** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

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**Form 10-QSB**

 

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**ý**** QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For theQuarterly Period Ended March 31, 2006**

 

**or**

 

**o**** TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**CommissionFile Number 000-25873**

 

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**Apollo Resources International, Inc.**

(Exact name of registrant asspecified in its charter)

 

| **Utah**                                                        | ** ** | **84-1431425**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or  other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification No.) |
|                                                            |       |                                  |
| **3001  Knox Street, Suite 403**                           |
| **Dallas,  TX 75205**                                           |
| (Address of  principal executive offices, including zip code)   |
|                                                            |       |                                  |
| **(214)  389-9800**                                             |
| (Registrant’s  telephone number, including area code)      |

 

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Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes ý    No o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes   ̈  No ý

 

As of May 18, 2006 there were 163,754,558 sharesof the registrant’s common stock outstanding.

 

 

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**EXPLANATORYNOTE**

 

*For the Period Ended March 31, 2005*

 

Apollo Resources International, Inc. (the “Company”)hereby amends Part I Items 1, 2 and 3 of its quarterly report on Form 10-QSBfor the three months period ended March 31, 2005. These amendments addressthe Company’s adoption of statement of Financial Accounting Standards No. 143,“Accounting for Asset Retirement Obligations” (SFAS No. 143), and therescinding its stock sale agreement with JSC Kaliningradneft executed on March 22,2005.

 

Upon adoption of SFAS No. 143the Company has restated its financial statement to reflect the inclusion ofasset retirement obligations of approximately $1.1million. The Company incurredan additional net loss of $19,093 related to depreciation expense on the assetand additional net loss of $10,083 on accretion of discount related to theliability. The following table illustrates the changes to the Company’sfinancial statements related to these asset retirement obligations:

 

The Company has alsoamended its 2004 financial statements to reflect the acquisition of BC&DOil and Gas Corporation in October of 2004, at historical cost with nostep up in basis under the purchase method of business combinations that wasoriginally used. The transaction is being amended using the guidance inStatement of Financial Accounting Standards No. 141 which requirestransactions between companies under common control to be accounted for at thehistorical cost basis. The transaction between the Company and TKM Oil and Gas, Inc.is a transaction between entities under common ownership. Therefore noadjustment for the fair value of the assets acquired is allowed.

 

The Company has made asimilar adjustment to reflect the acquisition of OGC Pipeline, LLC per thediscussion of BC&D Oil and Gas Corporation above. This acquisition was alsoa transaction between entities under common control and therefore no step up inbasis for fair value should have been recorded. The Company has reduced theamount recorded for property plant and equipment related to the pipelineeasements acquired from OGC Pipeline, LLC to $2,154,000 from the originalamount recorded by the seller of $8,330,430.

 

The following tableillustrates the change to the Company’s financial statements for the periodended March 31, 2005 related to the notes above.

 
| ** **                               | ** ** | ** **             | ** ** | **Previously** | ** ** |
|------------------------------------------|------------|------------------------|------------|----------------|------------|
| ** **                               | ** ** | **(As Restated)** | ** ** | **Reported**   | ** ** |
| Property and  equipment, net             |       | $                      | 5,489,532  |           | $          | 16,081,534 |   |
| Asset  retirement obligations-short term |       | $                      | 40,682     |           | $          | — |   |
| Asset  retirement obligations            |       | $                      | 1,121,673  |           | $          | — |   |
| Accumulated  deficit                     |       | $                      | (1,608,877 | )              | $          | (1,560,289 | ) |
| Selling,  general and administrative     |       | $                      | 2,086,128  |           | $          | 2,056,952 |   |
| Net Income                               |       | $                      | 20,716     |           | $          | 49,892 |   |

 

2

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**APOLLORESOURCES INTERNATIONAL, INC.**

**BALANCESHEETS**

 
| ** **                                                                                                                                                                                        | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                                        |       |                     |       |                        |       |
| Current  Assets                                                                                                                                                                                   |       |                     |       |                        |       |
| Cash and  cash equivalents                                                                                                                                                                        |       | $                        | 384,426    |                        | $          | 2,400,457 |   |
| Trade  accounts receivable, net of $206,173 allowances at March 31, 2006                                                                                                                     |       | 3,269,229                |       | 3,646,097                   |       |
| Accounts  receivable working interest owners                                                                                                                                                      |       | 357,300                  |       | 183,559                     |       |
| Accounts  receivable other                                                                                                                                                                        |       | 254,514                  |       | 626,273                     |       |
| Prepaid  expenses and deposits                                                                                                                                                                    |       | 2,604,021                |       | 2,325,083                   |       |
| Inventory                                                                                                                                                                                         |       | 791,329                  |       | 685,660                     |       |
| Other  current assets                                                                                                                                                                             |       | 111,812                  |       | 718,937                     |       |
| Total  Current Assets                                                                                                                                                                             |       | 7,772,631                |       | 10,586,066                  |       |
| Property and  equipment, net                                                                                                                                                                      |       | 33,968,580               |       | 24,612,083                  |       |
| Goodwill                                                                                                                                                                                          |       | 30,601,554               |       | 30,601,554                  |       |
| Deposits                                                                                                                                                                                          |       | 4,068,500                |       | 3,360,000                   |       |
| Investment  in joint ventures                                                                                                                                                                     |       | 380,464                  |       | 230,000                     |       |
| Other assets                                                                                                                                                                                      |       | 1,002,991                |       | 1,659,912                   |       |
|                                                                                                                                                                                              |       | $                        | 77,794,720 |                        | $          | 71,049,615 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                    |       |                     |       |                        |       |
| Current  Liabilities                                                                                                                                                                              |       |                     |       |                        |       |
| Accounts  payable and accrued liabilities                                                                                                                                                         |       | $                        | 6,978,292  |                        | $          | 6,495,562 |   |
| Shares  payable - acquisition                                                                                                                                                                     |       | —                   |       | 4,210,248                   |       |
| Royalty  payable                                                                                                                                                                                  |       | 817,761                  |       | 772,350                     |       |
| Accounts  payable related party                                                                                                                                                                   |       | 296,082                  |       | 503,056                     |       |
| Lease  payable                                                                                                                                                                                    |       | 346,071                  |       | 346,071                     |       |
| Notes  payable                                                                                                                                                                                    |       | 4,430,206                |       | 2,428,952                   |       |
| Notes  payable related party                                                                                                                                                                      |       | 235,167                  |       | —                      |       |
| Asset  retirement obligations short-term                                                                                                                                                          |       | 59,023                   |       | 58,512                      |       |
| Other  current liabilities                                                                                                                                                                        |       | 860,000                  |       | —                      |       |
| Total  Current Liabilities                                                                                                                                                                        |       | 14,022,602               |       | 14,814,751                  |       |
| Notes  payable                                                                                                                                                                                    |       | 10,608,316               |       | 10,267,618                  |       |
| Asset  retirement obligations                                                                                                                                                                     |       | 1,627,392                |       | 1,613,275                   |       |
| Other  long-term liabilities                                                                                                                                                                      |       | 156,561                  |       | 156,561                     |       |
| Total  Liabilities                                                                                                                                                                                |       | 26,414,871               |       | 26,852,205                  |       |
|                                                                                                                                                                                              |       |                     |       |                        |       |
| Minority  interest                                                                                                                                                                                |       | 3,232,991                |       | —                      |       |
|                                                                                                                                                                                              |       |                     |       |                        |       |
| Stockholders’  Equity                                                                                                                                                                        |       |                     |       |                        |       |
| Preferred  stock Series A, $1.00 par; 8.5% cumulative non-voting convertible;  12,500,000 shares authorized and outstanding at March 31, 2006 and December 31,  2005, respectively |       | $                        | 12,500,000 |                        | $          | 12,500,000 |   |
| Preferred  stock Series B, $1.00 par; 8.5% cumulative non-voting convertible;  12,500,000 shares authorized and outstanding at March 31, 2006 and December 31,  2005, respectively |       | 12,500,000               |       | 12,500,000                  |       |
| Common  stock, $.001 par value; 500,000,000 shares authorized; 151,824,847 and  139,595,810 shares issued and outstanding at March 31, 2006 and December 31,  2005, respectively        |       | 151,825                  |       | 139,596                     |       |
| Additional  paid-in capital                                                                                                                                                                       |       | 79,339,319               |       | 63,350,615                  |       |
| Accumulated  deficit                                                                                                                                                                              |       | (47,895,945              | )          | (34,973,382                 | )          |
| Common stock  issued for future services                                                                                                                                                          |       | (8,448,341               | )          | (9,319,419                  | )          |
| Total  Stockholders’ Equity                                                                                                                                                                  |       | 48,146,858               |       | 44,197,410                  |       |
|                                                                                                                                                                                              |       | $                        | 77,794,720 |                        | $          | 71,049,615 |   |

 

See accompanying notes to financialstatements.

 

3

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**APOLLORESOURCES INTERNATIONAL, INC.**

** STATEMENT OF OPERATIONS**

 
| ** **                                  | ** ** | **Three Months Ended** | ** **  | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|-------------|----------------------------------|------------|
| ** **                                  | ** ** | **March 31, 2006**     | ** **  | **March 31, 2005**     | ** ** |
| ** **                                  | ** ** | ** **                       | ** **  | **(Restated)**                   | ** ** |
| Revenue                                     |       | $                                | 9,459,223   |                             | $          | 148,492 |   |
| Cost of  sales                              |       | 11,854,583                       |        | 158,206                          |       |
| Gross loss                                  |       | (2,395,360                       | )           | (9,714                           | )          |
| Selling,  general and administrative        |       | 12,895,871                       |        | 2,086,128                        |       |
| Operating  loss                             |       | (15,291,231                      | )           | (2,095,842                       | )          |
|                                        |       |                             |        |                             |       |
| Interest  expense                           |       | (406,862                         | )           | (71,423                          | )          |
| Gain on  marketable equity securities       |       | 485,230                          |        | —                           |       |
| Other income,  net                          |       | 2,290,300                        |        | (5,295                           | )          |
| Loss from  operations before income taxes   |       | (12,922,563                      | )           | (2,161,970                       | )          |
| Income taxes                                |       | —                           |        | —                           |       |
| Loss before  extraordinary item             |       | (12,922,563                      | )           | (2,161,970                       | )          |
|                                        |       |                             |        |                             |       |
| Extraordinary  item:                        |       |                             |        |                             |       |
| Gain on  extinguishment of debt, net of tax |       | —                           |        | 2,182,686                        |       |
| Net loss                                    |       | $                                | (12,922,563 | )                                | $          | 20,716 |   |
|                                        |       |                             |        |                             |       |
| Income  (loss) per common share:            | ** ** | ** **                       | ** **  | ** **                       | ** ** |
| ** **                                  | ** ** | ** **                       | ** **  | ** **                       | ** ** |
| Basic and  diluted:                         |       |                             |        |                             |       |
| Loss before  extraordinary item             |       | $                                | (.09        | )                                | $          | (.07 | ) |
| Extraordinary  item                         |       | —                           |        | .07                              |       |
| Net loss                                    |       | $                                | (.09        | )                                | $          | — |   |
| ** **                                  | ** ** | ** **                       | ** **  | ** **                       | ** ** |
| Weighted  average shares:                   | ** ** | ** **                       | ** **  | ** **                       | ** ** |
| ** **                                  | ** ** | ** **                       | ** **  | ** **                       | ** ** |
| Basic and  diluted                          |       | 144,677,196                      |        | 32,027,005                       |       |

 

See accompanying notes to financialstatements.

 

4

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**APOLLORESOURCES INTERNATIONAL, INC.**

**STATEMENTSOF STOCKHOLDERS’ EQUITY**

 
| ** **                                       | ** ** | **Common  Shares** | ** ** | **Preferred  Stock Series  A and B** | ** ** | **Common   tock**     | ** ** | **Additional  Paid In Capital** | ** ** | **Common  Stock Issued  for Future  Services** | ** ** | **Accumulated  Deficit** | ** ** | **Totals**  | ** ** |
|--------------------------------------------------|------------|--------------------|------------|-----------------------------------------------------|------------|----------------------------|------------|-------------------------------------------|------------|----------------------------------------------------------|------------|--------------------------|------------|-------------|------------|
| ** **                                       | ** ** | ** **         | ** ** | **($ 1.00 par)**                          | ** ** | **($ .001 par)** | ** ** | **(Restated)**                            | ** ** | ** **                                               | ** ** | **(Restated)**           | ** ** | ** **  | ** ** |
| **Balance December 31, 2005**               |       | 139,595,750        |       | $                                                   | 25,000,000 |                       | $          | 139,596                                   |       | $                                                        | 63,350,615 |                     | $          | (9,319,419  | )          | $ | (34,973,382 | ) | $ | 44,197,410 |   |
|                                             |       |               |       |                                                |       |                       |       |                                      |       |                                                     |       |                     |       |        |       |
| Stock issued to retire debt                      |       | 783,335            |       | —                                              |       | 783                        |       | 279,050                                   |       | —                                                   |       | —                   |       | 279,833     |       |
| Common stock issued in private equity sales      |       | 10,116,773         |       | —                                              |       | 10,117                     |       | 4,044,898                                 |       | —                                                   |       | —                   |       | 4,055,015   |       |
| Common stock issued for services                 |       | 1,115,129          |       | —                                              |       | 1,115                      |       | 483,213                                   |       | 871,078                                                  |       | —                   |       | 1,355,406   |       |
| Common stock cancelled for employee compensation |       | (120,000           | )          | —                                              |       | (120                       | )          | (61,080                                   | )          | —                                                   |       | —                   |       | (61,200     | )          |
| Stock issued in litigation settlement            |       | 120,000            |       | —                                              |       | 120                        |       | 50,280                                    |       | —                                                   |       | —                   |       | 50,400      |       |
| Stock issued to acquire assets                   |       | 213,800            |       | —                                              |       | 214                        |       | 113,091                                   |       | —                                                   |       | —                   |       | 113,305     |       |
| Rounding adjustment                              |       | 60                 |       | —                                              |       | —                     |       | —                                    |       | —                                                   |       | —                   |       | —      |       |
| Contributions from minority shareholders’   |       | —             |       | —                                              |       | —                     |       | 11,079,252                                |       | —                                                   |       | —                   |       | 11,079,252  |       |
| Net and comprehensive loss                       |       | —             |       | —                                              |       | —                     |       | —                                    |       | —                                                   |       | (12,922,563              | )          | (12,922,563 | )          |
| **Balance March 31, 2006**                  |       | 151,824,847        |       | $                                                   | 25,000,000 |                       | $          | 151,825                                   |       | $                                                        | 79,339,319 |                     | $          | (8,448,341  | )          | $ | (47,895,945 | ) | $ | 48,146,858 |   |

 

See accompanying notes to financialstatements

 

5

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**APOLLORESOURCES INTERNATIONAL, INC.**

**STATEMENTSOF CASH FLOWS**

 
| ** **                                                                   | ** ** | **Three Months  Ended** | ** **  | **Three Months  Ended** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|-------------|------------------------------|------------|
| ** **                                                                   | ** ** | **March 31, 2006** | ** **  | **March 31, 2005** | ** ** |
| ** **                                                                   | ** ** | ** **                   | ** **  | **(Restated)**               | ** ** |
| Cash Flows  from Operating Activities:                                       | ** ** | ** **                   | ** **  | ** **                   | ** ** |
|                                                                         |       |                         |        |                         |       |
| Net income  (loss)                                                           |       | $                            | (12,922,563 | )                            | $          | 20,716 |   |
| Non-cash  items included in net income (loss):                               |       |                         |        |                         |       |
| Depreciation,  amortization and depletion                                    |       | 1,249,430                    |        | 47,489                       |       |
| Accretion of  discount on asset retirement obligations and convertible notes |       | 227,419                      |        | 10,083                       |       |
| Write down  of assets pledged as collateral                                  |       | 358,364                      |        | —                       |       |
| Bad debt  expense                                                            |       | 51,906                       |        | —                       |       |
| Common stock  issued for services                                            |       | 5,971,356                    |        | 878,095                      |       |
| Common stock  issued (cancelled) for compensation                            |       | (61,200                      | )           | 173,400                      |       |
| Stock  issuance expense                                                      |       | —                       |        | 472,574                      |       |
| Stock issued  to retire debt and settle litigation                           |       | 134,400                      |        | —                       |       |
| Common stock  issued to acquire assets                                       |       | 4,214,340                    |        | —                       |       |
| Gain on sale  of assets                                                      |       | (97,815                      | )           | —                       |       |
| Gain on  marketable equity securities                                        |       | (485,230                     | )           | —                       |       |
| Gain on  extinguishment of debt                                              |       | —                       |        | (2,182,686                   | )          |
| Minority  interest                                                           |       | (2,171,560                   | )           | —                       |       |
| Other                                                                        |       | (17,379                      | )           | (3,894                       | )          |
|                                                                         |       |                         |        |                         |       |
| Changes in  assets and liabilities, net of acquisitions:                     |       |                         |        |                         |       |
| Decrease  (increase) in:                                                     |       |                         |        |                         |       |
| Accounts  receivable                                                         |       | 530,743                      |        | (12,551                      | )          |
| Prepaid and  other assets                                                    |       | (139,249                     | )           | (19,196                      | )          |
| Inventory                                                                    |       | (105,669                     | )           | —                       |       |
| Increase  (decrease) in:                                                     |       |                         |        |                         |       |
| Accounts  payable and accrued expenses                                       |       | (3,357,905                   | )           | 334,605                      |       |
| Net cash  used in operating activities                                       |       | (6,620,612                   | )           | (281,365                     | )          |
|                                                                         |       |                         |        |                         |       |
| Cash Flows  From Investing Activities:                                       |       |                         |        |                         |       |
| Cash  acquired in acquisitions                                               |       | —                       |        | 2,003                        |       |
| Investments  in joint ventures                                               |       | (150,464                     | )           | —                       |       |
| Purchase of  property, plant and equipment                                   |       | (1,757,274                   | )           | (325                         | )          |
| Proceeds  from sale of assets                                                |       | 125,000                      |        | —                       |       |
| Net cash  provided by (used in) investing activities                         |       | (1,782,738                   | )           | 1,678                        |       |
|                                                                         |       |                         |        |                         |       |
| Cash Flows  From Financing Activities:                                       |       |                         |        |                         |       |
| Proceeds  from note payable                                                  |       | 1,709,720                    |        | 112,005                      |       |
| Proceeds  from sale of common stock                                          |       | 4,927,212                    |        | 382,434                      |       |
| Proceeds  from related party notes                                           |       | 235,167                      |        | —                       |       |
| Repayments  of notes and capital leases payable                              |       | (484,780                     | )           | (215,211                     | )          |
| Net cash  provided by financing activities                                   |       | 6,387,319                    |        | 279,228                      |       |
|                                                                         |       |                         |        |                         |       |
| Net decrease  in cash                                                        |       | (2,016,031                   | )           | (459                         | )          |
|                                                                         |       |                         |        |                         |       |
| Cash and  cash equivalents                                                   |       |                         |        |                         |       |
| Beginning of  year                                                           |       | 2,400,457                    |        | 56,018                       |       |
| End of period                                                                |       | $                            | 384,426     |                         | $          | 55,559 |   |

 

 

See accompanying notes to financialstatements.

 

6

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**1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

*Company and Purpose* – Apollo Resources International, Inc. (the “Company”) wasincorporated on July 9, 1997 under the laws of the State of Utah.Effective October 28, 2004, the Company executed a share exchangeagreement, in which the Company acquired an oil and natural gas productioncompany. With this acquisition the Company changed its primary business focusto oil & natural gas production. Subsequent acquisitions and ventureshave added oil and natural gas transportation via the acquisition of pipelines,developed an alternative fuels segment focused on the production and sale ofbio diesel fuel, and the production and distribution of liquefied natural gas (“LNG”).

 

*Basis of Presentation* - The accompanying consolidated financial statements include theaccounts of the Company and its wholly owned subsidiaries. All significantinter-company transactions and balances have been eliminated.

 

The following relates to the 2005 financial presentation.Results of operations for the Company’s gas pipeline transmission company OGCPipeline, LLC (“OGC”) have been consolidated since February 7, 2005 theeffective date of the acquisition. Results of operations of Earth Biofuels, Inc.(“Earth Biofuels”) have been consolidated since the Company acquired an 80%interest on September 13, 2005. The Company initially acquired a 50%interest in Earth Biofuels on February 25, 2005 and was accounted forunder the equity method from such date until September 13, 2005. Resultsof operations for the Company’s LNG businesses, Applied LNG Technologies USA,LLC (“ALT”), TxHLDM, Inc. and its wholly owned subsidiary Arizona LNG,LLC, (“Arizona LNG”) have been consolidated since November 30, 2005 theeffective date of the acquisition. The Company’s other oil and natural gasproduction company Mountain States Petroleum Corporation (“Mountain States”)has been consolidated since November 30, 2005 the effective date of theacquisition.

 

Certain amounts from prior years have beenreclassified to conform to the 2006 presentation.

 

*Restatement of March 31, 2005 Financial Statements*

 

Apollo Resources International, Inc. (the “Company”)hereby amends Part I Items 1, 2 and 3 of its quarterly report on Form 10-QSBfor the three months period ended March 31, 2005. These amendments addressthe Company’s adoption of statement of Financial Accounting Standards No. 143,“Accounting for Asset Retirement Obligations” (SFAS No. 143), and therescinding its stock sale agreement with JSC Kaliningradneft executed on March 22,2005.

 

Upon adoption of SFAS No. 143the Company has restated its financial statement to reflect the inclusion ofasset retirement obligations of approximately $1.1million. The Company incurredan additional net loss of $19,093 related to depreciation expense on the assetand additional net loss of $10,083 on accretion of discount related to theliability. The following table illustrates the changes to the Company’sfinancial statements related to these asset retirement obligations:

 

The Company has alsoamended its 2004 financial statements to reflect the acquisition of BC&DOil and Gas Corporation in October of 2004, at historical cost with nostep up in basis under the purchase method of business combinations that wasoriginally used. The transaction is being amended using the guidance inStatement of Financial Accounting Standards No. 141 which requirestransactions between companies under common control to be accounted for at thehistorical cost basis. The transaction between the Company and TKM Oil and Gas, Inc.is a transaction between entities under common ownership. Therefore noadjustment for the fair value of the assets acquired is allowed.

 

The Company has made asimilar adjustment to reflect the acquisition of OGC Pipeline, LLC per thediscussion of BC&D Oil and Gas Corporation above. This acquisition was alsoa transaction between entities under common control and therefore no step up inbasis for fair value should have been recorded. The Company has reduced theamount recorded for property plant and equipment related to the pipelineeasements acquired from OGC Pipeline, LLC to $2,154,000 from the originalamount recorded by the seller of $8,330,430.

 

7

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The following table illustrates the change to theCompany’s financial statements for the period ended March 31, 2005 relatedto the notes above.

 
| ** **                               | ** ** | ** **             | ** ** | **Previously** | ** ** |
|------------------------------------------|------------|------------------------|------------|----------------|------------|
| ** **                               | ** ** | **(As Restated)** | ** ** | **Reported**   | ** ** |
| Property and  equipment, net             |       | $                      | 5,489,532  |           | $          | 16,081,534 |   |
| Asset  retirement obligations-short term |       | $                      | 40,682     |           | $          | — |   |
| Asset  retirement obligations            |       | $                      | 1,121,673  |           | $          | — |   |
| Accumulated  deficit                     |       | $                      | (1,608,877 | )              | $          | (1,560,289 | ) |
| Selling,  general and administrative     |       | $                      | 2,086,128  |           | $          | 2,056,952 |   |
| Net Income                               |       | $                      | 20,716     |           | $          | 49,892 |   |

 

The results of operations of JSC Kaliningradneft (“Kaliningrad”)acquired March 22, 2005, are not included with the accounts presented inthis Form 10-QSB. Effective November 3, 2005, the Company announcedthat it was exercising its contractual right to rescind the March 2005stock sale transaction with shareholders of Kaliningrad. The Company’s decisioncame after protracted efforts to resolve serious issues that were discovered bythe Company post-closing, as well as efforts to resolve the failure ofKaliningrad to provide certain critical financial data that was represented inthe March agreement. Specifically, shareholders of Kaliningrad hadpurported to transfer 90% of its issued and outstanding shares of stock to theCompany; however, it had become apparent that shareholders of Kaliningrad werenot in a position to transfer more than 50.10% of its stock. The Company was inprotracted discussion with the owners of the remaining shares but was unable toreach a new agreement with them and agreed to release any claims it may havehad in regard to their shares. Additionally, Kaliningrad, pursuant to the March agreement,was required to provide the Company with audited statements for fiscal years2003 and 2004, prepared in accordance with U.S. Generally Accepted AccountingPrinciples, which Kaliningrad failed to do despite repeated efforts on the part ofthe Company to secure them. As a result of the above issues, the Companyexercised the contractual right of rescission that was reserved to the Companyunder the March 2005 stock sale agreement, bill of sale, and $18.5 millionconvertible debenture. The Company remains in contact with the ownership ofKaliningrad and a new agreement may be reached. In the meantime, theconvertible debenture issued by the Company was cancelled and the Company hasreserved certain rights that it may have had under the March agreementwith respect to the rescission of the stock sale transaction.

 

In management’s opinion, these financial statementsinclude all adjustments necessary to present fairly the financial position ofthe Company at March 31, 2006 and the results of operations and changes incash flows for the three month periods ended March 31, 2006. Theaccounting and reporting policies of the Company conform to generallyaccepted accounting principles and reflect practices appropriate for itsindustry. Revenue is recognized when earned in accordance with the accrualbasis of accounting. These policies are summarized below.

 

*Management’s Estimates and Assumptions* – The presentation of financial statementsin conformity with accounting principles generally accepted in the UnitedStates requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates. The Company reviews all significantestimates affecting the financial statements on a recurring basis and recordsthe effect of any necessary adjustments prior to their issuance.

 

*Oil and Gas Properties*— The Company follows the full cost method of accounting forexploration and development of oil and gas properties whereby all costs inacquiring, exploring and developing properties are capitalized, includingestimate of abandonment costs, net of estimated equipment salvage costs. Nocosts related to production, general corporate overhead, or similar activitieshave been capitalized. At March 31, 2006 the Company had no capitalizedcosts of unproved properties and major development projects excluded fromcapitalized costs being amortized. Leasehold costs are depleted based on theunits-of-production method based on estimated proved reserves.

 

In accordance with Statement of Financial AccountingStandards No. 144 “Accounting for the Impairment or Disposal of Long-LivedAssets”, the Company reviews its long-lived assets to be held and used,excluding proved oil and gas properties accounted for under the full costmethod of accounting, whenever events or circumstances indicate that thecarrying value of those assets may not be recoverable. An impairment lossis indicated if the sum of the expected future net cash flows is less than thecarrying amount of the assets. In this circumstance, the Company

 

8

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recognizesan impairment loss for the amount by which the carrying amount of the assetexceeds the estimated fair value of the asset. The Company’s long-lived assetsrelated to its proved oil and gas properties accounted for under the full costmethod of accounting are prescribed by the Securities and Exchange Commission(Regulation S-X, Rule 4-10, “Financial Accounting and Reporting for Oiland Gas Producing Activities Pursuant to the Federal Securities Laws and theEnergy Policy and Conservation Act of 1975”).

 

*Adoption of SFAS 143*— The Company has adopted the provisions of Statement of FinancialAccounting Standards No. 143, “Accounting for Asset Retirement Obligations”(SFAS 143”). SFAS 143 amended Statement of Financial Accounting Standards No. 19,“Financial Accounting and Reporting by Oil and Gas Production Companies” torequire that the fair value of a liability for an asset retirement obligationbe recognized in the period in which it is incurred if a reasonable estimate offair value can be made. Under the provisions of SFAS 143, asset retirementobligations are capitalized as part of the carrying value of thelong-lived asset.

 

*Cash and Cash Equivalents*—Cash equivalents consist of highly liquid investments with originalmaturities of three months or less.

 

*Allowance for Doubtful Accounts*— Allowance for doubtful accounts isestablished through a provision for bad debts charged to expense. Tradeaccounts receivable are charged against the allowance for doubtful accountswhen management believes that collection of the account is unlikely. Theallowance is an amount that management believes will be adequate to absorbestimated losses on existing accounts, based on an evaluation of the future collectionof accounts, prior loss experience and current economic conditions. At March 31,2006 there was $ 206,173 of receivables written off against the allowance. Therewere no receivables written off against the allowance for the comparativeperiod March 31, 2005.

 

*Accounts Receivable Working Interest Owners*— The Company previously advanced funds toworking interest owners. As net royalties are earned, the working interestowners are reducing their receivable on a quarterly basis. The working interestowners receive 54% of the revenue and are billed 54% of the direct expenses. Asof December 31, 2005 the working interest owners owed the Companyapproximately $357,300.

 

*Concentration of Credit Risk —*Financial instruments which potentiallysubject the Company to concentrations of credit risk consist principally ofaccounts receivable and temporary cash investments. Exposure to losses onreceivables is principally dependent on each customer’s financial condition. TheCompany controls its exposure to credit risk through credit approvals, creditlimits and monitoring procedures and establishes allowances for anticipatedlosses. The Company places its temporary cash investments with qualityfinancial institutions and, by policy, limits the amount of credit exposurewith any one financial instrument. The Company maintains its cash in bankdeposit accounts, which, at times, may exceed federally insured limits. AtMarch 31, 2006, the Company had $384,426 in bank deposit accounts, ofwhich $80,679 was in excess of the federally insured limit. The Company has notexperienced any losses in such accounts and believes it is not exposed to anysignificant credit risk on cash and cash equivalents.

 

*Fair Market Value of Financial Instruments*— Estimated fair value of cash and cashequivalents, accounts receivable, accounts payable and accrued expenses andother liabilities approximate their carrying amounts in the financialstatements. The Company’s financial instruments include notes payable. Thecarrying value of notes payable approximates market value because the borrowingrate is similar to other financial instruments with similar terms.

 

*Marketable Equity Securities*— Marketable equity securities (“MES”) consisting of common stockpurchased in open market transactions, by the Company, are subject to thegeneral volatility of financial markets. The following table summarizes theinvestment in the Company’s marketable equity securities at March 31,2006.

 
| ** **              | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**         | ** ** |
|-------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|-------------------|------------|
| ** **              | ** ** | **Adjusted  Cost  Basis**              | ** ** | **Gain  (Loss)**                       | ** ** | **Market  Value** | ** ** | **Adjusted  Cost  Basis** | ** ** | **Unrealized  Gain  (Loss)** | ** ** | **Market  Value** | ** ** | **Adjusted  Cost  Basis** | ** ** | **Gain  (Loss)** | ** ** | **Market Value** | ** ** |
|                    |       |                                   |       |                                   |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Trading Securities:     |       |                                   |       |                                   |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                    |       |                                   |       |                                   |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| MES – Common Stock |       | $                                      | 84,725     |                                   | $          | 485,230           |       | $ | 569,955 |   | $ | — |   | $ | — |   | $ | — |   | $ | 84,725 |   | $ | 485,230 |   | $ | 569,955 |   |
|                         |            |                                        |            |                                        |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

On February 28, 2006, the Company transferred600,000 shares of Earth Biofuels common stock that it purchased in open markettransactions to a lender as collateral for a note payable in the principalamount of $330,720.

 

9

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On March 31,2005, the Company assigned a notereceivable valued at $495,000 in exchange for 495,000 shares, $1.00 par value,convertible preferred stock of Blue Wireless and Data, Inc. Thisinvestment was written off during the fourth quarter of 2005.

 

*Prepaid expenses and deposits*— The Company had approximately $2.6 million of prepaid expenses anddeposits classified as current assets at March 31, 2006. These balancesconsisted of $1.4 million of prepaid feedstock and $0.5 million of LNG gasbalancing deposits related to its LNG business, $0.3 million deposit for atruck stop related to its Biodiesel operations and $0.2 million for deposits ondrilling rig equipment.

 

The Company also had approximately $4.0 million ofdeposits classified as long-term assets at March 31, 2006. These depositsconsist of 12,000,000 shares of the Company’s common stock valued at $3.3million issued to BC&D for collateral on a line of credit and 600,000shares of Earth Biofuels common stock, valued at $0.7 million, that the Companypurchased in open market transactions and used as collateral for a loan.

 

*Goodwill*—Goodwill recorded on the Company’s balance sheet reflects the purchase price ofthe Company’s acquisitions exceeding the fair market value of the net assets.At March 31, 2006 the Company had recorded $22,107,382 of goodwill relatedto its acquisition of its LNG businesses and its oil and gas production companyMountain States. The remaining, $8,494,172, of goodwill relates to theacquisition of Earth Biofuels and its subsequent acquisition of DistributionDrive in November of 2005.

 

*Inventory* —Inventory balances at March 31, 2006 were $791,329 consisting of wellequipment purchased in bulk for use on the Company’s oil and gas leases totaling$56,966, inventories of biodiesel fuel and products purchased for resale totaling$208,603 and inventory related to LNG in storage was $19,336 and LNG equipmentinventory totaled $506,424.

 

*Warrants* – The Company issued warrants to theinvestors that participated in the Company’s recent private placement of 8%secured convertible promissory notes. In total, the Company issued warrants topurchase an aggregate of 12,000,000 shares of its common stock. The warrantshave an exercise price of $0.30 per share, and expire in June 2010. Thewarrant exercise price is subject to adjustment upon the occurrence of certainspecified events, including stock dividends and stock splits, pro ratadistributions of equity securities, evidences of indebtedness, rights orwarrants to purchase common stock or cash or any other asset, mergers orconsolidations, or certain issuances of common stock at a price below theinitial exercise price of $0.30 per share. The warrants include a “cashlessexercise” feature, which permits the holder to exercise the warrants bysurrender of a portion of the warrants. The cashless exercise feature is availableto the holder, if at the time of exercise, there is not in effect aregistration statement covering the shares underlying the warrants. At the dateof issuance, June 30, 2005, these warrants had a fair value of $.61 basedon the Black-Scholes option pricing model.

 

During 2003, the Company issued a former officer inconnection with such officer’s employment agreement, a warrant for 65,000shares of restricted common stock. Such warrant has an exercise price of $4.50per share and expires on December 11, 2006.

 

*Stock Options and Warrants*—The Company accounts for its stock-based compensation plans inaccordance with Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (APB 25) and related interpretations. TheCompany accounts for stock-based compensation for non-employees under the fairvalue method prescribed by Statement of Financial Accounting Standards No. 123,“Accounting for Stock-Based Compensation.” Through March 31, 2005, therehave been no significant grants to non-employees.

 

The Company grants incentive and non-qualified stockoptions and has reserved 23,282,000 shares of common stock for issuance underits stock option plans. The majority of the options granted become exercisableat the date of grant, and generally expire three years after the date of grant.

 

The Company adopted the disclosure provisions ofStatement of Financial Accounting Standards No. 123 (SFAS No. 123), “Accountingfor Stock Based Compensation.” This statement requires the Company to providepro forma information regarding net income and net income per share as ifcompensation cost for the Company’s stock options had been determined inaccordance with the fair value method. The fair value of these options wasestimated at the date of grant using a Black-Scholes option pricing model withthe following weighted average assumptions for 2006 and 2005.

 

10

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| Dividend  Yield          |   | 0    | %      |
|--------------------------|--------|------|--------|
| Expected  volatility     |   | 80   | %      |
| Risk free  interest rate |   | 3.25 | %      |
| Expected life  (years)   |   | 3    |   |

 

Had compensation cost for the Company’s stock optionplans been determined based on the fair value at the grant date consistent withthe provisions of SFAS No. 123, the Company’s net loss and loss per sharewould have been reduced to the pro forma amounts indicated below:

 

| ** **                                                                                                        | ** ** | **December 31,  2005** | ** **  | **March 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|-------------|--------------------------|------------|
| ** **                                                                                                        | ** ** | ** **                  | ** **  | **(Restated)**           | ** ** |
|                                                                                                              |       |                        |        |                     |       |
| Net income  (loss), as reported                                                                                   |       | $                           | (12,922,563 | )                        | $          | 20,716 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  based method for all awards |       | (5,460,430                  | )           | (937                     | )          |
| Adjusted net  income (loss)                                                                                       |       | $                           | (18,382,993 | )                        | $          | 19,779 |   |
| Earnings  (loss) per share                                                                                        |       |                        |        |                     |       |
| As reported                                                                                                       |       |                        |        |                     |       |
| Basic and  diluted                                                                                                |       | $                           | (0.09       | )                        | $          | — |   |
| As adjusted                                                                                                       |       |                        |        |                     |       |
| Basic and  diluted                                                                                                |       | $                           | (0.13       | )                        | $          | — |   |

 

*Revenue –*Oiland natural gas production revenue is recognized at the time and point of saleafter the product has been extracted from the ground. Revenue from pipelinerental fees for natural gas transmission is based on volume of Mcf of naturalgas metered monthly. Revenue from product sales of bio diesel fuel and othersales related to service station operations are point of sale transactions. TheCompany uses the sales method of accounting for LNG revenues. Under thismethod, revenues are recognized based on actual volumes of LNG sold tocustomers.

 

*Comprehensive Income*—Comprehensive income includes all changes in equity except those resulting from investments by stockholders and distributions to stockholders.

 

*Earnings per Share*- Earnings (loss) per common share is presentedin accordance with the provisions of the Statement of Financial AccountingStandards No. 128, “Earnings Per Share” (SFAS 128), which requiresthe presentation of “basic” and “diluted” earnings per share. Basic earnings(loss) per share are based on the weighted average shares outstanding. Dilutedearnings per share include the effect of dilutive securities such as stockoptions and warrants.

 

The following table reconciles basic earnings pershare to diluted earnings per share under the provisions of SFAS 128.

 
| ** **                            | ** ** | **Net Loss  (Numerator)**                                   | ** **  | **Shares  (Denominator)** | ** **  | **Per Share  Amount** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------------|-------------|---------------------------|-------------|----------------------------|------------|
| ** **                            | ** ** | **(Restated)**                                                   | ** **  | ** **                | ** **  | ** **                 | ** ** |
| ** **                            | ** ** | **In thousands, except per share data** | ** **  |
| **Period  Ended March 31, 2006** |       |                                                             |        |                      |        |                       |       |
| Basic  earnings per share             |       | $                                                                | (12,922,563 | )                         | 144,677,196 |                       | $          | (.09 | ) |
| Effect of  dilutive securities:       |       |                                                             |        |                      |        |                       |       |
| Stock  options and warrants           |       | —                                                           |        | —                    |        | —                     |       |
| Diluted  earnings per share           |       | $                                                                | (12,922,563 | )                         | 144,677,196 |                       | $          | (.09 | ) |

 

11

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| ** **                            | ** ** | **Net Income  (Numerator)**                                 | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------------|------------|---------------------------|------------|----------------------------|------------|
| ** **                            | ** ** | **(Restated)**                                                   | ** ** | ** **                | ** ** | ** **                 | ** ** |
| ** **                            | ** ** | **In thousands, except per share data** | ** ** |
| **Period  Ended March 31, 2005** |       |                                                             |       |                      |       |                       |       |
| Basic  earnings per share             |       | $                                                                | 20,716     |                      | 32,027,005 |                       | $          | — |   |
| Effect of  dilutive securities:       |       |                                                             |       |                      |       |                       |       |
| Stock  options and warrants           |       | —                                                           |       | 403,516                   |       | —                     |       |
| Diluted earnings  per share           |       | $                                                                | 20,716     |                      | 33,430,521 |                       | $          | — |   |

 

Total stock options and warrants outstanding at March 31,2006 that are not included in the diluted earnings per share computation due tothe antidilutive effects are 12,080,875. Convertible notes not included in thecomputation of diluted earnings per share are equivalent to approximately 12,953,884shares. Convertible preferred stock not included in the diluted earnings pershare computation due to the antidilutive effects are 5,000,000 shares. Thesestock options, warrants, convertible notes and convertible preferred stock werenot included in the computation of earnings per share at March 31, 2006due to exercise prices exceeding the average market value of the Company’scommon stock, and due to the Company’s incurring a net loss during the period.

 

Total stock options and warrants outstanding At March 31,2005 that are not included in the diluted earnings per share computation areapproximately 80,875. These stock options and warrants were not included at March 31,2005 due to exercise prices exceeding the average market value of the Company’scommon stock. Convertible notes included in the computation of diluted earningsper share are approximately 403,516 shares.

 

Basic net income (loss) per share is computed bydividing net income (loss) available to common shareholders (numerator) by theweighted average number of common shares outstanding during the year(denominator). Diluted net income (loss) per share is computed using theweighted average number of common shares and potential common sharesoutstanding during the year. Potential common shares result from the assumedexercise, using the treasury stock method, of outstanding stock options,warrants and convertible notes having a dilutive effect. The numerator for theperiods presented is equal to the reported net loss.

 

Income Taxes—The Company has adopted FinancialAccounting Standards No. 109, which requires the recognition of deferredtax assets and liabilities for the expected future tax consequences of eventsthat have been included in the financial statements or tax returns. Under thismethod, deferred tax assets and liabilities are determined based on thedifference between financial statements and tax bases of assets and liabilitiesusing enacted tax rates in effect for the year in which the differences areexpected to reverse.

 

For income tax reporting purposes, the Company’saggregate unused net operating losses approximate $6.2 million which expire inyears 2013 through 2020, subject to limitations of Section 382 of theInternal Revenue Code, as amended. The Company has provided a valuationallowance against the full amount of net operating loss benefit, since in theopinion of management based upon the earnings history of the Company, it is morelikely then not that the benefits will not be realized. Deferred tax assets of$590,029 relate to the differences associated with the Company’s depletion ofits oil and gas assets. The deferred tax liabilities of $156,561 relate to thedifferences associated with the depreciation related to the Company’s oil andgas assets.

 

**2. GOING CONCERN AND MANAGEMENT PLANS**

 

During the period ending March 31, 2006, theCompany recorded a net loss of $12,922,563. Since the Company completed itsinitial acquisition of BC&D on October 28, 2004, the Company hasaccumulated losses aggregating $47.9 million. The Company’s continued existenceis dependent upon its ability to take advantage of acquisition opportunities,raise capital through private securities offerings, secure collateralized debtfinancing and use these sources of capital to grow and enhance its oil and gasproduction, gas pipeline transmission operations and its biodiesel and LNGsales and production. The following addresses the Company’s efforts regarding itsrecent acquisitions and financings.

 

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*Acquisitions*

 

During the fourth quarter of fiscal 2004 the Companycompleted the acquisition of BC&D. The acquisition of BC&D marked theinitial entrance of the Company into the oil and natural gas productionbusiness. During the first quarter of fiscal 2005, the Company completed theacquisition of OGC. The OGC acquisition added a pipeline network to the Company’sassets enabling the Company to diversify into the oil and gas transmissionbusiness. In addition in December of 2005, the Company acquired anotheroil and gas production company Mountain States which added approximately 50 oiland gas wells to the Company’s operations. Also in December of 2005, theCompany acquired businesses specializing in LNG sales and production. TheCompany believes these acquisitions will be a major part of establishingfuture financial stability. The Mountain States and LNG company acquisitionshave produced revenue in excess on $20 million over the preceding two fiscalyears.

 

The Company has acquired an interest in EarthBiofuels. Earth Biofuels produces and distributed bio-diesel fuel. EarthBiofuels assets consist primarily of a biodiesel refinery and refuelingstation. In response to soaring fuel costs, and to avail itself of governmentsubsidies and tax incentives, the Company has pursued a strategy of developingrenewable forms of energy, such as bio diesel. Consequently, on February 25,2005 the Company acquired a 50% interest in Earth Biofuels, a Mississippi-basedcompany and on August 19, 2005, acquired an additional 30% ownershipinterest. On September 13, 2005, the Company executed a share exchangewith Meadows Springs, Inc. whereby the Company contributed its 80%interest in Earth Biofuels in exchange for 21,000,000 shares of the commonstock of Meadows Springs. As a consequence of the share exchange the Companymaintained a controlling interest in Meadows Springs of approximately 89% andEarth Biofuels remains an indirect subsidiary of the Company. As of May 18,2006, the Company owned 129,381,182 shares of common stock of Earth Biofuelsrepresenting a 62.39% majority ownership.

 

*Financing*

 

On July 7, 2005 the Company completed a $3.0million financing consisting of convertible notes with related warrants. TheCompany collateralized certain of its oil and gas assets and properties alongwith its pipeline assets to secure this funding. This financing enabled theCompany to pay in full the mortgage due on its pipeline assets and fund workingcapital.

 

On February 7, 2006, the Company finalizednegotiations to provide a $3.5 million line of credit for working capitalrelated to its oil and gas assets acquired in the BC&D acquisition. TheCompany plans to use this capital to restart production. The credit line issubject to a borrowing base and funds are pre approved and borrowed forproduction purposes only at the discretion of the lender. This facility bearsinterest at the prime rate + 3.0% and matures on February 1, 2007. At May 18,2006 the Company had borrowed $500,000 on this credit line.

 

On April 13, 2006, the Company completed an$8.0 million loan agreement to fund working capital for its LNG businesses.This facility consists of a three year $3.0 million revolver, collateralized bythe receivables of ALT, and a five year $5.0 million term loan collateralizedby the remaining assets of ALT and Arizona LNG, which consists primarily of anLNG plant. The facility bears interest at the greater of 7% or the prime rate +1.5%. At May 10, 2006 the Company had borrowed $4.0 million on the termloan and $1.1 million on the line of credit. The Company plans to use thisfacility to enhance its operations and provide working capital.

 

The Company has also continued to raise capitalthrough a variety of private securities offerings of its common stock.

 

Management is focusing on expanding and improvingits oil and natural gas production operations, leveraging its opportunitiesregarding its pipeline assets and continuing to develop its biodiesel and LNGproduction and sales through acquisition, organic growth and funding viacollateralized loans and private placement offerings, the Company plans tocontinue to increase the profitability of its operations necessary to supportoperations.

 

There can be no assurance that any of management’splans as described above will be successfully implemented or that the Companywill continue as a going concern.

 

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*The Company’s Liquidity Plan*

 

Recent operating results give rise to concerns aboutthe Company’s ability to generate cash flow from operations sufficient to makescheduled debt payments as they become due. The Company has completed threerecent financings to help fund its working capital needs. On July 7, 2005the Company completed a $3.0 million financing. This financing allowed theCompany to secure full payment of its pipeline assets and infuse capital intoits oil and gas subsidiary BC&D as well as continue funding its biodieseljoint venture. On February 7, 2006 the Company executed a $3.5 millionline of credit for its oil and gas operations related to its BC&Dsubsidiary. On April 13, 2006 the Company completed an $8.0 millionfinancing facility for its LNG operations, As of December 31, 2005, theCompany continued to seek other financing from private placements and otheracquisitions to expand its opportunities in the areas of oil and gasproduction, oil and gas transmission and biodiesel and LNG businesses. TheCompany has implemented cost saving measures, primarily in its oil and gasoperations, by implementing cost controls designed to reduce unnecessaryexpenditures and operate production activities within the current economicconstraints with which the Company currently operates. The Company will takeadditional cost savings measures, if necessary, to enhance its liquidityposition.

 

The Company’s need to raise additional equity ordebt financing and the Company’s ability to generate cash flow from operationssufficient to make scheduled payments on its debts as they become due willdepend on its future performance and the Company’s ability to successfullyraise capital and implement business and growth strategies. The Company’sperformance will also be affected by prevailing economic conditions. Many ofthese factors are beyond the Company’s control. If future cash flows andcapital resources are insufficient to meet the Company’s debt obligations andcommitments, the Company may be forced to reduce or delay activities andcapital expenditures, obtain additional equity capital or restructure orrefinance its debt. In the event that the Company is unable to do so, theCompany may be left without sufficient liquidity and it may not beable to meet its debt service requirements. In such a case, this could resultin a substantial portion of the Company’s indebtedness becoming immediately dueand payable. As a result, the Company may not be able to continueoperations due to liens, collateralized notes or other secured positions placedon the Company’s assets.

 

**3. PROPERTY AND EQUIPMENT**

 

The Company follows the full cost method ofaccounting for exploration and development of oil and gas properties wherebyall costs in acquiring, exploring and developing properties are capitalized,including estimates of abandonment costs, net of estimated equipment salvagecosts. No costs related to production, general corporate overhead, or similaractivities have been capitalized. Leasehold costs are depleted based on theunits-of-production method based on estimated proved reserves. Property andequipment are stated at cost less accumulated depreciation. The Company recordsimpairment losses on long-lived assets used in operations when events andcircumstances indicate that the assets might be impaired and the undiscountedcash flows estimated to be generated by those assets are less than the carryingamounts of those assets.

 

Depreciationis calculated on a straight-line basis over the estimated useful lives of thevarious assets as follows:

 

| Leasehold  improvements  |   | 5-7 Years |   |
|--------------------------|--------|-----------|--------|
| Machinery  and equipment |   | 5-7 Years |   |
| Gas plant                |   | 7 Years   |   |
| Automobiles              |   | 5 Years   |   |

 

Property, plant andequipment consist of the following:

 
| ** **                           | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Land                                 |       | $                        | 240,004    |                        | $          | 221,841 |   |
| Building                             |       | 314,717                  |       | 213,842                     |       |
| Machinery  and equipment             |       | 13,516,869               |       | 12,564,146                  |       |
| Computer and  office equipment       |       | 282,356                  |       | 242,199                     |       |
| LNG and  Biodiesel plants            |       | 17,748,149               |       | 8,286,042                   |       |
| Intangible  drilling costs           |       | 229,848                  |       | 247,221                     |       |
| Pipeline  easements                  |       | 2,151,815                |       | 2,154,000                   |       |
| Asset  retirement obligations        |       | 1,608,570                |       | 1,608,570                   |       |
| Automobiles                          |       | 234,407                  |       | 161,447                     |       |
| Leasehold  improvements              |       | —                   |       | 3,216                       |       |
|                                 |       | 36,326,735               |       | 25,702,524                  |       |
| Less  accumulated depreciation       |       | 9,828,706                |       | 9,368,157                   |       |
| Sub total                            |       | 26,498,029               |       | 16,334,367                  |       |
| Oil &  gas leases           |       | 8,972,550                |       | 8,990,835                   |       |
| Less  accumulated depletion          |       | 1,501,999                |       | 713,119                     |       |
| Net oil and  gas leases              |       | 7,470,551                |       | 8,277,716                   |       |
| Total  property, plant and equipment |       | $                        | 33,968,580 |                        | $          | 24,612,083 |   |

 

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Depreciation, amortizationand depletion expense for the three months ended March 31, 2006 was $1,249,430.At March 31, 2006 $788,880 of depletion was recorded using theunits-of-production method on the Company’s only cost center consisting of oiland gas properties in the Four Corners area of New Mexico, Arizona and Utah.

 

Depreciation, amortizationand depletion expense for the three and year ended December 31, 2005 was$885,098. At December 31, 2005 $165,464 of depletion was recorded usingthe units-of-production method on the Company’s only cost center consisting ofoil and gas properties in the Four Corners area of New Mexico, Arizona andUtah.

 

At March 31, 2006 theCompany had no capitalized costs of unproved properties and major developmentprojects excluded from capitalized costs being amortized under the full costmethod of accounting for oil and gas properties.

 

**4. EQUITY TRANSACTIONS**

 

During the first quarterended March 31, 2006, the Company issued 10,116,773 shares of its commonstock, via private placement. The common stock was sold at prices ranging from$0.25 to $0.52 per share to accredited investors. The aggregate purchase pricewas $4,382,376 cash, less $2,353,231 in commissions.

 

During the first quarterended March 31, 2006 the Company issued 1,115,129 shares of the Company’scommon stock to consultants in restricted form and pursuant to the Company’s2004 and 2005 Stock Option and Award Plans. These shares of common stock wereissued at the fair market value price on the date of issuance and resulted inapproximately $484,328 of non-cash consulting services expense.

 

During the first quarterended March 31, 2006 120,000 shares of the Company’s common stock,originally issued for compensation to the Company’s Chief Operating Officer,were returned and cancelled in exchange for $21,942 in cash.

 

During the first quarterended March 31, 2006, the Company issued 120,000 shares of the Company’scommon stock valued at $50,400 as part of a litigation settlement. See Item1 of Part II – Other Information in this document.

 

During the first quarterended March 31, 2006 the Company issued 600,000 shares of its common stockvalued at approximately $234,000 to retire two notes payable with principalamounts of  $100,000 and $50,000 payableto JPB Resources, Inc. In addition, the Company issued 183,335 shares ofthe Company’s common stock valued at $45,833 to retire two months of principaldue on a $550,000 note payable to an investor related to the Company’s $3.0million convertible notes.

 

During the first quarterended March 31, 2006, the Company issued 213,800 shares of the Company’scommon stock valued at $113,314 to acquire a truck.

 

**5. LEASES**

 

The Company leases fourteenLNG trailers under two separate lease agreements. The lease agreements requiremonthly rental payments of $40,960 and expire during 2006. Future minimumpayments under the remaining lease terms were approximately $99,476 as of March 31,2006. The lease agreements

 

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allow the Company to purchase the trailers at theend of the lease term for residual payments aggregating approximately $840,000.

 

The Company leases twomobile fueling units used in its LNG businesses. The lease agreements requiremonthly rental payments of $7,200 and expire during 2008. Future minimumpayments under the remaining lease terms were approximately $99,476 as of March 31,2006.

 

The Company maintainsseveral leasing arrangements for trailers and LNG equipment on a month to monthbasis approximating $64,175 per month.

 

The Company maintains amortgage on a building in Trona, California for $38,278. The office lease isfor a term of 59 months commencing on March 31, 2005 at $917 per month.

 

The following is a schedule of future minimumrent payments due:

 

| **Year Ending December 31,** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|
| 2006                                        |       |       | $          | 172,529 |   |
| 2007                                        |       |       | 97,404     |   |
| 2008                                        |       |       | 83,004     |   |
| 2009                                        |       |       | 11,004     |   |
| 2010                                        |       |       | 1,834      |   |
| Thereafter                                  |       |       | —     |   |
| Total                                       |       |       | $          | 365,775 |   |

 

Rent expense was $323,942and $1,800 for the three months ended March 31, 2006 and 2005.

 

**6. NOTES PAYABLE**

 

At March 31, 2006 the Company maintained notespayable due to secured lenders and to various investors. All notes having amaturity date of less than twelve months are classified as current liabilities.

 

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| **Lender**                                | ** ** | **Maturity Date** | ** ** | **Interest Rate** | ** ** | **Original Principal  Amount  March 31, 2006** | ** ** | **Original Principal  Amount  December 31, 2005** | ** ** |
|-------------------------------------------|------------|------------------------|------------|------------------------|------------|---------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| Jimmy Brown                               |       | On Demand              |       | 13.00                  | %          | $                                                             | 200,000    |                                                             | $          | 200,000 |   |
| JPB  Resources, Inc.                 |       | —                 |       | 13.00                  | %          | —                                                        |       | 50,000                                                           |       |
| JPB  Resources, Inc.                 |       | —                 |       | 11.00                  | %          | —                                                        |       | 100,000                                                          |       |
| Dennis Lueng                              |       | On Demand              |       | 6.00                   | %          | 10,000                                                        |       | 10,000                                                           |       |
| Peter  Knollenberg                        |       | On Demand              |       | 6.00                   | %          | 150,000                                                       |       | 150,000                                                          |       |
| TelcoEnergy  Corporation                  |       | On Demand              |       | 6.00                   | %          | 179,000                                                       |       | 179,000                                                          |       |
| Convertible  Notes OGC (2)                |       | On Demand              |       | 10.00                  | %          | 575,907                                                       |       | 575,907                                                          |       |
| $3.0 million convertible notes (1)        |       | 12/31/2007             |       | 8.00                   | %          | 1,135,465                                                     |       | 1,297,674                                                        |       |
| Bruce Ivey                                |       | 3/31/2010              |       | 7.00                   | %          | 38,278                                                        |       | 43,024                                                           |       |
| Oliver  Kendall Kelley                    |       | 4/1/2011               |       | 8.50                   | %          | 6,000,000                                                     |       | 6,000,000                                                        |       |
| Jack B.  Kelley, Inc.                |       | 9/20/2011              |       | 7.50                   | %          | 3,898,544                                                     |       | 4,041,620                                                        |       |
| Navistar  Financial Corporation           |       | 10/27/2007             |       | 8.50                   | %          | 41,554                                                        |       | 49,345                                                           |       |
| West Texas  National Bank                 |       | 2/1/2007               |       | Prime +3               | %          | 260,000                                                       |       | —                                                           |       |
| Argyll  Equities, LLC                     |       | 2/8/2009               |       | 7.50                   | %          | 330,720                                                       |       | —                                                           |       |
| Marc Weill  convertible note (3)          |       | 1/11/2007              |       | 8.00                   | %          | 500,000                                                       |       | —                                                           |       |
| Marc Weill  convertible note (3)          |       | 1/25/2007              |       | 8.00                   | %          | 250,000                                                       |       | —                                                           |       |
| Jack Haigh  convertible note (4)          |       | —                 |       | —                 |       | 100,000                                                       |       | —                                                           |       |
| Brian  Quarles convertible note (4)       |       | —                 |       | —                 |       | 19,000                                                        |       | —                                                           |       |
| Tom Groos  convertible note (3)           |       | 1/25/2007              |       | 8.00                   | %          | 250,000                                                       |       | —                                                           |       |
| Southern Bio  Fuels                       |       | 6/29/2006              |       | 7.25                   | %          | 1,100,054                                                     |       | —                                                           |       |
| Total notes  payable                      |       |                   |       |                   |       | 15,038,522                                                    |       | 12,696,570                                                       |       |
| Less current  portion of notes payable    |       |                   |       |                   |       | 4,430,206                                                     |       | 2,428,952                                                        |       |
| Long –term  portion of notes payable |       |                   |       |                   |       | $                                                             | 10,608,316 |                                                             | $          | 10,267,618 |   |

 

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(1)   On June 30, 2005, the Company enteredinto (and on July 7, 2005 completed the transaction contemplated by) aNote and Warrant Purchase Agreement with certain investors, pursuant to whichthe Company issued $3,000,000 principal amount of 8% Secured ConvertiblePromissory Notes and related securities. Pursuant to the Note and WarrantPurchase Agreement, the Company sold to the investors an aggregate of$3,000,000 principal amount of 8% secured convertible promissory notes,together with warrants to purchase an aggregate of 12,000,000 shares of theCompany’s common stock, and an additional investment right entitling theholders to purchase from the Company up to an additional $3,000,000 of 8%secured convertible promissory notes and warrants to purchase an aggregate of12,000,000 shares of the Company’s common stock. These notes are secured by acontinuing security interest in certain of the Company’s assets pursuant to theterms of a security agreement among the Company and  its wholly owned subsidiaries BC&D andOGC, and the investors. These notes are recorded at their fair value based onthe allocation of the fair value of the convertible notes and related warrants.The notes accrete interest in the amount of $70,930 per month until maturity orconversion by the investors. Additional terms of the 8% secured convertiblenotes include:

 

•  Unless converted or redeemed as describedbelow, the 8% secured convertible notes are due on December 30, 2007.

 

•  8% annual interest, payable semi-annually inarrears beginning December 1, 2005. The interest is payable either in cashor at the Company’s option (subject to the satisfaction of certain conditions)in shares of the Company’s common stock valued at 92.55% of the volume weightedaverage price of the Company’s common stock for the 5 trading days prior to thepayment date.

 

•  While the notes are outstanding, if theCompany issues equity or equity linked securities at a price lower than theconversion price, then the conversion price of these 8% secured convertiblenotes will be reduced to the same price.

 

•  The notes are convertible at any time at theoption of the holder into shares of the Company’s common stock at a conversionprice of $0.25 per share. The conversion price is also subject to adjustmentupon the occurrence of certain specified events, including stock dividends andstock splits, mergers or consolidations, or certain issuances of common stockat a price below the initial conversion price of $0.25 per share.

 

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•  The number of shares of the Company’s commonstock acquired by any holder upon conversion of the notes is limited to theextent necessary to ensure that following the conversion the total number ofshares of the Company’s common stock beneficially owned by the holder does notexceed 4.999% of our issued and outstanding common stock.

 

•  The Company can prepay all or any portion ofthe principal amount of the notes, plus any accrued but unpaid interest at 120%of face amount, but only if certain conditions are satisfied, including aneffective registration. If the Company should elect to prepay the notes, theholders will have 30 calendar days to convert the notes into shares of ourcommon stock. If the Company elects to prepay the notes, it must do so pro-rataamongst the holders.

 

(2)   Convertible notes due to former owners of OGC Pipeline, LLC.

(3)   During the three months ended March 31, 2006,Earth Biofuels issued 8% convertible debt agreements for proceeds totaling$1,000,000. The debt matures twelve months from the issue date and isconvertible to Earth Biofuels common stock at a rate of $0.50 per share. Thedebt is unsecured. Earth Biofuels recorded a discount on the debt for thebeneficial conversion feature (“BCF”) in the amount of $610,000. The BCF willbe amortized to interest expense over the terms of the debt agreements.

 

Earth Biofuels analyzed its shortterm convertible debt instruments for derivative accounting under SFAS 133 andEITF 00-19. Earth Biofuels determined the conversion feature met the criteriafor classification in stockholders’ equity under SFAS 133 and EITF 00-19 due tothe agreement containing an explicit limit on the number of shares to bedelivered upon settlement. Therefore, derivative accounting is not applicablefor the convertible instruments.

(4) Notes converted to common stock of EarthBiofuels, Inc. subsequent to March 31, 2006.

 

**7. ROYALTY PAYABLE**

 

The Company has various royalty arrangements withnon-working interest owners. As of March 31, 2006 the Company owedroyalties of $817,761 to non-working interest owners and regulatory agencies.

 

**8. EXTRAORDINARY ITEM**

 

Effective March 31, 2005 the Company executed aCompromise of Debt Agreement with Koch. This agreement effectively reduced theprincipal and interest obligation on the note payable assumed in theacquisition of OGC in February 2005. The principal and interest wasreduced to $1,100,000 as full payment on the pipeline assets resulting in forgivenessof debt in the amount of $2,182,686 in principal and accrued interest. TheCompany made payments totaling $100,000 to Koch during the second quarter of2005. In July 2005, the remaining balance of $1,000,000 was paid in full.

 

**9. RELATED PARTY TRANSACTIONS**

 

The Company entered into a management services agreementwith DGMAC, LLC effective March 15, 2005. Under the terms of thisagreement the Company is charged $40,000 monthly for services provided byDennis McLaughlin, its Chief Executive Officer and Chairman of the Board. TheCompany and Mr. McLaughlin agreed to make no accrual of Mr. McLaughlin’scompensation, related to his management services agreement during the firstquarter of 2005. The Company resumed accrual of Mr. McLaughlin’smanagement service agreement effective July 1, 2005 upon completion of theCompany’s funding of $3.0 million of convertible notes in July of 2005.

 

The Company entered into a management servicesagreement with Johnny Flame Consulting, LLC effective March 15, 2005. Underthe terms of the agreement the Company is charged $15,000 monthly for servicesprovided by Christopher Chambers, its Corporate Secretary.The Company and Mr. Chambers agreed tomake no accrual of Mr. Chamber compensation, related to his managementservices agreement during the first quarter of 2005. The Company resumedaccrual of Mr. Chambers management service agreement effective July 1,2005 upon completion of the Company’s funding of $3.0 million of convertiblenotes in July of 2005.

 

The Company entered into a management services agreement with MAC Partners, LP (“MAC”) effective November 12, 2004. Under the terms of this agreement the Company is charged $45,000 monthly for general administration, human resources, turnkey office and legal services. In addition, MAC provides the services of Mr. J. Mark Ariail and Mr. Wayne McPherson, the Company’s Chief Financial Officer and Chief Operating Officer. Effective March 15, 2005, Mr. Ariail and Mr. McPherson’s services were no longer provided by MAC and they became employees of the Company. On February 15, 2005, MAC loaned the Company $112,015 through a promissory note bearing interest at 7% per annum. This promissory note was paid in full during the second quarter of 2005.

 

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 On January 17,2005 the Company entered into a Bill of Sale and Assignment Agreement wherebyit conveyed ownership of two generators and a gas plant, valued atapproximately $500,000, to Sovereign Strategic Partners, Ltd. (“Sovereign”) inexchange for a promissory note in the amount of $495,000. This note was securedby an Agreement of Pledge pursuant to which 20,000,000 shares of Blue Wirelessand Data, Inc. (“Blue”) were contributed as collateral. Subsequently, theCompany entered into a Capital Lease Agreement with Sovereign whereby Sovereignleased the generators and gas plant to the Company. The Company subsequentlyassigned the Sovereign promissory note to MAC in exchange for 495,000 shares ofconvertible preferred stock of Blue. This convertible preferred stock waswritten off during the fourth quarter of 2005. Mr. McLaughlin currentlyserves as the Chairman of the Board of Blue and Mr. Chambers serves asBlue’s President.

 

During the first quarter of 2005, the Company issued150,000 shares of its common stock valued at $222,000 to Blue to be pledged ascollateral for an equipment loan for Blue. During the second quarter of 2005 anadditional 681,818 shares of the Company’s common stock valued at $136,364 wereissued directly to Blue’s vendor for additional collateral required on theequipment loan due to fluctuations in the Company’s stock price. During thefirst quarter of 2006, both issuances of the Company’s common stock werewritten off when the Company reached an agreement with the vendor to allow thevendor to liquidate the shares to satisfy an unpaid loan balance. Mr. McLaughlincurrently serves as the Chairman of the Board of Blue and Mr. Chambersserves as Blue’s President.

 

During the fourth quarter of 2005, the Companyissued 500,000 shares of its common stock valued at $145,000 to MammothCorporation to provide partial security for a loan in the amount of $125,000the makers of which are Blue, TKM and Dennis McLaughlin, the Company’s ChiefExecutive Officer and Chairman. During the second quarter of 2006, the 500,000shares of the Company’s common stock were returned to the Company andsubsequently cancelled upon repayment of the loan. Mr. McLaughlin servesas Blue’s Chairman of the Board and is a Director of TKM. Christopher Chambersthe Company’s Corporate Secretary and Director serves as Blue’s CorporateSecretary and Director.

 

At December 31, 2005 the Company’s 62% ownedsubsidiary Earth Biofuels had outstanding accounts payable to DGMAC, LLC for $81,479.DGMAC, LLC is a company operated by Dennis McLaughlin the Chairman and CEO ofthe Company and Earth Biofuels. In addition, Earth Biofuels had outstandingaccounts payable and note payable totaling $139,603 and $139,134 to BruceBlackwell, a Director of Earth Biofuels. Also Earth Biofuels owed Peter Bell, theformer owner of Distribution Drive, a current employee of Earth Biofuels, a notepayable of $96,033. DGMAC, LLC was also owed $75,000 to Apollo DrillingCompany, LLC, a new venture of the Company formed in the first quarter of 2006.

 

 These amountsare classified in the Company’s balance sheet under the caption “Accountspayable related party” and “Notes payable related party”.

 

**10. SUPPLEMENTAL CASH FLOW INFORMATION**

 

Significantnon-cash transactions are summarized as follows:

 
| ** **                                            | ** ** | **March 31,  2006** | ** ** | **March 31,  2005** | ** ** |
|-------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Common stock  issued for services                     |       | $                        | 5,971,356  |                     | $          | 878,095 |   |
| Contribution  from minority shareholders’        |       | $                        | 9,326,471  |                     | $          | — |   |
| Common stock  issued to acquire assets                |       | $                        | 4,214,340  |                     | $          | — |   |
| Common stock  issued in acquisition of subsidiary     |       | $                        | —     |                     | $          | 4,000,000 |   |
| Common stock  issued for investment in joint ventures |       | $                        | —     |                     | $          | 1,700,000 |   |
| Gain on  extinguishment of debt                       |       | $                        | —     |                     | $          | 2,182,686 |   |

 

**11. SEGMENT INFORMATION**

 

The Company maintains threeoperating segments. Apollo Production and Operating, Inc. is the holdingcompany that contains the Company’s oil and gas production operations andpipeline gas transmission operations. Apollo Alternative Fuels, LLC is theholding company which contains the Company’s bio diesel

 

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production and distribution operations. Apollo LNG, Inc.is the holding company which contains the Company’s LNG production,distribution and marketing operations.

 

Certain segment data isincluded in the table below as follows:

 
| ** **                            | ** ** | **Production and   Operating** | ** ** | **Alternative  Fuels** | ** ** | **LNG**    | ** ** |
|---------------------------------------|------------|------------------------------------------|------------|------------------------|------------|------------|------------|
| **Period  Ended March 31, 2006** |       |                                     |       |                   |       |       |       |
| Revenue                               |       | $                                        | 842,096    |                   | $          | 1,886,119  |       | $ | 6,731,008 |   |
| Operating  loss                       |       | $                                        | (1,398,920 | )                      | $          | (6,453,629 | )          | $ | (1,900,056 | ) |
| Long – lived  assets             |       | $                                        | 14,110,358 |                   | $          | 10,004,658 |       | $ | 10,650,776 |   |
|                                  |       |                                     |       |                   |       |       |       |
| **Period  Ended March 31, 2005** |       |                                     |       |                   |       |       |       |
| Revenue                               |       | $                                        | 148,492    |                   | $          | —     |       | $ | — |   |
| Operating  loss                       |       | $                                        | (97,201    | )                      | $          | (8,854     | )          | $ | — |   |
| Long – lived  assets             |       | $                                        | 5,013,640  |                   | $          | 85,079     |       | $ | — |   |

 

**12. SUBSEQUENT EVENTS**

 

On May 1, 2006, OGC Pipeline, a wholly-ownedsubsidiary of the Company, sold approximately 500 miles of its pipeline systemin central Oklahoma and north Texas, as well as the easements, surface leaseagreements, rights-of-way, permits, licenses, leases and other rights of accessand agreements related to such pipeline segment, to Cimmarron Gathering, LP (“Cimmarron”).The consideration for the sale was $1 million. The Company has begun leasingmineral rights adjacent to certain portions of these sold segments, inanticipation of a strategic working relationship with Cimmarron.

 

On May 5, 2006, the Company’s majority ownedsubsidiary, Earth Biofuels, signed a Letter of Intent to acquire a biodieselproduction facility from Systems Management Solutions, Inc. (“SMS”). TheSMS facility, located near San Antonio, Texas, currently supplies most of itsproduction of biodiesel to Earth Biofuels, and is in the process of expandingits production capacity. Earth Biofuels plans to sell the fuel produces by thisfacility, under the brand name “Bio Willie”, to local markets and other areasof Texas.

 

On May 12, 2006, Siam Imports, Inc. aNevada corporation (“Siam”) entered into a Securities Purchase Agreement (the “Agreement”)with the Company. Pursuant to the Agreement, Siam has purchased from theCompany all of the Company’s ownership in Apollo Drilling, LLC a Texas limitedliability company (“Apollo Drilling”), in consideration of the issuance to theCompany of 13,700,000 restricted shares of common stock of Siam, representing acontrolling interest in Siam. The assets of Apollo Drilling are comprised ofone fully operational drilling rig, two disassembled, partial drilling rigsthat require refurbishment, an inventory of drill pipe, and spare equipment,all of which is located in Oklahoma.

 

On April 27, 2006, Earth acquired approximatelyeight acres of land in Durant, Oklahoma in anticipation of the company’s plansto build an ethanol production facility. The land is immediately adjacent toEarth’s existing biodiesel production facility such that the two facilitieswill be able to share the rail access at the site. Earth has not yet acquiredthe equipment nor obtained the permits necessary for ethanol production at thesite.

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

**Overview**

 

The Company derives its revenue primarily frommonthly oil and natural gas production sales, rental fees related to its gaspipeline and sales of bio diesel fuel and LNG. During the first quarter of2005, the Company started its alternative fuels business segment designed to complementthe growing need for alternative energy sources versus the increasing demand oftraditional oil and natural gas energy sources. In December of 2005, theCompany added a oil and gas production company and businesses related theproduction and sale of LNG. The Company also focused on raising capital throughprivate placements of its common stock and securing collateralized debtfinancing essential to providing the capital to expand its business segments.

 

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*Critical Accounting Policies*

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the amountsreported in the accompanying financial statements and related footnotes.Management bases its estimates and assumptions on historical experience,observance of industry trends and various other sources of information andfactors. Actual results could differ from these estimates. Critical accountingpolicies are defined as those that are reflective of significant judgments anduncertainties, and potentially could result in materially different resultsunder different assumptions and conditions.

 

*Revenue Recognition*

 

Oil and natural gas production revenue is recognizedat the time and point of sale after the product has been extracted from theground. Revenue from pipeline rental fees for natural gas transmission is basedon volume of Mcf of natural gas metered monthly. Revenue from product sales ofbio diesel fuel and other sales related to service station operations are pointof sale transactions. The Company uses the sales method of accounting for LNGrevenues. Under this method, revenues are recognized based on actual volumes ofLNG sold to customers.

 

*Business Combinations*

 

Business combinations are accounted for using thepurchase method. Under the purchase method the Company reports the acquiredentities assets and liabilities at fair market value. Any excess of the fairmarket value of the consideration given over the fair market value of the netassets acquired is reported as goodwill. If the fair market value of theconsideration given is less than the fair market value of the net assetsacquired, the resulting excess of fair value of acquired net assets over thecost of the acquired entity is allocated, on a pro rata basis, against certainassets acquired in the business combination. If any excess over cost remainsafter reducing certain assets to zero, the remaining excess is recognized as anextraordinary gain. The operating statements of the Company for purchase methodcombinations report combined results only for the period subsequent to thecombination.

 

**RESULTS OF OPERATIONS FOR THE THREE MONTH PERIOD ENDED MARCH 31,2006 COMPARED TO THE THREE MONTH PERIOD ENDED MARCH 31, 2005**

 

*Revenue*

 

The Company recorded revenue of $9,459,223 in thefirst quarter of 2006 compared to revenue of $148,492 for the same period in 2005.The increase reflects the Company’s acquisition of its LNG businesses in December of2005, which contributed $6,731,008 of LNG sales for the first quarter of 2006.In addition, the Company’s bio diesel production and sales subsidiarycontributed $1,886,119 of revenue during the first quarter of 2006. The additionof Mountain States, an oil and gas production company, acquired in December of2005, contributed to increased oil and gas production revenue of $842,096compared to $148,492 of oil and gas production revenue in 2005.

 

# ***Gross Loss***

# ** **

Gross loss increased to $2,395,360in the first quarter of 2006 compared to a gross loss of $9,714 for the sameperiod in 2005. The increase in gross loss is attributable to losses at theCompany’s LNG and oil and gas production operations. LNG operations experiencedapproximately $1,055,892 of gross loss due to fixed priced customer contracts, costof LNG purchased on the open market to supplement LNG produced at the Company’sLNG plant, and transportation costs associated with delivery of purchased LNGto customers. Oil and gas operations recorded a gross loss of $1,458,331compared to $9,714 in 2005, primarily due to increased refurbishment costsrelated to bringing wells back online. The Company’s biodiesel operationsrecorded gross profit of $118,862 for the first quarter of 2006.

 

*Selling, General andAdministrative Expenses*

 

Selling,general and administrative expenses were $12,895,871 in the first quarter of2006 compared to $2,086,128 in the same period in 2005.

 

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The increase in selling, general and administrativeexpenses is attributable to $2.9 million of commission expense primarilyrelated to stock sales, $0.7 million of costs related to personnel salary andbenefits, $0.3 million of sales and marketing expenses primarily related to theCompany’s efforts to market its biodiesl products, and $0.3 million ofequipment rentals for the Company’s LNG operations. In addition the Companyincurred non cash expenditures related to the issuance of its common stock.These costs include approximately $1.4 million of cost related to professionalservices rendered on behalf of the Company, approximately $0.2 million of costrelated to the retirement of debt, acquiring assets and a legal settlement, and$0.4 million of expenses related to stock pledged as collateral for a loan to athird party, which was liquidated by the lender in satisfaction of theliability. The Company’s majority owned subsidiary Earth Biofuels incurredapproximately $4.6 million of non-cash consulting expense elated to theissuance of Earth Biofuels common stock during the first quarter of 2006.

 

Selling , general and administrative expenses were$2,086,128 for the three months ended March 31, 2004. These costs reflect$1,350,669 of non-cash stock compensation expense incurred through the issuanceof common stock in private placements and the issuance of stock to consultants.The Company also incurred non-cash expense for the issuance of common stockvalued at $173,400 as compensation to non-executive employees. The balance ofthe increase in operating expenses was primarily related to investor relations,travel, business insurance and professional fees for management, legal andaccounting services.

 

*Other income (expense), net*

 

Other income consisted primarily of $2,171,560 ofminority interest related to the net loss recorded by the Company’s majorityowned subsidiary Earth Biofuels, and $97,815 of gain related to a sale ofapproximately 33 miles of pipeline segments and related easements.

 

**Liquidity and Capital Resources**

 

Cash used in operating activities was $6,620,612 in the first quarter of 2006 compared to$281,365 in 2005. The increase is primarily related to the increase in net lossexperienced by the Company in the first quarter of 2006 and a decrease in accountspayable.

 

Net cash used in investing activities was $1,757,274in the first quarter of 2006 compared to cash provided by investing activitiesof $1,678 in 2005. This decrease reflects cash paid related to investments injoint ventures and the purchase of property plant and equipment.

 

Net cash provided by financing activities was $6,387,319in the first quarter of 2006 compared to $279,228 in 2005. This increasereflects increased proceeds from sales of common stock and notes payable. Thisincrease was partially offset by $1,584,726 of payments on outstanding debts

 

During the period ending March 31, 2006, theCompany recorded a net loss of $12,922,563. Since the Company completed itsinitial acquisition of BC&D on October 28, 2004, the Company has accumulatedlosses aggregating $47.9 million. The Company’s continued existence isdependent upon its ability to take advantage of acquisition opportunities,raise capital through private securities offerings, secure collateralized debtfinancing and use these sources of capital to grow and enhance its oil and gasproduction, gas pipeline transmission operations and its biodiesel and LNGsales and production. The following addresses the Company’s efforts regardingits recent acquisitions and financings.

 

*Acquisitions*

 

During the fourth quarter of fiscal 2004 the Companycompleted the acquisition of BC&D. The acquisition of BC&D marked theinitial entrance of the Company into the oil and natural gas productionbusiness. During the first quarter of fiscal 2005, the Company completed theacquisition of OGC. The OGC acquisition added a pipeline network to the Company’sassets enabling the Company to diversify into the oil and gas transmissionbusiness. In addition in December of 2005, the Company acquired another oiland gas production company Mountain States which added approximately 50 oil andgas wells to the Company’s operations. Also in December of 2005, theCompany acquired businesses specializing in LNG sales and production. TheCompany believes these acquisitions will be a major part of

 

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establishingfuture financial stability. The Mountain States and LNG company acquisitionshave produced revenue in excess on $20 million over the preceding two fiscalyears.

 

The Company has acquired an interest in EarthBiofuels. Earth Biofuels produces and distributed bio-diesel fuel. EarthBiofuels assets consist primarily of a biodiesel refinery and refuelingstation. In response to soaring fuel costs, and to avail itself of governmentsubsidies and tax incentives, the Company has pursued a strategy of developingrenewable forms of energy, such as bio diesel. Consequently, on February 25,2005 the Company acquired a 50% interest in Earth Biofuels, a Mississippi-basedcompany and on August 19, 2005, acquired an additional 30% ownershipinterest. On September 13, 2005, the Company executed a share exchangewith Meadows Springs, Inc. whereby the Company contributed its 80%interest in Earth Biofuels in exchange for 21,000,000 shares of the commonstock of Meadows Springs. As a consequence of the share exchange the Companymaintained a controlling interest in Meadows Springs of approximately 89% andEarth Biofuels remains an indirect subsidiary of the Company. As of May 18,2006, the Company owned 129,381,182 shares of common stock of Earth Biofuelsrepresenting a 62.39% majority ownership.

 

*Financing*

 

On July 7, 2005 the Company completed a $3.0million financing consisting of convertible notes with related warrants. TheCompany collateralized certain of its oil and gas assets and properties alongwith its pipeline assets to secure this funding. This financing enabled theCompany to pay in full the mortgage due on its pipeline assets and fund workingcapital.

 

On February 7, 2006, the Company finalizednegotiations to provide a $3.5 million line of credit for working capitalrelated to its oil and gas assets acquired in the BC&D acquisition. TheCompany plans to use this capital to restart production. The credit line issubject to a borrowing base and funds are pre approved and borrowed forproduction purposes only at the discretion of the lender. This facility bearsinterest at the prime rate + 3.0% and matures on February 1, 2007. At May 18,2006 the Company had borrowed $500,000 on this credit line.

 

On April 13, 2006, the Company completed an$8.0 million loan agreement to fund working capital for its LNG businesses.This facility consists of a three year $3.0 million revolver, collateralized bythe receivables of ALT, and a five year $5.0 million term loan collateralizedby the remaining assets of ALT and Arizona LNG, which consists primarily of anLNG plant. The facility bears interest at the greater of 7% or the prime rate +1.5%. At May 10, 2006 the Company had borrowed $4.0 million on the termloan and $1.1 million on the line of credit. The Company plans to use thisfacility to enhance its operations and provide working capital.

 

The Company has also continued to raise capitalthrough a variety of private securities offerings of its common stock.

 

Management is focusing on expanding and improvingits oil and natural gas production operations, leveraging its opportunitiesregarding its pipeline assets and continuing to develop its biodiesel and LNGproduction and sales through acquisition, organic growth and funding viacollateralized loans and private placement offerings, the Company plans tocontinue to increase the profitability of its operations necessary to supportoperations.

 

There can be no assurance that any of management’splans as described above will be successfully implemented or that the Companywill continue as a going concern.

 

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*The Company’s Liquidity Plan*

 

Recent operating results give rise to concerns aboutthe Company’s ability to generate cash flow from operations sufficient to makescheduled debt payments as they become due. The Company has completed threerecent financings to help fund its working capital needs. On July 7, 2005the Company completed a $3.0 million financing. This financing allowed theCompany to secure full payment of its pipeline assets and infuse capital intoits oil and gas subsidiary BC&D as well as continue funding its biodieseljoint venture. On February 7, 2006 the Company executed a $3.5 millionline of credit for its oil and gas operations related to its BC&Dsubsidiary. On April 13, 2006 the Company completed an $8.0 millionfinancing facility for its LNG operations, As of December 31, 2005, theCompany continued to seek other financing from private placements and otheracquisitions to expand its opportunities in the areas of oil and gasproduction, oil and gas transmission and biodiesel and LNG businesses. TheCompany has implemented cost saving measures, primarily in its oil and gasoperations, by implementing cost controls designed to reduce unnecessaryexpenditures and operate production activities within the current economicconstraints with which the Company currently operates. The Company will takeadditional cost savings measures, if necessary, to enhance its liquidityposition.

 

The Company’s need to raise additional equity ordebt financing and the Company’s ability to generate cash flow from operationssufficient to make scheduled payments on its debts as they become due willdepend on its future performance and the Company’s ability to successfullyraise capital and implement business and growth strategies. The Company’sperformance will also be affected by prevailing economic conditions. Many ofthese factors are beyond the Company’s control. If future cash flows andcapital resources are insufficient to meet the Company’s debt obligations andcommitments, the Company may be forced to reduce or delay activities andcapital expenditures, obtain additional equity capital or restructure orrefinance its debt. In the event that the Company is unable to do so, theCompany may be left without sufficient liquidity and it may not beable to meet its debt service requirements. In such a case, this could resultin a substantial portion of the Company’s indebtedness becoming immediately dueand payable. As a result, the Company may not be able to continueoperations due to liens, collateralized notes or other secured positions placedon the Company’s assets.

 

*Off-Balance Sheet Arrangements*

 

# **At March 31, 2006 the Company had no obligationsthat would qualify to be disclosed as off-balance sheet arrangements.**

# ** **

RiskFactors

 

TheCompany’s revenue and operating results may fluctuate significantly fromquarter to quarter, and fluctuations in operating results could cause its stockprice to decline.

 

The Company’s revenue andoperating results may vary significantly from quarter-to-quarter due to anumber of factors. In future quarters, operating results may be below theexpectations of public market analysis or investors, and the price of itscommon stock may decline. Factors that could cause quarterly fluctuationsinclude:

 

•                                          the ability to secure new significantcontracts during a quarter; and

 

•                                          the ability to raise the necessary capital tofund working capital, execute mergers, acquisitions and asset purchases.

 

The market in which the Company competes isintensely competitive and actions by competitors could render its services lesscompetitive, causing revenue and income to decline.

 

The ability to compete depends on a number offactors outside of the Company’s control, including:

 

•                                          the prices at which others offer competitiveservices, including aggressive price competition and discounting;

 

•                                          the ability of competitors to undertake moreextensive marketing campaigns;

 

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•                                          the extent, if any, to which competitorsdevelop proprietary tools that improve their ability to compete; and

 

•                                          the extent of competitors’ responsiveness tocustomer needs.

 

The Company may not be able to competeeffectively on these or other factors. If the Company is unable to competeeffectively, market position, and therefore revenue and profitability, woulddecline.

 

TheCompany must continually enhance its services to meet the changing needs of itscustomers or face the possibility of losing future business to competitors.

 

Future success will depend upon the Company’sability to enhance existing services and to introduce new services to meet therequirements of customers in a rapidly developing and evolving market. Presentor future services may not satisfy the needs of the market. If the Companyis unable to anticipate or respond adequately to its customers’ needs, lostbusiness may result and financial performance will suffer.

 

TheCompany is dependent on a limited number of key personnel, and the loss ofthese individuals could harm its competitive position and financialperformance.

 

The Company’s business consists primarily of thedelivery of oil and natural gas and, accordingly, its success depends upon theefforts, abilities, business generation capabilities and project execution ofits executive officers. The Company’s success is also dependent upon themanagerial, operational and administrative skills of its executive officers.The loss of any executive officer could result in a loss of customers orrevenue, and could therefore harm the Company’s financial performance.

 

TheCompany’s ability to secure debt and equity financing could have an adverseeffect on the Company’s financial health.

 

The inability to raise debt to fund working capitalmay:

 

•                                          require the Company to dedicate a substantialportion of its cash flows to pay down debt;

 

•                                          increase the Company’s vulnerability togeneral adverse economic and industry conditions;

 

•                                          limit the Company’s ability to fund futureworking capital and other general corporate requirements; and

 

•                                          limit the Company’s flexibility in planningfor, or reacting to, changes in the Company’s business and the industry inwhich it operates.

 

The ability to make payments on and to refinance theCompany’s debt will depend on financial and operating performance, which may fluctuatesignificantly from quarter to quarter and is subject to prevailing economicconditions and to financial, business and other factors beyond the Company’scontrol.

 

There can be no assurance that the Company’sbusiness will generate sufficient cash flow from operations or that futureborrowings will be available to it in an amount sufficient to enable it to paydebt or to fund other liquidity needs. The Company may need to refinanceall or a portion of its debt on or before maturity. The Company can give noassurance that it will be able to refinance any of its debt on commerciallyreasonable terms or at all.

 

“SafeHarbor” Statement Under The Private Securities Litigation Reform Act:

 

With the exception of historical information, thematters discussed in this report are “forward looking statements” as that termis defined in Section 21E of the Securities Exchange Act of 1934.

 

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Cautionaryand Forward Looking Statements

 

In addition to statements of historical fact, this Form 10-QSBcontains forward-looking statements. The presentation of future aspects of theCompany found in these statements is subject to a number of risks anduncertainties that could cause actual results to differ materially from thosereflected in such statements. Readers are cautioned not to place undue relianceon these forward-looking statements, which reflect management’s analysis onlyas of the date hereof. Without limiting the generality of the foregoing wordssuch as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” or “could”or the negative variations thereof or comparable terminology are intended toidentify forward-looking statements.

 

These forward-looking statements are subject tonumerous assumptions, risks and uncertainties that may cause the Company’sactual results to be materially different from any future results expressed orimplied by the Company in those statements.

 

Some of these risks might include, but are notlimited to, the following:

 

(a)                                 volatility or decline of the Company’s stockprice;

 

(b)                                 potential fluctuation in quarterly results;

 

(c)                                  failure of the Company to earn revenues orprofits;

 

(d)                                 inadequate capital to continue or expand itsbusiness, inability to raise additional capital or financing to implement itsbusiness plans;

 

(e)                                  failure to commercialize its technology or tomake sales;

 

(f)                                   rapid and significant changes in markets;

 

(g)                                  litigation with or legal claims andallegations by outside parties; and

 

(h)                                 insufficient revenues to cover operatingcosts.

 

Thereis no assurance that the Company will be profitable, the Company may notbe able to successfully develop, manage or market its products and services,the Company may not be able to attract or retain qualified executives andtechnology personnel, the Company’s products and services may becomeobsolete, government regulation may hinder the Company’s business, and additionaldilution in outstanding stock ownership may be incurred due to theissuance of more shares, warrants and stock options, or the exercise ofwarrants and stock options, and there exist other risks inherent in the Company’sbusinesses.

 

TheCompany undertakes no obligation to publicly revise these forward-lookingstatements to reflect events or circumstances that arise after the date hereof.Readers should carefully review the factors described in other documents theCompany files from time to time with the Securities and Exchange Commission,including the Quarterly Reports on Form 10-QSB and Annual Report on Form 10-KSBfiled by the Company and any Current Reports on Form 8-K filed by theCompany.

 

**Controls and Procedures**

 

Based on the evaluation of the Company’s disclosurecontrols and procedures as of the end of the period covered by this quarterlyreport, Dennis G. McLaughlin, the President and Chief Executive Officer and J.Mark Ariail, Chief Financial Officer, have concluded that, in their judgment,the Company’s disclosure controls and procedures are effective to ensure thatinformation required to be disclosed by the Company, including the Company’ssubsidiaries, in the reports it files, or submits under the Securities ExchangeAct of 1934, as amended, is recorded, processed, summarized, and reportedwithin the time periods specified in the Securities and Exchange Commission’s rules andforms. Management necessarily applied its judgment in assessing the costs andbenefits of such controls and procedures. The Company’s disclosure controls andprocedures are designed to provide reasonable assurance of achieving theirobjectives. The Company’s executive officers, listed above, have concluded thatthe Company’s disclosure controls and procedures are effective at thatreasonable assurance level. There were no changes in the Company’s internalcontrols over financial reporting during the Company’s last fiscal quarter thathave materially affected, or are reasonably likely to materially affect, theCompany’s internal controls over financial reporting.

 

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**PART II – OTHER INFORMATION**

 

**Item 1.****        ****Legal Proceedings**

 

On March 7, 2005, the Company received noticethat it has been named as a defendant, among others, by plaintiffs Donnie Hill,a former employee of the Company, and BC&D Operating Co., Inc. Case No. CV-2005-128in the Fifth Judicial District Court, State of New Mexico, for the County ofLea. The plaintiffs allege breach of contract related to certain stock purchaseagreements with the preceding owner of BC&D, breach of contract related to Mr. Hill’semployment agreement with the preceding owner of BC&D, breach of covenantof good faith and fair dealing, negligent misrepresentation, fraudulentmisrepresentation, violation of the New Mexico Securities Act by the precedingowner of BC&D, civil conspiracy, calling for the appointment of a receiverfor the assets and business affairs of BC&D, constructive trust,declaratory judgment related to the Company election as successor operators andlastly punitive damages related to the above allegations. These allegationsstem from the Company’s execution of a share exchange agreement with TKM,whereby the Company gained control of 100% of the assets of BC&D.

 

On August 31, 2005, the parties agreed tosettle the case. Under the terms of the settlement the Company will pay to theplaintiffs a) $125,000 in cash, with which the Company has complied; (b) paymentin the form of the Company’s common stock totaling $300,000, payable over6 months; of which the Company has made payments totaling $152,473; (c) 260,000shares of the Company’s common stock; and (d) the issuance of common stockwith a value of $63,000 dated August 31, 2005, with which the Company hascomplied.

 

On March 16, 2006, the parties agreed to settleoutstanding amounts due in items (b) and (c) above by payment of$167,720 on or before June 1, 2006 in reference to item (b) andpayment of $146,250 on or before August 1, 2006 in reference to item (c).

 

The Company has become subject to various claims andother legal matters in the course of conducting its business. The Companybelieves that neither such claims and legal matters nor the cost of prosecutingand/or defending such claims and legal matters will have a material adverseeffect on the Company’s results of operations, financial condition or cashflows. No material claims are currently pending; however, no assurances can begiven that future claims, if any, may not be material.

 

**Item 2.****        ****Change in Securities and Use ofProceeds**

 

During the first quarter ended March 31, 2006,the Company issued 10,116,773 shares of its common stock, via private placement.The common stock was sold at prices ranging from $0.25 to $0.52 per share toaccredited investors. The aggregate purchase price was $4,382,376 cash, less$2,353,231 in commissions.

 

**Item 3.****        ****Defaults upon Senior Securities** – None

 

**Item 4.****        ****Submission of Matters to a Voteof Security Holders**– None

 

**Item 5.****        ****Other Information** – None

 

**Item 6.****        ****Exhibits and Reports on Form 8-K**

 

Reportson Form 8-K.

 
| **Date of Filing** | ** ** | **Subject**                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| January 20, 2006        |       | Announcement of the rescinding of the  contract with JSC Kaliningradneft.                                                                                                                                                                                                                                                                                                                                                                                                   |
| February 23, 2006       |       | Amendment to execution of Transfer And  Exchange Agreement to acquire 100% of the membership units of Applied LNG  Technologies USA, LLC. Execution of Stock Purchase Agreement to acquire 100%  of the outstanding stock of TxHLDM, Inc. and the membership units of  Arizoa LNG, L.L.C. Execution of a Stock Purchase Agreement to acquire all of  the outstanding common stock of Mountain States Petroleum, Corporation to  reflect audited financial information. |

 

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| **Exhibits.**     | ** ** | ** **                                                                                                                                                     |
|-------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 31.1 |       | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under  the Securities Act on 1934.                                               |
| Exhibit 31.2 |       | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under  the Securities Act on 1934.                                               |
| Exhibit 32.1 |       | Certification of Chief Executive Officer pursuant to 18 U.S.C., Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| Exhibit 32.2 |       | Certification of Chief Financial Officer pursuant to 18 U.S.C., Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURES**

 

Pursuantto the requirement of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized this 22nd day of May,  2006.

 
|   | Apollo Resources International, Inc. |
|--------|-------------------------------------------|
|   |                                      |
|   | /s/ Dennis G. McLaughlin, III        |   |
|   | Dennis G. McLaughlin, III            |
|   | Chief Executive Officer                   |

 

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