##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended April 30, 2006
 Commission File No. 001-32695
 
 BPI Energy Holdings, Inc.
  British Columbia, Canada
    
    75-3183021(State or Other Jurisdiction of
    
    (I.R.S. Employer Identification No.)Incorporation or Organization)30775 Bainbridge Road, Suite 280, Solon, Ohio
    
    44139(Address of Principal Executive Offices)
    
    (Zip Code)
 (440) 248-4200
 þ o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer þ
 o þ




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TABLE OF CONTENTS  PART I. FINANCIAL INFORMATIONItem 1. Financial StatementsItem 2. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresPART II. OTHER INFORMATIONItem 1. Legal ProceedingsItem 2. Unregistered Sales of Equity Securities and Use of ProceedsItem 3. Defaults Upon Senior SecuritiesItem 4. Submission of Matters to a Vote of Security HoldersItem 5. Other InformationItem 6. ExhibitsSIGNATURESEX-10.3 Settlement Memorandum of UnderstandingEX-31.1 CertificationEX-31.2 CertificationEX-32.1    Table of Contents  
 PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 BPI Energy Holdings, Inc.
Consolidated Balance Sheets
 April 30, 2006
    
    July 31, 2005(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    24,793,727
    
    
    $
    7,251,503Accounts receivable
    
    
    126,102
    
    
    
    34,671Other current assets
    
    
    225,024
    
    
    
    23,534Total current assets
    
    
    25,144,853
    
    
    
    7,309,708Property and equipment, at cost:Oil and gas properties, full cost method of accounting:Proved, net of accumulated depreciation,
depletion and amortization of $226,927
and $58,523
    
    
    20,973,084
    
    
    
    10,190,929Unproved
    
    
    1,274,205
    
    
    
    3,149,372Net oil and gas properties
    
    
    22,247,289
    
    
    
    13,340,301Other property and equipment, net of accumulated
depreciation and amortization of $567,614 and $398,988
    
    
    4,723,150
    
    
    
    1,769,812Net property and equipment
    
    
    26,970,439
    
    
    
    15,110,113Investment in Hite Coalbed Methane, L.L.C.
    
    
    
    
    
    
    846,766Restricted cash
    
    
    134,173
    
    
    
    100,000Other non-current assets
    
    
    161,125
    
    
    
    161,12552,410,590
    
    
    
    23,527,712LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    
    897,010
    
    
    
    2,144,066Current maturity of long-term notes payable
    
    
    201,533
    
    
    
    42,227Accrued liabilities and other
    
    
    3,038,601
    
    
    
    31,405Total current liabilities
    
    
    4,137,144
    
    
    
    2,217,698Long-term notes payable, less current portion
    
    
    83,458
    
    
    
    507,595Other non-current liabilities
    
    
    51,678
    
    
    
    Total liabilities
    
    
    4,272,280
    
    
    
    2,725,293Shareholders equity:Common shares, no par value, authorized 200,000,000
shares, 70,812,540 and 43,912,961 outstanding
    
    
    68,593,404
    
    
    
    34,666,022Additional paid-in capital
    
    
    4,891,266
    
    
    
    4,493,680Accumulated deficit
    
    
    (25,346,360
    )
    
    
    (18,357,283
    )Total shareholders equity
    
    
    48,138,310
    
    
    
    20,802,419$
    52,410,590
    
    
    $
    23,527,712
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BPI Energy Holdings, Inc.
Consolidated Statements of Operations
(Unaudited)
 Three Months Ended April 30
    
    Nine Months Ended April 302006
    
    2005
    
    2006
    
    2005Revenues:Gas sales
    
    $
    262,860
    
    
    $
    46,925
    
    
    $
    800,365
    
    
    $
    53,266Expenses:Lease operating expense
    
    
    290,844
    
    
    
    203,289
    
    
    
    752,454
    
    
    
    203,289General and administrative
expenses
    
    
    2,054,434
    
    
    
    1,847,554
    
    
    
    4,491,676
    
    
    
    5,012,641Depreciation, depletion and
amortization
    
    
    189,988
    
    
    
    83,129
    
    
    
    402,680
    
    
    
    140,8012,535,266
    
    
    
    2,133,972
    
    
    
    5,646,810
    
    
    
    5,356,731Other income (expenses):Interest income
    
    
    229,888
    
    
    
    62,012
    
    
    
    632,693
    
    
    
    66,859Interest expense
    
    
    (4,276
    )
    
    
    (3,804
    )
    
    
    (18,054
    )
    
    
    (14,386
    )Other income (expense), net
    
    
    (2,894,794
    )
    
    
    24,053
    
    
    
    (2,757,271
    )
    
    
    27,299(2,669,182
    )
    
    
    82,261
    
    
    
    (2,142,632
    )
    
    
    79,772Loss before income taxes
    
    
    (4,941,588
    )
    
    
    (2,004,786
    )
    
    
    (6,989,077
    )
    
    
    (5,223,693
    )Deferred income tax benefit
    
    
    
    
    
    
    270,587
    
    
    
    
    
    
    
    615,304Net loss
    
    $
    (4,941,588
    )
    
    $
    (1,734,199
    )
    
    $
    (6,989,077
    )
    
    $
    (4,608,389
    )Basic and diluted loss per share
    
    ($
    0.07
    )
    
    ($
    0.04
    )
    
    ($
    0.12
    )
    
    ($
    0.13
    )Weighted average common shares
outstanding
    
    
    66,395,782
    
    
    
    43,128,791
    
    
    
    60,686,413
    
    
    
    35,640,418
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BPI Energy Holdings, Inc.
Consolidated Statements of Shareholders Equity
(Unaudited)
 Additional
    
    
    
    
    
    TotalCommon Shares
    
    Paid-in
    
    Accumulated
    
    ShareholdersShares
    
    Amounts
    
    Capital
    
    Deficit
    
    EquityBalance, July 31, 2005
    
    
    43,912,961
    
    
    $
    34,666,022
    
    
    $
    4,493,680
    
    
    $
    (18,357,283
    )
    
    $
    20,802,419Proceeds from stock
options exercised
    
    
    396,667
    
    
    
    382,239
    
    
    
    
    
    
    
    
    
    
    
    382,239Proceeds from warrants
exercised
    
    
    5,822,075
    
    
    
    5,013,928
    
    
    
    
    
    
    
    
    
    
    
    5,013,928Net proceeds from
shares issued in
private placement 
September 23, 2005 (1)
    
    
    18,000,000
    
    
    
    27,883,954
    
    
    
    
    
    
    
    
    
    
    
    27,883,954Stock-based
compensation  stock
options
    
    
    
    
    
    
    
    
    
    
    397,586
    
    
    
    
    
    
    
    397,586Stock-based
compensation  common
stock, including
vesting of restricted
stock
    
    
    496,339
    
    
    
    647,261
    
    
    
    
    
    
    
    
    
    
    
    647,261Unvested portion of
restricted shares
issued
    
    
    2,184,498
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,989,077
    )
    
    
    (6,989,077
    )Balance, April 30, 2006
    
    
    70,812,540
    
    
    $
    68,593,404
    
    
    $
    4,891,266
    
    
    $
    (25,346,360
    )
    
    $
    48,138,310
 
 (1)
    
    Net of share issuance costs of $2,619,953.  3




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BPI Energy Holdings, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
 Nine Months Ended April 302006
    
    2005Operating activities:Net loss
    
    $
    (6,989,077
    )
    
    $
    (4,608,389
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation, depletion and amortization
    
    
    402,680
    
    
    
    140,801Stock-based compensation expense
    
    
    1,044,847
    
    
    
    3,240,183Gain on sale of investment
    
    
    (127,416
    )
    
    
    (14,844
    )Deferred income tax benefit
    
    
    
    
    
    
    (615,304
    )Other
    
    
    
    
    
    
    17,610Changes in assets and liabilities:Accounts receivable
    
    
    (91,431
    )
    
    
    (23,910
    )Other current assets
    
    
    (201,490
    )
    
    
    (12,902
    )Accounts payable
    
    
    (1,247,056
    )
    
    
    236,852Accrued liabilities and other
    
    
    3,038,378
    
    
    
    8,277Other non-current liabilities
    
    
    51,678
    
    
    
    Net cash used in operating activities
    
    
    (4,118,887
    )
    
    
    (1,631,626
    )Investing activities:Proceeds from sale of investments
    
    
    551,000
    
    
    
    62,160Business acquisition, net of cash acquired
    
    
    
    
    
    
    (857,638
    )Additions to oil and gas properties
    
    
    (9,075,392
    )
    
    
    (2,969,450
    )Additions to other property and equipment
    
    
    (2,954,139
    )
    
    
    (414,041
    )Acquisition of equity interest in joint venture
    
    
    
    
    
    
    (78,112
    )Increase in restricted cash
    
    
    (34,173
    )
    
    
    (100,000
    )Net cash used in investment activities
    
    
    (11,512,704
    )
    
    
    (4,357,081
    )Financing activities:Payments on long-term notes payable
    
    
    (106,306
    )
    
    
    (28,843
    )Net proceeds from issuance of common shares
    
    
    33,280,121
    
    
    
    14,942,359Net cash provided by financing activities
    
    
    33,173,815
    
    
    
    14,913,516Net increase in cash and cash equivalents
    
    
    17,542,224
    
    
    
    8,924,809Cash and cash equivalents at the beginning of the period
    
    
    7,251,503
    
    
    
    970,795Cash and cash equivalents at the end of the period
    
    $
    24,793,727
    
    
    $
    9,895,604Supplementary disclosure of cash flow information:Non-cash investing and financing activity:Acquisition of equipment by issuance of notes payable
    
    $
    233,475
    
    
    $
    Interest paid
    
    $
    14,132
    
    
    $
    12,043
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BPI Energy Holdings, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
 1.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESBasis of PresentationThese unaudited consolidated interim financial statements include the accounts of BPI Energy
Holdings, Inc. and its wholly owned U.S. subsidiary, BPI Energy, Inc. (collectively, the
Company). All inter-company transactions and balances have been eliminated upon
consolidation.BPI Energy Holdings, Inc. is incorporated in British Columbia, Canada and, through its wholly
owned U.S. subsidiary, BPI Energy, Inc., is involved in the acquisition, exploration for and production of coalbed methane properties located in the United States of America. The
Company conducts its operations in one reportable segment, which is oil and gas exploration and
production. On December 13, 2005, the Companys common shares began trading on the American
Stock Exchange (AMEX) under the symbol BPG. As a result of the shares being listed on the
AMEX, the Company voluntarily de-listed from trading its shares on the TSX Venture Exchange.
Amounts shown are in U.S. Dollars unless otherwise indicated.The accompanying unaudited consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation have been included.
Operating results for the quarter and nine months ended April 30, 2006 are not necessarily
indicative of the results that may be expected for the full fiscal year. For further
information, refer to the consolidated financial statements and notes thereto included in the
Post-Effective Amendment No.1 to Form S-1 filed with the Securities and Exchange Commission on
May 11, 2006. Certain prior period amounts have been reclassified to conform to the current period
presentation.Use of EstimatesThe preparation of these unaudited consolidated financial statements requires the use of
certain estimates by management in determining the Companys assets, liabilities, revenues and
expenses. Actual results could differ from such estimates. Depreciation, depletion and
amortization of oil and gas properties and the impairment of oil and gas properties are
determined using estimates of oil and gas reserves. There are numerous uncertainties in
estimating the quantity of reserves and in projecting the future rates of production and
timing of development expenditures, including future costs to dismantle, dispose, and restore
the Companys properties. Oil and gas reserve engineering must be recognized as a subjective
process of estimating underground accumulations of oil and gas that cannot be measured in an
exact way. Proved reserves of oil and natural gas are estimated quantities that geological and
engineering data demonstrate with reasonable certainty to be recoverable in the future from
known reservoirs under existing conditions.Oil and Gas PropertiesThe Company follows the full cost method of accounting for oil and gas properties. Under this
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method, all costs associated with the acquisition of, exploration for and development of oil
and gas reserves are capitalized in cost centers on a country-by-country basis (currently the Company has one cost center, the United States). Such costs
include lease acquisition costs, geological and geophysical studies, carrying charges on
non-producing properties, costs of drilling both productive and non-productive wells, and
overhead expenses directly related to these activities. Internal costs associated with oil
and gas activities that are not directly attributable to acquisition, exploration or
development activities are expensed as incurred.Unevaluated oil and gas properties and major development projects are excluded from
amortization until a determination of whether proved reserves can be assigned to the
properties or impairment occurs. Unevaluated properties are assessed at least annually to
ascertain whether an impairment has occurred. Sales or dispositions of properties are credited
to their respective cost centers and a gain or loss is recognized when all the properties in a
cost center have been disposed of, unless such sale or disposition significantly alters the
relationship between capitalized costs and proved reserves attributable to the cost center.Capitalized costs of proved oil and gas properties, including estimated future costs to
develop the reserves and estimated abandonment cost, net of salvage, are amortized on the
units-of-production method using estimates of proved reserves.A ceiling test is applied to each cost center by comparing the net capitalized costs, less
related deferred income taxes, to the estimated future net revenues from production of proved
reserves, discounted at 10%, plus the costs of unproved properties net of impairment. Any
excess capitalized costs are written off in the current year. The calculation of future net
revenues is based upon prices, costs and regulations in effect at each year end.In general, the Company determines if a property is impaired if one or more of the following
conditions exist:
 i)
    
    there are no firm plans for further drilling on the unproved property;ii)
    
    negative results were obtained from studies of the unproved property;iii)
    
    negative results were obtained from studies conducted in the vicinity of the
unproved property; oriv)
    
    the remaining term of the unproved property does not allow sufficient time
for further studies or drilling.
 Other Property and EquipmentProperty and equipment are stated at cost. Gas collection equipment is depreciated on the
units-of-production method based on proved reserves. Support equipment and other property and
equipment are depreciated using the straight-line method over the estimated useful lives of
the assets, ranging from three to ten years. Major classes of property and equipment
consisted of the following:
 April 30
    
    
    July 312006
    
    
    2005Other Property and Equipment:Gas collection equipment
    
    $
    4,149,653
    
    
    $
    1,332,012Support equipment
    
    
    1,046,989
    
    
    
    760,467Other
    
    
    94,122
    
    
    
    76,321Less: Accumulated depreciation and amortization
    
    
    (567,614
    )
    
    
    (398,988
    )$
    4,723,150
    
    
    $
    1,769,812
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Asset Retirement ObligationsThe Company follows Statement of Financial Accounting Standards (SFAS) No. 143, Accounting
for Asset Retirement Obligations. SFAS No. 143 requires the Company to record the fair value
of an asset retirement obligation as a liability in the period in which it is incurred, if a
reasonable estimate of fair value can be made. The present value of the estimated asset
retirement costs is capitalized as part of the carrying amount of the associated long-lived
asset. Amortization of the capitalized asset retirement cost is determined on a
units-of-production method. Accretion of the asset retirement obligation is recognized over
time until the obligation is settled. The Companys asset retirement obligations relate to
the plugging of wells upon exhaustion of gas reserves. The Company assessed its asset
retirement obligation in prior periods and deemed it to be immaterial. The initial liability
for our asset retirement obligations was recorded as of August 1, 2005 in the amount of
$19,778.The following table summarizes the activity for the Companys asset retirement obligations for
the nine months ended April 30, 2006 and 2005:
 Nine Months Ended April 302006
    
    2005Asset retirement obligation at beginning of
period
    
    $
    19,778
    
    
    $
    Accretion expense
    
    
    2,464
    
    
    
    Liabilities incurred
    
    
    29,436
    
    
    
    Asset retirement obligation at end of period
    
    $
    51,678
    
    
    $
    
 Loss Per ShareLoss per share is calculated using the weighted average number of common shares outstanding
during the year. Diluted loss per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted into common
stock. Diluted loss per share is not disclosed as all common share equivalents were
anti-dilutive for the quarters and nine months ended April 30, 2006 and 2005. The following
items were excluded from the computation of diluted loss per share at April 30, 2006 and 2005,
respectively, as the effect of their assumed exercises would be anti-dilutive:
 2006
    
    2005Outstanding warrants
    
    
    5,311,600
    
    
    
    11,306,175Outstanding stock options
    
    
    1,872,812
    
    
    
    4,245,612Unvested portion of restricted shares issued
    
    
    2,184,498
    
    
    
    9,368,910
    
    
    
    15,551,787
 Share-Based PaymentPrior to December 13, 2005 the Company administered a stock-based compensation plan (the
Incentive Stock Option Plan) under which stock options were issued to directors, officers,
employees and consultants as determined by the Board of Directors and subject to the
provisions of the Incentive Stock Option Plan. The Incentive Stock Option Plan permitted
options to be issued with exercise prices at a discount to the market price of the Companys
common stock on the day prior to the date of grant. However, the majority of all stock
options issued under the Incentive Stock Option Plan were issued with exercise prices equal to
the quoted market price of the stock on the date of grant. Options granted under the
Incentive Stock Option Plan vested immediately and were exercisable over a period not
exceeding five years. The Company had 1,872,812 options outstanding under the Incentive Stock
Option Plan at April 30, 2006.
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On December 13, 2005, the shareholders of the Company approved the 2005
Omnibus Stock Plan (the Omnibus Stock Plan) and it became effective on that date. The
Omnibus Stock Plan replaces the Incentive Stock Option Plan under which stock options were
previously granted. The Omnibus Stock Plan will be administered by the Compensation Committee
of the Board of Directors (the Committee) and will remain in effect for five years. All
employees and Directors of the Company and its subsidiaries, and all consultants or agents of
the Company designated by the Committee, are eligible to participate in the Omnibus Stock
Plan. The Committee has authority to: grant awards; select the participants who will receive
awards; determine the terms, conditions, vesting periods and restrictions applicable to the
awards; determine how the exercise price is to be paid; modify or replace outstanding awards
within the limits of the Omnibus Stock Plan; accelerate the date on which awards become
exercisable; waive the restrictions and conditions applicable to awards; and establish rules
governing the Omnibus Stock Plan. No options have been issued under the Omnibus Stock Plan.
During the current quarter, the Committee granted stock awards under the Omnibus Stock Plan in
the form of restricted and unrestricted stock to employees and directors of the Company. The
transactions involving the granting of these stock awards are described more fully in Note 2.In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment. This Statement revises
SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. SFAS No. 123(R) focuses primarily on the
accounting for transactions in which an entity obtains employee services in share-based
payment transactions. The key provision of SFAS No. 123(R) requires companies to record
share-based payment transactions as compensation expense at fair market value based on the
grant-date fair value of those awards. Previously under SFAS 123, companies had the option of
either recording expense based on the fair value of stock options granted or continuing to
account for stock-based compensation using the intrinsic value method prescribed by APB No.
25.The Company adopted SFAS No. 123(R), using the modified-prospective method, effective August
1, 2005. Since August 1, 2001, the Company followed the fair value provisions of SFAS 123 and
recorded all share-based payment transactions as compensation expense at fair market value
based on the grant-date fair value of those awards. In addition, all stock options previously
granted by the Company vested immediately on the date of grant, and
there was thus no unvested portion of previous stock option grants which vested during the
quarter or nine months ended April 30, 2006. Therefore, SFAS 123(R) had no impact on the
Companys consolidated financial position or results of operations for the quarter and nine
months ended April 30, 2006. The Company continues to use the Black-Scholes formula to
estimate the fair value of stock options granted under the Incentive Stock Option Plan.2.
    
    STOCK-BASED COMPENSATIONStock OptionsThe tables below summarize stock options activity for the nine months ended April 30, 2006.
All stock options were granted with exercise prices denominated in Canadian Dollars and equal
to the quoted market price of the stock on the date of grant. U.S. Dollar amounts shown in
the tables below were derived using published exchange rates on the date of the transaction
for grants, cancellations, exercises and expirations and at period-end exchange rates for
options outstanding at April 30, 2006 and July 31, 2005.
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Weighted-AverageExercise PriceNumber of options
    
    CAD$
    
    USD$Outstanding at July 31, 2005
    
    
    4,227,279
    
    
    $
    1.82
    
    
    $
    1.49Granted
    
    
    495,000
    
    
    
    2.05
    
    
    
    1.79Exercised
    
    
    (396,667
    )
    
    
    1.22
    
    
    
    0.97Cancelled or surrendered
    
    
    (2,452,800
    )
    
    
    2.23
    
    
    
    1.81Outstanding at April 30, 2006
    
    
    1,872,812
    
    
    $
    1.48
    
    
    $
    1.19
 The Company recorded stock-based compensation expense for stock options granted to employees
and directors in the amount of $397,586 and $2,200,777 during the nine months ended April 30,
2006 and 2005, respectively, which is included in general and administrative expenses in the
Statements of Operations. The fair value of stock options granted was estimated using the
Black-Scholes Option Pricing Model with the following assumptions:
 Nine Months Ended April 30,2006
    
    2005Risk-free interest rate
    
    
    3.3
    %
    
    
    3.0  3.5
    %Expected dividend yield
    
    Nil
    
    NilExpected stock price volatility
    
    
    66
    %
    
    
    74  81
    %Expected option life
    
    3 years
    
    3 years
 Option pricing models require the input of highly subjective assumptions, particularly as to
the expected price volatility of the stock. Changes in these assumptions can materially
affect the fair value estimate, and therefore it is managements view that the existing models
do not necessarily provide a single reliable measure of the fair value of the Companys stock
option grants.The following table summarizes information about options outstanding as of April 30, 2006:
 ExercisePrice
    
    Number
    
    
    Remaining
    
    
    ExpiryCAD$
    
    Outstanding
    
    
    Life (Years)
    
    
    Date$
    0.65
    
    
    345,000
    
    
    
    2.5
    
    
    
    November 3, 20080.90
    
    
    293,334
    
    
    
    0.7
    
    
    
    January 10, 20070.90
    
    
    10,000
    
    
    
    3.4
    
    
    
    September 22, 20091.49
    
    
    695,666
    
    
    
    3.6
    
    
    
    November 29, 20092.05
    
    
    10,000
    
    
    
    4.4
    
    
    
    September 22, 20102.19
    
    
    136,000
    
    
    
    3.9
    
    
    
    March 27, 20102.40
    
    
    382,812
    
    
    
    3.7
    
    
    
    January 20, 2010$
    1.48
    
    
    1,872,812
    
    
    
    3.0
 Restricted Stock Awards and Grants of Common SharesOn April 12, 2006, the Compensation Committee approved an exchange of common shares for
outstanding stock options held by various key employees and directors of the Company (Option
Exchange). The Option Exchange effectively cancelled stock option awards for 2,025,000 of
the Companys common shares previously granted during fiscal years 2005 and 2006. The
Option Exchange replaced the cancelled options with restricted stock awards of 2,025,000 of
the Companys common shares. The shares of restricted stock are included in common shares
outstanding when issued, but only the vested portion of such shares are included in the
 9




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computation of basic earnings per share. The restrictions required the covered individuals to be continuously employed through
certain vesting dates. Vesting of some or all of the restricted shares will be accelerated in the event
an employee is no longer employed due to death, disability or discharge by the Company for any
reason other than just cause or if a director stands for reelection to the board and does not
receive enough votes to be reelected to the board. The restricted shares are scheduled to
vest over the requisition service period as follows:
 January 1, 2007
    
    680,000 sharesJanuary 1, 2008
    
    680,000 sharesJanuary 1, 2009
    
    665,000 shares
 The Company accounted for the Option Exchange as a modification of the original shared-based
payment awards (stock options) in accordance with SFAS No. 123(R). Accordingly, the Company
recorded compensation expense based on the excess of the fair value of the restricted stock
award grants over the fair value of the original award (stock options) measured immediately
before the transaction based on current circumstances. The fair value of the restricted stock
awards was determined based on the number of shares granted and the quoted price of our common
stock on the date of the grant of $1.42 per share. The value of the stock options surrendered
was computed immediately before the modification using the Black Scholes valuation model with
the following assumptions:
 Risk-free interest rate
    
    
    4.75
    %Expected dividend yield
    
    
    NilExpected stock price volatility
    
    
    171% - 178
    %Expected option remaining life
    
    3.8  4.5  years
 In estimating expected volatility, the Company considered its historical volatility for the
period that its stock began trading on the American Stock Exchange (approximately 120 days)
and the historical volatility of a similar entity (guideline company) whose share price was
publicly available for the necessary period in order to reflect the expected remaining life
of the stock options.The Option Exchange resulted in incremental compensation expense of $230,900, which will be
recognized over the requisite service period. The Company recorded $15,458 of compensation
expense related to the Option Exchange in the quarter ended April 30, 2006. Future
amortization of the unearned incremental compensation expense will result in additional
compensation expense of $27,020 in the fourth quarter of fiscal year ended 2006 and $89,971,
$70,806 and $27,645 in fiscal years ended July 31, 2007, 2008 and 2009, respectively.On April 12, 2006, the Company granted 300,000 shares of
restricted stock and 300,000 shares of unrestricted common stock to
its newly hired senior vice president of operations. On that same
date, the Company granted 140,000 shares of unrestricted common
stock to its newly appointed independent director. The fair
value of the restricted stock was determined based on the number of shares granted and the
quoted price of our common stock on the date of the grant of $1.42 per share. The restricted
stock is scheduled to vest over the requisition service period in the amount of 100,000
shares each on January 1, 2007, 2008 and 2009. The Company recorded $7,003 of compensation
expense related to this grant of restricted stock in the quarter ended April 30, 2006.
Future amortization of the unearned compensation expense will result in additional
compensation expense of $35,792 in the fourth quarter of fiscal year
ended 2006 and $142,000,
$142,000 and $99,205 in fiscal years ended July 31, 2007, 2008 and 2009, respectively. The
Company recorded the fair value of the award of unrestricted common shares of $624,800 as
compensation expense in the quarter ended April 30, 2006.
 10




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3.
    
    INCOME TAXESWe operate in two tax jurisdictions, the United States and Canada. Primarily as a result
of the net operating losses that we have generated (NOL Carryforwards) in both Canada and
the United States, we have generated deferred tax benefits available for tax purposes to
offset net income in future periods. SFAS No. 109, Accounting for Income Taxes, requires that
we record a valuation allowance when it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of deferred tax assets
is dependent upon the generation of sufficient future taxable income before the expiration of
the NOL Carryforwards. Because of the Companys limited operating history, limited financial
performance and cumulative tax loss from inception, it is managements judgment that SFAS No.
109 requires the recording of a full valuation allowance for net deferred tax assets in both
Canada and the United States as of April 30, 2006.We recorded a tax benefit in the United States for the nine months ended April 30, 2005 to
partially offset a net deferred tax liability at April 30, 2005; however, no tax benefit was
recognized for the nine months ended April 30, 2006 as the Company had no net deferred tax
liability to offset.4.
    
    LONG-TERM NOTES PAYABLEThe Company has outstanding notes payable as follows:
 April 30,
    
    
    July 31,2006
    
    
    2005Case Credit term note due in fiscal year 2006, 6.50%
    
    $
    19,872
    
    
    $
    32,833GMAC term notes due in fiscal year 2009, 6.50%
    
    
    22,151
    
    
    
    26,633GMAC term notes due in fiscal year 2010, 6.1% to 6.50%
    
    
    85,632
    
    
    
    98,356Convertible note due in fiscal year 2008, 3.25%
    
    
    
    
    
    
    392,000Caterpillar Financial Services Corp
    
    
    157,336
    
    
    
    284,991
    
    
    
    549,822Less current maturities
    
    
    (201,533
    )
    
    
    (42,227
    )Long-term notes payable
    
    $
    83,458
    
    
    $
    507,595
 The notes are collateralized by the related vehicles and equipment. The convertible note
payable outstanding at July 31, 2005 was issued in June 2003 with a face value of $392,000 and
maturing on June 10, 2008, bearing interest at 3.25%, convertible at the option of the
holder, prior to June 10, 2008, into 390,537 common shares of the Company. The convertible
note payable was cancelled on January 4, 2005 pursuant to the sale of the Companys interest
in Hite Coalbed Methane, L.L.C.  see Note 7.
 11




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##### Table of Contents



The annual principal maturities of all notes for the remaining three months of fiscal year 2006 and the
four fiscal years thereafter are as follows:
 2006
    
    
    
    
    
    
    
    
    
    $
    68,9772007
    
    
    
    
    
    
    
    
    
    
    140,8622008
    
    
    
    
    
    
    
    
    
    
    27,9822009
    
    
    
    
    
    
    
    
    
    
    29,7672010
    
    
    
    
    
    
    
    
    
    
    17,403$
    284,991
 5.
    
    SHAREHOLDERS EQUITYIn September 2005, the Company sold 18,000,000 common shares in a private placement. The
proceeds from this private placement of $27,883,954, net of $2,619,953 of share issuance costs,
will be used to fund the Companys plan of operations and for working capital and general
corporate purposes. The Company has share purchase warrants outstanding at April 30, 2006 as follows:
 Number
    
    Exercise
    
    
    ExpiryOutstanding
    
    Price
    
    Date4,274,400
    
    USD $1.50
    
    January 12, 20091,037,200
    
    USD $1.25
    
    January 12, 20105,311,600
 During the third quarter of fiscal year 2006, the shareholders voted to increase the number of
shares of common stock the Company is authorized to issue from 100,000,000 shares to 200,000,000
shares.
 6.
    
    RELATED PARTY TRANSACTIONSThe Company enters into various transactions with related parties in the normal course of
business operations.Randy Oestreich, the Companys Vice President of Field
Operations, owns and operates A-Strike
Consulting, a consulting company that provides, among other things, laboratory testing
related to coalbed methane. Beginning in fiscal year ended July 31, 2005, the Company owns
and maintains a lab testing facility and allows A-Strike Consulting to operate the facility.
The Company pays all expenses related to the facility and, in return, receives 80% of the
revenue generated from the operations of the facility as reimbursement of the Companys
expenses. The Company received approximately $68,674 and $59,000 in expense reimbursement
related to this arrangement during the nine months ended
April 30, 2006 and 2005,
respectively. Mr. Ostreichs brother owns Dependable Service Company, a company that provides general labor
services to the Company. The Company paid Dependable Services Company $227,626 and $54,929 during
the nine months ended April 30, 2006 and 2005, respectively.David Preng, a director of the Company, is a principal in the executive search firm Preng & Associates. The Company paid Preng &
Associates approximately $150,000 and $0 for executive placement services during the nine
months ended April 30, 2006 and 2005, respectively.7.
    
    SALE OF INVESTMENT IN HITE COALBED METHANE, L.L.C.On January 4, 2006, the Company sold its 49% interest in Hite Coalbed Methane, L.L.C.
(HCM) for $551,000 in cash and cancellation of the Companys convertible note payable in
the amount of $392,000, plus accrued interest of $31,182. The note was convertible into
390,537 of the Companys common shares. The Company accounted for its investment in HCM under
the cost method of accounting. The total consideration received of $974,182 resulted in a
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gain on the sale of the investment of $127,416, which is included in other income in the
Companys statement of operations for the nine months ended April 30, 2006. The Company also
received its final distribution of net income from HCM during the quarter ended April 30,
2006 in the amount of $51,452, which is included as part of other income (expense), net in the
statement of operations for the quarter and nine months ended April 30, 2006.8.

OTHER INCOME (EXPENSE), NETOther income (expense), net consisted of the following:


Three Months Ended April 302006
    
    
    2005Settlement of lawsuit
    
    $
    (2,949,907
    )
    
    $
    Distribution from HCM
    
    
    51,452
    
    
    
    Gain on sale of marketable securities
    
    
    
    
    
    
    11,598Other
    
    
    3,661
    
    
    
    12,455$
    (2,894,794
    )
    
    $
    24,053


Nine Months Ended April 302006
    
    
    2005Settlement of lawsuit
    
    $
    (2,949,907
    )
    
    $
    Gain on sale of investment in HCM
    
    
    127,416Distribution from HCM
    
    
    51,452
    
    
    
    Gain on sale of marketable securities
    
    
    
    
    
    
    14,844Other
    
    
    13,768
    
    
    
    12,455$
    (2,757,271
    )
    
    $
    27,299


9.
    
    SUBSEQUENT EVENT  LEGAL PROCEEDINGSOn March 15, 2006, the Company filed a complaint against Colt LLC and other defendants
alleging tortious interference with business relations and breach of contract relating to the
interruptions of our development plans at the Companys Southern Illinois Basin Project. The
Company sought a preliminary injunction (which was denied by the court) against Colt LLC and
related parties from terminating the lease agreement covering its CBM rights in 43,000 acres
at the Southern Illinois Basin Project or taking any other action that interferes with the
Companys right to mine CBM under the lease agreement, pending a final judgment on the merits
of the complaint.On April 5, 2006, Colt filed an answer and counterclaim in response to the Companys
complaint. In its counterclaim, Colt sought a declaratory judgment asking the court to
declare, among other things, that: (a) BPI committed multiple breaches of the lease
agreement; (b) the lease agreement automatically terminated due to BPIs failure to cure its
alleged breaches; (c) the lease agreement automatically terminated by its own terms on April
3, 2006; and (d) to the extent the lease agreement already terminated, BPI is wrongfully
holding over and/or trespassing and Colt is entitled to an award of damages as a result.In June 2006, the Company reached a settlement with
the defendants in this lawsuit. The
following list summarizes the key terms of the settlement:


1.
    
    All parties to the suit will release all of the other parties from any claims they
may have had against each other;2.
    
    BPI will pay Colt $3,000,000;3.
    
    BPI will surrender any interest it had in the lease;4.
    
    BPI acquired ownership of the CBM estate covering approximately 10,000 of the
43,000 acres previously covered by the lease (which acreage includes all of the
currently producing CBM wells and proved reserves at our Southern Illinois Basin
Project);5.
    
    BPI will be relieved of any future obligation to make royalty payments as was
previously required under the terms of the lease (under the terms of the lease BPI was
obligated to make royalty payments of 15% of gross sales and minimum royalties totaling
at least $42,000 per month); and6.
    
    The deed will provide that CBM operations take priority over coal mining
operations for as long as CBM is being produced from the covered acreage; however, Colt
has the right to acquire any CBM wells located in these 10,000 acres. If Colt exercises
this option, they will be required to pay the fair market value (as established by a
mutually agreed upon expert) of such well.


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##### Table of Contents



In conjunction with this proposed settlement, during the quarter ended April 30, 2006 the
Company recorded $2,949,907 as other expense, approximately $50,000 as a
deduction to sales for royalties due on production that Colt, LLC had previously rejected,
and $3,000,000 as accrued liabilities for the pending payment. In addition, the Company
reclassified approximately $2,226,000 from the cost of Unevaluated Properties to the cost of
Proved Properties to recognize the impairment resulting from the loss of approximately 33,000
acres of mineral rights.
 14




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Overview and Outlook
      
    
    negotiating to obtain leases that grant us the broadest possible rights to CBM for
any given tract of land;
    
    conducting ongoing title reviews of existing mineral interests;
    
    where possible, negotiating and securing long-term service company commitments to
ensure availability of equipment and services; and
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##### Table of Contents




    
    attempting to create a low cost structure in order to reduce our vulnerability to
many of these factors.
   
    
    developing the in-house capabilities necessary to enable us to meet our regulatory
and reporting obligations to various regulatory agencies, constituencies and our
shareholders;
    
    raising the capital necessary to achieve our plans and goals;
    
    transitioning BPI from a company focused primarily on the acquisition of mineral
rights to a company focused on producing CBM; and
    
    developing and expanding our in-house technical team necessary for large scale
development and production of CBM assets.
     16




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##### Table of Contents



Wells DrilledProductive
    
    but not yet in
    
    Shut-in
    
    Test
    
    TotalProject
    
    Wells
    
    Production
    
    Wells
    
    Wells
    
    WellsSouthern Illinois Basin Project
    
    
    77
    
    
    
    8
    
    
    
    17
    
    
    
    0
    
    
    
    102Northern Illinois Basin Project
    
    
    0
    
    
    
    2
    
    
    
    0
    
    
    
    3
    
    
    
    5Western Illinois Basin Project
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Total
    
    
    77
    
    
    
    10
    
    
    
    17
    
    
    
    3
    
    
    
    107
  Results of Operations
 Three Months Ended April 30, 2006 Compared to Three Months Ended April 30, 2005
  Three Months Ended April 30Dollar
    
    %2006
    
    2005
    
    Variance
    
    ChangeRevenues:Gas sales
    
    $
    262,860
    
    
    $
    46,925
    
    
    $
    215,935
    
    
    
    460
    %Expenses:Lease operating expense
    
    
    290,844
    
    
    
    203,289
    
    
    
    87,555
    
    
    
    43
    %General and administrative expense
    
    
    2,054,434
    
    
    
    1,847,554
    
    
    
    206,880
    
    
    
    11
    %Depreciation, depletion and amortization
    
    
    189,988
    
    
    
    83,129
    
    
    
    106,859
    
    
    
    129
    %2,535,266
    
    
    
    2,133,972
    
    
    
    401,294
    
    
    
    19
    %Other income (expenses):Interest income
    
    
    229,888
    
    
    
    62,012
    
    
    
    167,876
    
    
    
    271
    %Interest expense
    
    
    (4,276
    )
    
    
    (3,804
    )
    
    
    (472
    )
    
    
    (12
    %)Other income (expense), net
    
    
    (2,894,794
    )
    
    
    24,053
    
    
    
    (2,918,847
    )
    
    
    (12,135
    %)(2,669,182
    )
    
    
    82,261
    
    
    
    (2,751,443
    )
    
    
    (3,345
    %)Loss before income taxes
    
    
    (4,941,588
    )
    
    
    (2,004,786
    )
    
    
    (2,936,802
    )
    
    
    (146
    %)Deferred income tax benefit
    
    
    
    
    
    
    270,587
    
    
    
    (270,587
    )
    
    
    (100
    %)Net loss
    
    $
    (4,941,588
    )
    
    $
    (1,734,199
    )
    
    $
    (3,207,389
    )
    
    
    (185
    %)
 Revenue
 Lease operating expense 
 17




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##### Table of Contents



General and administrative expense 
 Three Months ended April 30Dollar
    
    %2006
    
    2005
    
    Variance
    
    ChangeSalaries and benefits
    
    $
    422,436
    
    
    $
    257,778
    
    
    $
    164,658
    
    
    
    64
    %Stock-based compensation
    
    
    647,261
    
    
    
    1,039,406
    
    
    
    (392,145
    )
    
    
    (38
    %)Professional fees
    
    
    853,324
    
    
    
    387,605
    
    
    
    465,719
    
    
    
    120
    %Other
    
    
    131,413
    
    
    
    162,765
    
    
    
    (31,352
    )
    
    
    (19
    %)Total general and
administrative expense
    
    $
    2,054,434
    
    
    $
    1,847,554
    
    
    $
    206,880
    
    
    
    11
    %
    Depreciation, depletion and amortization expense
 Interest income
 Other income (expense), net
 Deferred income tax benefit
 18




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##### Table of Contents



Nine Months Ended April 30, 2006 Compared to Nine Months Ended April 30, 2005
  Nine Months Ended April 30Dollar
    
    %2006
    
    2005
    
    Variance
    
    ChangeRevenues:Gas sales
    
    $
    800,365
    
    
    $
    53,266
    
    
    $
    747,099
    
    
    
    1,403
    %Expenses:Lease operating expense
    
    
    752,454
    
    
    
    203,289
    
    
    
    549,165
    
    
    
    270
    %General and administrative expense
    
    
    4,491,676
    
    
    
    5,012,641
    
    
    
    (520,965
    )
    
    
    (10
    %)Depreciation, depletion and
amortization
    
    
    402,680
    
    
    
    140,801
    
    
    
    261,879
    
    
    
    186
    %5,646,810
    
    
    
    5,356,731
    
    
    
    290,079
    
    
    
    5
    %Other income (expenses):Interest income
    
    
    632,693
    
    
    
    66,859
    
    
    
    565,834
    
    
    
    846
    %Interest expense
    
    
    (18,054
    )
    
    
    (14,386
    )
    
    
    (3,668
    )
    
    
    (25
    %)Other income (expense), net
    
    
    (2,757,271
    )
    
    
    27,299
    
    
    
    (2,784,570
    )
    
    
    (10,200
    %)(2,142,632
    )
    
    
    79,772
    
    
    
    (2,222,404
    )
    
    
    (2,786
    %)Loss before income taxes
    
    
    (6,989,077
    )
    
    
    (5,223,693
    )
    
    
    (1,765,384
    )
    
    
    (34
    %)Deferred income tax benefit
    
    
    
    
    
    
    615,304
    
    
    
    (615,304
    )
    
    
    (100
    %)Net loss
    
    $
    (6,989,077
    )
    
    $
    (4,608,389
    )
    
    $
    (2,380,688
    )
    
    
    (52
    %)
 Revenue
 Lease operating expense 
 19




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##### Table of Contents



General and administrative expense 
 Nine Months ended April 30Dollar
    
    %2006
    
    2005
    
    Variance
    
    ChangeSalaries and benefits
    
    $
    1,149,675
    
    
    $
    766,283
    
    
    $
    383,392
    
    
    
    50
    %Stock-based compensation
    
    
    1,044,847
    
    
    
    3,240,184
    
    
    
    (2,195,337
    )
    
    
    (68
    %)Professional fees
    
    
    1,871,393
    
    
    
    555,785
    
    
    
    1,315,608
    
    
    
    237
    %Other
    
    
    425,761
    
    
    
    450,389
    
    
    
    (24,628
    )
    
    
    (5
    %)Total general and
administrative expense
    
    $
    4,491,676
    
    
    $
    5,012,641
    
    
    $
    (520,965
    )
    
    
    (10
    %)
    Depreciation, depletion and amortization expense
 Interest income
 Other income (expense), net
 Deferred income tax benefit
 20




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Critical Accounting Policies and Estimates
  21




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##### Table of Contents



Financial Condition
    
    
    the price of, and demand for, natural gas;
    
    availability of drilling equipment;
    
    lease terms;
    
    availability of sufficient capital resources; and
    
    the accuracy of production estimates for current and future wells.
  22




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##### Table of Contents



Cautionary Statement Concerning Forward-Looking Statements
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Commodity Risk
  Interest Rate Risk
  Financial Instruments
  23




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##### Table of Contents



Inflation and Changes in Prices
  
 Item 4. Controls and Procedures
   
 PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
    1.
    
    All parties to the suit will release all of the other parties from any claims
they may have had against each other;2.
    
    BPI will pay Colt $3,000,000;3.
    
    BPI will surrender any interest it had in the lease;4.
    
    BPI acquired ownership of the CBM estate covering approximately 10,000 of the
43,000 acres previously covered by the lease (which acreage includes all of the
currently producing CBM wells and proved reserves at our Southern Illinois Basin
Project);5.
    
    BPI will be relieved of any future obligation to make royalty payments as was
previously required under the terms of the lease (under the terms of the lease we were obligated to make royalty payments of 15% of gross sales and minimum royalties
totaling at least $42,000 per month); and
 24




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##### Table of Contents





6.
    
    The deed will provide that CBM operations take priority over coal mining
operations for as long as CBM is being produced from the covered acreage; however,
Colt has the right to acquire any CBM wells located in these 10,000 acres. If Colt
exercises this option, they will be required to pay the fair market value (as
established by a mutually agreed upon expert) of such well.







Item 2. Unregistered Sales of Equity Securities and Use of Proceeds







Item 3. Defaults Upon Senior Securities







Item 4. Submission of Matters to a Vote of Security Holders






Votes For
    
    
    26,256,513Votes Against
    
    
    1,101Abstentions
    
    
    13,527Broker Non-Votes
    
    
    26,780


(b)
    
    Increase authorized capital. The shareholders voted to increase the number of shares of our
common stock that we are authorized to issue to 200,000,000 shares:
 Votes For
    
    
    25,970,829Votes Against
    
    
    288,280Abstentions
    
    
    12,031Broker Non-Votes
    
    
    26,781
 (c)
    
    Increase quorum. The shareholders voted to increase the quorum requirement for meetings of
shareholders to 33 and 1/3 percent of our shares of common stock:
 Votes For
    
    
    12,034,147Votes Against
    
    
    115,589Abstentions
    
    
    56,331Broker Non-Votes
    
    
    14,091,854
 (d)
    
    Permit meetings outside of British Columbia. The shareholders voted to permit shareholder
meetings to be held outside British Columbia, Canada:
 Votes For
    
    
    26,264,525Votes Against
    
    
    296Abstentions
    
    
    6,319Broker Non-Votes
    
    
    26,781
 
 Item 5. Other Information
  
 Item 6. Exhibits
 10.1
    
    Coal Seam Gas Lease Agreement, dated April 26, 2006, by and between BPI Energy, Inc.
and IEC (Montgomery), LLC (Northern Illinois Basin Project) (Filed as Exhibit 10.1 to
the Form 8-K of BPI Energy Holdings, Inc. filed with the SEC on April 28, 2006 and
incorporated herein by reference).10.2
    
    Coal Seam Gas Lease Agreement, dated April 26, 2006, by and between BPI Energy, Inc.
and Christian Coal Holdings, LLC (Northern Illinois Basin Project) (Filed as Exhibit
10.2 to the Form 8-K of BPI Energy Holdings, Inc. filed with the SEC on April 28, 2006
and incorporated herein by reference).10.3
    
    Settlement Memorandum of Understanding by and among BPI Energy, Inc., Colt LLC, AFC
Coal Properties, Inc., American Premier Underwriters, Inc. and Central States Coal
Reserves of Illinois, LLC, dated June 13, 2006.31.1
    
    Section 302 Certification By Chief Executive Officer (Principal Executive Officer)31.2
    
    Section 302 Certification By Chief Financial Officer (Principal Financial Officer)32.1
    
    Section 906 Certification of Principal Executive Officer and Principal Financial Officer
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##### Table of Contents



SIGNATURES
  BPI ENERGY HOLDINGS, INC.DATE: June 14, 2006
    
    
    
    /s/ James G. AzleinJames G. Azlein,President and Chief Executive Officer/s/ George J. ZilichGeorge J. Zilich,Chief Financial Officer and General Counsel