**UNITED STATES**SECURITIES ANDEXCHANGE COMMISSIONWashington, D.C. 20549

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**Form 10-QSB**

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**þ**** QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

**For theQuarterly Period Ended September 30, 2006**

**or**

**o**** TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

Commission File Number000-25873

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**Apollo Resources International, Inc.******(Exact name of registrant as specified in its charter)

| **Utah**                                                        |   | **84-1431425**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

**3001 Knox Street, Suite 403Dallas, 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 by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes þ   No o

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

Asof November 14, 2006 there were 204,629,840 shares of the registrant’s commonstock outstanding.

 

 

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**EXPLANATORYNOTE**

*For the Three and NineMonth Periods Ended September 30, 2005*

Apollo Resources International,Inc. (the “Company”) hereby amends Part I, Items 1, 2 and 3 of its quarterlyreport on Form 10-QSB for the three and nine month periods ended September 30,2005. These amendments address the Company’s adoption of statement of FinancialAccounting Standards No. 143, “Accounting for Asset Retirement Obligations”(SFAS No. 143), the recording of the acquisitions of BC&D Oil and GasCorporation (“BC&D”) and OGC Pipeline, LLC (“OGC”) at historical cost, thereclassification of direct expenses related to offering costs associated withthe Company’s Regulation S common stock offering, the reversal of expensesrecorded in relation to the Company’s private placement memorandum, therecording of warrants, and the rescinding of its stock sale agreement with JSCKaliningradneft executed on March 22, 2005.

Uponadoption of SFAS No. 143, the Company has restated its financial statements toreflect the inclusion of asset retirement obligations of approximately $1.1million.  The Company incurred anadditional net loss of $19,093 and $57,279 related to depreciation expense onthe asset and $10,083 and $30,249 related to accretion of discount pertainingto the liability for the three and nine months ended September 30, 2005.

TheCompany has amended its September 30, 2005 financial statements to reflect theacquisition of BC&D in October of 2004 and the acquisition of OGC inFebruary of 2005 using the carryover basis of accounting under the guidance inStatement of Financial Accounting Standards No. 141. Therefore, the property,plant and equipment originally recorded at fair market value has been amendedto reflect a reduction of assets of approximately $6.3 million related to theBC&D assets and approximately $5.8 million related to the OGC assets with acorresponding reduction of additional paid-in capital.

Inaddition, we have made an amendment to our September 30, 2005 financialstatements related to certain offering costs associated with our offering ofcommon stock to foreign investors under Regulation S. These offering costsrelate to brokerage fees associated with each individual sale which wereinitially recorded as selling, general and administrative expenses. Per theguidance of generally accepted accounting principles, the Company hasreclassified approximately $0.8 million and $2.7 million from selling, generaland administrative expense to additional paid-in capital for the three and ninemonths ended September 30, 2005.

TheCompany has also amended its September 30, 2005 financial statements toreclassify expenses related to the sale of the Company’s common stock throughits private placement memorandum. Originally the Company had recorded anexpense for the difference between the market price per share on the date ofthe sale and the discounted price at which the stock was sold.  The majority of the Company’s common stockwas sold at a discount to market value based on the terms of the Company’sprivate placement memorandum. The Company took into consideration theaccounting treatment of other companies with like transactions and hasdetermined that the discounted price was representative of the market pricewhen taking into consideration the restrictive nature of the common stock beingsold. Therefore, the Company has reclassified approximately $0.7 million and$2.3 million from selling, general and administrative expense to additionalpaid-in capital for the three and nine months ended September 30, 2005.

TheCompany amended its September 30, 2005 financial statements for the fair valueof warrants issued with convertible debt. The initial fair value of $2.1 million has been reclassified fromadditional paid-in capital to a liability account.  At September 30, 2005 the warrants had a fairvalue of $1.5 million.  The Companyrecorded a gain of $0.6 million related to the adjustment of the warrants tofair value.

Pleasesee footnote 1 to the Company’s consolidated financial statements for adetailed discussion of its decision to rescind its stock sale transaction withJSC Kaliningradneft.

2

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 The following table illustrates the change tothe Company’s consolidated financial statements for the three and nine monthperiods ended September 30, 2005 related to the notes above.

|                                          | ** ** | ** **           | ** **  | **Previously** | ** ** |
|------------------------------------------|------------|----------------------|-------------|----------------|------------|
| ** **                               | ** ** | **As Restated** | ** **  | **Reported**   | ** ** |
| Property and  equipment, net             |       | $                    | 5,331,289   |           | $          | 16,420,079 |   |
| Total assets                             |       | $                    | 11,372,675  |           | $          | 22,694,441 |   |
| Asset retirement  obligations-short term |       | $                    | 41,386      |           | $          | — |   |
| Asset retirement  obligations            |       | $                    | 1,141,135   |           | $          | — |   |
| Derivative  liabilities                  |       | $                    | 1,500,000   |           | $          | — |   |
| Additional paid  in capital              |       | $                    | 26,503,975  |           | $          | 45,663,972 |   |
| Accumulated  deficit                     |       | $                    | (13,119,578 | )              | $          | (18,339,527 | ) |
| Total stockholders’  equity         |       | $                    | 3,011,387   |           | $          | 16,951,435 |   |

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **September 30, 2005** | ** ** | **September 30, 2005** | ** ** |
| ** **                           | ** ** | ** **                       | ** ** | **Previously**                   | ** ** | ** ** | ** ** | **Previously** | ** ** |
| ** **                           | ** ** | **As Restated**             | ** ** | **Reported**                     | ** ** | **As Restated** | ** ** | **Reported** | ** ** |
| Selling, general  and administrative |       | $                                | 8,813,088  |                             | $          | 10,504,361 |   | $ | 13,336,102 |   | $ | 18,419,179 |   |
| Gain on derivatives                  |       | $                                | 627,907    |                             | $          | — |   | $ | 627,907 |   | $ | — |   |
| Net loss                             |       | $                                | (8,990,367 | )                                | $          | (10,838,391 | ) | $ | (11,489,518 | ) | $ | (16,729,346 | ) |

 

*For December 31, 2005 and the year then ended*

The restatements noted above also impacted the December 31, 2005financial statements.  As a result, theCompany hereby amends Part II, Item 7 of its annual report filed on form 10-KSBfor the year ended December 31, 2005.  Asummary of the impact of the items noted above on the December 31, 2005financial statements follows:

|                                  | ** ** | ** **           | ** **  | **Previously** | ** ** |
|----------------------------------|------------|----------------------|-------------|----------------|------------|
| ** **                       | ** ** | **As Restated** | ** **  | **Reported**   | ** ** |
| Property and  equipment, net     |       | $                    | 25,423,982  |           | $          | 24,612,083 |   |
| Total assets                     |       | $                    | 71,839,817  |           | $          | 71,049,615 |   |
| Derivative liabilities           |       | $                    | 837,209     |           | $          | — |   |
| Additional paid  in capital      |       | $                    | 56,636,831  |           | $          | 63,350,615 |   |
| Accumulated deficit              |       | $                    | (28,321,460 | )              | $          | (34,973,382 | ) |
| Total stockholders’  equity |       | $                    | 44,150,403  |           | $          | 44,197,410 |   |

 

|                                      | ** ** | **Year Ended**             | ** **  |
|--------------------------------------|------------|---------------------------------|-------------|
| ** **                           | ** ** | **December 31, 2005** | ** **  |
| ** **                           | ** ** | ** **                      | ** **  | **Previously** | ** ** |
| ** **                           | ** ** | **As Restated**            | ** **  | **Reported** | ** ** |
| Selling, general  and administrative |       | $                               | 27,508,659  |   | $ | 32,883,002 |   |
| Gain on derivatives                  |       | $                               | 1,290,698   |   | $ | — |   |
| Net loss                             |       | $                               | (26,691,400 | ) | $ | (33,343,789 | ) |

 

The significant changes in the Company’s amendment aredescribed in the following paragraphs.

Theportion of the amendment to our December 31, 2005 financial statements relatingto certain offering costs associated with our offering of common stock toforeign investors under Regulation S amounted to $2.9 million.  This amount was reclassified from selling,general and administrative expense to additional paid-in capital.

Thereclassification of expenses from selling, general and administrative expenseto additional paid-in capital related to the sale of the Company’s common stockthrough its private placement memorandum amounted to $2.4 million for the yearended December 31, 2005.

Thewarrant liability of $2.1 million transferred from additional paid-in capitalin the amendment of the financial statements as of September 30, 2005 wasadjusted to market at December 31, 2005. This adjustment was a reduction of the liability in the amount of $1.3million along with a corresponding gain on derivatives.

 

3

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| **PART I FINANCIAL INFORMATION** |
|----------------------------------|
| ** **                       | ** ** | ** ** |
| Item 1.                          |   | Financial Statements |
|                             |   |   |
|                             |   | Interim  Consolidated Balance Sheets at September 30, 2006 (unaudited) and  December 31, 2005 |
|                             |   |   |
|                             |   | Interim Consolidated Statements of Operations for the  Three and Nine Months Ended September 30, 2006 and 2005  (unaudited) |
|                             |   |   |
|                             |   | Interim Consolidated Statements of Cash Flows for the  Nine Months Ended September 30, 2006 and 2005 (unaudited) |
|                             |   |   |
|                             |   | Notes to  Consolidated Financial Statements (unaudited) |
|                             |   |   |
| Item 2.                          |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |
|                             |   |   |
| Item 3.                          |   | Controls and Procedures |
|                             |   |   |
| **PART II OTHER INFORMATION**    |
| ** **                       | ** ** | ** ** |
| Item  1.                         |   | Legal  Proceedings |
|                             |   |   |
| Item 2.                          |   | Unregistered Sales of Equity Securities and Use of  Proceeds |
|                             |   |   |
| Item 3.                          |   | Defaults upon Senior Securities |
|                             |   |   |
| Item 4.                          |   | Submission of Matters to a Vote of Security Holders |
|                             |   |   |
| Item  5.                         |   | Other  Information |
|                             |   |   |
| Item 6.                          |   | Exhibits |
|                             |   |   |
| Signatures                       |

 

4

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**APOLLO RESOURCES INTERNATIONAL, INC.**

**CONSOLIDATEDBALANCE SHEETS**
| ** **                                                                                                                                                                           | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **2006**               | ** **  | **2005**              | ** ** |
| ** **                                                                                                                                                                           | ** ** | ** **             | ** **  | **Restated**          | ** ** |
| **ASSETS**                                                                                                                                                                           |       |                   |        |                  |       |
| Current Assets:                                                                                                                                                                      |       |                   |        |                  |       |
| Cash and cash  equivalents                                                                                                                                                           |       | $                      | 1,002,359   |                  | $          | 2,400,457 |   |
| Trade accounts  receivable, net of $164,667 and $0 allowances at September 30, 2006 and  December 31, 2005, respectively                                                             |       | 5,157,817              |        | 3,646,097             |       |
| Accounts  receivable other                                                                                                                                                           |       | 33,614                 |        | 626,273               |       |
| Accounts  receivable working interest owners                                                                                                                                         |       | 419,947                |        | 183,559               |       |
| Prepaid expenses  and current deposits                                                                                                                                               |       | 22,889,792             |        | 2,325,083             |       |
| Marketable  securities                                                                                                                                                               |       | 894,069                |        | —                |       |
| Inventory                                                                                                                                                                            |       | 1,190,072              |        | 685,660               |       |
| Notes receivable                                                                                                                                                                     |       | 3,764,171              |        | —                |       |
| Other current  assets                                                                                                                                                                |       | 422,285                |        | 718,937               |       |
| Total Current  Assets                                                                                                                                                                |       | 35,774,126             |        | 10,586,066            |       |
| Property and equipment,  net                                                                                                                                                         |       | 44,607,335             |        | 25,423,982            |       |
| Goodwill                                                                                                                                                                             |       | 31,035,021             |        | 30,601,554            |       |
| Deposits                                                                                                                                                                             |       | 3,360,000              |        | 3,360,000             |       |
| Investment in joint  ventures                                                                                                                                                        |       | 42,856,395             |        | 230,000               |       |
| Deferred financing  costs                                                                                                                                                            |       | 2,588,703              |        | —                |       |
| Other assets                                                                                                                                                                         |       | 835,204                |        | 1,638,215             |       |
| ** **                                                                                                                                                                           |       | $                      | 161,056,784 |                  | $          | 71,839,817 |   |
| ** **                                                                                                                                                                           |       |                   |        |                  |       |
| **LIABILITIES  AND STOCKHOLDERS' EQUITY**                                                                                                                                            |       |                   |        |                  |       |
| Current Liabilities:                                                                                                                                                                 |       |                   |        |                  |       |
| Accounts payable  and accrued liabilities                                                                                                                                            |       | $                      | 9,606,924   |                  | $          | 6,495,562 |   |
| Shares payable—acquisition                                                                                                                                                      |       | —                 |        | 4,210,248             |       |
| Royalty payable                                                                                                                                                                      |       | 826,200                |        | 772,350               |       |
| Payables to  related parties                                                                                                                                                         |       | 510,429                |        | 503,056               |       |
| Leases payable                                                                                                                                                                       |       | —                 |        | 346,071               |       |
| Notes  payable—short-term                                                                                                                                                       |       | 8,039,572              |        | 2,428,952             |       |
| Derivative  liabilities                                                                                                                                                              |       | 5,465,104              |        | 837,209               |       |
| Asset retirement  obligations—short-term                                                                                                                                        |       | 58,100                 |        | 58,512                |       |
| Other current  liabilities                                                                                                                                                           |       | 72,242                 |        | —                |       |
| Total Current  Liabilities                                                                                                                                                           |       | 24,578,571             |        | 15,651,960            |       |
| Notes payable                                                                                                                                                                        |       | 28,344,443             |        | 10,267,618            |       |
| Asset retirement  obligations                                                                                                                                                        |       | 1,657,571              |        | 1,613,275             |       |
| Other long-term  liabilities                                                                                                                                                         |       | —                 |        | 156,561               |       |
| Total  Liabilities                                                                                                                                                                   |       | 54,580,585             |        | 27,689,414            |       |
|                                                                                                                                                                                 |       |                   |        |                  |       |
| Minority  interest                                                                                                                                                                   |       | 28,764,544             |        | —                |       |
|                                                                                                                                                                                 |       |                   |        |                  |       |
| Stockholders' Equity:                                                                                                                                                                |       |                   |        |                  |       |
| Preferred stock  Series A, $1.00 par; 8.5% cumulative non-voting convertible; 12,500,000  shares authorized and outstanding at June 30, 2006                                         |       | 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 June 30, 2006                                         |       | 12,500,000             |        | 12,500,000            |       |
| Common stock,  $.001 par value; 500,000,000 shares authorized; 202,931,911 and 154,450,740  shares issued and outstanding at September 30, 2006 and December 31, 2005,  respectively |       | 202,932                |        | 154,451               |       |
| Additional paid-in  capital                                                                                                                                                          |       | 150,397,961            |        | 56,636,831            |       |
| Accumulated  other comprehensive income                                                                                                                                              |       | 350,146                |        | —                |       |
| Accumulated  deficit                                                                                                                                                                 |       | (91,756,697            | )           | (28,321,460           | )          |
| Common stock  issued for future services                                                                                                                                             |       | (6,482,687             | )           | (9,319,419            | )          |
| Total  Stockholders' Equity                                                                                                                                                          |       | 77,711,655             |        | 44,150,403            |       |
|                                                                                                                                                                                 |       | $                      | 161,056,784 |                  | $          | 71,839,817 |   |

 

See accompanying notes to consolidated financialstatements.

5

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**APOLLO RESOURCESINTERNATIONAL, INC.CONSOLIDATED STATEMENTS OF OPERATIONS**
| ** **                                    | ** ** | **Three Months Ended September 30,** | ** **  | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|-------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                                 | ** **  | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                    | ** ** | ** **                                               | ** **  | **Restated**                                            | ** ** | ** ** | ** ** | **Restated** | ** ** |
|                                          |       |                                                     |        |                                                    |       |   |   |   |   |
| Revenue                                       |       | $                                                        | 18,161,494  |                                                    | $          | 89,983 |   | $ | 37,728,323 |   | $ | 280,341 |   |
| Cost of sales                                 |       | 19,308,521                                               |        | 332,910                                                 |       | 41,059,138 |   | 585,842 |   |
| Gross profit (loss)                           |       | (1,147,027                                               | )           | (242,927                                                | )          | (3,330,815 | ) | (305,501 | ) |
| Selling, general  and administrative          |       | 19,739,001                                               |        | 8,813,088                                               |       | 45,036,242 |   | 13,336,102 |   |
| Operating loss                                |       | (20,886,028                                              | )           | (9,056,015                                              | )          | (48,367,057 | ) | (13,641,603 | ) |
|                                          |       |                                                     |        |                                                    |       |   |   |   |   |
| Other income  (expense), net:                 |       |                                                     |        |                                                    |       |   |   |   |   |
| Interest expense                              |       | (7,999,704                                               | )           | (453,355                                                | )          | (11,867,513 | ) | (625,178 | ) |
| Financing expense                             |       | (6,299,342                                               | )           | —                                                  |       | (9,611,342 | ) | — |   |
| Gain on derivatives                           |       | 26,601,957                                               |        | 627,907                                                 |       | 27,288,071 |   | 627,907 |   |
| Gain on sale of assets                        |       | 1,004,727                                                |        | —                                                  |       | 1,692,569 |   | — |   |
| Loss on marketable equity securities          |       | (892,070                                                 | )           | —                                                  |       | (398,989 | ) | — |   |
| Minority interest                             |       | (28,543,004                                              | )           | —                                                  |       | (22,282,615 | ) | — |   |
| Other, net                                    |       | 20,163                                                   |        | (108,904                                                | )          | 111,639 |   | (33,330 | ) |
| Loss from  operations before income tax       |       | (36,993,301                                              | )           | (8,990,367                                              | )          | (63,435,237 | ) | (13,672,204 | ) |
| Income tax                                    |       | —                                                   |        | —                                                  |       | — |   | — |   |
| Loss before  extraordinary item               |       | (36,993,301                                              | )           | (8,990,367                                              | )          | (63,435,237 | ) | (13,672,204 | ) |
|                                          |       |                                                     |        |                                                    |       |   |   |   |   |
| Extraordinary  item:                          |       |                                                     |        |                                                    |       |   |   |   |   |
| Gain on extinguishment of debt, net of tax    |       | —                                                   |        | —                                                  |       | — |   | 2,182,686 |   |
| Net loss                                      |       | $                                                        | (36,993,301 | )                                                       | $          | (8,990,367 | ) | $ | (63,435,237 | ) | $ | (11,489,518 | ) |
|                                          |       |                                                     |        |                                                    |       |   |   |   |   |
| Basic and  diluted earnings (loss) per share: |       |                                                     |        |                                                    |       |   |   |   |   |
| Loss before extraordinary item                |       | $                                                        | (.19        | )                                                       | $          | (.11 | ) | $ | (.36 | ) | $ | (.25 | ) |
| Extraordinary item                            |       | —                                                   |        | —                                                  |       | — |   | .04 |   |
| Net loss                                      |       | $                                                        | (.19        | )                                                       | $          | (.11 | ) | $ | (.36 | ) | $ | (.21 | ) |
|                                          | ** ** | ** **                                               | ** **  | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted average  shares:                     |       |                                                     |        |                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic and  diluted                            |       | 198,001,096                                              |        | 81,056,761                                              |       | 178,217,458 |   | 54,926,122 |   |

 

See accompanying notes to consolidated financialstatements.

 

6

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**APOLLO RESOURCESINTERNATIONAL, INC.CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**
| ** **                                                           | ** ** | **Common  Shares** | ** ** | **Preferred  Stock  Series A  and B** | ** ** | **Common  Stock** | ** ** | **Additional  Paid In  Capital** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** **  | **Accumulated  Deficit** | ** ** | **Common  Stock  Issued for  Future  Services** | ** ** | **Totals**  | ** **  |
|----------------------------------------------------------------------|------------|--------------------|------------|-------------------------------------------------|------------|-------------------|------------|---------------------------------------|------------|-----------------------------------------------|-------------|--------------------------|------------|------------------------------------------------------|------------|-------------|-------------|
| ** **                                                           |       |               |       |                                            |       |              |       |                                  |       |                                          |        |                     |       |                                                 |       |        |        |
| **Balance December 31,  2005—Restated**                         |       | 154,450,740        |       | $                                               | 25,000,000 |              | $          | 154,451                               |       | $                                             | 56,636,831  |                     | $          | ——                                         |       | $           | (28,321,460 | ) | $ | (9,319,419 | ) | $ | 44,150,403 |   |
|                                                                 |       |               |       |                                            |       |              |       |                                  |       |                                          |        |                     |       |                                                 |       |        |        |
| Common stock issued in  private equity sales                         |       | 38,022,689         |       | —                                          |       | 38,022            |       | 9,613,006                             |       | —                                        |        | —                   |       | —                                               |       | 9,651,028   |        |
| Common stock issued for  services                                    |       | 2,572,761          |       | —                                          |       | 2,573             |       | 1,154,155                             |       | —                                        |        | —                   |       | 2,836,732                                            |       | 3,993,460   |        |
| Common stock issued from  exercise of warrant                        |       | 273,910            |       | —                                          |       | 274               |       | 99,722                                |       | —                                        |        | —                   |       | —                                               |       | 99,996      |        |
| Common stock issued to  retire debt                                  |       | 7,275,789          |       | —                                          |       | 7,276             |       | 1,901,909                             |       | —                                        |        | —                   |       | —                                               |       | 1,909,185   |        |
| Common stock issued for  employee compensation, net of cancellations |       | 102,222            |       | —                                          |       | 102               |       | 38,698                                |       | —                                        |        | —                   |       | —                                               |       | 38,800      |        |
| Common stock issued in  litigation settlement                        |       | 120,000            |       | —                                          |       | 120               |       | 50,280                                |       | —                                        |        | —                   |       | —                                               |       | 50,400      |        |
| Common stock issued to  acquire assets                               |       | 213,800            |       | —                                          |       | 214               |       | 113,091                               |       | —                                        |        | —                   |       | —                                               |       | 113,305     |        |
| Common stock issued for  investment in joint venture                 |       | 250,000            |       | —                                          |       | 250               |       | 124,750                               |       | —                                        |        | —                   |       | —                                               |       | 125,000     |        |
| Common stock cancelled  for collateral, net of issuances             |       | (350,000           | )          | —                                          |       | (350              | )          | (59,150                               | )          | —                                        |        | —                   |       | —                                               |       | (59,500     | )           |
| Adjustment related to  acquisition                                   |       | —             |       | —                                          |       | —            |       | (52,359                               | )          | —                                        |        | —                   |       | —                                               |       | (52,359     | )           |
| Unrealized gain on  marketable securities                            |       | —             |       | —                                          |       | —            |       | —                                |       | 350,146                                       |        | —                   |       | —                                               |       | 350,146     |        |
| Capital from minority  shareholders                                  |       | —             |       | —                                          |       | —            |       | 80,777,028                            |       | —                                        |        | —                   |       | —                                               |       | 80,777,028  |        |
| Net and comprehensive  loss                                          |       | —             |       | —                                          |       | —            |       | —                                |       |                                          |        | (63,435,237              | )          | —                                               |       | (63,435,237 | )           |
| **Balance September 30, 2006**                                       |       | 202,931,911        |       | $                                               | 25,000,000 |              | $          | 202,932                               |       | $                                             | 150,397,961 |                     | $          | 350,146                                              |       | $           | (91,756,697 | ) | $ | (6,482,687 | ) | $ | 77,711,655 |   |

 

See accompanying notes toconsolidated financial statements.

 

7

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**APOLLO RESOURCESINTERNATIONAL, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                                                                                   | ** ** | **Nine Months Ended September 30,** | ** **  |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|-------------|
| ** **                                                                                                                                   | ** ** | **2006**                                                | ** **  | **2005** | ** ** |
| ** **                                                                                                                                   | ** ** | ** **                                              | ** **  | **Restated** | ** ** |
| Cash Flows from  Operating Activities:                                                                                                       |       |                                                    | ** **  | ** ** | ** ** |
| Net loss                                                                                                                                     |       | $                                                       | (63,435,237 | ) | $ | (11,489,518 | ) |
| Non-cash items  included in net income (loss):                                                                                               |       |                                                    |        |   |   |
| Depreciation,  amortization and depletion                                                                                                    |       | 5,243,140                                               |        | 213,852 |   |
| Accretion of  discount on asset retirement obligations and convertible notes                                                                 |       | 1,325,134                                               |        | 207,575 |   |
| (Gain) on sale  of assets                                                                                                                    |       | (687,842                                                | )           | — |   |
| Warrant expense                                                                                                                              |       | 9,618,157                                               |        | 1,507,201 |   |
| Common stock  issued for services                                                                                                            |       | 4,793,460                                               |        | 3,659,339 |   |
| Common stock  issued for compensation                                                                                                        |       | 16,779,700                                              |        | 4,893,828 |   |
| (Gain) on  derivatives                                                                                                                       |       | (27,288,071                                             | )           | (627,907 | ) |
| Gain on  litigation settlement                                                                                                               |       | —                                                  |        | (497,430 | ) |
| Amortization of  debt discount and debt issuance costs                                                                                       |       | 6,717,147                                               |        | — |   |
| Loss (gain) on  extinguishment of debt                                                                                                       |       | 389,792                                                 |        | (2,182,686 | ) |
| Minority  interest                                                                                                                           |       | 22,282,615                                              |        | — |   |
| Other                                                                                                                                        |       | 30,398                                                  |        | (30,663 | ) |
| Changes in assets  and liabilities, net of acquisitions:                                                                                     |       |                                                    |        |   |   |
| Decrease  (increase) in:                                                                                                                     |       |                                                    |        |   |   |
| Accounts  receivable                                                                                                                         |       | (1,259,711                                              | )           | 15,611 |   |
| Notes receivable                                                                                                                             |       | (3,764,171                                              | )           | — |   |
| Prepaid and  other assets                                                                                                                    |       | (57,990                                                 | )           | (228,844 | ) |
| Inventory                                                                                                                                    |       | (504,412                                                | )           | — |   |
| Other current assets                                                                                                                         |       | 349,763                                                 |        | — |   |
| Increase  (decrease) in:                                                                                                                     |       |                                                    |        |   |   |
| Accounts payable  and accrued expenses                                                                                                       |       | (223,408                                                | )           | 620,365 |   |
| Advances from  related party                                                                                                                 |       | 7,373                                                   |        | — |   |
| Other current  liabilities                                                                                                                   |       | 72,242                                                  |        | — |   |
| Net cash used in  operating activities                                                                                                       |       | (29,611,921                                             | )           | (3,939,277 | ) |
|                                                                                                                                         |       |                                                    |        |   |   |
| Cash Flows From  Investing Activities:                                                                                                       |       |                                                    |        |   |   |
| Cash acquired in  acquisitions                                                                                                               |       | —                                                  |        | 10,374 |   |
| Purchase of  marketable securities                                                                                                           |       | (1,595,303                                              | )           | — |   |
| Investments in  joint ventures                                                                                                               |       | (27,042,001                                             | )           | — |   |
| Purchase of  property, plant and equipment                                                                                                   |       | (15,632,243                                             | )           | (153,401 | ) |
| Proceeds from  sale of assets                                                                                                                |       | 875,000                                                 |        | — |   |
| Net cash used in  investing activities                                                                                                       |       | (43,394,547                                             | )           | (143,027 | ) |
|                                                                                                                                         |       |                                                    |        |   |   |
| Cash Flows From  Financing Activities:                                                                                                       |       |                                                    |        |   |   |
| Proceeds from  notes payable                                                                                                                 |       | 90,285,339                                              |        | 3,112,005 |   |
| Proceeds from  sale of common stock                                                                                                          |       | 10,979,623                                              |        | 2,462,163 |   |
| Proceeds from  related party notes                                                                                                           |       | 235,167                                                 |        | — |   |
| Advances  (repayments) line of credit, net                                                                                                   |       | 1,362,363                                               |        | (261,127 | ) |
| Repayments of  notes and capital leases payable                                                                                              |       | (27,802,289                                             | )           | (1,253,591 | ) |
| Cash paid for  debt issuance costs                                                                                                           |       | (3,451,833                                              | )           | — |   |
| Net cash provided by  financing activities                                                                                                   |       | 71,608,370                                              |        | 4,059,450 |   |
|                                                                                                                                         |       |                                                    |        |   |   |
| Net decrease in cash                                                                                                                         |       | (1,398,098                                              | )           | (22,854 | ) |
|  Cash and cash equivalents: Beginning of year                                                                                           |       | 2,400,457                                               |        | 56,018 |   |
|                      End  of period |       | $                                                       | 1,002,359   |   | $ | 33,164 |   |

 

See accompanyingnotes to consolidated financial statements.

 

8

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

**1.  NATURE OF OPERATIONS AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

*Company and Purpose* — ApolloResources International, Inc. (the “Company”) was incorporated on July 9, 1997under the laws of the State of Utah. Effective October 28, 2004, the Companyexecuted a share exchange agreement, in which the Company acquired an oil andnatural gas production company. With this acquisition the Company changed itsprimary business focus to oil and natural gas production. Subsequentacquisitions and ventures have added oil and natural gas transportation via theacquisition of pipelines, developed an alternative fuels segment focused on theproduction and sale of biodiesel fuel, and the production and distribution ofliquefied natural gas (“LNG”).

*Basis of Presentation* — Theaccompanying consolidated financial statements include the accounts of theCompany, its wholly-owned and its majority-owned subsidiaries. All significantintercompany transactions and balances have been eliminated.

Thefollowing relates to the 2005 financial presentation. Results of operations forthe Company’s gas pipeline transmission company OGC Pipeline, LLC (“OGC”) havebeen consolidated since February 7, 2005 the effective date of the acquisition.Results of operations of Earth Biofuels, Inc. (“Earth”) have been consolidatedsince the Company acquired an 80% interest on August  19, 2005. The Company initially acquired a50% interest in Earth on February 25, 2005 and was accounted for under theequity method from such date until  August 19, 2005, when an additional 30%ownership interest was acquired. On September 13, 2005, the Company executed ashare exchange with Meadows Springs, Inc. (“Meadows Springs”) whereby theCompany contributed its 80% interest in Earth in exchange for 21,000,000 sharesof the common stock of Meadows Springs. As a consequence of the share exchange,the Company maintained a controlling interest in Meadows Springs ofapproximately 89% and Earth remains an indirect subsidiary of the Company. Asof September 30, 2006, the Company owned 129,381,182 shares of common stock ofEarth representing a 59.06% majority ownership. Results of operations for theCompany’s LNG businesses, Applied LNG Technologies USA, LLC (“ALT”), TxHLDM,Inc. and its wholly-owned subsidiary, Arizona LNG, LLC (“Arizona LNG”), havebeen consolidated since November 30, 2005 the effective date of theacquisition. The Company’s other oil and natural gas production company,Mountain States Petroleum Corporation (“Mountain States”), has beenconsolidated since November 30, 2005, the effective date of the acquisition.

Thefollowing relates to the 2006 financial presentation.  On May 12, 2006 the Company entered into aSecurities Purchase Agreement with Siam Imports, Inc. (“Siam”) whereby theCompany sold its wholly-owned subsidiary, Apollo Drilling Company, LLC, to Siamin exchange for 13,700,000 shares of common stock of Siam. As a consequence ofthe Securities Purchase Agreement, the Company maintained a controllinginterest in Siam of approximately 91.70% and Apollo Drilling Company, LLCremains an indirect subsidiary of the Company. Subsequent to the third quarter,Siam changed its name to Apollo Drilling, Inc. (“Apollo Drilling”).  As of September 30, 2006, the Company owned19,900,000 shares of common stock of Apollo Drilling, representing an 82.06%majority ownership.

*Reclassifications—*Certain amountsfrom prior years have been reclassified to conform to the 2006 presentation.

*Restatement of September 30, 2005and December 31, 2005 Financial Statements—*Apollo Resources International, Inc. (the “Company”)has amended its financial statements as of September 30, 2005 and for theperiods of three and nine months then ended. These amendments address the Company’sadoption of statement of Financial Accounting Standards No. 143, “Accountingfor Asset Retirement Obligations” (SFAS No. 143), the recording of theacquisitions of BC&D Oil and Gas Corporation (“BC&D”) and OGC Pipeline,LLC (“OGC”) at historical cost, the reclassification of direct expenses relatedto offering costs associated with the Company’s Regulation S common stockoffering, the reversal of expenses recorded in relation to the Company’sprivate placement memorandum, the recording of warrants, and the rescinding ofits stock sale agreement with JSC Kaliningradneft executed on March 22, 2005.

Uponadoption of SFAS No. 143, the Company has restated its financial statements toreflect the inclusion of asset retirement obligations of approximately $1.1million.  The Company incurred anadditional net loss of $19,093 and $57,279 related to depreciation expense onthe asset and $10,083 and $30,249 related to accretion of discount pertainingto the liability for the three and nine months ended September 30, 2005.

9

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TheCompany has amended its September 30, 2005 financial statements to reflect theacquisition of BC&D in October of 2004 and the acquisition of OGC inFebruary of 2005 using the carryover basis of accounting under the guidance inStatement of Financial Accounting Standards No. 141. Therefore, the property,plant and equipment originally recorded at fair market has been amended toreflect a reduction of assets of approximately $6.3 million related to theBC&D assets and approximately $5.8 million related to the OGC assets with acorresponding reduction of additional paid-in capital.

Inaddition, we have made an amendment to our September 30, 2005 financialstatements related to certain offering costs associated with our offering ofcommon stock to foreign investors under Regulation S. These offering costsrelate to brokerage fees associated with each individual sale which wereinitially recorded as selling, general and administrative expenses. Per theguidance of generally accepted accounting principles, the Company hasreclassified approximately $0.8 million and $2.7 million from selling, generaland administrative expense to additional paid-in capital for the three and ninemonths ended September 30, 2005.

TheCompany has also amended its September 30, 2005 financial statements toreclassify expenses related to the sale of the Company’s common stock throughits private placement memorandum. Originally the Company had recorded anexpense for the difference between the market price per share on the date ofthe sale and the discounted price at which the stock was sold.  The majority of the Company’s common stockwas sold at a discount to market value based on the terms of the Company’sprivate placement memorandum. The Company took into consideration theaccounting treatment of other companies with like transactions and hasdetermined that the discounted price was representative of the market pricewhen taking into consideration the restrictive nature of the common stock beingsold. Therefore, the Company has reclassified approximately $0.7 million and$2.3 million from selling, general and administrative expense to additionalpaid-in capital for the three and nine months ended September 30, 2005.

TheCompany has amended its September 30, 2005 financial statements for the fairvalue of warrants issued with convertible debt. The value of $2.1 million has been reclassified from additional paid-incapital to a liability account.  AtSeptember 30, 2005 the warrants had a fair value of $1.5 million.  The Company recorded a gain of $0.6 millionrelated to the adjustment of the warrants to fair value.

Thefollowing table illustrates the change to the Company’s financial statementsfor the three and nine month periods ended September 30, 2005 related to thenotes above.

|                                          | ** ** | ** **           | ** **  | **Previously** | ** ** |
|------------------------------------------|------------|----------------------|-------------|----------------|------------|
| ** **                               | ** ** | **As Restated** | ** **  | **Reported**   | ** ** |
| Property and  equipment, net             |       | $                    | 5,331,289   |           | $          | 16,420,079 |   |
| Total assets                             |       | $                    | 11,372,675  |           | $          | 22,694,441 |   |
| Asset retirement  obligations-short term |       | $                    | 41,386      |           | $          | — |   |
| Asset retirement  obligations            |       | $                    | 1,141,135   |           | $          | — |   |
| Derivative  liabilities                  |       | $                    | 1,500,000   |           | $          | — |   |
| Additional paid  in capital              |       | $                    | 26,503,975  |           | $          | 45,663,972 |   |
| Accumulated  deficit                     |       | $                    | (13,119,578 | )              | $          | (18,339,527 | ) |
| Total stockholders’  equity         |       | $                    | 3,011,387   |           | $          | 16,951,435 |   |

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **September 30, 2005** | ** ** | **September 30, 2005** | ** ** |
| ** **                           | ** ** | ** **                       | ** ** | **Previously**                   | ** ** | ** ** | ** ** | **Previously** | ** ** |
| ** **                           | ** ** | **As Restated**             | ** ** | **Reported**                     | ** ** | **As Restated** | ** ** | **Reported** | ** ** |
| Selling, general  and administrative |       | $                                | 8,813,088  |                             | $          | 10,504,361 |   | $ | 13,336,102 |   | $ | 18,419,179 |   |
| Gain (loss) on  derivatives          |       | $                                | 627,907    |                             | $          | — |   | $ | 627,907 |   | $ | — |   |
| Net loss                             |       | $                                | (8,990,367 | )                                | $          | (10,838,391 | ) | $ | (11,489,518 | ) | $ | (16,729,346 | ) |

 

Theresults of operations of JSC Kaliningradneft (“Kaliningrad”) acquired March 22,2005, are not included with the accounts presented in this Form 10-QSB.Effective November 3, 2005, the Company announced that it was exercising itscontractual right to rescind the March 2005 stock sale transaction withshareholders of Kaliningrad. The Company’s decision came after protractedefforts to resolve serious issues that were discovered by the Companypost-closing, as well as efforts to resolve the failure of Kaliningrad toprovide certain critical financial data that was 

10

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represented in theMarch agreement. Specifically, shareholders of Kaliningrad had purported totransfer 90% of its issued and outstanding shares of stock to the Company;however, it had become apparent that shareholders of Kaliningrad were not in aposition 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 Marchagreement, was required to provide the Company with audited statements forfiscal years 2003 and 2004, prepared in accordance with U.S. Generally AcceptedAccounting Principles, which Kaliningrad failed to do despite repeated effortson the part of the Company to secure them. As a result of the above issues, theCompany exercised the contractual right of rescission that was reserved to theCompany under the March 2005 stock sale agreement, bill of sale, and $18.5million convertible debenture. The Company remains in contact with the ownershipof Kaliningrad 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 agreement withrespect to the rescission of the stock sale transaction.

The restatements noted above also impacted the December 31, 2005financial statements.  As a result, theCompany hereby amends Part II, Item 7 of its annual report filed on form 10-KSBfor the year ended December 31, 2005.  Asummary of the impact of the items noted above on the December 31, 2005financial statements follows:

|                                  | ** ** | ** **           | ** **  | **Previously** | ** ** |
|----------------------------------|------------|----------------------|-------------|----------------|------------|
| ** **                       | ** ** | **As Restated** | ** **  | **Reported**   | ** ** |
| Property and  equipment, net     |       | $                    | 25,423,982  |           | $          | 24,612,083 |   |
| Total assets                     |       | $                    | 71,839,817  |           | $          | 71,049,615 |   |
| Derivative  liabilities          |       | $                    | 837,209     |           | $          | — |   |
| Additional paid  in capital      |       | $                    | 56,636,831  |           | $          | 63,350,615 |   |
| Accumulated  deficit             |       | $                    | (28,321,460 | )              | $          | (34,973,382 | ) |
| Total stockholders’  equity |       | $                    | 44,150,403  |           | $          | 44,197,410 |   |

 

|                                      | ** ** | **Year Ended**             | ** **  |
|--------------------------------------|------------|---------------------------------|-------------|
| ** **                           | ** ** | **December 31, 2005** | ** **  |
| ** **                           | ** ** | ** **                      | ** **  | **Previously** | ** ** |
| ** **                           | ** ** | **As Restated**            | ** **  | **Reported** | ** ** |
| Selling, general  and administrative |       | $                               | 27,508,659  |   | $ | 32,883,002 |   |
| Gain on  derivatives                 |       | $                               | 1,290,698   |   | $ | — |   |
| Net loss                             |       | $                               | (26,691,400 | ) | $ | (33,343,789 | ) |

 

The significant changes in the Company’s amendment aredescribed in the following paragraphs.

Theportion of the amendment to our December 31, 2005 financial statements relatingto certain offering costs associated with our offering of common stock toforeign investors under Regulation S amounted to $2.9 million.  This amount was reclassified from selling,general and administrative expense to additional paid-in capital.

Thereclassification of expenses from selling, general and administrative expenseto additional paid-in capital related to the sale of the Company’s common stockthrough its private placement memorandum amounted to $2.4 million for the yearended December 31, 2005.

Thewarrant liability of $2.1 million transferred from additional paid-in capitalin the amendement of the financial statements as of September 30, 2005 wasadjusted to market at December 31, 2005. This adjustment was a reduction of the liability in the amount of $1.3million.

Inmanagement’s opinion, these financial statements include all adjustments necessaryto present fairly the financial position of the Company at September 30, 2006and the results of operations and changes in cash flows for the three and ninemonths periods ended September 30, 2006. The accounting and reporting policiesof the Company conform to generally accepted accounting principles and reflectpractices appropriate for its industry. These policies are summarized below.

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*Management’s Estimates and Assumptions*— The presentation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates. The Companyreviews all significant estimates affecting the financial statements on arecurring basis and records the effect of any necessary adjustments prior totheir issuance.

*Oil and Gas Properties*— TheCompany follows the full cost method of accounting for exploration anddevelopment of oil and gas properties whereby all costs in acquiring, exploringand developing properties are capitalized, including estimate of abandonmentcosts, net of estimated equipment salvage costs.  No costs related to production, generalcorporate overhead, or similar activities have been capitalized. At September30, 2006 the Company had no capitalized costs of unproved properties and majordevelopment projects excluded from capitalized costs being amortized. Leaseholdcosts are depleted based on the units-of-production method based on estimatedproved reserves.

*SFAS 144—*In accordance withStatement of Financial Accounting Standards No. 144 “Accounting for theImpairment or Disposal of Long-Lived Assets”, the Company reviews itslong-lived assets to be held and used, excluding proved oil and gas propertiesaccounted for under the full cost method of accounting, whenever events orcircumstances indicate that the carrying value of those assets may not berecoverable. An impairment loss is indicated if the sum of the expected futurenet cash flows is less than the carrying amount of the assets. In this circumstance,the Company recognizes an impairment loss for the amount by which the carryingamount of the asset exceeds the estimated fair value of the asset.

*Adoption of SFAS 143*— The Companyhas adopted the provisions of Statement of Financial Accounting Standards No.143, “Accounting for Asset Retirement Obligations” (SFAS 143”). SFAS 143amended Statement of Financial Accounting Standards No. 19, “FinancialAccounting and Reporting by Oil and Gas Production Companies” to require thatthe fair value of a liability for an asset retirement obligation be recognizedin the period in which it is incurred if a reasonable estimate of fair valuecan be made. Under the provisions of SFAS 143, asset retirement obligations arecapitalized as part of the carrying value of the long-lived asset.

*Business Combinations—*Businesscombinations are accounted for using the purchase method. Under the purchasemethod the Company reports the acquired entities assets and liabilities at fairmarket value. Any excess of the fair market value of the consideration givenover the fair market value of the net assets acquired is reported as goodwill.If the fair market value of the consideration given is less than the fairmarket value of the net assets acquired, the resulting excess of fair value ofacquired net assets over the cost of the acquired entity is allocated, on a prorata basis, against certain assets acquired in the business combination. If anyexcess over cost remains after reducing certain assets to zero, the remainingexcess is recognized as an extraordinary gain. The operating statements of theCompany for purchase method combinations report combined results only for theperiod subsequent to the combination.

*Cash and Cash Equivalents*—Cashequivalents consist of highly liquid investments with original maturities ofthree months or less.

*Allowance for Doubtful Accounts*—Allowance for doubtful accounts is established through a provision for baddebts charged to expense.  Trade accountsreceivable are charged against the allowance for doubtful accounts whenmanagement believes that collection of the account is unlikely.  The allowance is an amount that managementbelieves will be adequate to absorb estimated losses on existing accounts, basedon an evaluation of the future collection of accounts, prior loss experienceand current economic conditions.  TheCompany has recorded an allowance of $164,667 at September 30, 2006.

*Accounts Receivable Working Interest Owners*—The Company previously advanced funds to working interest owners.  As net royalties are earned, the workinginterest owners are reducing their receivable on a quarterly basis. The workinginterest owners receive 54% of the revenue and are billed 54% of the directexpenses. As of September 30, 2006 the working interest owners owed the Companyapproximately $419,947.

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*Concentration of Credit Risk —*Financialinstruments which potentially subject the Company to concentrations of creditrisk consist principally of accounts receivable and temporary cashinvestments.  Exposure to losses onreceivables is principally dependent on each customer’s financialcondition.  The Company controls itsexposure to credit risk through credit approvals, credit limits and monitoringprocedures and establishes allowances for anticipated losses. The Companyplaces its temporary cash investments with quality financial institutions and,by policy, limits the amount of credit exposure with any one financialinstrument.  The Company maintains itscash in bank deposit accounts, which, at times, may exceed federally insuredlimits.  At September 30, 2006, theCompany had $1,002,359 in bank deposit accounts, of which $486,544 was inexcess of the federally insured limit. The Company has not experienced any losses in such accounts and believesit is not exposed to any significant credit risk on cash and cash equivalents.

*Fair Market Value of Financial Instruments*—Estimated fair value of cash and cash equivalents, accounts receivable,accounts payable and accrued expenses and other liabilities approximate theircarrying amounts in the financial statements. The Company’s financialinstruments include notes payable. The carrying value of notes payableapproximates market value because the borrowing rate is similar to otherfinancial instruments with similar terms.

*Marketable Equity Securities*—Marketable equity securities consist of financial instruments purchased in openmarket transactions by the Company, are subject to the general volatility offinancial markets.  These financialinstruments have been classified as available-for-sale in accordance with theprovisions of SFAS No. 114, “Accounting for Certain Investments in Debt andEquity Securities”.  Accordingly, thegain calculated upon adjustment to market at September 30, 2006 of $350,146 hasbeen excluded from earnings and recorded in a separate component ofstockholders’ equity.

*Prepaid expenses and current deposits*—Prepaid expenses and current deposits of approximately $22.9 million consistedof $20.5 million of prepaid services, $1.3 million of prepaid feedstockand  $0.5 million of LNG gas balancingdeposits related to its LNG operations, $0.2 million for an escrow deposit topay unsettled property taxes related to the sale of pipeline easements, and $0.4million of general prepaid corporate expenses.

TheCompany also had approximately $3.4 million of deposits classified as long-termassets at September 30, 2006 which consisted of 12,000,000 shares of theCompany’s common stock issued to BC&D for collateral on a line of credit.

*Inventory* — Inventory balance atSeptember 30, 2006 was $1,190,072, consisting of drilling rig equipmenttotaling $451,500, biodiesel fuel and products purchased for resale totaling$252,638, inventory related to LNG in storage of $13,625 and LNG equipmentinventory totaled $472,309.

*Goodwill*— Goodwill recorded onthe Company’s balance sheet reflects the purchase price of the Company’sacquisitions exceeding the fair market value of the net assets. At September30, 2006 the Company had recorded $22.6 million of goodwill related to itsacquisition of its LNG businesses and its oil and gas production company,Mountain States. The remaining $8.5 million of goodwill relates to theacquisition of Earth and its subsequent acquisition of Distribution Drive inNovember of 2005.

*Stock Options*— The Company grantsincentive and non-qualified stock options and has reserved 23,282,000 shares ofcommon stock for issuance under its stock option plans. The majority of theoptions granted become exercisable at the date of grant, and generally expirethree years after the date of grant. Effective January 1, 2006, the Companyadopted the provisions of Statement of Financial Accounting Standards No.123(R), “Share-Based Payment” (SFAS No. 123(R). Based on this statement, compensation cost is recorded based on the fairvalue on the grant date of stock options granted to employees.   The adoption of SFAS 123(R) did not have amaterial impact of the financial statements of the Company.

The Company accounts for stock-based compensation for non-employeesunder the fair value method prescribed by Statement of Financial AccountingStandards No. 123, “Accounting for Stock-Based Compensation.”Through September 30, 2006, there have been no significant grants tonon-employees.

*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 biodiesel 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.

13

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*Comprehensive Income*—Comprehensiveincome includes all changes in equity except those resulting from investmentsby stockholders and distributions to stockholders.  The following is a summary of comprehensiveincome for the periods of three and nine months ended September 30, 2006 ond2005, respectively:
| ** **                               | ** ** | **Period of Three Months Ended** | ** **  | **Period of Nine Months Ended** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|-------------|-----------------------------------------------------|------------|
| ** **                               | ** ** | **September 30, 2006**                     | ** **  | **September 30, 2005**                    | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|                                     |       |                                                 |        |                                                |       |   |   |   |   |
| Net loss                                 |       | $                                                    | (36,993,301 | )                                                   | $          | (8,990,367 | ) | $ | (63,435,237 | ) | $ | (11,489,518 | ) |
| Other  Comprehensive Income:             |       |                                                 |        |                                                |       |   |   |   |   |
| Unrealized gain on Marketable Securities |       | 350,146                                              |        | —                                              |       | 350,146 |   | — |   |
| Comprehensive loss                       |       | $                                                    | (36,643,155 | )                                                   | $          | (8,990,367 | ) | $ | (63,085,091 | ) | $ | (11,489,518 | ) |

 

*Earnings per Share—* Earnings(loss) per common share is presented in accordance with the provisions of theStatement of Financial Accounting Standards No. 128, “Earnings Per Share”(SFAS 128), which requires the presentation of “basic” and “diluted”earnings per share. Basic earnings (loss) per share are based on the weightedaverage shares outstanding. Diluted earnings per share include the effect ofdilutive securities such as stock options and warrants.  Since the impact of including the effect ofsuch items as stock options and warrants would be antidilutive, there is not adiluted earnings (loss) per share calculation. The following table summarizes the outstanding instruments that wouldhave been included in the diluted earnings (loss) per share calculation:

| Item                         | ** ** | ** ** | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|------------------------------|------------|------------|------------|----------------------------------|------------|----------------------------------|------------|
| Options and  warrants        |       | 31,928,244 |       | 80,875                           |       |
| Convertible  notes           |       | 5,829,728  |       | 1,378,755                        |       |
| Convertible preferred  stock |       | 5,000,000  |       | —                           |       |

 

*Income Taxes—*The Company hasadopted Financial Accounting Standards No. 109, which requires the recognitionof deferred tax assets and liabilities for the expected future tax consequencesof events that have been included in the financial statements or taxreturns.  Under this method, deferred taxassets and liabilities are determined based on the difference between financialstatements and tax bases of assets and liabilities using enacted tax rates ineffect for the year in which the differences are expected to reverse.

For income tax reporting purposes, the Company’s aggregate unused netoperating losses approximate $6.2 million which expire in years 2013 through2020, subject to limitations of Section 382 of the Internal Revenue Code, asamended.  The Company has provided avaluation allowance against the full amount of net operating loss benefit,since in the opinion of management based upon the earnings history of theCompany, the realization of these net operating losses is not assured beyond areasonable doubt.

*Recent Accounting Pronouncements—*TheFASB has issued SFAS No. 158, “Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans”. This pronouncement will have no impact on the Company since the Companyhas no defined benefit or other postretirement plans.

The FASB has issued staff position 19-1, “Accounting for Suspended WellCosts”.  This staff position applies tothe expensing of capitalized exploratory well costs.  Since the Company uses the full cost methodof accounting for oil and gas operations, this pronouncement has no affect.

**2.  GOING CONCERN AND MANAGEMENT’S PLANS**

For the nine month period ended September 30, 2006, the Companyrecorded a net loss of $63.4 million. Since the Company completed itsinitial acquisition of BC&D on October 28, 2004, the Company hasaccumulated losses aggregating $91.8 million. The Company’s continuedexistence is dependent upon its ability to take advantage of acquisitionopportunities, raise capital through private securities offerings, securecollateralized debt financing and use these sources of capital to grow andenhance its oil and gas production, gas pipeline transmission operations andits biodiesel and LNG sales and production.

14

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*TheCompany’s Liquidity Plan*

Recentoperating results give rise to concerns about the Company’s ability to generatecash flow from operations sufficient to make scheduled debt payments as theybecome due. The Company has completed recent financings, described above, tohelp fund its working capital needs. As of September 30, 2006, the Companycontinued to seek other financing from private placements, convertible debtinstruments and other acquisitions to expand its opportunities in the areas ofoil and gas production, oil and gas transmission and biodiesel and LNGproduction and sales. The Company has implemented cost saving measures,primarily in its oil and gas operations, by implementing cost controls designedto reduce unnecessary expenditures and operate production activities within thecurrent economic constraints with which the Company currently operates.  The Company will take additional cost savingsmeasures, if necessary, to enhance its liquidity position.

TheCompany’s need to raise additional equity or debt financing and the Company’sability to generate cash flow from operations sufficient to make scheduledpayments on its debts as they become due will depend on its future performanceand the Company’s ability to successfully raise capital and implement businessand growth strategies. The Company’s performance will also be affected byprevailing economic conditions. Many of these factors are beyond the Company’scontrol. If future cash flows and capital resources are insufficient to meetthe Company’s debt obligations and commitments, the Company may be forced toreduce or delay activities and capital expenditures, obtain additional equitycapital or restructure or refinance its debt. In the event that the Company isunable to do so, the Company may be left without sufficient liquidity and itmay not be able to meet its debt service requirements. In such a case, thiscould result in a substantial portion of the Company’s indebtedness becomingimmediately due and payable. As a result, the Company may not be able tocontinue operations due to liens, collateralized notes or other securedpositions placed on the Company’s assets.

**3.  PROPERTY AND EQUIPMENT**

TheCompany follows the full cost method of accounting for exploration anddevelopment of oil and gas properties whereby all costs in acquiring, exploringand developing properties are capitalized, including estimates of abandonmentcosts, net of estimated equipment salvage costs.  No costs related to production, generalcorporate overhead, or similar activities have been capitalized. Leaseholdcosts are depleted based on the units-of-production method based on estimatedproved reserves. Property and equipment are stated at cost less accumulateddepreciation. The Company records impairment losses on long-lived assets usedin operations when events and circumstances indicate that the assets might beimpaired and the undiscounted cash flows estimated to be generated by thoseassets are less than the carrying amounts 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 |   |
|---------------------------------------------|--------|-----------|--------|
| Furniture,  fixtures and computer equipment |   | 3-5 Years |   |
| Machinery and  equipment                    |   | 5-7 Years |   |
| Gas plant                                   |   | 7 Years   |   |
| Automobiles                                 |   | 5 Years   |   |

 

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Property,plant and equipment consist of the following:

|                                                       | ** ** | **September 30,  2006** | ** ** | **December 31, 2005  (Restated)** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|---------------------------------------------|------------|
| Land                                                  |       | $                            | 685,543    |                                        | $          | 221,841 |   |
| Building                                              |       | 280,407                      |       | 213,842                                     |       |
| Machinery and  equipment                              |       | 17,269,626                   |       | 13,592,084                                  |       |
| Office furniture  and fixtures and computer equipment |       | 647,362                      |       | 242,199                                     |       |
| LNG and  biodiesel plants                             |       | 22,432,000                   |       | 8,425,426                                   |       |
| Pipeline  easements                                   |       | 1,759,984                    |       | 2,172,142                                   |       |
| Capitalized  asset retirement cost                    |       | 1,608,570                    |       | 1,608,570                                   |       |
| Vehicles                                              |       | 541,778                      |       | 213,844                                     |       |
| Leasehold  improvements                               |       | 275,741                      |       | 3,216                                       |       |
|                                                  |       | 45,501,011                   |       | 26,693,164                                  |       |
| Less accumulated  depreciation                        |       | 11,656,437                   |       | 9,350,164                                   |       |
| Sub total                                             |       | 33,844,574                   |       | 17,343,000                                  |       |
|                                                  |       |                         |       |                                        |       |
| Oil & gas  leases                                 |       | 15,162,702                   |       | 9,356,219                                   |       |
| Less accumulated  depletion                           |       | 4,399,941                    |       | 1,275,237                                   |       |
| Net oil and gas leases                                |       | 10,762,761                   |       | 8,080,982                                   |       |
| Total property,  plant and equipment—net         |       | $                            | 44,607,335 |                                        | $          | 25,423,982 |   |

 

Depreciation,amortization and depletion expense for the three and nine months endedSeptember 30, 2006 was $2,495,808 and $5,243,140, respectively. At September30, 2006 $3,124,704 of depletion was recorded using the units-of-productionmethod on the Company’s only cost center consisting of oil and gas propertiesin the Four Corners area of New Mexico, Arizona and Utah.

AtSeptember 30, 2006 the Company had no capitalized costs of unproved propertiesand major development projects excluded from capitalized costs being amortizedunder the full cost method of accounting for oil and gas properties.

**4.**** INVESTMENTS IN JOINT VENTURES**

OnApril 24, 2006, Earth entered into a letter of intent with HPSDevelopment, L.L.C., which contemplates a joint venture in which a newlycreated limited liability company (New Orleans Facility) will own and operate afuel ethanol distillery located on the Mississippi River in Plaquemines Parish,Louisiana, approximately nine miles southeast of New Orleans. OnJune 13, 2006, Earth entered into a new letter of intent with HPSDevelopment, which replaced the April letter of intent in its entirety and madea deposit in the amount of $7,000,000.  As contemplated by the letter ofintent, HPS Development will acquire a 50% interest in the newly createdlimited liability company in exchange for contributing to the new operatingcompany real property and improvements, including a currently idle ethanoldistillery.  Earth will acquire a 50% interest in the operating company inexchange for the payment of $50,000,000 and the issuance of 5,829,005 shares ofEarth’s common stock to HPS Development. As of September 30, 2006 the total investment was $25,066,996.

On May 2, 2006, Earth entered into a letterof intent with Vertex Energy, L.P., which contemplates a joint venture in whicha newly created company will own and operate a biodiesel production facility onthe Houston Ship Channel in Houston, Texas.  The fuel produced by thisfacility will be sold under the “BioWillie” brand name to local markets andother areas of Texas.  As contemplated by the letter of intent, VertexEnergy will acquire a 49% interest in the newly created company in exchange forcontributing to the new operating company real property and improvements,including an existing chemical processing facility.  Earth will acquire a51% interest in the operating company in exchange for the payment of $2,500,000and the issuance of 1,500,000 shares of Earth’s common stock to VertexEnergy.  The facility will then be converted into a biodiesel productionfacility.  Pursuant to the letter of intent dated May 2, 2006,Earth has deposited $500,000 of the purchase price with Vertex Energy. The deposit will reduce the purchase price payable at closing or will berefunded by Vertex if Earth cannot agree on definitive documents.  In theevent the parties execute definitive documents and the transaction closes, theletter of intent provides that Vertex Energy will have an option, exercisableon the 180th day after the closing, to require Earth to repurchase the1,500,000 shares of its common stock issued to Vertex Energy in the closing fora purchase price of $2,000,000.  Earth’s rights and 

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obligations set forth in the non-binding letter ofintent are subject to the negotiation and execution of definitivedocumentation.  Earth can make no assurances that the final terms of thetransaction will conform to the terms of the letter of intent or that theparties will even enter into definitive documents.  As of September 30, 2006, the totalinvestment was $3,524,000 relating to Vertex.

On June 7, 2006, Earth entered into a letterof intent, with  DFI Group, Inc. andAlbermarle Bio-Refinery, Inc., which contemplates a joint venture in whichAlbermarle Bio-Refinery will convert into a limited liability company and ownand operate an ethanol facility in Martin County, North Carolina.  Inconnection with the non-binding letter of intent, Earth has loaned an aggregateof $2,000,000 to Albermarle Bio-Refinery, Inc. as of the quarter endedSeptember 30, 2006 for the purposes of acquiring 51% investment in a50-million gallon ethanol production plant in Jamesville, NC.  The notebears interest at 4.85% and matures one year from the date of the note. Principal and accrued interest are due at maturity.  Upon the closing ofthe transaction, the notes will automatically convert into equity of the new operatingcompany and the purchase price payable by Earth will be reduced by the amountof any remaining principal and accrued and unpaid interest.  As of September 30, 2006 the total investmentwas $5,150,000.

On September 21, 2006 Earth invested $5,000,000 for anequity interest in a newly-formed company named “Biodiesel Investment Group”.Biodiesel Investment Group and Bunge North America, Inc. (“Bunge”), one of thenation’s leading agribusiness firms, have partnered to start the constructionof a jointly-owned biodiesel plant with an annual capacity of 45 milliongallons.  Once completed, the plant will be Illinois’ largest biodieselproduction plant. It is anticipated that Earth will enter into an off-takeagreement with the new Illinois LLC for some potion of the biodiesel productionoutput of the plant.  Earth plans to market its share of the new plant’sproduction to local and other new markets under its “BioWillie” brand name.

**5.  ROYALTY PAYABLE**

The Company has variousroyalty arrangements with non-working interest owners.  As of September 30, 2006 the Company owedroyalties of $826,200 to non-working interest owners.

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**6.  NOTES PAYABLE**

AtSeptember 30, 2006 the Company maintained notes payable due to secured lendersand to various investors. All notes having a maturity date of less than twelvemonths are classified as current liabilities.

 
| **Lender**                                                                       | ** ** | **Maturity Date** | ** ** | **Interest Rate** | ** ** | **Original Principal  Amount  September 30, 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                                                          |       |
| West Texas  National Bank                                                        |       | 2/1/2007               |       | Prime +3               | %          | 726,263                                                           |       | —                                                           |       |
| Convertible  Notes OGC (2)                                                       |       | On Demand              |       | 10.00                  | %          | 575,907                                                           |       | 575,907                                                          |       |
| Navistar  Financial Corporation                                                  |       | 10/27/2007             |       | 8.50                   | %          | 28,568                                                            |       | 49,345                                                           |       |
| Convertible  notes (1)                                                           |       | 12/31/2007             |       | 8.00                   | %          | 320,943                                                           |       | 1,297,674                                                        |       |
| Argyll Equities,  LLC                                                            |       | 2/8/2009               |       | 7.50                   | %          | 330,720                                                           |       | —                                                           |       |
| Greenwich Power  Ltd.(5)                                                         |       | 5/31/2011              |       | 7.00                   | %          | 8,000,000                                                         |       | —                                                           |       |
| Greenwich Power  Ltd.                                                            |       | On Demand              |       | 7.00                   | %          | 1,000,000                                                         |       | —                                                           |       |
| Oliver Kendall  Kelley                                                           |       | 4/1/2011               |       | 8.50                   | %          | 5,000,000                                                         |       | 6,000,000                                                        |       |
| Jack B. Kelley, Inc.                                                             |       | 9/20/2011              |       | 7.50                   | %          | 1,241,568                                                         |       | 4,041,620                                                        |       |
| First Capital —  revolving line of credit                                   |       | 4/13/2009              |       | ***                    |       | 1,362,364                                                         |       | —                                                           |       |
| First Capital -  term                                                            |       | 4/13/2011              |       | ***                    |       | 4,639,579                                                         |       | —                                                           |       |
| Neptune Leasing,  Inc.                                                           |       | 12/31/2006             |       | 8.00                   | %          | 400,000                                                           |       | —                                                           |       |
| Bruce Ivey                                                                       |       | 3/31/2010              |       | 7.00                   | %          | 36,887                                                            |       | 43,024                                                           |       |
| First Capital -  term                                                            |       | 12/20/2006             |       | Prime +3               | %          | 1,000,000                                                         |       | —                                                           |       |
| Group of eight  institutional investors (3)                                      |       | 12/31/2011             |       | 8.00                   | %          | 52,500,000                                                        |       | —                                                           |       |
| Excaliber  Limited Partnership (4)                                               |       | 12/31/2011             |       | 8.00                   | %          | 600,000                                                           |       | —                                                           |       |
| Whalehaven  capital fund (4)                                                     |       | 12/31/2011             |       | 8.00                   | %          | 500,000                                                           |       | —                                                           |       |
| Other                                                                            |       |                   |       |                   |       | 2,859                                                             |       | —                                                           |       |
| Less Discount                                                                    |       |                   |       |                   |       | (42,420,643                                                       | )          | —                                                           |       |
|           Total  notes payable |       |                   |       |                   |       | 36,384,015                                                        |       | 12,696,570                                                       |       |
| Less short-term  portion of notes payable                                        |       |                   |       |                   |       | 8,039,572                                                         |       | 2,428,952                                                        |       |
| Long-term portion of  notes payable                                              |       |                   |       |                   |       | $                                                                 | 28,344,443 |                                                             | $          | 10,267,618 |   |

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***      Greaterof 7.0% or prime + 1.5%

(1)             OnJune 30, 2005, the Company entered into (and on July 7, 2005 completed the transactioncontemplated by a Note and Warrant Purchase Agreement with certain investors,pursuant to which the Company issued $3,000,000 principal amount of 8% SecuredConvertible Promissory Notes and related securities. Pursuant to the Note andWarrant Purchase 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 ownedsubsidiaries BC&D and OGC, and the investors. These notes are recorded attheir fair value based on the allocation of the fair value of the convertiblenotes and related warrants. The notes accrete interest until maturity orconversion by the investors. Additional terms of the 8% secured convertiblenotes include:

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·       Unless converted or redeemed as described below,the 8% secured convertible notes are due on December 30, 2007.

·       8% annual interest, payablesemi-annually in arrears beginning December 1, 2005. The interest is payableeither in cash or at the Company’s option (subject to the satisfaction ofcertain conditions) in shares of the Company’s common stock valued at 92.55% ofthe volume weighted average price of the Company’s common stock for the 5trading days prior to the payment date.

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

·       The notes are convertibleat any time at the option of the holder into shares of the Company’s commonstock at a conversion price of $0.25 per share. The conversion price is alsosubject to adjustment upon the occurrence of certain specified events,including stock dividends and stock splits, mergers or consolidations, orcertain issuances of common stock at a price below the initial conversion priceof $0.25 per share.

·       The number of shares of theCompany’s common stock acquired by any holder upon conversion of the notes islimited to the extent necessary to ensure that following the conversion thetotal number of shares of the Company’s common stock beneficially owned by theholder does not exceed 4.999% of our issued and outstanding common stock.

·       TheCompany can prepay all or any portion of the principal amount of the notes,plus any accrued but unpaid interest at 120% of face amount, but only ifcertain conditions are satisfied, including an effective registration. If theCompany should elect to prepay the notes, the holders will have 30 calendardays to convert the notes into shares of our common stock. If the Companyelects to prepay the notes, it must do so pro-rata amongst the holders.

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

(3)             OnJuly 24, 2006, Earth entered into a securities purchase agreementpursuant to which Earth issued $52.5 million aggregate senior convertible notesthat are due in 2011 to eight institutional investors.  Thenotes initially carry an 8% coupon, payable quarterly, and are convertible intoshares of Earth’s common stock at $2.90 per share.  In 2007, thecoupon may decline to 6% upon Earth achieving certain financialmilestones.  The notes will begin to amortize in equal, quarterly paymentsbeginning in 2007.  In connection with the issuance of the notes,Earth also issued five-year warrants to purchase 9,051,725 shares of Earth’scommon stock to the investors and five-year warrants to purchase 1,357,759shares of Earth’s common stock to its placement agent, at $2.90 per share. Atthe date of issuance the warrants had a relative fair value of $18,808,359, andEarth recognized a beneficial conversion feature in the amount of $42,906,599based on the intrinsic value of the conversion feature. Amortization on thedebt discount totaled $678,245 for the quarter ended September 30, 2006. Earth used the net proceeds from this offering to repay in full the remainingunpaid principal and accrued and unpaid interest on its $20.0 million aggregateprincipal amount of senior convertible promissory notes issued in May, June andJuly 2006, and expects to use the remaining proceeds from the offering forits program of building and acquiring interests in biodiesel and ethanolproduction facilities, and for other general corporate purposes.

(4)             OnAugust 11, 2006, Earth entered into a securities purchase agreementpursuant to which Eartrh issued $1.1 million aggregate senior convertible notesthat are due in 2011 to two institutional investors.  The notesinitially carry an 8% coupon, payable quarterly, and are convertible intoshares of Earth’s common stock at $2.90 per share.  In 2007, thecoupon may decline to 6% upon Earth achieving certain financialmilestones.  The notes will begin to amortize in equal, quarterly paymentsbeginning in March, 2007.  In connection with the issuance of the notes,Earth also issued five-year warrants to purchase 232,759 shares of common stockto the investors at $2.90 per share.

(5)             OnJuly 21, 2006, the Company entered into a securities purchase agreement withGreenwich Power, Ltd whereby the Company received $8,000,000 before payment ofcommissions and expenses, in exchange for $8,000,000 notes (the “Notes”),bearing interest at 7% and maturing on May 31, 2011.  The Notes are exchangeable at a price of$1.00 per share into company-owned shares of common stock of Earth at a priceof $1.00 per share. This agreement contains a detachable and separate right toan option to purchase, from the Company, an additional 8,000,000 shares ofcommon stock of Earth owned by the Company.

**7.  WARRANTS AND DERIVATIVES**

* Warrants*—The warrants for 12,000,000 shares issued in connection with the $3.0 millionconvertible debt issuance had an original exercise price of $0.30 per share,and expire in June, 2010. Per the terms of the warrants, the Company hasadjusted the warrant price to $.25 due to the Company’s sale of stock at thatprice subsequent to the 

19

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issuance of the warrants.  In July of 2006, 600,000 of these warrantswere exercised via the cashless exercise option. At the date of issuance, June30, 2005, these warrants had a fair value of $.61 based on the Black-Scholesoption pricing model.

As of May 1, 2006, the Company issued additionalwarrants to the investors that participated in the $3.0 million, June 30, 2005,private placement. In total, the Company issued warrants to purchase anaggregate of 4,000,000 shares of its common stock. These warrants contain thesame attributes as the original warrants to purchase an aggregate of 12,000,000million shares of the Company’s common stock issued on June 30, 2005. The4,000,000 warrants have an exercise price of $0.30 per share, and expire inMay, 2011.  At the date of issuance,May 1, 2006, these warrants had a fair value of $.83 based on the Black-Scholesoption pricing model.  These warrantswere issued as consideration for penalties related to the Company’s noncompliance, regarding the timing of the effective date of the Company’sregistration statement.

The warrant exercise price for both of the aboveissuances is subject to adjustment upon the occurrence of certain specifiedevents, including stock dividends and stock splits, pro rata distributions ofequity securities, evidences of indebtedness, rights or warrants to purchasecommon stock or cash or any other asset, mergers or consolidations, or certainissuances of common stock at a price below the initial exercise price of $0.30per share. The warrants include a “cashless exercise” feature, which permitsthe holder to exercise the warrants by surrender of a portion of the warrants.The cashless exercise feature is available to the holder, if at the time ofexercise, there is not in effect a registration statement covering the sharesunderlying the warrants.

On July 25, 2006, the Company issued a warrant for16,447,369 shares of its common stock to an accredited investor who alsopurchased 13,157,895 shares of the Company’s common stock.  These warrants have an exercise price of$0.38 per share, and expire in July, 2011. At the date of issuance, July 25, 2006, this warrant had a fair value of$.38 per share based on the Black-Scholes option pricing model using thefollowing assumptions:

| Warrants   | ** ** | **Dividend  Yield** | ** ** | **Expected  Volatility** | ** ** | **Risk Free  Interest  Rate** | ** ** | **Expected  Life (Years)** | ** ** |
|------------|------------|---------------------|------------|--------------------------|------------|------------------------------------|------------|---------------------------------|------------|
| 16,447,369 |       | 0%                  |       | 143.37%                  |       | 4.50%                              |       | 5                               |       |

 

*Derivatives—*The Company evaluatedthe application of Statement of Financial Accounting Standards (“SFAS”) No.133, “Accounting for Derivative Instruments and Certain Hedging Activities”(SFAS No. 133”), and EITF 00-19, for all its issuances of convertible debt andwarrants. The Company concluded that provisions of Earth’s convertible debtissuances were required to be accounted for as derivatives during the secondquarter of fiscal 2006.   The Company determined that theconversion features and the warrants met the attributes of a liability andtherefore recorded the fair value of the conversion features and the warrantsas current liabilities in the second quarter.  The Company recorded thefair value of the conversion features and the warrants on its balance sheet atfair value with changes in the values of these derivatives reflected in theconsolidated statement of operations as “Gain (loss) on embedded derivativeliability for the second quarter. Certain convertible debt of Earth was converted on August 4, 2006, andthe remaining instruments were repaid with the proceeds from the July 24, 2006issues.  Based on the companies analysisand application of Statement of Financial Accounting Standards (“SFAS”)No. 133, “*Accounting for DerivativeInstruments and Certain Hedging Activities*“ (“SFAS No. 133”), thereare no derivatives or liabilities necessary to be recorded by Earth for thethird quarter security issues, and as a result the prior derivative liabilitywas reversed as appropriate.

Basedon the guidance in SFAS No. 133 and EITF 00-19, the Company concluded that eachof the warrants was required to be accounted for as derivatives.  The convertible debt, which can be convertedinto free trading stock was not determined to have an embedded derivative.  The Company determined that the conversionfeature of the warrants met the attributes of a liability and thereforerecorded the fair value of the warrants as current liabilities.  The Company is required to record the changein fair value in operations as “Gain (loss) on derivatives.”

20

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Theimpact of the application of SFAS No. 133 and EITF 00-19 on the balance sheetand statement of operations as of September 30, 2006 is as follows:
| ** **                  | ** ** | ** **  | ** ** | **Fair Value of**    | ** ** | ** **                       | ** ** | **Gain/(Loss)**                  | ** ** |
|-----------------------------|------------|-------------|------------|--------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | ** **  | ** ** | **Warrants at Date** | ** ** | **Fair Value of**      | ** ** | **Period of Three**    | ** ** | **Period of Nine** | ** ** |
| **Shares Represented** | ** ** | ** **  | ** ** | **of Issuance or**   | ** ** | **Warrants at**             | ** ** | **Months Ended**            | ** ** | **Months Ended** | ** ** |
| **by Warrants**        | ** ** | **Company** | ** ** | **June 30, 2006****  | ** ** | **September 30, 2006** | ** ** | **September 30, 2006** | ** ** | **September 30, 2006** | ** ** |
|                        |       |        |       |                           |       |                             |       |                             |       |   |   |
| 14,642,243                  |       | Earth       |       | $                              | 22,805,483 |                             | $          | 0                                |       | $ | 22,805,483 |   | $ | 22,404,620 |   |
| 11,400,000                  |       | Apollo      |       | $                              | 1,330,237  |                             | $          | 762,210                          |       | $ | 568,027 |   | $ | (24,996 | ) |
| 4,000,000                   |       | Apollo      |       | $                              | 1,632,000  |                             | $          | 920,000                          |       | $ | 712,000 |   | $ | 2,392,000 |   |
| 16,447,369                  |       | Apollo      |       | $                              | 6,299,342  |                             | $          | 3,782,895                        |       | $ | 2,516,447 |   | $ | 2,516,447 |   |
|                        |       |        |       |                           |       |                             |       | $                                | 26,601,957 |   | $ | 27,288,071 |   |

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**             Thelatest date used for the calculation of any gain or loss in the current quarter

**8.  EQUITY TRANSACTIONS**

Asummary of the Apollo Resources, Intenational common stock transactionscompleted during the nine months ended September 30, 2006 follows:

Sold 38,022,704 shares ofits common stock, via private placement, at prices ranging from $0.25 to $0.99per share to accredited investors. The aggregate purchase price was $9,651,028.

Issued 2,572,761 sharesof its common  stock to consultants, inrestricted form and pursuant to the Company’s 2004 and 2005 Stock Option andAward Plans. These shares were issued at the fair market value price on thedate of issuance and resulted in approximately $3,964,710 of non-cashconsulting services expense.

Retired two notes payablewith principal amounts of $100,000 and $50,000 payable to JPB Resources, Inc.by issuing 600,000 shares of the Company’s common stock valued at approximately$234,000.

Issued 6,675,789 sharesof the Company’s common stock valued at $1,675,185 to retire principal due toinvestors whom participated in the Company’s $3.0 million convertible notes.

Cancelled 120,000 sharesof its common stock, originally issued as compensation to the Company’s ChiefOperating Officer, which were returned in exchange for $21,942 in cash.

Issued 273,910 shares ofthe Company’s common stock for warrants exercised.

Issued 222,222 shares ofthe Company’s common stock to an employee as a signing bonus valued at$100,000.

Settled certainlitigation in the first quarter by issuing 120,000 shares of  the Company’s common stock valued at $50,400.

Issued  213,800 shares of the Company’s common stockto acquire a truck.

Invested in a jointventure by issuing 250,000 shares of its common stock valued at $125,000.  The joint venture is related to Earth, itsbiodiesel subsidiary.

Cancelled 350,000 sharesof its common stock valued at $145,000 which were returned and originally wereheld as collateral for a loan to a related party,

 

21

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**9.  EXTRAORDINARY ITEM**

EffectiveMarch 31, 2005 the Company executed a Compromise of Debt Agreement with Koch.This agreement effectively reduced the principal and interest obligation on thenote payable assumed in the acquisition of OGC in February 2005. The principaland interest was reduced to $1,100,000 as full payment on the pipeline assetsresulting in forgiveness of debt in the amount of $2,182,686 in principal andaccrued interest. The Company made payments totaling $100,000 to Koch duringthe second quarter of 2005. In July 2005, the remaining balance of $1,000,000was paid in full.

**10.  RELATED PARTY TRANSACTIONS**

The Company entered into a management servicesagreement with 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.

The Company entered into a management servicesagreement with Johnny Flame Consulting, LLC effective March 15, 2005. Under theterms of the agreement the Company is charged $15,000 monthly for servicesprovided by Christopher Chambers, its Corporate Secretary.  Effective October 16, 2006 Mr. Chambersbecame a full-time employee of the Company effectively terminating this managementservices agreement.

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.  This agreement is being renegotiated and it is anticipated that services will continue to be provided by MAC in the future.  Earth also receives similar services from MAC.  Payments by Earth for services rendered by MAC were $46,169 and $184,975 for the period of three and nine months ended September 30, 2006, respectively.

On January 17, 2005 the Company entered into a bill ofsale and assignment agreement whereby it conveyed ownership of two generatorsand a gas plant, valued at approximately $500,000, to Sovereign StrategicPartners, Ltd. (“Sovereign”) in exchange for a promissory note in the amount of$495,000.  This note was secured by anAgreement of Pledge pursuant to which 20,000,000 shares of Blue Wireless andData, Inc. (“Blue”) were contributed as collateral. Subsequently, the Companyentered into a capital lease agreement with Sovereign whereby Sovereign leasedthe generators and gas plant to the Company. The Company subsequently assignedthe 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. Dennis McLaughlin, the Company’sChief Executive Officer and Chairman, serves as the Chairman of the Board ofBlue.  Christopher Chambers, the Company’sCorporate Secretary and Director, served as the Corporate Secretary and Directorof Blue until his resignation effective September 13, 2006.

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. During thesecond quarter of 2006, the Company agreed to forgive the debt associated withthe issuances of the Company’s common stock in exchange for 5,000,000 shares ofBlue. The Company now owns approximately 32% of Blue. Dennis McLaughlin, theCompany’s Chief Executive Officer and Chairman, serves as the Chairman of theBoard of Blue.  Christopher Chambers, theCompany’s Corporate Secretary and Director, served as the Corporate Secretaryand Director of Blue until his resignation effective September 13, 2006.

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During the fourth quarter of 2005, the Company issued500,000 shares of its common stock valued at $145,000 to Mammoth Corporation toprovide partial security for a loan in the amount of $125,000 the makers ofwhich are Blue, TKM and Dennis McLaughlin, the Company’s Chief ExecutiveOfficer and Chairman. During the second quarter of 2006, the 500,000 shares ofthe Company’s common stock were returned to the Company and subsequentlycancelled upon repayment of the loan. Dennis McLaughlin, the Company’s ChiefExecutive Officer and Chairman serves as the Chairman of the Board of Blue andhe is Director of TKM.  ChristopherChambers, the Company’s Corporate Secretary and Director, served as theCorporate Secretary and Director of Blue until his resignation effectiveSeptember 13, 2006.

At December 31, 2005 the Company’s 59% ownedsubsidiary, Earth, had outstanding accounts payable to DGMAC, LLC for $81,479.Payments made to DGMAC, LLC by Earth were $100,000 and $234,500 for the periodof three and nine months ended September 30, 2006, respectively.  DGMAC, LLC is a company operated by DennisMcLaughlin the Chairman and CEO of the Company and Earth. In addition, Earthhad outstanding accounts payable and a note payable totaling $139,603 and$139,134, respectively, to Bruce Blackwell, a Director of Earth. Also Earthowed Peter Bell, the former owner of Distribution Drive and a current employeeof Earth, a note payable of $96,033. As of June 30, 2006, these debts had beenpaid in full.

On August 11, 2006 the Company entered into aninformation services agreement with Blue. Under terms of the agreement, Blue is to provide to the Company supportservices related to voice, internet and computer operations.  The charge for these services is $8,000 permonth.  Payments made to Blue by Earthtotaled $97,415 and $101,453 for the period of three and nine months endedSeptember 30, 2006, respectively.

DGMAC, LLC is owed $75,000 by Apollo Drilling.   Earth owes $90,000 to Dennis McLaughlin theChairman of the Board of the Company and Earth. These amounts are unpaid at September 30, 2006.

Earth has notes receivable of $302,311 and $471,041,respectively, due from MAC Partners and Blue at September 30, 2006.

**11.  SUPPLEMENTAL CASH FLOW DISCLOSURES**

TheCompany paid cash for interest in the amounts of $305,864 and $137,190 for theperiods of three and nine months ended September 30, 2006, respectively.  There has been no cash paid for income taxesin either period.

Significantnon-cash transactions are summarized as follows:

|                                                       | ** ** | **For the Period of Nine Months Ended** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
|                                                       | ** ** | **September 30,  2006**                                          | ** ** | **September 30,  2005** | ** ** |
| Common stock  issued to acquire assets                |       | $                                                                     | 113,305    |   | $ | — |   |
| Common stock  issued in acquisition of subsidiary     |       | $                                                                     | —     |   | $ | 4,000,000 |   |
| Common stock  issued for investment in joint ventures |       | $                                                                     | 125,000    |   | $ | 4,410,800 |   |
| Cashless  exercise of stock warrants                  |       | $                                                                     | 99,996     |   | $ | 1,507,201 |   |
| Other non-cash common  stock issuances                |       | $                                                                     | —     |   | $ | 224,000 |   |

 

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**12.  SEGMENT INFORMATION**

In2006, the Company operates four business segments. Apollo Production andOperating, Inc. is the holding company that contains the Company’s oil and gasproduction operations and pipeline gas transmission operations.  Apollo Drilling is the holding company whichcontains the oil and gas drilling operations. Apollo Alternative Fuels, LLC is the holding company which contains theCompany’s biodiesel production and distribution operations. Apollo LNG, Inc. isthe holding company which contains the Company’s LNG production, distributionand marketing operations.

Certainsegment data is included in the table below. The LNG and Oil and Gas Drilling segment are not presented for the threeand nine month periods ended September 30, 2005 since there was no revenue,operations or assets related to these segments at that time.
| ** **        | ** ** | **Period of Three Months Ended September 30,** | ** ** |
|-------------------|------------|------------------------------------------------------------------------------|------------|
| ** **        | ** ** | **2006**                                                                     | ** ** | **2005** | ** ** |
| ** **        | ** ** | **Production and**                                                      | ** ** | **Oil and Gas** | ** ** | **Alternative** | ** ** | ** ** | ** ** | **Production and** | ** ** | **Alternative** | ** ** |
| ** **        | ** ** | **Operating**                                                                | ** ** | **Drilling** | ** ** | **Fuels** | ** ** | **LNG** | ** ** | **Operating** | ** ** | **Fuels** | ** ** |
|              |       |                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Revenue           |       | $                                                                            | 1,563,391  |   | — |   | $ | 10,302,461 |   | $ | 6,295,642 |   | $ | 9,023 |   | $ | 80,960 |   |
| Operating loss    |       | $                                                                            | (6,027,966 | ) | $ | (646,365 | ) | $ | (12,707,728 | ) | $ | (1,503,969 | ) | $ | (8,944,627 | ) | $ | (45,740 | ) |
| Long-lived assets |       | $                                                                            | 17,104,480 |   | $ | 1,725,994 |   | $ | 15,090,606 |   | $ | 10,653,846 |   | $ | 5,293,446 |   | $ | 37,843 |   |

 
| ** **        | ** ** | **Period of Nine Months Ended September 30,** | ** **  |
|-------------------|------------|-----------------------------------------------------------------------------|-------------|
| ** **        | ** ** | **2006**                                                                    | ** **  | **2005** | ** ** |
| ** **        | ** ** | **Production and**                                                     | ** **  | **Oil and Gas** | ** ** | **Alternative** | ** ** | ** ** | ** ** | **Production and** | ** ** | **Alternative** | ** ** |
| ** **        | ** ** | **Operating**                                                               | ** **  | **Drilling** | ** ** | **Fuels** | ** ** | **LNG** | ** ** | **Operating** | ** ** | **Fuels** | ** ** |
|              |       |                                                                        |        |   |   |   |   |   |   |   |   |   |   |
| Revenue           |       | $                                                                           | 3,507,055   |   | — |   | $ | 15,096,503 |   | $ | 19,124,765 |   | $ | 199,381 |   | $ | 80,960 |   |
| Operating loss    |       | $                                                                           | (13,696,271 | ) | $ | (1,332,328 | ) | $ | (28,904,063 | ) | $ | (4,434,395 | ) | $ | (11,434,893 | ) | $ | (54,625 | ) |
| Long-lived assets |       | $                                                                           | 17,104,480  |   | $ | 1,725,994 |   | $ | 15,090,606 |   | $ | 10,653,846 |   | $ | 5,293,446 |   | $ | 37,843 |   |

 

**13.  SUBSEQUENT EVENTS**

In October, 2006 the Company completed a $5,000,000financing to provide capital for a 12 well drilling program in SouthTexas.  The financing cost is prime plus2 points.  Under terms of the financing,Apollo will enter into a participation agreement with the investor which givesthe investor a 2.5% revenue interest along with certain other rights.

Effective November 10, 2006, Apollo Drilling, Inc., amajority-owned subsidiary of the Company entered into a Drilling ServicesAgreement (“Agreement”) with Mex Tex Operating Company (“Mex Tex”).  TheAgreement calls for the Company to contract its first drilling rig and workoverequipment to Mex Tex for a term of two years at a standard day rate of $15,000per day. The rig is initially being utilized by Mex Tex for a drilling programin Sutton County, Texas and recently completed three commercial gas wells forMex Tex pursuant to an interim short-term day-rate contract. The Agreement alsocontains customary provisions for drilling services arrangements, includingprovisions regarding the performance standards, insurance obligations,confidentiality requirements, provisions for changes in the services andindemnities.

Subsequent to September 30, 2006 Earth renegotiatedthe securities purchase agreement originally entered into on July 24, 2006. Theconversion features and warrant exercise prices were amended to reflect moremarketable rates.  As such, anyderivative issues and re-measurement of beneficial conversion features will beproperly reflected in subsequent periods. The new terms significantly impactthe conversion features and related debt discounts. See Note 6. Notes Payable(3) of the Company’s Notes to Consolidated Financial Statements.

24

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**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OFOPERATIONS**

**Overview**

TheCompany derives its revenue primarily from monthly oil and natural gasproduction sales and sales of biodiesel fuel and LNG. During the first quarterof 2005, the Company started its alternative fuels business segment designed tocomplement the growing need for alternative energy sources versus theincreasing demand of traditional oil and natural gas energy sources. InDecember of 2005, the Company added an oil and gas production company andbusinesses related to the production and sale of LNG. The Company also focusedon raising capital through private placements of its common stock and securingcollateralized debt financing essential to providing the capital to expand itsbusiness segments.

**RESULTSOF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2006COMPARED TO THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2005**

Thisdiscussion combines the comparison of the results of operations for the periodof three months and nine months ended September 30, 2006, respectively, sincethe reasons for changes in the revenue and expenses are very similar for bothperiods.

*Revenue and Gross Profit (Loss)*

A summary of revenue and gross profit/(loss) for thethree and nine month periods ended September 30, 2006 and 2005 follows (notethat the oil and gas drilling segment is not listed due to the fact that thissegment had no revenue for the three and nine month periods ended September 30,2005 and 2006.  The LNG segment is notshown for 2005 since this business was not acquired until the fourth quarter of2005.):

 
| ** **          | ** ** | **Period of Three Months Ended September 30,** | ** ** |
|---------------------|------------|------------------------------------------------------------------------------|------------|
| ** **          | ** ** | **2006**                                                                     | ** ** | **2005** | ** ** |
| ** **          | ** ** | ** **                                                                   | ** ** | **Production  and** | ** ** | **Alternative** | ** ** | ** ** | ** ** | ** ** | ** ** | **Production  and** | ** ** | **Alternative** | ** ** |
| ** **          | ** ** | **Consolidated**                                                             | ** ** | **Operating** | ** ** | **Fuels** | ** ** | **LNG** | ** ** | **Consolidated** | ** ** | **Operating** | ** ** | **Fuels** | ** ** |
|                |       |                                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue             |       | $                                                                            | 18,161,494 |   | $ | 1,563,391 |   | $ | 10,302,461 |   | $ | 6,295,642 |   | $ | 89,983 |   | $ | 9,023 |   | $ | 80,960 |   |
| Cost of Sales       |       | $                                                                            | 19,308,521 |   | $ | 3,204,137 |   | $ | 9,862,837 |   | $ | 6,241,547 |   | $ | 332,910 |   | $ | 253,741 |   | $ | 79,169 |   |
| * *            | * *   | * *                                                                     | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| Gross Profit/(Loss) |       | $                                                                            | (1,147,027 | ) | $ | (1,640,746 | ) | $ | 439,624 |   | $ | 54,095 |   | $ | (242,927 | ) | $ | (244,718 | ) | $ | 1,791 |   |

 
| ** **          | ** ** | **Period of Nine Months Ended September 30,** | ** ** |
|---------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **          | ** ** | **2006**                                                                    | ** ** | **2005** | ** ** |
| ** **          | ** ** | ** **                                                                  | ** ** | **Production  and** | ** ** | **Alternative** | ** ** | ** ** | ** ** | ** ** | ** ** | **Production  and** | ** ** | **Alternative** | ** ** |
| ** **          | ** ** | **Consolidated**                                                            | ** ** | **Operating** | ** ** | **Fuels** | ** ** | **LNG** | ** ** | **Consolidated** | ** ** | **Operating** | ** ** | **Fuels** | ** ** |
|                |       |                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue             |       | $                                                                           | 37,728,323 |   | $ | 3,507,055 |   | $ | 15,096,503 |   | $ | 19,124,765 |   | $ | 280,341 |   | $ | 199,381 |   | $ | 80,960 |   |
| Cost of Sales       |       | $                                                                           | 41,059,138 |   | $ | 7,552,136 |   | $ | 14,249,523 |   | $ | 19,257,479 |   | $ | 585,842 |   | $ | 506,673 |   | $ | 79,169 |   |
| * *            | * *   | * *                                                                    | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| Gross Profit/(Loss) |       | $                                                                           | (3,330,815 | ) | $ | (4,045,081 | ) | $ | 846,980 |   | $ | (132,714 | ) | $ | (305,501 | ) | $ | (307,292 | ) | $ | 1,791 |   |

 

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Thechange in revenue and cost of sales in all segments is due to acquisitions madein the third and fourth quarters of 2005. For this reason, the operations discussion will focus more on theanalysis of the current year than the comparison with the prior year, since thecomparison with the prior year is not very meaningful.

Forthe three months ended September 30, 2006, the Company had a gross profit inthe production and operating segment before the charge for depletion anddepreciation of $1,830,671.  The grossprofit is before depletion and depreciation can be attributed to the fact thatthe refurbishment costs in this quarter were less than in the first half of theyear.  This segment has also benefitedfrom the increase in oil and gas prices experienced in the quarter.  The alternative fuels segment had a grossprofit due to the energy production credits of $919,809 earned in thequarter.  The LNG business operates on avery tight margin.  The gross profitrealized in the third quarter was .86% of sales.  This gross profit represents the realizationof efficiency improvements made in the LNG plant in the first half of the year.

For the nine months ended September 30, 2006, theproduction and operating segment had a gross loss.  Even before the depreciation and depletioncharge of $3,788,972 the results were a gross loss of $246,464, which is 7% ofsales.  This can be attributed to theexpenses incurred in the first half of 2005 to refurbish wells.  As with the quarter ended September 30, 2006,the gross profit is directly the result of the energy production creditsearned.  For the nine months endedSeptember 30, 2006 these credits amounted to $1,817,961. The LNG businessincurred a gross loss.  The gross loss asa percent of sales was .69%.  This grossloss for the nine months is due to losses from earlier in the year when theCompany incurred costs to improve plant efficiencies.

*Selling, General and Administrative Expenses andOther (income) and Expense*

A summary of consolidated selling, general andadministrative expenses and other (income) and expense for the three and ninemonth periods ended September 30, 2006 and 2005 follows:

|                                      | ** ** | **Period of Three Months** | ** ** | **Period of Nine Months** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                           | ** ** | **Ended September 30,**         | ** ** | **Ended September 30,**        | ** ** |
| ** **                           | ** ** | **2006**                                  | ** ** | **2005**                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                 |       |                                      |       |                                     |       |   |   |   |   |
| Selling, General  and Administrative |       | $                                         | 19,739,001 |                                     | $          | 8,813,088 |   | $ | 45,036,242 |   | $ | 13,336,102 |   |
| Other expense/(income)               |       | $                                         | 16,107,273 |                                     | $          | (65,648 | ) | $15,068,180 |   | $ | 30,601 |   |
|                                      |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |

 

The above tableshows that as the Company has grown it has incurred more expense in the abovetwo areas.  A more detailed comparison ofthe expenses follows:
| ** **                           | ** ** | **Period of Three Months Ended September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                                                     | ** ** | **2005** | ** ** |
| ** **                           | ** ** | ** **                                                                   | ** ** | **Production** | ** ** | **Oil and** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Production** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                                                                   | ** ** | **and** | ** ** | **Gas** | ** ** | **Alternative** | ** ** | ** ** | ** ** | ** ** | ** ** | **and** | ** ** | **Alternative** | ** ** |
| ** **                           | ** ** | **Corporate**                                                                | ** ** | **Operating** | ** ** | **Drilling** | ** ** | **Fuels** | ** ** | **LNG** | ** ** | **Corporate** | ** ** | **Operating** | ** ** | **Fuels** | ** ** |
|                                 |       |                                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, General  and Administrative |       | $                                                                            | 3,830,605  |   | $ | 564,792 |   | $ | 638,170 |   | $ | 13,147,370 |   | $ | 1,558,064 |   | $ | 8,634,233 |   | $ | 103,729 |   | $ | 75,126 |   |
| Other expense/  (income)             |       | $                                                                            | 32,604,724 |   | $ | 67,183 |   | $ | 28,750 |   | $ | (16,131,585 | ) | $ | (461,799 | ) | $ | 176,529 |   | — |   | $ | (242,177 | ) |
|                                      |            |                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                           | ** ** | **Period of Nine Months Ended September 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                                                    | ** ** | **2005** | ** ** |
| ** **                           | ** ** | ** **                                                                  | ** ** | **Production** | ** ** | **Oil and** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Production** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                                                                  | ** ** | **and** | ** ** | **Gas** | ** ** | **Alternative** | ** ** | ** ** | ** ** | ** ** | ** ** | **and** | ** ** | **Alternative** | ** ** |
| ** **                           | ** ** | **Corporate**                                                               | ** ** | **Operating** | ** ** | **Drilling** | ** ** | **Fuels** | ** ** | **LNG** | ** ** | **Corporate** | ** ** | **Operating** | ** ** | **Fuels** | ** ** |
|                                 |       |                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, General  and Administrative |       | $                                                                           | 8,622,262  |   | $ | 1,038,573 |   | $ | 1,322,683 |   | $ | 29,751,043 |   | $ | 4,301,681 |   | $ | 12,942,323 |   | $ | 318,653 |   | $ | 75,126 |   |
| Other expense/  (income)             |       | $                                                                           | 28,658,853 |   | $ | (492,884 | ) | $ | 31,809 |   | $ | (12,926,065 | ) | $ | (203,533 | ) | $ | 274,254 |   | $ | (1,476 | ) | $ | (242,177 | ) |

----

Note—The Oil and GasDrilling and LNG businesses are not shown for 2005 since they were not part ofthe Company’s operations.

 

26

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As compared to 2005, the selling, general and administrative expensesare much higher.  This is due to therapid growth of the Company. Consolidated selling, general and administrative expenses were $19,739,013and $45,036,242 for the period of three months and nine months ended September30, 2006, respectively.  In both periodsthe largest components were personnel costs, professional fees andconsultants.  A large portion of theexpenses incurred have been the result of issuances of common stock and notpayment in cash.  Non-cash expenses were$6,730,717 and $21,573,160 for the three and nine month periods ended September30, 2006, respectively.  The personnelcosts have increased due to the need for more employees as the Companygrows.  Professional fees and consultantshave increased due to the need of the expertise to support the growth of theCompany.

The other income and expense is chiefly made up of minority interest, financingand interest costs.  One of the Company’smajority-owned subsidiaries, Earth, realized a significant equity increase asthe result of renegotiation of its convertible debt.  This increase in equity resulted in theCompany recording an increase in minority interest of $28,543,004 and$22,282,615 for the periods of three and nine months ended September 30, 2006,respectively.  The Company has usedconvertible debt to a great extent to finance its growth.  In connection with this debt the Company hasincurred financing costs related to derivatives in addition to interestexpense.

**Liquidityand Capital Resources**

Cash used in operating activities was $29,611,921 in the first ninemonths of 2006 compared to $3,939,277 for the same period in 2005. The increaseis primarily related to the increase in net loss (after removing non-cashexpenses) experienced by the Company in the first nine months of 2006.

Net cash used in investing activities was $43,394,547 in the first ninemonths of 2006 compared to cash used in investing activities of $143,027 in2005. This increase in the use of cash reflects $27.0 million  paid for investments in joint venturesrelated to biodiesel and ethanol plants. In addition, the Company purchased $15.6 million of property, plant andequipment primarily related to improvements to its LNG plant, biodiesel plant,and machinery and equipment related to drilling rig equipment and oil and gasproduction equipment.

In order to fund operations and capital acquisitions, cash was providedby financing activities of the Company. The cash provided from financing activities was $71,608,370 in the firstnine months of 2006 compared to $4,059,450 in 2005. This increase reflects increased proceeds (net of repayments)from convertible debt instruments and other debt totaling $63,845,413, andsales of common stock totaling $10,979,623.

Duringthe period ending September 30, 2006, the Company recorded a net loss of $63.4 million.Since the Company completed its initial acquisition of BC&D on October 28,2004, the Company has accumulated losses of $91.8 million. The Company’s continued existence is dependent uponits ability to take advantage of acquisition opportunities, raise capitalthrough private securities offerings, secure collateralized debt financing anduse these sources of capital to grow and enhance its oil and gas production,gas pipeline transmission operations and its biodiesel and LNG sales andproduction. The following addresses the Company’s efforts regarding its recentacquisitions and financings.

*Acquisitions*

Duringthe fourth quarter of fiscal 2004 the Company completed the acquisition ofBC&D. The acquisition of BC&D marked the initial entrance of theCompany into the oil and natural gas production business. During the firstquarter of fiscal 2005, the Company completed the acquisition of OGC. The OGCacquisition added a pipeline network to the Company’s assets enabling theCompany to diversify into the oil and gas transmission business. In addition,in December of 2005, the Company acquired another oil and gas productioncompany, Mountain States, which added approximately 50 oil and gas wells to theCompany’s operations. Also in December of 2005, the Company acquired businessesspecializing in LNG sales and production. The Company believes these acquisitionswill be a major part of establishing future financial stability. The MountainStates and LNG company acquisitions have produced revenue in excess on $20million over the preceding two fiscal years.

TheCompany has acquired an interest in Earth. Earth produces and distributedbiodiesel fuel. Earth’s assets consist primarily of a biodiesel refinery andrefueling station. In response to soaring fuel costs, and to avail itself ofgovernment subsidies and tax incentives, the Company has pursued a strategy ofdeveloping renewable forms of energy, such as bio diesel.  Consequently, on February 25, 2005 theCompany acquired a 50% interest in Earth, a Mississippi-based company and onAugust 19, 2005, acquired an additional 30% ownership interest. On September13, 2005, the Company executed a share exchange with Meadows Springs, Inc.whereby the Company contributed its 80% interest in 

27

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Earth in exchangefor 21,000,000 shares of the common stock of Meadows Springs. As a consequenceof the share exchange the Company maintained a controlling interest in MeadowsSprings of approximately 89% and Earth remains an indirect subsidiary of theCompany. As of September 30, 2006, the Company owned 129,381,182 shares ofcommon stock of Earth Biofuels representing a 59.22% majority ownership.

Inaddition, on May 12, 2006 the Company entered into a Securities PurchaseAgreement with Siam Imports, Inc. (“Siam”) whereby the Company sold itswholly-owned subsidiary Apollo Drilling Company, LLC (“Apollo Drilling”) toSiam in exchange for 13,700,000 shares of common stock of Siam. As aconsequence of the Securities Purchase Agreement the Company maintained acontrolling interest in Siam of approximately 91.70% and Apollo Drillingremains an indirect subsidiary of the Company. As of September 30, 2006, theCompany owned 19,900,000 shares of common stock of Siam representing an 82.06%majority ownership.

*Financings*

OnFebruary 7, 2006, the Company finalized negotiations to provide a $3.5 millionline of credit for working capital related to its oil and gas assets acquiredin the BC&D acquisition. The Company plans to use this capital to restartproduction. The credit line is subject to a borrowing base and funds are preapproved and borrowed for production purposes only at the discretion of thelender. This facility bears interest at the prime rate + 3.0% and matures onFebruary 1, 2007. At August 18, 2006 the Company had borrowed $726,263 on thiscredit line.

OnApril 13, 2006, the Company completed an $8.0 million loan agreement to fundworking capital for its LNG businesses. This facility consists of a three year$3.0 million revolver, collateralized by the receivables of ALT, and a fiveyear $5.0 million term loan collateralized by the remaining assets of ALT andArizona LNG, which consists primarily of an LNG plant. The facility bearsinterest at the greater of 7% or the prime rate + 1.5%. At June 30, 2006 theCompany had borrowed $4.9 million on the term loan and $1.4 million on the lineof credit. The Company plans to use this facility to enhance its operations andprovide working capital.

OnJune 20, 2006 the Company completed a $1.0 million loan agreement to fundworking capital for its drilling subsidiary. This loan bears interest at Prime+ 3% and matures December 20, 2006. The Company plans to use this loan torefurbish its drilling rig assets and fund working capital. This loan has beenprovided by the same lender that provided the $8.0 million loan agreement forthe Company’s LNG businesses and is collateralized with the same assets.

OnJuly 21, 2006, the Company entered into a Securities Purchase Agreement with anaccredited investor whereby the Company received $8,000,000 before payment ofcommissions and expenses, in exchange for $8,000,000 notes (the “Notes”),bearing interest at 7% and maturing on May 31, 2011.The Notes are exchangeableat a price of $1.00 per share company-owned into shares of common stock ofEarth, a majority owned subsidiary of the Company, at a price of $1.00 pershare. This agreement contains a detachable and separate right to an option topurchase, from the Company, an additional 8,000,000 shares of common stock ofEarth owned by the Company.

OnJuly 25, 2006, the Company entered into a Securities Purchase Agreement with anaccredited investor relating to the sale and issuance of 13,157,895 shares ofcommon stock of the Company, par value $.001 per share (the “Common Stock”) at$0.38 per share for gross proceeds of approximately $5,000,000 before paymentof commissions and expenses. The Company also issued a five-year warrantexercisable into 16,447,369 shares of its common stock at an exercise price of$0.38 per share, subject to adjustment in certain circumstances. The warrantsinclude a cashless exercise feature under certain circumstances when there isnot an effective registration statement available for the resale of the sharesof the Company’s common stock issuable upon exercise of the Warrants.

OnNovember 1, 2006 the Company completed a $5,000,000 financing to providecapital for a 12 well drilling program in South Texas.  The financing cost is prime plus 2points.  Under terms of the financing,Apollo will enter into a participation agreement with the investor which givesthe investor a 2.5% revenue interest along with certain other rights.

EffectiveNovember 10, 2006, Apollo Drilling, Inc., a majority-owned subsidiary of theCompany entered into a Drilling Services Agreement (“Agreement”) with Mex TexOperating Company (“Mex Tex”).  The Agreement calls for the Company tocontract its first drilling rig and workover equipment to Mex Tex for a term oftwo years at a standard day rate of $15,000 per day. The rig is initially beingutilized by Mex Tex for a drilling program in Sutton County, Texas and recentlycompleted three commercial gas wells for Mex Tex pursuant to an interimshort-term day-rate contract. The Agreement also contains customary provisionsfor drilling services arrangements, including provisions regarding theperformance standards, insurance obligations, confidentiality requirements,provisions for changes in the services and indemnities.

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The Company’s biodiesel subsidiary, Earth, has beenable to raise approximately $24.2 million over the first half of 2006. $17.5million relates to convertible debt*,*and $6.7million relates to sales from the issuance of Earth’s common stock. Thiscapital will be used to for the acquisition of an ethanol plant, two biodieselproduction facilities and for other general corporate purposes, includingworking capital to support growth and capital expenditures associated with newproject development.

On July 10, 2006, Earth entered into asecurities purchase agreement, pursuant to which it issued, onJuly 11, 2006, a senior convertible note with a principal amount of$5.0 million to one institutional investor.  The note carries an 8%coupon, payable quarterly, and may be redeemed by Earth at par at any timeprior to its initial maturity date in October 2006.  The note is notconvertible by the holder until after October 2006, at which time the maturitydate may be extended to January 2007 at the holder’s option.  Thenotes are convertible into Earth’s common stock at a conversion price equal tothe greater of $1.00 per share or 75% of the weighted average price per shareof its common stock on a five-day volume weighted average prior toclosing.  Earth also issued five-year warrants to purchase an aggregate of1,500,000 shares of its common stock to the investor and five-year warrants topurchase 15,000 shares of its common stock to Earth’s placement agent, both atan exercise price of $2.50 per share.  On July 24, 2006, Earthused a portion of the net proceeds from its July 24, 2006 offering torepay in full the remaining unpaid principal and accrued and unpaid interest onthe note issued on July 11, 2006.

On July 24, 2006, Earth entered into asecurities purchase agreement pursuant to which it issued $52.5 millionaggregate senior convertible notes that are due in 2011 to eightinstitutional investors.  The notes initially carry an 8% coupon, payablequarterly, and are convertible into shares of its common stock at $2.90 pershare.  In 2007, the coupon may decline to 6% upon Earth achievingcertain financial milestones.  The notes will begin to amortize in equal,quarterly payments beginning in 2007.  In connection with theissuance of the notes, Earth also issued five-year warrants to purchase9,051,725 shares of common stock to the investors and five-year warrants topurchase 1,357,759 shares of common stock to Earth’s placement agent, at $2.90per share.  Earth used the net proceeds from this offering to repay infull the remaining unpaid principal and accrued and unpaid interest on its$20.0 million aggregate principal amount of senior convertible promissory notesissued in May, June and July of 2006, and expects to use the remainingproceeds from the offering for its program of building and acquiring interestsin biodiesel and ethanol production facilities, and for other general corporatepurposes.

On July 21, 2006, the Company entered into a securitiespurchase agreement with Greenwich Power, Ltd whereby the Company received$8,000,000 before payment of commissions and expenses, in exchange for$8,000,000 notes (the “Notes”), bearing interest at 7% and maturing on May 31,2011.  The Notes are exchangeable at aprice of $1.00 per share into company-owned shares of common stock of Earth ata price of $1.00 per share. This agreement contains a detachable and separateright to an option to purchase, from the Company, an additional 8,000,000shares of common stock of Earth owned by the Company.

TheCompany has also continued to raise capital through a variety of privatesecurities offerings of its common stock. During the first nine months of 2006,the Company and its subsidiary, Earth, have been able to raise $10.4 millionthrough private equity sales to accredited investors.

Managementbelieves these recent financings greatly enhance its ability to execute itsbusiness plan and mitigate its risk of continuing as a going concern.

Managementis focusing on expanding and improving its oil and natural gas productionoperations and continuing to develop its biodiesel and LNG production and salesthrough acquisition, organic growth and funding via collateralized loans,private placement offerings and convertible debt instruments. The Company plansto continue to increase the profitability of its operations necessary tosupport operations.

Therecan be no assurance that any of management’s plans as described above will besuccessfully implemented or that the Company will continue as a going concern.

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*TheCompany’s Liquidity Plan*

Recent operating results give rise to concerns about the Company’sability to generate cash flow from operations sufficient to make scheduled debtpayments as they become due. The Company’s has completed recent financings,described above, to help fund its working capital needs. As of September 30,2006, the Company continued to seek other financing from private placements,convertible debt instruments and other acquisitions to expand its opportunitiesin the areas of oil and gas production, oil and gas transmission and biodieseland LNG production and sales. The Company has implemented cost saving measures,primarily in its oil and gas operations, by implementing cost controls designedto reduce unnecessary expenditures and operate production activities within thecurrent economic constraints with which the Company currently operates.  The Company will take additional cost savingsmeasures, if necessary, to enhance its liquidity position.

The Company’s need to raise additional equity or debt financing and theCompany’s ability to generate cash flow from operations sufficient to makescheduled payments on its debts as they become due will depend on its futureperformance and the Company’s ability to successfully raise capital andimplement business and growth strategies. The Company’s performance will alsobe affected by prevailing economic conditions. Many of these factors are beyondthe Company’s control. If future cash flows and capital resources areinsufficient to meet the Company’s debt obligations and commitments, theCompany may be forced to reduce or delay activities and capital expenditures,obtain additional equity capital or restructure or refinance its debt. In theevent that the Company is unable to do so, the Company may be left withoutsufficient liquidity and it may not be able to meet its debt servicerequirements. In such a case, this could result in a substantial portion of theCompany’s indebtedness becoming immediately due and payable. As a result, theCompany may not be able to continue operations due to liens, collateralizednotes or other secured positions placed on the Company’s assets.

*Off-Balance Sheet Arrangements*

At September 30,2006 the Company had no obligations that would qualify to be disclosed asoff-balance sheet arrangements**.**

*Critical Accounting Policies*

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the amounts reported in the accompanying financialstatements and related footnotes. Management bases its estimates andassumptions on historical experience, observance of industry trends and variousother sources of information and factors. Actual results could differ fromthese estimates. Critical accounting policies are defined as those that arereflective of significant judgments and uncertainties, and potentially couldresult in materially different results under different assumptions andconditions.

**RiskFactors**

The Company’s revenue and operating results may fluctuate significantlyfrom quarter to quarter, and fluctuations in operating results could cause itsstock price 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:

·                                          theability to secure new significant contracts during a quarter; and

·                                          theability to raise the necessary capital to fund working capital, executemergers, acquisitions and asset purchases.

The market in which the Company competes is intensely competitive andactions by competitors could render its services less competitive, causingrevenue and income to decline.

The ability to compete depends on a number of factors outside of theCompany’s control, including:

·                                          theprices at which others offer competitive services, including aggressive pricecompetition and discounting;

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·                                          theability of competitors to undertake more extensive marketing campaigns;

·                                          theextent, if any, to which competitors develop proprietary tools that improvetheir ability to compete; and

·                                          theextent of competitors’ responsiveness to customer needs.

The Company may not be able to compete effectively on these or otherfactors. If the Company is unable to compete effectively, market position, andtherefore revenue and profitability, would decline.

The Company must continually enhance its services to meet the changingneeds of its customers or face the possibility of losing future business tocompetitors.

Future success will depend upon the Company’s ability to enhanceexisting services and to introduce new services to meet the requirements ofcustomers in a rapidly developing and evolving market. Present or futureservices may not satisfy the needs of the market. If the Company is unable toanticipate or respond adequately to its customers’ needs, lost business mayresult and financial performance will suffer.

The Company is dependent on a limited number of key personnel, and theloss of these individuals could harm its competitive position and financialperformance.

The Company’s business consists primarily of the delivery of oil andnatural gas and, accordingly, its success depends upon the efforts, abilities,business generation capabilities and project execution of its executiveofficers. The Company’s success is also dependent upon the managerial,operational and administrative skills of its executive officers. The loss ofany executive officer could result in a loss of customers or revenue, and couldtherefore harm the Company’s financial performance.

The Company’s ability to secure debt and equity financing could have anadverse effect on the Company’s financial health.

The inability to raise debt to fund working capital may:

·                                          requirethe Company to dedicate a substantial portion of its cash flows to pay downdebt;

·                                          increasethe Company’s vulnerability to general adverse economic and industryconditions;

·                                          limitthe Company’s ability to fund future working capital and other generalcorporate requirements; and,

·                                          limitthe Company’s flexibility in planning for, or reacting to, changes in theCompany’s business and the industry in which it operates.

The ability to make payments on and to refinance the Company’s debtwill 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’s business will generatesufficient cash flow from operations or that future borrowings will beavailable to it in an amount sufficient to enable it to pay debt or to fundother liquidity needs. The Company may need to refinance all or a portion ofits debt on or before maturity. The Company can give no assurance that it willbe able to refinance any of its debt on commercially reasonable terms or atall.

**“SafeHarbor” Statement under The Private Securities Litigation Reform Act:**

With the exception of historical information, the matters discussed inthis report are “forward looking statements” as that term is defined inSection 21E of the Securities Exchange Act of 1934.

**Cautionaryand Forward Looking Statements**

Inaddition to statements of historical fact, this Form 10-QSB containsforward-looking statements.  The presentationof future aspects of the Company found in these statements is subject to anumber of risks and uncertainties that could cause actual results to differmaterially from those reflected 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 limitingthe generality of the foregoing words such as “may,” “will,” “expect,” “believe,”“anticipate,” 

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“intend,” or “could”or the negative variations thereof or comparable terminology are intended toidentify forward-looking statements.

Theseforward-looking statements are subject to numerous assumptions, risks anduncertainties that may cause the Company’s actual results to be materiallydifferent from any future results expressed or implied by the Company in thosestatements.

Someof these risks might include, but are not limited to, the following:

(a)                                  volatilityor decline of the Company’s stock price;

(b)                                 potentialfluctuation in quarterly results;

(c)                                  failureof the Company to earn revenues or profits;

(d)                                 inadequatecapital to continue or expand its business, inability to raise additionalcapital or financing to implement its business plans;

(e)                                  failureto commercialize its technology or to make sales;

(f)                                    rapidand significant changes in markets;

(g)                                 litigationwith or legal claims and allegations by outside parties; and

(h)                                 insufficientrevenues to cover operating costs.

Thereis no assurance that the Company will be profitable, the Company may not beable to successfully develop, manage or market its products and services, theCompany may not be able to attract or retain qualified executives andtechnology personnel, the Company’s products and services may become obsolete,government regulation may hinder the Company’s business, and additionaldilution in outstanding stock ownership may be incurred due to the issuance ofmore shares, warrants and stock options, or the exercise of warrants and stockoptions, and there exist other risks inherent in the Company’s businesses.

TheCompany undertakes no obligation to publicly revise these forward-lookingstatements to reflect events or circumstances that arise after the datehereof.  Readers should carefully reviewthe factors described in other documents the Company files from time to timewith the Securities and Exchange Commission, including the Quarterly Reports onForm 10-QSB and Annual Report on Form 10-KSB filed by the Company and anyCurrent Reports on Form 8-K filed by the Company

**Controls and Procedures**

Basedon the evaluation of the Company’s disclosure controls and procedures as of theend of the period covered by this quarterly report, Dennis G. McLaughlin, thePresident and Chief Executive Officer and J. Mark Ariail, Chief FinancialOfficer, have concluded that, in their judgment, the Company’s disclosurecontrols and procedures are effective to ensure that information required to bedisclosed by the Company, including the Company’s subsidiaries, in the reportsit files, or submits under the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized, and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms. Managementnecessarily applied its judgment in assessing the costs and benefits of suchcontrols and procedures. The Company’s disclosure controls and procedures aredesigned to provide reasonable assurance of achieving their objectives. TheCompany’s executive officers, listed above, have concluded that the Company’sdisclosure controls and procedures are effective at that reasonable assurancelevel. There were no changes in the Company’s internal controls over financialreporting during the Company’s last fiscal quarter that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrols over financial reporting.

**PART II —OTHER INFORMATION**

**Item 1.        LegalProceedings**

H.C. Wainwright &Co., Inc. (“HCW”) commenced an arbitration against Earth onJuly 20, 2006, asserting a claim for breach of contract relating to aMarch 7, 2006 letter allegedly appointing H.C. Wainwright Earth’splacement 

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agent for a limited time for the sale of Earth’ssecurities.  H.C. Wainwright is seeking an award of unpaid commissions,warrants for the purchase our common stock, and attorneys’ fees and costs.  Earth filed an answering statement on August25, 2006, and denied that it was liable to HCW for breach of contract.  Among other things, Earth asserts that any agreementwas terminated prior to any alleged breach, HCW failed to perform as promised,and HCW made material misrepresentations of fact to induce the Company in tothe alleged agreement. The arbitration proceeding is at an early stage and nodiscovery has been taken or dates established. Earth intends to vigorously defend this claim.

The Company has become subject to various claims and other legalmatters in the course of conducting its business. The Company believes thatneither such claims and legal matters nor the cost of prosecuting and/ordefending such claims and legal matters will have a material adverse effect onthe Company’s results of operations, financial condition or cash flows. Nomaterial claims are currently pending; however, no assurances can be given thatfuture claims, if any, may not be material.

**Item 2.        UnregisteredSales of Equity Securities and Use of Proceeds—**None

**Item 3.        Defaultsupon Senior Securities** — None

**Item 4.        Submissionof Matters to a Vote of Security Holders**— None

**Item 5.        OtherInformation** — None

**Item 6.        Exhibitsand Reports on Form 8-K**

Reports on Form 8-K.
| Date of Filing      | ** ** | **Subject**                                                                                                  |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                         |
| July 27, 2006       |       | Announcement that the Company had entered into a  Securities Purchase Agreement with an accredited investor. |
| September 29,  2006 |       | Resignation of Mr. Wayne McPherson as Director and  Chief Operating Officer.                                 |

 
| **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**

Pursuant to the requirement of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized this 21st dayof November, 2006.
|        | Apollo Resources International, Inc. |   |
|--------|--------------------------------------|--------|
|   |                                 |   |
|        | /s/ Dennis G. McLaughlin, III        |   |
|   | Dennis G. McLaughlin, III            |   |
|   | Chief Executive Officer              |   |

 

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