------------------|------------|
| Pipeline                |       |       | $          | 5,578                 |       |   |
| Compressor sites        |       |       | 788        |                  |       |
| Gathering  contracts    |       |       | 1,280      |                  |       |
| Total                   |       |       | $          | 7,646                 |       |   |

 

The Company had notrecorded an asset retirement obligation at the date of the BPE acquisitionrelating to obligations under certain of these contracts as a reasonabledetermination of the timing of the asset retirement obligations could not bemade at the time. Effective December 31, 2005, the Company recorded anasset retirement obligation in respect to the BPE assets, in accordance withFIN No. 47. See also Note 7—Asset Retirement Obligations.

**Note 5—Property,Equipment and Contracts**

Propertyand equipment consists of the following:

| ** **                                      | ** ** | **Useful Lives**   | ** **    | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------------------------------------|------------|-------------------------|---------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **(in thousands)** | ** **    |
| Compressor sites,  pipelines and interconnect   |       |                    | 1-10 yea | r                               |       |                            | $          | 6,806 |   |   |   | $ | 8,591 |   |   |
| Computer  equipment                             |       |                    | 3 years  |                            |       |                            | 29         |   |   |   | 11 |   |   |
| Office furniture  and equipment and related     |       |                    | 5-7 year | s                               |       |                            | 98         |   |   |   | 30 |   |   |
| Automobiles                                     |       |                    | 3 years  |                            |       |                            | 60         |   |   |   | — |   |   |
|                                            |       |                    |          |                            |       |                            | 6,993      |   |   |   | 8,632 |   |   |
| Less accumulated  depreciation and amortization |       |                    |          |                            |       |                            | (969       | ) |   |   | (496 | ) |   |
| Total                                           |       |                    |          |                            |       |                            | $          | 6,024 |   |   |   | $ | 8,136 |   |   |

 

The Company’s compressor sites, pipeline and equipmentare in respect to gas gathering operations. Depreciation expense in respect toproperty and equipment totaled $843 thousand and $496 thousand forthe years ended December 31, 2005 and 2004, respectively.

The Company reviewed the carrying value of the TOPsystem as associated revenue had declined due to decreasing producer volumes aswell as the loss of a customer. Based on this review, the Company recorded anasset impairment charge of $2.487 million relative to the TOP gasgathering system during the year ended December 31, 2005. The impairmentcharge included $1.645 million for property and equipment and$842 thousand for contracts. The Company based its impairment on anindependent evaluation of the fair market value of the TOP system.

The Company initially recorded an estimated impairmentof $2.372 million for the TOP system during the period ended September 30,2005. The Company estimated the system’s fair market value based on management’sevaluation of several potential scenarios based on estimated fair marketvalues, using a probabilistic assessment of estimated future cash flows forthose scenarios.

F-14

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The Company subsequently engaged the services of anindependent appraisal firm to estimate the system’s fair market value as of December 31,2005. Based on the evaluation of the independent appraisal firm, and theresulting estimated fair market value, the Company recorded an additional impairmentcharge of $115 thousand during the fourth quarter of 2005. The estimated fairmarket value at December 31, 2005 was based on the review of threepotential scenarios. The first included estimated future cash flows determinedby assigning probabilities to potential ranges of equipment dispositionproceeds and contract cancellation costs in respect to the “shut down and sellremaining asset” scenario. The second and third scenarios included a similarprobability weighted evaluation performed in respect to scenarios that assumedthe Company would continue to operate the system for two different lengths oftime. The estimated future cash flows that were evaluated for the threescenarios were assigned a probability of occurrence to determine the estimatedfair market value. The probabilities of occurrence were assigned based onmanagement’s plans and knowledge as of December 31, 2005. These estimatesmay change as facts and circumstances change.

In accordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” the estimated fair valueof the assets becomes the new cost basis for the assets, and, as such,accumulated depreciation and amortization of $589 thousand related tothese assets, including contracts, was eliminated in connection with theCompany’s accounting for this impairment. As a result of the Company’s initialimpairment review during the period ended September 30, 2005, the Companyreduced the estimated useful life of the TOP system to four years effective October 1,2005. Previously a ten-year life was used to calculate the TOP system’sdepreciation expense. Based on the Company’s plans to continue to run or shutdown the system at December 31, 2005, the Company has further reduced itsestimated useful life of the system to one year. The effect of this reduceduseful life will be to increase depreciation expense by $133 thousand per yearcompared to the revised useful life determined in the third quarter of 2005,and to reduce annual depreciation and amortization by $103 thousand compared tothe Company’s original useful life of 10 years. The Company will continue toassess the affect of the TOP system impairment on its asset retirementobligation accretion expense.

On March 21, 2006, the Company advised its customersserved by the TOP system of a temporary price increase and the Company’s plansto shut-down the site. See Note 17—Subsequent Events.

Contracts valued at $1.28 million (on the date ofacquisition, August 2004) in respect to the BPE assets are being amortizedover 10 years which is the estimated life of the contracts and the naturalgas reserves underlying the contracts. Amortization expense in respect tocontracts totaled $213 thousand and $155 thousand for the years endedDecember 31, 2005 and 2004, respectively. The amortization expense for theyear ended December 31, 2005 included amortization of the TOP contractsthrough September 30, 2005, when the TOP contracts were impaired in full.

Futureperiod amortization expense in respect to the BPE contracts is as follows:

| **Year ending December 31,** | ** ** | ** ** | ** ** | **In thousands** | ** ** |
|---------------------------------------------|------------|------------|------------|-----------------------|------------|
| 2006                                        |       |       | $          | 128                   |       |   |
| 2007                                        |       |       | 128        |                  |       |
| 2008                                        |       |       | 128        |                  |       |
| 2009                                        |       |       | 128        |                  |       |
| 2010                                        |       |       | 128        |                  |       |
| Thereafter                                  |       |       | 459        |                  |       |
| Total                                       |       |       | $          | 1,099                 |       |   |

 

 

F-15

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**Note 6—Inventory**

Inventory consists ofapproximately 32 miles of 8-inch steel pipe that was purchased for an oiland gas pipeline project that was being planned to transport a customer’s oiland gas production. This project has been suspended pending the finalevaluation of the commercial reserves and the project’s development plan. Asthe pipe is not required for current operations, the customer and the Companyare jointly pursuing the disposition of this pipe. The customer agreed toshare, on an equal basis, all costs in respect to holding and selling thisinventory. See Note 17—Subsequent Events and Note 15—Related PartyTransactions. The Company has recorded a reserve of approximately $27 thousandin respect to this inventory for the period ended December 31, 2005. TheCompany will continue to review the carrying value of this inventory until itis sold.

**Note 7—AssetRetirement Obligations**

Property and equipment includes platforms for theleased compressors at the Company’s TOP gas gathering facilities. The Companyis required to dismantle these compressor platforms at the end of their usefullives. In accordance with SFAS No. 143, the Company recognized the fairvalue of a liability for an asset retirement obligation (“ARO”) in the amountof $60 thousand as part of the purchase accounting at the time of theacquisition. The Company capitalized that cost as a part of the carrying valueof the compressor site which is depreciated over the estimated life of thecompressors’ use. See Note 5—Property, Equipment and Contracts fordiscussion of the impairment of the TOP assets.

During the year ended December 31, 2005, theCompany reviewed its asset retirement obligations in respect to its BPE assetsand determined an estimate of those future liabilities as determined inaccordance with FIN No. 47. The Company was previously unable to determinea reasonable estimate of the timing of future period estimated dismantlementliabilities in accordance with SFAS No. 143. Those future liabilitiesinclude the removal of pipelines and compressor stations per the associatedcontracts. The Company estimated its future obligations in respect to the BPEassets based on estimated probabilities that the surface-use agreement basedobligation would occur and also assigned probabilities as to potentialsettlement dates. The agreements with the lessors include provisions allowingthe lessor to decide at a future date whether the lessor requires that theCompany dismantle its sites and lines. Accordingly, the Company recorded itsestimated asset retirement obligation liabilities of $259 thousand in respectto the BPE systems effective December 31, 2005, upon adoption of FIN No. 47.This included $76 thousand of accretion and depreciation expense that has beenrecorded as a cumulative effect of change in accounting principle in theCompany’s statement of operations for the year ended December 31, 2005.The $76 thousand cumulative effect of change in accounting principle included$30 thousand for the year ended December 31, 2004 and $46 thousand for theyear ended December 31, 2005. The changes to the Company’s assetretirement obligation liabilities and the pro forma effect of adopting FIN No. 47are detailed in the following tables.

F-16

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Thefollowing table details the effect on net loss, and net loss per share andasset retirement obligation liabilities as if the Company had adopted theprovisions of FIN No.47 on August 1, 2004:

| **For the year ended**         | ** ** | ** **                                                      | ** ** | **December 31,  2005** | ** ** | **December 31, 2004  (as restated)** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **In thousands,  except per share amounts** | ** ** |
| Net loss  applicable to common stockholders:  |       |                                                            |       |                        |       |                                                |       |   |   |
| As reported                                   |       |                                                            | $          | (4,829                      | )          |                                                |       | $ | (651 | ) |   |
| Pro forma                                     |       |                                                            | $          | (4,799                      | )          |                                                |       | $ | (681 | ) |   |
| Net loss per  share:                          |       |                                                            |       |                        |       |                                                |       |   |   |
| As reported                                   |       |                                                            | $          | (0.69                       | )          |                                                |       | $ | (1.33 | ) |   |
| Pro forma                                     |       |                                                            | $          | (0.69                       | )          |                                                |       | $ | (1.35 | ) |   |
| Asset retirement  obligations, end of period: |       |                                                            |       |                        |       |                                                |       |   |   |
| As reported                                   |       |                                                            | $          | 387                         |       |                                                |       | $ | 65 |   |   |
| Pro forma                                     |       |                                                            | $          | 387                         |       |                                                |       | $ | 299 |   |   |

 

During the year ended December 31, 2005, theCompany established an asset retirement obligation of $59 thousand in respectto its oil and gas properties. The Company recognizes an estimate of theliability associated with the abandonment of its oil and gas properties at thetime the well is completed. The Company estimated its asset retirementobligation liabilities for these wells based on estimated costs to plug andabandon the wells and the Company’s respective ownership percentage in thewells.

Thefollowing table details all changes to the Company’s estimated asset retirementobligation liabilities during the years ended December 31, 2005 and 2004:

| ** **                                                           | ** ** | **For the  Year Ended  December 31,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                                             | ** ** | **2004** | ** ** |
| ** **                                                           | ** ** | **(in thousands)**                              | ** ** |
| Asset retirement  obligations, beginning of period                   |       | $                                                    | 65         |   |   | $ | — |   |   |
| Acquisition of  TOP assets                                           |       | —                                               |       |   | 60 |   |   |
| Cumulative effect  of change in accounting principle—BPE assets |       | 259                                                  |       |   | — |   |   |
| Proved properties                                                    |       | 59                                                   |       |   | — |   |   |
| Accretion expense                                                    |       | 4                                                    |       |   | 5 |   |   |
| Asset retirement  obligations, end of period                         |       | $                                                    | 387        |   |   | $ | 65 |   |   |

 

The Company will continueto review its asset retirement obligations and will adjust its estimates whenfacts and circumstances warrant.

F-17

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**Note 8—Income Taxes**

Incometax benefit for the years ended December 31, 2005 and December 31,2004 are as follows:

| ** **                         | ** ** | **December 31, 2005** | ** ** | **December 31, 2004**                     | ** ** |
|------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | ** **                      | ** ** | **(As restated,   see Note 3)** | ** ** |
| ** **                         | ** ** | **In thousands**           | ** ** |
| Current:                           |       |                            |       |                                                |       |   |   |   |   |
| Federal                            |       |                            | $          | —                                              |       |   |   | $ | — |   |   |
| State                              |       |                            | —     |                                                |       |   | — |   |   |
| Total current  income tax benefit  |       |                            | —     |                                                |       |   | — |   |   |
| Deferred:                          |       |                            |       |                                                |       |   |   |   |   |
| Federal                            |       |                            | 1,883      |                                                |       |   | 71 |   |   |
| Valuation allowance                |       |                            | (1,883     | )                                                   |       |   | (71 | ) |   |
| Total deferred  income tax benefit |       |                            | —     |                                                |       |   | — |   |   |
| Total income tax benefit           |       |                            | $          | —                                              |       |   |   | $ | — |   |   |

 

Thereconciliation between tax benefit computed by applying the estimated effectivetax rate of 35% to loss before income taxes at December 31, 2005 and December 31,2004 and the reported amount of income tax benefit is as follows:

| ** **                                    | ** ** | **December 31, 2005** | ** ** | **December 31, 2004**                     | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | ** **                      | ** ** | **(As restated,   see Note 3)** | ** ** |
| ** **                                    | ** ** | **In thousands**           | ** ** |
| Computed at the  estimated effective tax rate |       |                            | $          | 1,619                                               |       |   |   | $ | 228 |   |   |
| Permanent  differences                        |       |                            | (14        | )                                                   |       |   | (157 | ) |   |
| Valuation  allowance                          |       |                            | (1,605     | )                                                   |       |   | (71 | ) |   |
| Income tax benefit                            |       |                            | $          | —                                              |       |   |   | $ | — |   |   |

 

Thecomponents of the net deferred income tax assets (liabilities) are as follows:

| ** **                          | ** ** | **December 31, 2005** | ** ** | **December 31, 2004**                     | ** ** |
|-------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------|------------|
| ** **                          | ** ** | ** **                      | ** ** | **(As restated,   see Note 3)** | ** ** |
| ** **                          | ** ** | **In thousands**           | ** ** |
| Non-current assets  (liabilities):  |       |                            |       |                                                |       |   |   |   |   |
| Property and equipment              |       |                            | $          | (215                                                | )          |   |   | $ | (276 | ) |   |
| Oil and gas properties              |       |                            | (372       | )                                                   |       |   | — |   |   |
| Contracts                           |       |                            | 331        |                                                |       |   | 18 |   |   |
| Organization costs                  |       |                            | 15         |                                                |       |   | 2 |   |   |
| Asset retirement obligations        |       |                            | 135        |                                                |       |   | 23 |   |   |
| Net operating loss carryforwards    |       |                            | 1,987      |                                                |       |   | 304 |   |   |
| Bonus accrual                       |       |                            | 2          |                                                |       |   | — |   |   |
| Valuation allowance                 |       |                            | (1,883     | )                                                   |       |   | (71 | ) |   |
| Net deferred tax asset  (liability) |       |                            | $          | —                                              |       |   |   | $ | — |   |   |

 

At December 31, 2005, the Company had netoperating loss carryforwards, for federal income tax purposes, of approximately$1.987 million. These net operating loss carryforwards, if not utilized toreduce taxable income in future periods, will expire in various amountsbeginning in 2024 through 2025. This net operating loss carryforward may besubject to U.S. Internal Revenue Code Section 382 limitations.

F-18

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The Company hasestablished a valuation allowance for deferred taxes that reduces its netdeferred tax assets as management currently believes that these losses will notbe utilized in the near term. The allowance recorded was $1.883 million and $71thousand for 2005 and 2004, respectively. The Company will continue to reviewthe valuation allowance recorded as of December 31, 2005 and will record anet deferred tax asset if and when the realization of the deferred tax asset ismore likely than not.

**Note 9—Commitmentsand Contingencies**

***Possible Rescission of Series C ConvertiblePreferred Stock Sale***

In December 2004, theCompany received $1.233 million from the sale of 411,000 shares of Series CConvertible Preferred stock. The Company paid no cash or other commissions orfinders’ fees in connection with this offering. In the view of the Securitiesand Exchange Commission, this placement might not have been eligible for anexemption from registration under the Securities Act of 1933. In the absence ofsuch an exemption, investors could bring suit against the Company to rescindtheir stock purchases, in which event the Company could be liable forrescission payments to these investors of up to $1.233 million exclusiveof interest and costs. In August 2005, the Company filed a registrationstatement on Form S-1 to register the underlying shares of commonstock issuable upon conversion of the Series C Convertible Preferredstock. The SEC declared the S-1 effective on August 16, 2005. As of December 31,2005, 371,000 Series C Convertible Preferred shares had been converted tocommon shares and 40,000 shares remained outstanding. See Note 17 fordiscussions of subsequent conversions.

***Commitments***

As a normal course of the Company’s businessoperations, the Company enters into operating leases for office space, officeequipment, vehicles and compression equipment. In addition, the Company hasentered into service agreements that provide compression equipment and relatedservices on a bundled basis. These agreements, which pertain to the Company’s TOPand BPE gas gathering systems, expire in 2006. The Company is in the process ofrenewing its BPE service agreement which expires in July 2006.

In addition, the Company is party to surface-useagreements in respect to the TOP and BPE gathering systems that are cancelablewhen gas volumes decline to a level where the contract is uneconomic to theCompany. The Company has estimated that future minimum lease commitments underthese agreements will expire in 2014 based on estimated reserves in place.

Rental payments under these operating leases andservice agreements totaled $1.781 million and $452 thousand for theperiods ended December 31, 2005 and 2004, respectively.

Futurepayments, by year, under these operating leases and service agreements are asfollows:

| ** ** | ** ** | **(in thousands)** | ** ** |
|------------|------------|-------------------------|------------|
| 2006       |       |                    | $          | 1,085 |   |   |
| 2007       |       |                    | 254        |   |   |
| 2008       |       |                    | 236        |   |   |
| 2009       |       |                    | 235        |   |   |
| 2010       |       |                    | 215        |   |   |
| Thereafter |       |                    | 514        |   |   |
| Total      |       |                    | $          | 2,539 |   |   |

 

F-19

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**Note 10—Borrowings**

***Note Payable to BPE***

In August 2004, theCompany signed a promissory note for $1.944 million as part of the purchaseconsideration paid for the gas gathering assets acquired from BPE. See Note 4—Acquisitions.The interest rate on the note was 8%. The note was paid in full on December 15,2004 including accrued interest of $30 thousand, with proceeds from the bankline of credit discussed below being used to repay this note.

***Retail Installment Sale Contract***

On August 3, 2005,the Company purchased a vehicle using a 0% retail installment sale contract fora total of $31 thousand.

***Promissory Note***

On December 14, 2004,the Company signed a promissory note with the Bank of Oklahoma (“BOK”) for a$1.75 million revolving line of credit that was due on the earlier of March 31,2005 or upon funding of the Company’s initial public offering. The noteincluded accrued interest, calculated at prime, that was payable monthly. Thenote was secured by the Company’s gas gathering assets, associated contractsand a $1.0 million certificate of deposit pledged by a preferred stockholder asdescribed below. The Company drew down $1.5 million upon signing and theproceeds were used in the payment of the BPE note. The Company drew down anadditional $50 thousand for working capital purposes in April 2005. Thispromissory note was paid in full in April 2005 from proceeds from theCompany’s initial public offering and the line of credit was withdrawn.

***Stockholder Pledge of Certificate of Deposit***

On December 14, 2004,a preferred stockholder (“Pledgor”) pledged a certificate of deposit in theamount of $1.0 million as collateral for the BOK line of credit, as discussedabove. The Company paid the stockholder a monthly fee of .529% of thecollateral value for this pledge. The Company paid $18 thousand and $3 thousandof fees to the Pledgor for the years ended December 31, 2005 and 2004. Thepledge was withdrawn upon payment of the BOK note in April 2005.

***Note Payable to Preferred Stockholder***

On October 1, 2004 the Company borrowed $800thousand from the above preferred stockholder. The unsecured note accruedinterest at 12% per annum, payable monthly. The principal and any unpaid,accrued interest were payable in one year or upon the closing of the Company’sinitial public offering, whichever occurred earlier. As of December 31,2004, the Company had paid $19 thousand of interest in respect to this note.Proceeds from the issuance of Series C Convertible Preferred shares wereused to pay off the note on December 10, 2004. See Note 11—Stockholders’Equity.

F-20

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**Note 11—Stockholders’Equity**

***Initial Public Offering***

On April 12, 2005,the Company’s registration statement on Form S-1 was declaredeffective by the Securities and Exchange Commission and the Company’s stockbegan trading on the American Stock Exchange under the trading symbol PRB. TheCompany sold 2,300,000 shares of common stock, including 300,000 sharespursuant to the underwriter’s exercise of its over-allotment option. Inconjunction with the offering, holders of Series A and Series Bpreferred stock converted their shares into an equal number of registeredcommon shares. The Company recorded proceeds of $10.169 million net ofunderwriter’s discounts, commissions and expenses, including warrants valued at$583 thousand.

***Series C Preferred Stock***

In December 2004, theCompany issued 411,000 shares of the convertible preferred series C sharesat a price of $3.00 per share resulting in proceeds of approximately$1.231 million, net of offering costs of approximately $2 thousand.See Note 9—Commitments and Contingencies for further discussion on theconvertible preferred series C shares.

***Dividends***

Both the ConvertiblePreferred Series A and Series B shares included dividend rights thatstated that dividends would accrue from the date of issuance until the datepaid, whether or not earned or declared. All of the Series A and Bpreferred stockholders converted to common shares during April 2005 andall of the related dividends were paid through the date of conversion. The Series CConvertible Preferred stock does not pay dividends.

***Warrants***

On June 28, 2004, the Company granted 45,000warrants to consultants as compensation for their work on the Company’s initialpublic offering. These warrants have a 5 year term with immediate vesting andan exercise price of $5.50. The estimated fair value of the warrants at December 31,2004 was $12 thousand based on the Black-Scholes option pricing model.

The Company entered into an underwriting agreement on April 12,2005. The agreement called for the underwriter to purchase the shares on a firmcommitment basis at an 8% discount to the offering price. The Company’sunderwriter also received a 3% non-accountable expense allowance of theaggregate offering price of the shares offered, excluding the 300,000over-allotment shares. At the closing of the underwriting, the Company soldwarrants to the underwriter to purchase 200,000 shares of common stock at aprice of $0.0001 per warrant. The warrants have an exercise price of $6.875(125% of the initial offering price) and are exercisable for 4 years fromthe first anniversary of their issuance. The estimated fair value of thewarrants at issuance was $571 thousand based on the Black-Scholes optionpricing model.

During the year ended December 31, 2004, theCompany recorded deferred offering costs of raising capital, with acorresponding increase in additional paid-in-capital in respect to the 45,000warrants issued during that period, of $12 thousand. In respect to the 200,000warrants issued during April 2005, the fair value of the warrants of $571thousand was also charged against additional paid-in-capital.

F-21

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Thefollowing assumptions were used in determining the fair values of the warrantsas described above:

| Risk-free  interest rate (%) |   | 3.89   |   |
|------------------------------|--------|--------|--------|
| Expected life  (years)       |   | 5      |   |
| Expected  volatility (%)     |   | 25     |   |
| Expected dividends           |   | — |   |

 

ThroughDecember 31, 2005, cumulative activity in respect to warrants is asfollows:

| ** **                  | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| Balance,  beginning of year |       |                            | 45,000     |                            |       |   | — |   |   |
| Issued                      |       |                            | 200,000    |                            |       |   | 45,000 |   |   |
| Exercised                   |       |                            | (15,000    | )                               |       |   | — |   |   |
| Balance, end of year        |       |                            | 230,000    |                            |       |   | 45,000 |   |   |

 

The warrants exercisedduring the year ended December 31, 2005 were exercised under the cashlessexercise provision.

**Note 12—CompensationPlans**

The Company has an Equity Compensation Plan (“OptionPlan”). The Plan grants options to purchase shares of the Company’s commonstock to eligible employees, contractors and current and former members of theBoard of Directors. There are 743,000 shares of the Company’s common stockreserved for issuance under the Plan.

All options granted to date under the Plan have beengranted at exercise prices equal to or greater than the respective marketprices of the Company’s common stock on the grant dates. There were 279,939shares available for grant under the Plan as of December 31, 2005.

Thefollowing table summarizes activity for options:

| ** **                                                      | ** ** | **For the Year Ended  December 31, 2005** | ** ** | **For the Year Ended  December 31, 2004** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **Number of  Share**s                                         | ** ** | **Weighted Avg.  Exercise Price**                        | ** ** | **Number of  Share**s | ** ** | **Weighted Avg.  Exercise Price** | ** ** |
| Outstanding,  beginning of year                                 |       |                                                               | 220,000    |                                                               |       |   | $ | 5.50 |   |   | — |   |   | — |   |   |
| Granted                                                         |       |                                                               | 299,000    |                                                               |       |   | $ | 7.59 |   |   | 220,000 |   |   | $ | 5.50 |   |   |
| Forfeitures                                                     |       |                                                               | (50,750    | )                                                                  |       |   | $ | 6.51 |   |   | — |   |   | — |   |   |
| Exercised                                                       |       |                                                               | (5,000     | )                                                                  |       |   | $ | 5.50 |   |   | — |   |   | — |   |   |
| Outstanding, end  of year                                       |       |                                                               | 463,250    |                                                               |       |   | $ | 6.74 |   |   | 220,000 |   |   | $ | 5.50 |   |   |
| Exercisable, end of year                                        |       |                                                               | 227,500    |                                                               |       |   | $ | 6.39 |   |   | 70,000 |   |   | $ | 5.50 |   |   |
| Weighted-average fair  value of options granted during the year |       |                                                               | —     |                                                               |       |   | $ | 3.19 |   |   | — |   |   | $ | 0.82 |   |   |

 

The weighted average remaining contractual life forthe options outstanding at December 31, 2005 is 7.4 years. The fairvalue of each option granted is estimated on the date of grant using theBlack-Scholes option pricing model. The weighted average fair value of optionsoutstanding at December 31, 2005 is $2.16. The weighted average fair valueof options granted and exercisable at December 31, 2005 is $1.63.

SFAS No. 123 establishes a fair value method ofaccounting for stock-based compensation plans through either recognition ordisclosure. The Company accounts for stock-based compensation under the 

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intrinsic value methodpursuant to Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB No. 25”) and has elected to adoptSFAS No. 123 through compliance with the disclosure requirements set forthin the Statement. Because the exercise price of the Company’s stock optionsequals the market price of the underlying stock on the date of the grant, nocompensation expense is recognized under APB No. 25. Pro forma informationregarding net loss and loss per share is required by SFAS No. 123 and hasbeen determined as if the Company had accounted for its employee stock optionsunder the fair value method of that Statement. See Note 2—Summary ofSignificant Accounting Policies for pro forma information.

Thefair value of options was measured at the date of grant using the Black-Scholesoption-pricing model. The fair values of options granted and employee stockpurchase plan shares issued were estimated using the following weighted-averageassumptions:

| **Assumption**                                                                     | ** ** | ** ** | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------|------------|
| Risk free  interest rate (%)                                                       |       |       | 3.9-4.5    |                        |       |                        | 3.89-4.73  |   |   |
| Volatility factor  of the expected market price of the Company’s common stock |       |       | 25         | %                           |       |                        | 25         | % |   |
| Expected life of  the options (in years)                                           |       |       | 5-10       |                        |       |                        | 5-10       |   |   |
| Expected dividend                                                                  |       |       | —     |                        |       |                        | —     |   |   |

 

The Black-Scholes optionvaluation model was developed for use in estimating the fair value of tradedoptions that have no vesting restrictions and are fully transferable. Inaddition, option valuation models incorporate highly subjective assumptionsincluding the expected stock price volatility. The Company’s stock options havecharacteristics significantly different from those of traded options and, aschanges in the subjective input assumptions can materially affect the fairvalue estimate, it is management’s opinion that the valuations as determined bythe existing models are different from the value that the options would realizeif traded in the market.

**Note 13—Disclosuresabout Oil and Gas Producing Activities**

***Costs Incurred in Oil and Gas Producing Activities***

TheCompany commenced its oil and gas activities during the year ended December 31,2005. The Company has incurred the following costs, both capitalized andexpensed, in respect to its oil and gas property acquisition, exploration anddevelopment activities during the year ended December 31, 2005:

| ** **          | ** ** | **In thousands** | ** ** |
|---------------------|------------|-----------------------|------------|
| Exploration         |       |                  | $          | 1,531 |   |   |
| Development         |       |                  | 314        |   |   |
| Unproved  leasehold |       |                  | 136        |   |   |
| Total               |       |                  | $          | 1,981 |   |   |

 

Included in the above are capitalized asset retirementobligations of $59 thousand.

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Thefollowing table details the net changes in capitalized exploratory well costsfor the year ended December 31, 2005:

| ** **                                                                                     | ** ** | **In thousands** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| Beginning  balance, January 1, 2005                                                       |       |                  | $          | — |   |   |
| Additions to  capitalized exploratory well costs pending the determination of proved  reserves |       |                  | 1,531      |   |   |
| Capitalized exploratory  well costs charged to exploration expense                             |       |                  | (450       | ) |   |
| Ending balance,  December 31, 2005                                                        |       |                  | $          | 1,081 |   |   |

 

Capitalized exploratorywell costs included $1.531 million of exploratory drilling costs. During 2005,the Company charged $450 thousand of these exploratory drilling costs, relatingto 6 wells, to exploration expense. At December 31, 2005, $1.081 millionof exploratory drilling costs, relating to 12 wells, remained capitalized aswells-in-progress pending the determination of proved reserves. None of thesewells are in areas requiring major capital expenditures before production canbegin, nor were any of these wells completed more than one year ago. Thesewells are currently undergoing de-watering and the Company believes that afterthese wells are de-watered it will be able to determine if proved reserves havebeen discovered. The Company estimates that in mid 2006 it will be able to makethis determination.

***Oil and Gas Reserve Quantities (Unaudited)***

The Company engages Sproule Associates Inc. todetermine its reserve information included herein. The Company reviews thereserve information in the report that Sproule prepares. The Company emphasizesthat reserve estimates are imprecise by their nature, and that reserveestimates on new discoveries and developments are less precise than reserveestimates for existing fields. Accordingly, the Company expects these estimatesto change as time passes and information as to actual well performance can beincluded in those future estimates.

Proved oil and gas reserves are estimates ofrecoverable quantities of oil, natural gas and natural gas liquids that aredetermined using engineering and geological data with reasonable certainty. Thereserve estimates are based on existing economic and operating conditions andinclude only existing wells from known reservoirs with existing equipment andtechnology. All of the Company’s proved reserves are located in the PowderRiver Basin area of Wyoming.

Thefollowing table summarizes estimated proved reserves as of December 31,2005:

| ** **                               | ** ** | **Gas-MMcf’s** | ** ** |
|------------------------------------------|------------|---------------------|------------|
| Developed and  undeveloped:              |       |                |       |   |   |
| Beginning of  year, January 1, 2005 |       |                | —     |   |   |
| Discoveries                              |       |                | 402        |   |   |
| Production                               |       |                | (6         | ) |   |
| End of year,  December 31, 2005     |       |                | 396        |   |   |

 

As of December 31,2005, all of the Company’s proved reserves are categorized as proved developedproducing.

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***Standardized Measure of Discounted Future Net CashFlows (Unaudited)***

SFAS No. 69, “Disclosuresabout Oil and Gas Producing Activities” (“SFAS 69”) details guidelines of howto determine the standardized measure of future net cash flows and changestherein relating to estimated proved reserves. The Company follows theseguidelines that are summarized as follows:

·       Futurecash inflows, production and development costs are determined by applying oiland gas prices and costs in effect at year-end, including overhead expenseallocable, transportation, quality and basis differentials to the year-endquantities of oil and gas to be produced in the future;

·       Futureincome taxes are estimated using current income tax rates and estimated futurestatutory depletion;

·       Futureoperating and development costs are based on estimates of expenditures indeveloping and producing proved oil and gas reserves in place at year-end,assuming continuity of year-end economic conditions;

·       Theresulting cash flows are reduced to present value using a ten percent discountrate; and

·       TheCompany used $5.27 as the year end price for natural gas on an Mcf basis, asadjusted for transportation, quality and basis differentials.

Thefollowing summarizes the Company’s standardized measure of future net cashflows relating to its proved reserves as prescribed in SFAS No. 69:

| ** **                                                | ** ** | **In thousands** | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|
| Future cash flows                                         |       |                  | $          | 2,089 |   |   |
| Future production  costs                                  |       |                  | (878       | ) |   |
| Future  abandonment costs                                 |       |                  | (75        | ) |   |
| Future income  taxes                                      |       |                  | (316       | ) |   |
| Future net cash  flows                                    |       |                  | 820        |   |   |
| Ten percent  discount                                     |       |                  | (132       | ) |   |
| Standardized measure of  discounted future net cash flows |       |                  | $          | 688 |   |   |

 

The Company initiated itsoil and gas activities during the year ended December 31, 2005.

**Note 14—SegmentInformation**

During the third quarter of 2005, the Company enteredinto the oil and gas exploration and production segment and began producing andselling natural gas during the fourth quarter of 2005.

The Company’s management,effective during the year ended December 31, 2005, monitors theperformance of its segments described as follows.

***Gas Gathering and Processing Segment***

The Company operates in the gathering and processingsegment and owns and operates gas gathering and processing systems it acquiredfrom TOP and BPE as earlier described. The Company charges a fee to itscustomers for these services based on a rate per Mcf, and/or based on a monthlyminimum fee and/or based on the level of compression services provided.

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***Oil and Gas Exploration and Production Segment***

The Company, beginning in the third quarter of 2005,commenced operations in the exploration and production segment. The Company’soperations in this segment include exploring for, developing and marketing naturalgas from coal-bed methane wells. For the year ended December 31, 2005, theCompany’s exploration and production segment operated in the Powder River Basinarea of Wyoming and Montana.

Throughthe Company’s Management Services Agreement with Rocky Mountain Gas, theCompany earned management fee revenue and has included that revenue underCorporate in the following table that details the performance of its segments.

| ** **                                           | ** ** | **For the Year Ended December 31, 2005** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **Gathering  and  Processing**                                         | ** ** | **Exploration  and  Production** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
| ** **                                           | ** ** | **In thousands**                                                  | ** ** |
| Revenue                                              |       |                                                                   | $          | 2,834 |   |   |   | $ | 51 |   |   |   | $ | 270 |   |   | $ | 3,155 |   |
| Operating expense                                    |       |                                                                   | 1,755      |   |   |   | 34 |   |   |   | — |   |   | 1,789 |   |
| Asset impairment  charge                             |       |                                                                   | 2,487      |   |   |   | — |   |   |   | — |   |   | 2,487 |   |
| Exploration  expense                                 |       |                                                                   | —     |   |   |   | 450 |   |   |   | — |   |   | 450 |   |
| Depreciation,  depletion, amortization and accretion |       |                                                                   | 1,041      |   |   |   | 4 |   |   |   | 22 |   |   | 1,067 |   |
| General and  administrative                          |       |                                                                   | —     |   |   |   | — |   |   |   | 2,029 |   |   | 2,029 |   |
| Operating loss                                       |       |                                                                   | (2,449     | ) |   |   | (437 | ) |   |   | (1,781 | ) |   | (4,667 | ) |
| Interest and  other-net                              |       |                                                                   | —     |   |   |   | — |   |   |   | 118 |   |   | 118 |   |
| Cumulative effect  of change in accounting principle |       |                                                                   | (76        | ) |   |   | — |   |   |   | — |   |   | (76 | ) |
| Net loss                                             |       |                                                                   | (2,525     | ) |   |   | (437 | ) |   |   | (1,663 | ) |   | (4,625 | ) |
| Preferred stock  dividends                           |       |                                                                   | —     |   |   |   | — |   |   |   | 204 |   |   | 204 |   |
| Net loss  attributable to common stockholders        |       |                                                                   | $          | (2,525 | ) |   |   | $ | (437 | ) |   |   | $ | (1,867 | ) |   | $ | (4,829 | ) |
| *Identifiable  assets*                               |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Property, plant  and equipment                       |       |                                                                   | $          | 5,747 |   |   |   | — |   |   |   | $ | 277 |   |   | $ | 6,024 |   |
| Contracts                                            |       |                                                                   | $          | 1,099 |   |   |   | — |   |   |   | — |   |   | $ | 1,099 |   |
| Oil and gas properties                               |       |                                                                   | —     |   |   |   | $ | 1,531 |   |   |   | — |   |   | $ | 1,531 |   |

 

The Company operated inonly one segment during the year ended December 31, 2004 and the Company’smanagement reviewed the results of its operations as a single segment duringthat period. Accordingly, segment information is not presented for the yearended December 31, 2004.

**Note 15—RelatedParty Transactions**

In October 2005, the Company and JMG Exploration, Inc.(“JMG”) entered into an agreement whereby the Company was to build and operatea 32 mile, 8-inch oil and gas pipeline in exchange for a cost-pluscompensation arrangement negotiated on an arms length basis. Thomas J.Jacobsen, Joseph Skeehan and Reuben Sandler are Directors on the Company’sBoard and also serve on the Board of Directors of JMG. During October 2005,the Company, based on its agreements with JMG, ordered the manufacture of the32 miles of 8-inch steel pipe at a cost of approximately $1.373 millionthat was intended to be used in an oil and gas pipeline the Company wasplanning to build to serve JMG’s oil and gas production anticipated in NorthDakota. See Note 6—Inventory for additional discussion regarding thistransaction.

Susan Wright, the Company’s Corporate Secretary andwife of the Company’s CEO, provides Corporate Secretary services to the Companyon a contract basis. During the years ended December 31, 2005 and December 31,2004, Mrs. Wright was paid $19 thousand and $18 thousand, respectively,for 

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contract services. Inaddition, during the year ended December 31, 2004, Mrs. Wrightreceived deemed compensation of $208 thousand in respect to the purchase of theCompany’s Series C Convertible Preferred stock.

Officers of the Company purchased 171,500 shares, or42%, of the Company’s Series C Convertible Preferred shares, that wereissued in December 2004.

Kevin P. Norris, a former Director from December 2003to May 2004 and a former principal stockholder in the Company, is theManager of TOP, a company from which the Company acquired certain assets in January 2004for $3.185 million. In January 2004, Mr. Norris purchased 800,000shares of the Company’s common stock for $0.0125 per share or $10 thousand. On September 30,2004, the Company repurchased Mr. Norris’s 800,000 shares of common stockfor $800 thousand. The Company provides gathering services that representedapproximately 8.4% and 29.2% of its total revenue for the years ended December 31,2005 and 2004, respectively, to e2 Business Services, Inc. Mr. Norrisis also a stockholder of e2 Business Services, Inc.

In January 2004, the Company sold 2,400,000shares of Series A Convertible Preferred stock to JMGG Partners, Ltd., aCalifornia limited partnership, of which John P. McGrain was the generalpartner. The Series A Convertible Preferred stock rights and preferencesincluded the right to vote equally with common stock and the right to electthree of five Directors as a class with the Series B Convertible Preferredstockholders. In January 2004, the Series A Convertible Preferredstock owned by JMGG represented 60% of the Company’s voting shares of stock.Mr. McGrain served as the Company’s non-executive Chairman of the Boardfrom January 2004 to June 2004. He resigned as the Company’snon-executive Chairman of the Board in June 2004 when JMGG dissolved itsoperations and distributed its assets, consisting solely of shares of theCompany’s Series A Convertible Preferred stock, to its partners. TheCompany did not compensate Mr. McGrain for any of his services as theCompany’s non-executive Chairman. Mr. McGrain was a control person withinthe meaning of federal securities laws for the period from January 2004through June 2004.

In June 2004, the Company issued Mr. McGrainwarrants to purchase 15,000 shares of common stock at an exercise price of$5.50 per share, valued at $4 thousand, as consideration for consultingservices in conjunction with the Company’s initial public offering. See Note 17—SubsequentEvents for information on warrants issued subsequent to December 31, 2005.

In October 2004, Mr. McGrain loaned theCompany $800 thousand in connection with the Company’s repurchase of 800,000shares of common stock from Mr. Norris. The Company repaid Mr. McGrainin full in December 2004, plus interest at a rate of 12% per year.

In December 2004, theCompany borrowed $1.5 million under a $1.75 million bank line of credit. Inaddition to a lien on all of the Company’s gathering assets, security for thisbank line of credit included a pledge to the bank of a $1.0 million certificateof deposit by Mr. McGrain. In consideration for this pledge, the Companyagreed to pay Mr. McGrain a monthly fee of approximately $5 thousand untilthe pledge was released upon the repayment of the line of credit. The Companypaid the bank line in full and the pledge was released following the Company’sinitial public offering.

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**Note 16—Quarterly Financial Information (Unaudited)**

| ** **                                                                     | ** ** | **First**                                                        | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------|------------|-----------|------------|------------|------------|-----------|------------|
| ** **                                                                     | ** ** | **In thousands, except per share data** | ** ** |
| 2005                                                                           |       |                                                             |       |       |       |      |       |       |       |      |       |
| Revenue                                                                        |       | $                                                                | 841        |       | $          | 715       |       | $          | 724        |      | $          | 875 |   | $ | 3,155 |   |
| Operating loss                                                                 |       | $                                                                | (189       | )          | $          | (415      | )          | $          | (2,931     | )         | $          | (1,132 | ) | $ | (4,667 | ) |
| Net loss before  cumulative effect of change in accounting principle           |       | $                                                                | (230       | )          | $          | (375      | )          | $          | (2,868     | )         | $          | (1,076 | ) | $ | (4,549 | ) |
| Cumulative effect  of change in accounting principle                           |       | —                                                           |       | —     |       | —    |       | $          | (76        | )         | $          | (76 | ) |
| Net loss                                                                       |       | $                                                                | (230       | )          | $          | (375      | )          | $          | (2,868     | )         | $          | (1,152 | ) | $ | (4,625 | ) |
| Net loss  applicable to common stockholders                                    |       | $                                                                | (412       | )          | $          | (397      | )          | $          | (2,868     | )         | $          | (1,152 | ) | $ | (4,829 | ) |
| Net loss per  share before cumulative effect of change in accounting principle |       | $                                                                | (0.52      | )          | $          | (0.06     | )          | $          | (0.40      | )         | $          | (0.15 | ) | $ | (0.68 | ) |
| Cumulative effect  of change in accounting principle per share of common stock |       | (0.00                                                            | )          | (0.00      | )          | (0.00     | )          | (0.01      | )          | (0.01     | )          |
| Net loss per  share—basic and diluted                                     |       | $                                                                | (0.52      | )          | $          | (0.06     | )          | $          | (0.40      | )         | $          | (0.16 | ) | $ | (0.69 | ) |
| 2004 (As  restated, see Note 3)                                                |       |                                                             |       |       |       |      |       |       |       |      |       |
| Revenue                                                                        |       | $                                                                | 399        |       | $          | 343       |       | $          | 841        |      | $          | 949 |   | $ | 2,532 |   |
| Operating income  (loss)                                                       |       | $                                                                | 8          |       | $          | (135      | )          | $          | (3         | )         | $          | (492 | ) | $ | (622 | ) |
| Net income (loss)                                                              |       | $                                                                | 11         |       | $          | (126      | )          | $          | 13         |      | $          | (549 | ) | $ | (651 | ) |
| Net loss  applicable to common stockholders                                    |       | $                                                                | (93        | )          | $          | (280      | )          | $          | (170       | )         | $          | (1,320 | ) | $ | (1,863 | ) |
| Net loss per share—basic  and diluted                                     |       | $                                                                | (0.06      | )          | $          | (0.17     | )          | $          | (0.11      | )         | $          | (1.65 | ) | $ | (1.33 | ) |

 

During the third quarterof 2005, the Company recorded an estimated impairment charge in respect to itsTOP gas gathering system of $2.372 million, and during the fourth quarter of2005 recorded an additional $115 thousand in respect to this impairment. SeeNote 5—Property, Equipment and Contracts. During the fourth quarter of 2005 theCompany recorded a $76 thousand cumulative effect of change in accountingprinciple. See Note 7—Asset Retirement Obligations.

**Note 17—SubsequentEvents**

During January 2006, the Company issued aconvertible subordinated debt offering. The aggregate amount of the offeringwas $21.965 million, before expenses, that included commissions andprofessional fees totaling  $1.045million. The terms of the notes include 10% interest paid quarterly in arrearswith maturity 30 months from date of closing. In addition, the holders have theright, after the shares have been registered, to convert the notes to theCompany’s common shares at a conversion price of $7 per share, which is subjectto certain anti-dilution adjustments. The Company pledged certain gas gatheringassets as collateral to the note holders. The terms of the SubscriptionAgreement provide that the Company will file a Registration Statement with theSEC within 90 days after the closing date of the offering. The SubscriptionAgreement includes 1% per month liquidated damages in the event the securitiesare not registered. In the event the common stock of the Company trades at $14per share or above for 10 consecutive days, the Company has a call provision toconvert these notes to its common shares at $7 per share. In addition, theCompany is prohibited from declaring or paying cash dividends on its commonstock during the period that any note is outstanding and unpaid. Futureinterest expense, assuming that the notes are held for the entire 30 months andthe notes are registered per the terms of the subscription agreement, isprojected to be $1.924 million, $2.227 million and $1.414 million for the yearsending December 31, 2006, 2007 and 2008, respectively.

The Company is currently evaluating the accountingtreatment applicable to the embedded conversion option contained in therecently issued convertible subordinated debt offering.

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In January 2006, the Company issued 40,000 warrantsto John McGrain, a related party, for services rendered in respect to itsrecent convertible debt offering. These warrants were issued at $7 per shareand were valued at $59 thousand on the date of issuance as determined by theBlack-Scholes model. See also Note—17, Related Party Transactions.

On January 17, 2006, the Termo Company informedthe Company it was designated as the preferred gatherer for its HomesteadProject containing 3,400 acres. The Company was offered a 9.25% workinginteresting in the project and paid $85,000 for the working interests in theundeveloped leaseholds that contain proved undeveloped reserves.

On January 25, 2006, the Company announced thatit had purchased a gas gathering system from Storm Cat Energy Corporation (“StormCat”) for $1 million. The Company also has entered into a related gasgathering and compression services agreement with Storm Cat covering 6,600acres.

On March 3, 2006, the Company entered into afarm-in agreement for a 15% working interest in leaseholds underlying its GAPand Bonepile gas gathering systems and plans to propose a drilling programduring 2006. The leaseholds cover 5 counties and a total of approximately 3,400net acres.

On March 3, 2006, the Company acquired a highpressure natural gas gathering line from Clear Creek Natural Gas, LLC for $450thousand. The newly acquired 6.5 miles of 6 and 8-inch steel pipe tiesinto the gathering and compression assets the Company purchased in January 2006,from Storm Cat. The Company will deliver gas from this line to the ThunderCreek interstate pipeline system.

On March 20, 2006, the Company withdrew from itsFarm-In and Development Agreement with Rocky Mountain Gas, as per the terms ofthe agreement. The Company will continue to provide operator and managementservices for at least a 60 day period as per the Management Services Agreement.

On March 21, 2006, the Company notified its 2customers served by its TOP system that the Company was raising its rates tocover its cash costs plus 15% for a 2 month period. The Company also advisedthese customers that it was planning to shut down the TOP system after the twomonth period elapsed. The customers have the right to purchase the TOP systemfrom the Company on to be negotiated terms, as per the related gas gatheringagreements.

Subsequent to December 31, 2005, 30,000 shares ofSeries C Convertible Preferred stock were converted to common shares andas of March 30, 2006, 10,000 Series C Convertible Preferred sharesremained outstanding.

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