**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**Form10-QSB**

 

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

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly Period Ended June 30, 2005**

 

**or**

 

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

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**Commission File Number 000-25873**

 

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**ApolloResources International, Inc.**

(Exact name of registrant as specified in itscharter)

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

 

**3001 Knox Street, Suite 403**

**Dallas, TX 75205**

(Address of principal executiveoffices, including zip code)

 

**(214) 389-9800**

(Registrant’s telephone number, includingarea code)

 

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

Yes ý    No o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act).Yes  o  No ý

 

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

 

As of August 19, 2005 therewere 82,614,213 shares of the registrant’s common stock outstanding.

 

 

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**APOLLORESOURCES INTERNATIONAL, INC.**

**BALANCESHEETS**

 
| ** **                                                                                                                                                                       | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                       | ** ** | ** **         | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                       |       |               |       |                   |       |
| Current Assets                                                                                                                                                                   |       |               |       |                   |       |
| Cash and cash equivalents                                                                                                                                                        |       | $                  | 4,737      |                   | $          | 56,018 |   |
| Accounts receivable working interest owners                                                                                                                                      |       | 138,739            |       | 102,790                |       |
| Trade accounts receivable                                                                                                                                                        |       | 20,474             |       | 35,063                 |       |
| Accounts receivable other                                                                                                                                                        |       | 171,688            |       | 30,709                 |       |
| Deposit – common stock pledged                                                                                                                                              |       | 1,000,000          |       | —                 |       |
| Other current assets                                                                                                                                                             |       | 36,374             |       | 7,643                  |       |
| Total Current Assets                                                                                                                                                             |       | 1,372,012          |       | 232,223                |       |
| Property and equipment, net                                                                                                                                                      |       | 16,045,975         |       | 7,564,531              |       |
| Investment in joint ventures                                                                                                                                                     |       | 1,690,016          |       | —                 |       |
| Investment in convertible preferred stock                                                                                                                                        |       | 495,000            |       | —                 |       |
| Patents and assigned technology net of  amortization of $15,300 at December 31, 2004                                                                                             |       | —             |       | 35,903                 |       |
| Other assets                                                                                                                                                                     |       | 439,839            |       | 56,475                 |       |
|                                                                                                                                                                             |       | $                  | 20,042,842 |                   | $          | 7,889,132 |   |
|                                                                                                                                                                             |       |               |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                   |       |               |       |                   |       |
| Current Liabilities                                                                                                                                                              |       |               |       |                   |       |
| Accounts payable and accrued liabilities                                                                                                                                         |       | $                  | 727,451    |                   | $          | 379,152 |   |
| Royalty payable                                                                                                                                                                  |       | 743,631            |       | 807,970                |       |
| Production, property and payroll taxes  payable                                                                                                                                  |       | 273,157            |       | 147,067                |       |
| Lease payable                                                                                                                                                                    |       | 511,071            |       | —                 |       |
| Notes payable                                                                                                                                                                    |       | 3,362,702          |       | 1,971,072              |       |
| Total Current Liabilities                                                                                                                                                        |       | 5,618,012          |       | 3,305,261              |       |
| Long-term debt                                                                                                                                                                   |       | 36,184             |       | —                 |       |
| Total Liabilities                                                                                                                                                                |       | 5,654,196          |       | 3,305,261              |       |
|                                                                                                                                                                             |       |               |       |                   |       |
| Stockholders’ Equity                                                                                                                                                        |       |               |       |                   |       |
| Common stock, $.001 par value; 150,000,000  shares authorized; and 71,784,405 and 23,853,900 shares issued and  outstanding at June 30, 2005 and December 31, 2004, respectively |       | $                  | 71,784     |                   | $          | 23,854 |   |
| Additional paid-in capital                                                                                                                                                       |       | 29,674,369         |       | 6,739,052              |       |
| Accumulated deficit                                                                                                                                                              |       | (7,501,136         | )          | (1,610,181             | )          |
| Common stock issued for future services                                                                                                                                          |       | (7,856,371         | )          | (568,854               | )          |
| Total Stockholders’ Equity                                                                                                                                                  |       | 14,388,646         |       | 4,583,871              |       |
|                                                                                                                                                                             |       | $                  | 20,042,842 |                   | $          | 7,889,132 |   |

 

Seeaccompanying notes to financial statements.

 

2

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**APOLLORESOURCES INTERNATIONAL, INC.**

**STATEMENTOF OPERATIONS**

 
| ** **                                 | ** ** | **Three Months  Ended** | ** ** | **Six Months  Ended** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **June 30, 2005**       | ** ** | **June 30, 2005**     | ** ** |
| Oil sales, net                             |       | $                       | 36,100     |                  | $          | 178,037 |   |
| Other revenue                              |       | 5,766                   |       | 12,321                |       |
| Total revenue                              |       | 41,866                  |       | 190,358               |       |
| Cost of sales                              |       | 94,726                  |       | 252,932               |       |
| Gross profit (loss)                        |       | (52,860                 | )          | (62,574               | )          |
| Selling, general and administrative        |       | 5,857,866               |       | 7,914,818             |       |
| Operating loss                             |       | (5,910,726              | )          | (7,977,392            | )          |
| Interest expense, net                      |       | (100,400                | )          | (171,823              | )          |
| Other income                               |       | 70,279                  |       | 75,574                |       |
| Loss from operations before income taxes   |       | (5,940,847              | )          | (8,073,641            | )          |
| Income taxes                               |       | —                  |       | —                |       |
| Loss before extraordinary item             |       | (5,940,847              | )          | (8,073,641            | )          |
|                                       |       |                    |       |                  |       |
| Extraordinary item:                        |       |                    |       |                  |       |
| Gain on extinguishment of debt, net of tax |       | —                  |       | 2,182,686             |       |
| Net Loss                                   |       | $                       | (5,940,847 | )                     | $          | (5,890,955 | ) |
|                                       |       |                    |       |                  |       |
| Income (loss) per common share:            | ** ** | ** **              | ** ** | ** **            | ** ** |
| ** **                                 | ** ** | ** **              | ** ** | ** **            | ** ** |
| Basic and diluted:                         |       |                    |       |                  |       |
| Loss before extraordinary item             |       | $                       | (.12       | )                     | $          | (.19 | ) |
| Extraordinary item                         |       | —                  |       | .05                   |       |
| Net loss                                   |       | $                       | (.12       | )                     | $          | (.14 | ) |
| ** **                                 | ** ** | ** **              | ** ** | ** **            | ** ** |
| Weighted average shares:                   | ** ** | ** **              | ** ** | ** **            | ** ** |
| ** **                                 | ** ** | ** **              | ** ** | ** **            | ** ** |
| Basic and diluted                          |       | 51,155,810              |       | 41,644,250            |       |

 

Seeaccompanying notes to financial statements.

 

3

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**APOLLO RESOURCES INTERNATIONAL, INC.**

**STATEMENTS OF STOCKHOLDERS’ EQUITY**

 
| ** **                                            | ** ** | **Common  Stock** | ** ** | **Additional  Paid In  Capital** | ** ** | **Common  Stock Issued  for Future  Services** | ** ** | **Accumulated  Deficit** | ** ** | **Totals** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------------------------------|------------|--------------------------|------------|------------|------------|
| **Balance December 31, 2004**                         |       | $                 | 23,854     |                             | $          | 6,739,052                                      |       | $                        | (568,854   | )          | $          | (1,610,181 | ) | $ | 4,583,871 |   |
| Common stock issued in acquisition                    |       | 8,000             |       | 3,992,000                        |       | —                                         |       | —                   |       | 4,000,000  |       |
| Common stock issued for investment in joint  ventures |       | 2,500             |       | 1,523,500                        |       | —                                         |       | —                   |       | 1,526,000  |       |
| Stock issued to retire debt                           |       | 300               |       | 110,610                          |       |                                           |       |                     |       | 110,910    |       |
| Stock pledged for note payable                        |       | 5,000             |       | 995,000                          |       |                                           |       |                     |       | 1,000,000  |       |
| Common stock issued in private equity sales           |       | 11,935            |       | 4,974,875                        |       | —                                         |       | —                   |       | 4,986,810  |       |
| Common stock issued for services                      |       | 16,983            |       | 9,751,552                        |       | (7,287,517                                     | )          | —                   |       | 2,481,018  |       |
| Common stock issued for employee  compensation        |       | 2,380             |       | 730,248                          |       | —                                         |       | —                   |       | 732,628    |       |
| Common stock issued as collateral for  purchases      |       | 832               |       | 357,532                          |       | —                                         |       | —                   |       | 358,364    |       |
| Capital contribution to subsidiary                    |       | —            |       | 500,000                          |       | —                                         |       | —                   |       | 500,000    |       |
| Net and comprehensive loss                            |       | —            |       | —                           |       | —                                         |       | (5,890,955               | )          | (5,890,955 | )          |
| **Balance June 30, 2005**                             |       | $                 | 71,784     |                             | $          | 29,674,369                                     |       | $                        | (7,856,371 | )          | $          | (7,501,136 | ) | $ | 14,388,646 |   |

 

Seeaccompanying notes to financial statements

 

4

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**APOLLORESOURCES INTERNATIONAL, INC.**

**STATEMENTSOF CASH FLOWS**

 
| ** **                                | ** ** | **Six Months Ended  June 30  2005** | ** ** |
|-------------------------------------------|------------|-------------------------------------|------------|
|                                      |       |                                |       |
| **Cash Flows from Operating Activities:** |       |                                |       |
| Net loss                                  |       | $                                   | (5,890,955 | ) |
| Non-cash items included in net loss:      |       |                                |       |
| Depreciation, amortization and depletion  |       | 108,166                             |       |
| Common stock issued for services          |       | 2,481,018                           |       |
| Stock issuance compensation expense       |       | 3,149,171                           |       |
| Common stock issued for compensation      |       | 723,400                             |       |
| Gain on extinguishment of debt            |       | (2,182,686                          | )          |
| Other                                     |       | (123,113                            | )          |
|                                      |       |                                |       |
| Changes in assets and liabilities:        |       |                                |       |
| Decrease (increase) in:                   |       |                                |       |
| Accounts receivable                       |       | (183,820                            | )          |
| Prepaid and other assets                  |       | (23,022                             | )          |
|                                      |       |                                |       |
| Increase (decrease) in:                   |       |                                |       |
| Accounts payable and accrued expenses     |       | 320,287                             |       |
| Net cash used in operating activities     |       | (1,621,554                          | )          |
|                                      |       |                                |       |
| **Cash Flows From Investing Activities:** |       |                                |       |
| Cash acquired in acquisitions             |       | 2,003                               |       |
| Purchase of equipment                     |       | (4,061                              | )          |
| Net cash used in investing activities     |       | (2,058                              | )          |
|                                      |       |                                |       |
| **Cash Flows From Financing Activities:** |       |                                |       |
| Proceeds from notes payable               |       | 112,005                             |       |
| Proceeds from sales of common stock       |       | 1,837,639                           |       |
| Repayments of notes payable               |       | (377,313                            | )          |
| Net cash provided by financing activities |       | 1,572,331                           |       |
|                                      |       |                                |       |
| Net decrease in cash                      |       | (51,281                             | )          |
|                                      |       |                                |       |
| Cash and cash equivalents                 |       |                                |       |
| Beginning of year                         |       | 56,018                              |       |
| End of period                             |       | $                                   | 4,737      |   |

Seeaccompanying notes to financial statements.

 

5

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**1.  NATURE OFOPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

Companyand Purpose – Apollo Resources International, Inc. (the “Company”) wasincorporated on July 9, 1997 under the laws of the State of Utah. EffectiveOctober 28, 2004, the Company executed a share exchange agreement, in which theCompany acquired an oil and natural gas production company. With thisacquisition the Company changed its primary business focus to oil & naturalgas production. Subsequent acquisitions and ventures have added oil and naturalgas transportation via the acquisition of pipelines and developed analternative fuels segment with ventures in biodiesel and hydrogen energyalternatives. Before October 28, 2004, the Company was accounted for as adevelopmental stage company for the purpose of raising capital to invest in ajoint venture which acquired a license to certain technology relating to theproduction of hydrogen, to generate hydrogen for sale, and to market hydrogengenerating equipment and products.

 

Basisof Presentation - The accompanying consolidated financial statements includethe accounts of the Company and its wholly owned subsidiaries. JSCKaliningradneft (“Kaliningrad”) management has to date not provided thefinancial statements of Kaliningrad in accordance with U.S. generally acceptedaccounting principles. Accordingly, the results of operations of Kaliningradhave not been included in the results of operations of the Company. Allsignificant intercompany transactions and balances have been eliminated.Results of operations for the Company’s gas transmission company, OGC Pipeline,LLC (“OGC”), have been consolidated since February 7, 2005, the effective dateof the acquisition.

 

Withthe execution of the share exchange agreement on October 28, 2004, the Company effecteda 2 for 1 reverse split of its common stock. Pursuant to the agreement, the Company acquired all of the issued andoutstanding shares of Theseus Resources, Inc. (“Theseus”), in exchange for theissuance of 18,000,000 post-split shares of the Company’s restricted commonstock.  This transaction was recorded asa reverse acquisition using the purchase method of business combinations.  In a reverse acquisition all accounting historybecomes that of the accounting acquirer. Therefore, all historical information prior to the acquisition is thatof Theseus.  Accordingly, there are nocomparative financial statements presented for the three and six month periodsended June 30, 2005.

 

Inmanagement’s opinion, these financial statements include all adjustmentsnecessary, accept those related to Kaliningrad discussed above, to presentfairly the financial position of the Company at June 30, 2005 and the resultsof operations and changes in cash flows for the three and six month periods endedJune 30, 2005. The accounting and reporting policies of the Company conform togenerally accepted accounting principles and reflect practices appropriate forits industry.  Revenue is recognized whenearned in accordance with the accrual basis of accounting.  These policies are summarized below.

 

Management’s Estimates and Assumptions – The presentation of financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual results coulddiffer from those estimates. The Company reviews all significant estimatesaffecting the financial statements on a recurring basis and records the effectof any necessary adjustments prior to their issuance.

 

Cash and Cash Equivalents—Cash equivalents consist of highly liquidinvestments with original maturities of three months or less.

 

Accounts Receivable– At June 30, 2005, the amounts carried in accountsreceivable were considered by management to be collectible in full.

 

Accounts Receivable Working Interest Owners— The Company previouslyadvanced funds to working interest owners. As net royalties are earned, the working interest owners are reducingtheir receivable on a quarterly basis. The working interest owners receive 54%of the revenue and are billed 54% of the direct expenses.  For the period ended June 30, 2005, theworking interest owners accrued revenue of $49,688. As of June 30, 2005 theworking interest owners owed the Company $138,739.

 

6

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Concentration of Credit Risk— Financial instruments which potentiallysubject the Company to concentrations of credit risk consist principally ofaccounts receivable and temporary cash investments.  Exposure to losses on receivables isprincipally dependent on each customer’s financial condition.  The Company controls its exposure to creditrisk through credit approvals, credit limits and monitoring procedures andestablishes allowances for anticipated losses. The Company places its temporarycash investments with quality financial institutions and, by policy, limits theamount of credit exposure with any one financial instrument.

 

Fair Market Value of Financial Instruments— The estimated fair value ofcash and cash equivalents, accounts receivable, investments in marketableequity securities, accounts payable, accrued expenses and other liabilitiesapproximate their carrying amounts in the financial statements. The Company’sfinancial instruments include notes payable. The carrying value of notespayable approximates market value because the borrowing rate is similar toother financial instruments with similar terms.

 

Patents and Assigned Technology — The Company contributed its Patenttechnology to Decarb Energy Technologies, LLC (“Decarb”) upon entering into ajoint venture with Decarb. This joint venture between the Company and a formerofficer of the Company, enables the Company to continue its research inhydrogen fuel alternatives. The Patent technology relates to a HydrogenGeneration System and Fuel Pellet technology relating to the production ofhydrogen.

 

Warrants - During 2003, the Company issued a former officer inconnection with such officer’s employment agreement, a warrant for 65,000shares of restricted common stock. Such warrant has an exercise price of $2.50per share and expires on December 11, 2006.

 

Stock Options and Warrants—The Company accounts for its stock-basedcompensation plans in accordance with Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (APB 25) andrelated interpretations. The Company accounts for stock-based compensation fornon-employees under the fair value method prescribed by Statement of FinancialAccounting Standards No. 123, “Accounting for Stock-Based Compensation.”Through June 30, 2005, there have been no significant grants to non-employees.

 

The Company grants incentive and non-qualified stock options and hasreserved 19,532,000 shares of common stock for issuance under its stock optionplans. The majority of the options granted become exercisable at the date ofgrant, and generally expire three years after the date of grant.

 

The Company adopted the disclosure provisions of Statement of FinancialAccounting Standards No. 123 (SFAS No. 123), “Accounting for StockBased Compensation.” This statement requires the Company to provide pro formainformation regarding net income and net income per share as if compensationcost for the Company’s stock options had been determined in accordance with thefair value method. The fair value of these options was estimated at the date ofgrant using a Black-Scholes option pricing model with the following weightedaverage assumptions for 2005.

 

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

 

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

 

7

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| ** **                                                                                                       | ** ** | **Three Months Ended  June 30, 2005** | ** ** | **Six Months Ended  June 30, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
|                                                                                                             |       |                                  |       |                                |       |
| Net loss, as reported                                                                                            |       | $                                     | (5,940,847 | )                                   | $          | (5,890,955 | ) |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards |       | —                                |       | (937                                | )          |
| Adjusted net loss                                                                                                |       | $                                     | (5,940,847 | )                                   | $          | (5,891,892 | ) |
|                                                                                                             |       |                                  |       |                                |       |   |   |
| Earnings per share                                                                                               |       |                                  |       |                                |       |
| As reported                                                                                                      |       |                                  |       |                                |       |
| Basic and diluted                                                                                                |       | $                                     | (.12       | )                                   | $          | (.14 | ) |
| As adjusted                                                                                                      |       |                                  |       |                                |       |
| Basic and diluted                                                                                                |       | $                                     | (.12       | )                                   | $          | (.14 | ) |

 

Revenue – Oil and natural gas production revenue is recognized at thetime and point of sale after the product has been extracted from the ground.

 

Comprehensive Income—Comprehensive income includes all changes inequity except those resulting from investments by stockholders anddistributions to stockholders.

 

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

 

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

 
| ** **                       | ** ** | **Net Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
|----------------------------------|------------|-----------------------------|------------|---------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | ** **                  | ** ** | ** **                | ** ** | ** **            | ** ** |
| Three Months Ended June 30, 2005 |       |                        |       |                      |       |                  |       |
| Basic earnings per share         |       | $                           | (5,940,847 | )                         | 51,155,810 |                  | $          | (.12 | ) |
| Effect of dilutive securities:   |       |                        |       |                      |       |                  |       |
| Stock options and warrants       |       | —                      |       | —                    |       | —                |       |
| Convertible notes                |       | —                      |       | —                    |       | —                |       |
| Diluted earnings per share       |       | $                           | (5,940,847 | )                         | 51,155,810 |                  | $          | (.12 | ) |

 
| ** **                     | ** ** | **Net Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
|--------------------------------|------------|-----------------------------|------------|---------------------------|------------|-----------------------|------------|
| Six Months Ended June 30, 2005 |       |                        |       |                      |       |                  |       |
| Basic earnings per share       |       | $                           | (5,890,955 | )                         | 41,644,250 |                  | $          | (.14 | ) |
| Effect of dilutive securities: |       |                        |       |                      |       |                  |       |
| Stock options and warrants     |       | —                      |       | —                    |       | —                |       |
| Convertible notes              |       | —                      |       | —                    |       | —                |       |
| Diluted earnings per share     |       | $                           | (5,890,955 | )                         | 41,644,250 |                  | $          | (.14 | ) |

 

8

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Total stock options and warrants outstanding at June 30, 2005 that arenot included in the diluted earnings per share computation are approximately80,875. Convertible notes not included in the computation of diluted earningsper share are equivalent to approximately 1,328,755 shares. These stockoptions, warrants and convertible notes were not included in the computation ofearnings per share at June 30, 2005 due to exercise prices exceeding theaverage market value of the Company’s common stock, and due to the Company’sincurring a net loss during the periods presented.

 

Basic net income per share is computed by dividing net income availableto common shareholders (numerator) by the weighted average number of commonshares outstanding during the year (denominator).  Diluted net income per share is computedusing the weighted average number of common shares and potential common sharesoutstanding during the year.  Potentialcommon shares result from the assumed exercise, using the treasury stockmethod, of outstanding stock options, warrants and convertible notes having adilutive effect. The numerator for the periods presented is equal to thereported net income.

 

Income Taxes— The Company utilizes the liability method for accountingfor income taxes.  The liability methodaccounts for deferred income taxes by applying enacted statutory rates ineffect at the balance sheet date to differences between financial statementamounts and tax bases of assets and liabilities.  The resulting deferred income tax liabilitiesare adjusted to reflect changes in tax laws and rates.  Temporary differences consist of the differencein financial statement and income tax bases for accounting for start-up andorganizational costs.  Deferred incometaxes related to an asset or liability are classified as current or non-currentbased on the classification of the related asset or liability.  Deferred tax assets related to lossesaccumulated during the development stage and thereafter have been reduced by acorresponding valuation allowance at June 30, 2005, and accordingly, no incometax expense or benefit has been recognized. Net operating loss carryforwardsapproximating $9.2 million expire in the years 2013 through 2019.

 

**2.GOING CONCERN AND MANAGEMENT PLANS**

 

During the period ending June 30, 2005, the Company recorded a net lossof $5,890,955. Since the Company completed its reverse merger on October 28,2004, the Company has accumulated losses aggregating $7.5 million.  The Company’s continued existence isdependent upon its ability to take advantage of acquisition opportunities,raise capital through private securities offerings, secure collateralized debtfinancing and use these sources of capital to grow and enhance its oil and gasproduction and gas pipeline transmission operations. During the fourth quarterof fiscal 2004 the Company completed the acquisition of BC&D Oil & GasCorporation (“BC&D”). The acquisition of BC&D marked the initialentrance of the Company into the oil and natural gas production business.During the first quarter of fiscal 2005, the Company negotiated the acquisitionof OGC, a gas gathering company. The OGC acquisition added a pipeline networkto the Company’s assets enabling the Company to diversify into the oil and gastransmission business. In addition, the Company has acquired a 50% interest inDecarb, Energy Ventures Organization, Inc. (“Energy Ventures”), and EarthBiofuels, Inc. (“Biofuels”). Decarb and Energy Ventures are focused ondeveloping hydrogen power projects, while Biofuels produces and distributesbio-diesel fuel. The Company believes these acquisitions will be a part ofestablishing future financial stability. In July of 2005 the Company completeda $3.0 million financing consisting of convertible notes with related warrants.The Company collateralized certain of its oil and gas assets and propertiesalong with its pipeline assets to secure this funding. Please see note 13 (SubsequentEvents) for terms relating to the $3.0 million financing. The Company has alsocontinued to raise capital through a variety of private securities offerings ofits common stock.

 

Managementis focusing on expanding and improving its oil and natural gas productionoperations and alternative fuels ventures. Through acquisition, organic growthand funding via collateralized loans and private placement offerings, theCompany plans to continue to increase the profitability of its operationsnecessary to support 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.

 

9

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The Company’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. On July 7, 2005 the Company completed a $3.0million financing. This financing allowed the Company to secure full payment ofits pipeline assets and infuse capital into its oil and gas subsidiary BC&Das well as continue funding its alternative fuels joint ventures. As of June30, 2005, the Company continued to seek other financing from private placementsand other acquisitions to expand its opportunities in the areas of oil and gasproduction, oil and gas transmission and alternative fuels businesses. TheCompany has implemented cost saving measures including staff reductions. TheCompany will take additional cost savings measures, if necessary, to enhanceits 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.

 

**3.PROPERTY AND EQUIPMENT**

 

The Company follows the full cost method of accounting for explorationand development of oil and gas properties whereby all costs in acquiring,exploring and developing properties are capitalized, including estimates ofabandonment costs, 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 |   |
|-------------------------|--------|-----------|--------|
| Machinery and equipment |   | 5-7 Years |   |
| Gas plant               |   | 7 Years   |   |
| Automobiles             |   | 5 Years   |   |

 

Property, plant and equipment consist of the following:

 
| ** **                                                 | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| Building                                                   |       | $                 | 46,297     |                  | $          | — |   |
| Machinery and equipment                                    |       | 1,949,547         |       | 2,036,501             |       |
| Computer equipment                                         |       | 3,737             |       | —                |       |
| Gas plant                                                  |       | 316,443           |       | 316,443               |       |
| Intangible drilling costs                                  |       | 229,848           |       | 229,848               |       |
| Oil & gas leases                                       |       | 7,694,708         |       | 7,694,708             |       |
| Pipeline easements                                         |       | 8,028,181         |       | —                |       |
| Automobiles                                                |       | 49,107            |       | 49,107                |       |
| Leasehold improvements                                     |       | —            |       | 22,091                |       |
|                                                       |       | 18,317,868        |       | 10,348,698            |       |
| Less accumulated depreciation, amortization  and depletion |       | 2,271,893         |       | 2,784,167             |       |
|                                                       |       | $                 | 16,045,975 |                  | $          | 7,564,531 |   |

 

Depreciation,amortization and depletion expense for the three and six months ended June 30,2005 was $28,396 and $108,166, respectively.

 

Depreciation,amortization and depletion expense for the year ended December 31, 2004 was$80,993.

 

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**4.ACQUISITIONS**

 

Effective February 7, 2005 the Company acquired 100%membership interest in OGC from SW Energy Investments, Inc. (“SW Energy”). Inconsideration of this acquisition the Company exchanged 8,000,000 shares of theCompany’s common stock valued at $.50, the closing market price on February 7,2005. In this acquisition the Company acquired approximately 1,800 miles ofpipeline used for the transmission of oil and natural gas. Post acquisition SWEnergy owned approximately 18% of the outstanding common stock of the Company.

 

This transaction was recorded using the purchasemethod of business combinations.

 

The following is a condensed balance sheetdisclosing the actual carrying values of OGC’s assets and liabilities at theacquisition date.

 
| ASSETS                                          |   |      |      |   |
|-------------------------------------------------|--------|-----------|-----------|--------|
|                                            |   |      |      |   |
| Cash and cash equivalents                       |   | $         | 2,003     |   |
| Pipeline easements                              |   | 7,987,706 |      |
|                                            |   |      |      |
| Total assets                                    |   | $         | 7,989,709 |   |
|                                            |   |      |      |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY      |   |      |      |
|                                            |   |      |      |
| Accounts payable and accrued expenses           |   | $         | 1,204,170 |   |
| Notes payable                                   |   | 2,785,539 |      |
| Stockholders’ equity                       |   | 4,000,000 |      |
|                                            |   |      |      |
| Total liabilities and stockholders’ equity |   | $         | 7,989,709 |   |

 

The following represents the approximate pro-formaeffect assuming the acquisition with OGC had occurred on January 1, 2005, thebeginning of the Company’s current fiscal year.

 
| ** **                                                     | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                     | ** ** | **June 30, 2005**    | ** ** |
|                                                           |       |                 |       |
| Net Loss, as reported                                          |       | $                    | (5,890,955 | ) |
| Additional estimated OGC net loss (prior to  acquisition date) |       | (27,916              | )          |
|                                                           |       |                 |       |
| Pro-forma net loss                                             |       | $                    | (5,918,871 | ) |
|                                                           |       |                 |       |
| Weighted average shares outstanding, as reported               |       | 41,644,250           |       |
| Adjustment to reflect common stock issued  to SW Energy        |       | 1,635,359            |       |
|                                                           |       |                 |       |
| Pro-forma weighted average shares  outstanding                 |       | 43,279,609           |       |
|                                                           |       |                 |       |
| Loss per  share, as reported                                   |       | $                    | (.14       | ) |
|                                                           |       |                 |       |
| Pro-forma loss per share                                       |       | $                    | (.14       | ) |

 

EffectiveMarch 18, 2005, the Company entered into a stock sale agreement withshareholders of Kaliningrad. Kaliningrad management has to date not providedthe financial statements of Kaliningrad in accordance with United Statesgenerally accepted accounting principles. Accordingly, the results ofoperations of Kaliningrad have not been included in the results of operationsof the Company. Pursuant to the stock sale agreement the Company acquired 90%of the equity interest of Kaliningrad. In consideration, the Company executed aconvertible debenture, maturing March 18, 2006, in the amount of $18,500,000payable to the shareholders of Kaliningrad. This convertible debenture accruesinterest annually at 6%. This debenture is convertible into the Company’scommon stock and is subject to a share price

 

11

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notless than $2.00 per share. This transaction marked the Company’s initialentrance into international oil and natural gas production. Kaliningradcurrently produces approximately 21,000 barrels of oil per month from eightwells. Kaliningrad is one of three oil exploration and production companiesthat currently operate in the far-western Russian province of Kaliningrad. Oilreserves for Kaliningrad have been certified by the government at 4.32 millionbarrels.

 

**5.EQUITY TRANSACTIONS**

 

On June 30, 2005, the Company issued 8,000,000shares of its common stock to acquire 100% membership interest in OGC. TheCompany also issued 1,700,000 shares of its common stock as consideration toenter into a 50% joint venture with Biofuels and 800,000 shares to acquire a50% interest in Energy Ventures.

 

During the first six months of 2005 the Companyissued 11,935,949 shares of its common stock through private placements.  Proceeds of these sales total $1,837,639 forthe six months ended June 30, 2005.

 

During the first six months of 2005 the Companyissued 16,983,604 shares of the Company’s common stock to consultants inrestricted form and pursuant to the Company’s 2004 and 2005 Stock Option andAward Plans. These shares of common stock were issued at the fair market valueprice on the date of issuance and resulted in approximately $2,271,076 and $3,149,171of consulting services expense for the three and six months ended June 30,2005.

 

During the first six months of 2005 the Companyissued 2,380,000 shares of its common stock to employees as compensation. Theseshares of common stock were issued at the fair market value price on the dateof issuance and resulted in approximately $550,000 and $723,400 of employeecompensation expense for the three and six months ended June 30, 2005.

 

The Company has issued a total of 831,818 shares ofits common stock valued at $358,364 as collateral for purchases made by BlueWireless and Data, Inc. The Company’s CEO and Corporate Secretary act asChairman of the Board and CEO of Blue Wireless and Data, Inc.

 

During the second quarter of 2005 the Company issued5,000,000 shares of its common stock to Koch Pipeline Company L.P. (“Koch”)valued at $1.0 million. These shares were pledged as collateral on the $1.0million note due to Koch and were held in escrow pending the Company’s finalpayment. In July of 2005, the Company made full payment to Koch. Subsequentlythe 5,000,000 shares of the Company’s common stock were returned to the Companyand cancelled.

 

During the second quarter of 2005 the Company issued300,000 shares of its common stock valued at approximately $111,000 to retire a$100,000 convertible note payable to Mr. Bruce Blackwell.

 

**6.LEASES**

 

The Company currently maintains an agreement topurchase office space in Trona, California to facilitate its hydrogenalternative fuel technology development for $54,994. The office lease is for aterm of 59 months commencing on March 31, 2005 at $917 per month.  The Company entered into a twelve monthcapital lease agreement valued at $511,071 for equipment and a gas plant onJanuary 17, 2005. The capital lease agreement calls for eleven monthlyinstallments of $15,000 with a final payment of $346,071 due at the end of thelease.

 

Thefollowing is a schedule of future minimum rent and lease payments due:

 

| **Year Ending December 31,** | ** ** | ** ** | ** ** |
|------------------------------|------------|------------|------------|
| 2005                         |       | 519,325    |       |
| 2006                         |       | 11,006     |       |
| 2007                         |       | 11,006     |       |
| 2008                         |       | 11,006     |       |
| 2009                         |       | 11,006     |       |
| Thereafter                   |       | 2,716      |       |
| Total                        |       | 566,065    |       |

 

Rent expense was $1,006 and $2,806 for the three andsix months ended June 30, 2005.

 

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**7.INVESTMENTS**

 

As part of establishing the Company’s investment in alternative fuels, the Company executed a purchase and sale agreement on February 25, 2005 to acquire a 50% interest in Biofuels in exchange for 1,700,000 shares of restricted common stock of the Company. On December 6, 2004, the Company formed Decarb, a joint venture between the Company and a former officer of the Company. In addition, on May 2, 2005 the Company reached agreement with Energy Ventures to acquire a 50% interest for 800,000 shares of restricted common stock valued at $200,000. At June 30, 2005 the Company’s investment in these ventures totaled $1,690,016.

 

The investments in Biofuels, Decarb and Energy Ventures have been accounted for using the equity method of accounting. During the three and six months ended June 30, 2005, the Company realized income of $67,218 and $72,513 related to these investments. These amounts have been classified in the Company’s statement of operations under the caption “Other income”.

 

On March 31, 2005 the Company assigned a note receivable valued at $495,000 in exchange for 495,000 shares, $1.00 par value, convertible preferred stock of Blue Wireless and Data, Inc. This investment is shown as a non-current liability in the Company’s balance sheet.

 

**8. NOTES PAYABLE**

 

AtJune 30, 2005 the Company maintained notes payable acquired with itsacquisitions of BC&D and OGC and to various vendors.  

 
| **Lender**                               | ** ** | **Maturity  Date** | ** ** | **Interest  Rate** | ** ** | **Original  Principal  Amount** | ** ** |
|------------------------------------------|------------|--------------------|------------|--------------------|------------|---------------------------------|------------|
| Jimmy Brown                              |       | On Demand          |       | 13.00              | %          | $                               | 200,000    |   |
| Convertible Note D. Hill (1)             |       |               |       | 6.00               | %          | 1,000,000                       |       |
| TelcoEnergy Corporation                  |       | 9/22/2005          |       | 6.00               | %          | 179,000                         |       |
| Peter Knollenberg                        |       | On Demand          |       | 6.00               | %          | 150,000                         |       |
| Convertible Notes OGC (2)                |       | On Demand          |       | 10.00              | %          | 598,241                         |       |
| JPB Resources, Inc.                      |       | 2/24/2006          |       | 13.00              | %          | 50,000                          |       |
| JPB Resources, Inc.                      |       | On Demand          |       | 11.00              | %          | 100,000                         |       |
| Koch Pipeline Co., L.P. (3)              |       |               |       | 9.00               | %          | 1,000,000                       |       |
| Other (4)                                |       |               |       |               |       | 121,645                         |       |
| Total notes payable                      |       |               |       |               |       | 3,398,886                       |       |
| Less current portion of notes payable    |       |               |       |               |       | 3,362,702                       |       |
| Long –term portion of notes payable |       |               |       |               |       | $                               | 36,184     |   |

 

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(1)          Convertible note due to the former owner of BC&D Oil & GasCorporation. The Company and Mr. Hill have reached an agreement to settle thisnote pending settlement negotiations pertaining to current litigation.

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

(3)          Note was paid in full in July 2005.

(4)          Miscellaneous notes for insurance and other vendors

 

**9.ROYALTY PAYABLE**

 

The Company has various royalty arrangements with non-working interestowners.  As of June 30, 2005 the Companyowed royalties of $783,764 to non-working interest owners and regulatoryagencies.

 

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**10.EXTRAORDINARY ITEM**

 

Effective March 31, 2005 the Company executed a Compromise of DebtAgreement with Koch. This agreement effectively reduced the principal andinterest obligation on the note payable assumed in the acquisition of OGC inFebruary. The principal and interest was reduced to $1,100,000 as full paymenton the pipeline assets resulting in forgiveness of debt in the amount of$2,182,686 in principal and accrued interest. The Company made paymentstotaling $100,000 to Koch during the second quarter of 2005. In July 2005, theremaining balance of $1,000,000 was paid in full.

 

**11.RELATED PARTY TRANSACTIONS**

 

The Company entered into a management services agreement with DGMAC,LLC effective March 15, 2005. Under the terms of this agreement the Company ischarged $40,000 monthly for services provided by Dennis McLaughlin, its ChiefExecutive Officer and Chairman of the Board. The Company and Mr. McLaughlinagreed to make no accrual of Mr. McLaughlin’s compensation, related to hismanagement services agreement during the first quarter of 2005. The Companyresumed accrual of Mr. McLaughlin’s management service agreement effective July1, 2005 upon completion of the Company’s current funding.

 

The Company entered into a management services agreement with JohnnyFlame Consulting, LLC effective March 15, 2005. Under the terms of theagreement the Company is charged $15,000 monthly for services provided byChristopher Chambers, its Corporate Secretary.The Company and Mr. Chambers agreed to makeno accrual of Mr. Chamber compensation, related to his management servicesagreement during the first quarter of 2005. The Company resumed accrual of Mr.Chambers management service agreement effective July 1, 2005 upon completion ofthe Company’s current funding.

 

The Company entered into a managementservices agreement with MAC Partners, LP (“MAC”) effective November 12, 2004.Under the terms of this agreement the Company is charged $45,000 monthly forgeneral administration, human resources, turnkey office and legal services. Inaddition, MAC provides the services of Mr. J. Mark Ariail and Mr. WayneMcPherson, the Company’s Chief Financial Officer and Chief Operating Officer.Effective March 15, 2005, Mr. Ariail and Mr. McPherson’s services were nolonger provided by MAC and they became employees of the Company. The Companyand MAC are currently under negotiations to restructure the management servicesagreement as provided under the terms of the agreement. On February 15, 2005,MAC loaned the Company $112,015 through a promissory note bearing interest at7% per annum. This promissory note matures on February 15, 2007 and contains adefault interest provision of 18% per annum. At June 30, 2005 there were noamounts outstanding on this promissory note.

 

On January 17, 2005 the Company entered into a Bill of Sale andAssignment Agreement whereby it conveyed ownership of two generators and a gasplant, valued at approximately $500,000, to Sovereign Strategic Partners, Ltd. (“Sovereign”)in exchange for a promissory note in the amount of $495,000.  This note was secured by an Agreement ofPledge pursuant to which 20,000,000 shares of Blue Wireless and Data, Inc. (“Blue”)were contributed as collateral. Subsequently, the Company entered into aCapital Lease Agreement with Sovereign whereby Sovereign leased the generatorsand gas plant to the Company. The Company subsequently assigned the Sovereignpromissory note to MAC in exchange for 495,000 shares of convertible preferred stockof Blue. Mr. McLaughlin currently serves as the Chairman of the Board of Blueand Mr. Chambers serves as Blue’s Chief Executive Officer.

 

During the half ended June 30, 2005, the Company issued 150,000 sharesof its common stock valued at $222,000 to Blue to be pledged as collateral foran equipment loan for Blue. During the second quarter of 2005 an additional681,818 shares of the Company’s common stock valued at $136,364 were issueddirectly to Blue’s vendor for additional collateral required on the equipmentloan due to fluctuations in the Company’s stock price. Mr. McLaughlin currentlyserves as the Chairman of the Board of Blue and Mr. Chambers serves as Blue’sChief Executive Officer.

 

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**12.SUPPLEMENTAL CASH FLOW INFORMATION**

 

Significantnon-cash transactions are summarized as follows:

 
| ** **                                            | ** ** | **June 30,  2005** | ** ** |
|-------------------------------------------------------|------------|--------------------|------------|
| Common stock issued for services                      |       | $                  | 2,481,018  |   |
| Common stock issued in acquisition of  subsidiary     |       | $                  | 4,000,000  |   |
| Stock issuance compensation expense                   |       | $                  | 3,149,171  |   |
| Common stock issued for investment in joint  ventures |       | $                  | 1,526,000  |   |
| Gain on extinguishment of debt                        |       | $                  | 2,182,686  |   |
| Stock pledged for note payable                        |       | $                  | 1,000,000  |   |

 

**13. SUBSEQUENT EVENTS**

 

*$3.0 Million Convertible Notes with Warrants*

 

On June 30, 2005, the Company entered into (and on July 7, 2005completed the transaction contemplated by) a Note and Warrant PurchaseAgreement with the certain investors, pursuant to which the Company issued$3,000,000 principal amount of 8% Secured Convertible Promissory Notes andrelated securities.

 

Thefollowing summarizes the principal terms of the transaction:

 

***Terms of Secured Convertible Promissory Notes***

 

Pursuantto the Note and Warrant Purchase Agreement, the Company sold to certaininvestors (the “Noteholders”) an aggregate of $3,000,000 principal amount of 8%secured convertible promissory notes, together with warrants to purchase anaggregate of 12,000,000 shares of the Company’s common stock, and an additionalinvestment right entitling the Noteholders to purchase up to an additional$3,000,000 of 8% secured convertible promissory notes and warrants to purchasean aggregate of 12,000,000 shares of the Company’s common stock.

 

Thesenotes are secured by a continuing security interest in certain of the Company’sassets pursuant to the terms of a security agreement among Apollo ResourcesInternational, Inc., its wholly owned subsidiaries BC&D Oil and GasCorporation (“BC&D”) and OGC Pipeline LLC (“OGC”), and theNoteholders.  Additional terms of the 8%secured convertible notes include:

 

•                  Unlessconverted or redeemed as described below, the 8% secured convertible notes aredue on December 30, 2007.

 

•                  8%annual interest, payable semi-annually in arrears beginning December 1, 2005.The interest is payable either in cash or at the Company’s option (subject tothe satisfaction of certain conditions) in shares of the Company’s common stockvalued at 92.55% of the volume weighted average price of the Company’s commonstock for the 5 trading days prior to the payment date.

 

•                  Whilethe notes are outstanding, if the Company issues equity or equity linkedsecurities at a price lower than the conversion price, then the conversionprice of these 8% secured convertible notes will be reduced to the same price.

 

•                  Thenotes are convertible at any time at the option of the Noteholders into sharesof the Company’s common stock at a conversion price of $0.25 per share.  The conversion price is also subject toadjustment upon the occurrence of certain specified events, including stockdividends and stock splits, mergers or consolidations, or certain issuances ofcommon stock at a price below the initial conversion price of $0.25 per share,subject to adjustment as set forth above.

 

•                  Thenumber of shares of the Company’s common stock acquired by any Noteholders uponconversion of the notes is limited to the extent necessary to ensure thatfollowing the conversion the total number of shares of the Company’s commonstock beneficially owned by the Noteholders does not exceed 4.999% of ourissued 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 Noteholders will have 30 calendardays to convert the notes into shares of the Company’s common stock. If theCompany elects to prepay the notes, the Company must do so pro-rata amongst theNoteholders.

 

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***Terms of Warrants***

 

TheCompany also issued warrants to purchase up to 12,000,000 shares of the Company’scommon stock. Thewarrants are exercisable for five years from the date of issuance at anexercise price of $0.30 per share.

 

Thewarrant exercise price is subject to adjustment upon the occurrence of certainspecified events, including stock dividends and stock splits, pro ratadistributions of equity securities, evidences of indebtedness, rights orwarrants to purchase common stock or cash or any other asset, mergers orconsolidations, or certain issuances of common stock at a price below theinitial exercise price of $0.30 per share.

 

Thewarrants include a “cashless exercise” feature, which permits the Noteholder toexercise the warrants by surrender of a portion of the warrants. The cashlessexercise feature is available to the Noteholder, if at the time of exercise,there is not in effect a registration statement covering the shares underlyingthe warrants.

 

***Terms of Additional Investment Right***

 

TheCompany also issued an additional investment right, which entitles theNoteholders to purchase (a) up to an additional $3,000,000 principal amount of8% secured convertible notes and (b) warrants to purchase up to an additional12,000,000 shares of the Company’s common stock.  This additional investment right vests 30days following the registration of the underlying shares of common stock andends six months thereafter. The terms and conditions of the securitiescontained in the additional investment right will be identical to the initialnotes and warrants.

 

***Registration of Common Stock***

 

TheCompany agreed to file a registration statement with the Securities andExchange Commission registering the shares of common stock issuable uponconversion of the notes and exercise of the warrants, as well as the sharesrelated to the additional investment right. If the Company fails to file the registration statement on a timelybasis, or if it is not declared effective by the Securities and ExchangeCommission within a maximum of 150 days from the date the Company closed thetransaction contemplated by the Note and Warrant Purchase Agreement (July 7,2005), the Company is required to pay to the Noteholders liquidated damagesequal to 2.0% of the amount invested and liquidated damages equal to 1.0% ofthe amount invested for each subsequent 30-day period.

 

***Exchange Rights***

 

Forthe 24-month period from the date of the closing, if the Company completes aprivate equity or equity-linked financing on terms more favorable than theterms governing the notes, the Noteholders may exchange the notes at 100% offace value for the securities in such new financing, provided that the exchangeis in compliance with applicable securities laws.

 

***Right of First Offer***

 

Forthe 12-month period from the date of the closing, the Noteholders will have theright of first offer to purchase all or part of any private financing, subjectto certain exceptions, including employee options plans, the issuance of stockfor situations involving strategic partnerships, acquisition candidates andunderwritten public offerings.

 

***Change of Control***

 

Inthe event a third party acquires greater than 50% of the Company’s outstandingshares of common stock, the Noteholders may elect to have the notes redeemed bythe Company at 110% of face value plus all accrued interest and unpaidinterest, which, at the Noteholders option, may be paid in cash or commonstock.

 

***Placement Agent Fees; Other Fees***

 

TheCompany engaged H.C. Wainwright & Co., Inc. (“Wainwright”), as theexclusive placement agent in connection with the private placement. Under theCompany’s agreement with Wainwright, a cash fee of $210,000 (7% of the grossproceeds of the financing) was paid and, in addition, issued to Wainwrightwarrants to purchase 1,200,000 shares of common stock at $0.25 and warrants topurchase 1,200,000 shares of common stock at $0.30. The warrants generally havethe same terms as the warrants issued to the Noteholders.  In addition, the Company agreed to pay to

 

16

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Wainwright a cash fee of 7% of the aggregateconsideration received by the Company from the exercise of any warrants.  The Company paid the Noteholders approximately$21,000 for the legal fees incurred in connection with this transaction.  The Company also engaged 1st SB Partners Ltd.as an advisor in connection with the private placement.  Under the Company’s agreement with 1st SB, theCompany paid a cash fee of $210,000 (7% of the gross proceeds of the financing)and, in addition, issued to 1st SB warrants to purchase 1,200,000 shares ofcommon stock at $0.25 and warrants to purchase 1,200,000 shares of common stockat $0.30.  The warrants generally havethe same terms as the warrants issued to the Noteholders.

 

*Acquisition of Earth Biofuels, Inc.*

 

On August 19, 2005 the Company entered into a Securities PurchaseAgreement to acquire additional shares of Biofuels, the Company’s 50% ownedsubsidiary.  As a consequence of theacquisition, the Company will own 80% of the issued and outstanding shares ofBiofuels.  Pursuant to the transaction,the Company will issue 6 million restricted shares of its common stock toBiofuels shareholders. 

 

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

 

Overview

 

The Company derives its revenue primarily from monthly oil and naturalgas production sales and rental fees related to its gas pipeline. During thefirst six months ended June 30, 2005, the Company entered into a stock saleagreement with shareholders of Kaliningrad, a Russian oil and natural gasproduction company. This agreement adds to the Company’s domestic oil andnatural gas production company, BC&D, acquired in 2004. With these eventsthe Company changed its business focus to oil and natural gas production fromthe development of hydrogen generating technology. The Company continued toexpand its capabilities in the oil and natural gas business by acquiring aseries of pipelines. In addition, during the first quarter of 2005, the Companystarted its alternative fuels business segment designed to complement thegrowing need for alternative energy sources versus the increasing demand oftraditional oil and natural gas energy sources. The Company also focused onraising capital through private placements of its common stock and securingcollateralized debt financing essential to providing the capital to expand itsbusiness segments.

 

CriticalAccounting Policies

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the amounts reported in the accompanyingfinancial statements 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.

 

RevenueRecognition

 

Oil and natural gas production revenue is recognized at the time andpoint of sale after the product has been extracted from the ground. Rental feerevenue related to transmission of gas through pipelines is collected on amonthly basis based on the volume of gas transmitted.

 

BusinessCombinations

 

Business combinations are accounted for using the purchase method.Under the purchase method the Company reports the acquired entities’ assets andliabilities at fair market value. Any excess of the fair market value of theconsideration given over the fair market value of the net assets acquired isreported as goodwill. If the fair market value of the consideration given isless than the fair market value of the net assets acquired, the resultingexcess of fair value of acquired net assets over the cost of the acquiredentity is allocated, on a pro rata basis, against certain assets acquired inthe business combination. If any excess over cost remains after reducingcertain assets to zero, the remaining excess is recognized as an extraordinarygain. The operating statements of the Company for purchase method combinationsreport combined results only for the period subsequent to the combination.

 

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**RESULTSOF OPERATIONS FOR THE THREE MONTH PERIOD ENDED JUNE 30, 2005**

 

Sales

 

Net sales for oil production were $36,100 for the quarter ended June30, 2005. The company also realized revenue of $5,478 on rental fees related toits pipeline assets. Gas sales were $288.

 

# **Cost of Sales**

 

Cost of sales were $94,726 consisting of employee benefit cost,consulting fees, regulatory taxes on oil and natural gas production, purchasesof supplies and equipment and electric utility cost for the oil and natural gasfield operations.

 

Selling, General andAdministrative Expenses

 

Selling, general and administrative expenses were $5,857,866 for thequarter ended June 30, 2005. These costs reflect $2.3 million of non-cash stockcompensation expense incurred through the issuance of common stock in privateplacements and $1.6 million of non-cash consulting expense incurred through theissuance of the Company’s common stock. The Company also incurred non-cashexpense for the issuance of common stock valued at $0.6 million as compensationto executive and non-executive employees. The balance of operating expenses wasprimarily related to personnel salary and benefit costs, travel, andprofessional fees for management, legal and accounting services.

 

OtherIncome

 

Other income for the quarter ended June 30, 2005 was $70,279. Thisincome is primarily related to increases in the Company’s investment in itsalternative fuels joint ventures.

 

**RESULTSOF OPERATIONS FOR THE SIX MONTH PERIOD ENDED JUNE 30, 2005**

 

Sales

 

Net sales for oil production were $178,037 for the six months endedJune 30, 2005. The company also realized revenue of $11,366 on rental feesrelated to its pipeline assets. Gas sales were $955.

 

# **Cost of Sales**

 

Cost of sales were $252,932 consisting of employee benefit cost,consulting fees, regulatory taxes on oil and natural gas production, purchasesof supplies and equipment and electric utility cost for the oil and natural gasfield operations.

 

Selling, General andAdministrative Expenses

 

Selling, general and administrative expenses were $7,914,818 for thesix months ended June 30, 2005. These costs reflect $3.1 million of non-cashstock compensation expense incurred through the issuance of common stock inprivate placements and $2.5 million of non-cash consulting expense incurredthrough the issuance of the Company’s common stock. The Company also incurrednon-cash expense for the issuance of common stock valued at $0.7 million ascompensation to executive and non-executive employees. The balance of operatingexpenses was primarily related to personnel salary and benefit costs, travel,and professional fees for management, legal and accounting services.

 

OtherIncome

 

Other income for the six months ended June 30, 2005 was $75,574. Thisincome is primarily related to increases in the Company’s investment in itsalternative fuels joint ventures.

 

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ExtraordinaryItem

 

Effective March 31, 2005 the Company executed a Compromise of DebtAgreement with Koch. This agreement effectively reduced the principal andinterest obligation on the note payable assumed in the acquisition of OGC inFebruary of 2005. The principal and interest was reduced to $1,100,000 as fullpayment on the pipeline assets resulting in forgiveness of debt in the amountof $2,182,686 in principal and accrued interest. In July of 2005, the Companypaid the note in full.

 

**Liquidity and Capital Resources**

 

Cash used in operating activities was $1,621,554 for the six monthsended June 30, 2005.  This use of cashreflects the cash portion of the Company’s net loss for the period as well as increasesin accounts receivable and other assets.

 

Net cash used in investing activities was $2,058 for the six monthsended June 30, 2005. This use of cash relates to purchases of computerequipment.

 

Net cash provided by financing activities was $1,572,331 for the sixmonths ended June 30, 2005. Proceeds from sales of common stock of $1,837,639and proceeds from notes payable of $112,005 primarily account for this positivecash flow. In addition, the Company paid down debt in the amount of $377,313.

 

Duringthe period ending June 30, 2005, the Company recorded a net loss of $5,890,955.Since the Company completed its reverse merger on October 28, 2004, the Companyhas accumulated losses aggregating $7.5 million.  The Company’s continued existence is dependentupon its 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 andgas pipeline transmission operations. During the fourth quarter of fiscal 2004the Company completed the acquisition of BC&D Oil & Gas Corporation (“BC&D”).The acquisition of BC&D marked the initial entrance of the Company into theoil and natural gas production business. During the first quarter of fiscal2005, the Company negotiated the acquisition of OGC, a gas gathering company.The OGC acquisition added a pipeline network to the Company’s assets enablingthe Company to diversify into the oil and gas transmission business. Inaddition, the Company has acquired a 50% interest in Decarb, Energy VenturesOrganization, Inc. (“Energy Ventures”), and Earth Biofuels, Inc. (“Biofuels”).Decarb and Energy Ventures are focused on developing hydrogen power projects,while Biofuels produces and distributes bio-diesel fuel. The Company believesthese acquisitions will be a part of establishing future financial stability.In July of 2005 the Company completed a $3.0 million financing consisting ofconvertible notes with related warrants. The Company collateralized certain of itsoil and gas assets and properties along with its pipeline assets to secure thisfunding. Please see note 13 (Subsequent Events) for terms relating to the $3.0million financing. The Company has also continued to raise capital through avariety of private securities offerings of its common stock.

 

Managementis focusing on expanding and improving its oil and natural gas productionoperations and alternative fuels ventures. Through acquisition, organic growth andfunding via collateralized loans and private placement offerings, the Companyplans to 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.

 

The Company’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. On July 7, 2005 the Company completed a $3.0million financing. This financing allowed the Company to secure full payment ofits pipeline assets and infuse capital into its oil and gas subsidiary BC&Das well as continue funding its alternative fuels joint ventures. As of June30, 2005, the Company continued to seek other financing from private placementsand other acquisitions to expand its opportunities in the areas of oil and gasproduction, oil and gas transmission and alternative fuels businesses. TheCompany has implemented cost saving measures including staff reductions. TheCompany will take additional cost savings measures, if necessary, to enhanceits liquidity position.

 

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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 the eventthat the Company is unable to do so, the Company may be left without sufficientliquidity and it may not be able to meet its debt service requirements. In sucha case, this could result in a substantial portion of the Company’sindebtedness becoming immediately due and payable. As a result, the Company maynot be able to continue operations due to liens, collateralized notes or othersecured positions placed on the Company’s assets.

 

# **Off-Balance Sheet Arrangements**

 

# **At June 30, 2005 the Company had no obligations thatwould qualify to be disclosed as off-balance sheet arrangements.**

 

RiskFactors

 

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

 

The Company’s revenue and operating results may vary significantly fromquarter-to-quarter due to a number of factors. In future quarters, operatingresults may be below the expectations of public market analysis or investors,and the price of its common stock may decline. Factors that could causequarterly fluctuations include:

 

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

 

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

 

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

 

The ability to competedepends on a number of factors outside of the Company’s control, including:

 

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

 

•                                          the ability of competitors to undertake moreextensive marketing campaigns;

 

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

 

•                                          the extent of competitors’ responsiveness tocustomer needs.

 

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

 

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

 

Future success will depend upon the Company’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.

 

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

 

The Company’s business consists primarily of 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.

 

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

 

The inability to raise debtto fund working capital may:

 

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

 

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

 

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

 

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

 

The ability to make payments on and to refinance 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

 

In addition to statements of historical fact, this Form 10-QSB containsforward-looking statements.  Thepresentation of future aspects of the Company found in these statements issubject to a number of risks and uncertainties that could cause actual resultsto differ materially from those reflected in such statements.  Readers are cautioned not to place unduereliance on these forward-looking statements, which reflect management’sanalysis only as of the date hereof. Without limiting the generality of the foregoing words such as “may,” “will,”“expect,” “believe,” “anticipate,” “intend,” or “could” or the negativevariations thereof or comparable terminology are intended to identifyforward-looking statements.

 

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These forward-looking statements are subject to numerous assumptions,risks and uncertainties that may cause the Company’s actual results to bematerially different from any future results expressed or implied by theCompany in those statements.

 

Some of these risks might include, but are not limited to, thefollowing:

 

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

 

(b)                                 potential fluctuation in quarterly results;

 

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

 

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

 

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

 

(f)                                    rapid and significant changes in markets;

 

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

 

(h)                                 insufficient revenues to cover operatingcosts.

 

Thereis no assurance that the Company will be profitable, the Company may 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 additional dilutionin outstanding stock ownership may be incurred due to the issuance of moreshares, 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**

 

Themanagement of the company has evaluated the effectiveness of the issuer’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of the report (evaluation date) and has concluded that thedisclosure controls and procedures are adequate and effective based upon itsevaluation as of the evaluation date.

 

Therewere no significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of the mostrecent evaluation of such, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

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**PART II – OTHER INFORMATION**

 

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

 

OnNovember 5, 2004, the Company received notice that it has been named as across-defendant by cross-complainants Omar V. Sanchez and SovCap Advisors,Inc., in Foster v SovCap, Case No. 04CC08470, as per a filing dated October 15,2004, in the Superior Court of the State of California for the County ofOrange, Central District Center. The complaint by the cross-defendants allegesbreach of an oral contract, fraud allegations and claims for indemnity in asuit by one of the Company’s shareholders against SovCap and Sanchez.  On May 5, 2005 the Company was dismissed as adefendant in this matter.

 

On March 7, 2005, the Company received notice that it has been named asa defendant, among others, by plaintiffs Donnie Hill, a former employee of theCompany, and BC&D Operating Co., Inc. Case No. CV-2005-128 in the FifthJudicial District Court, State of New Mexico, for the County of Lea. Theplaintiffs allege breach of contract related to certain stock purchaseagreements with the preceding owner of BC&D, breach of contract related toMr. Hill’s employment agreement with the preceding owner of BC&D, breach ofcovenant of good faith and fair dealing, negligent misrepresentation,fraudulent misrepresentation, violation of the New Mexico Securities Act by thepreceding owner of BC&D, civil conspiracy, calling for the appointment of areceiver for the assets and business affairs of BC&D, constructive trust,declaratory judgment related to the Company election as successor operators andlastly punitive damages related to the above allegations. These allegationsstem from the Company’s execution of a share exchange agreement with TKM,whereby the Company gained control of 100% of the assets of BC&D. On July11, 2005, the parties met and during mediation agreed to settle the case andare in the process of finalizing those negotiations.

 

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.****       ****Change in Securities and Use of Proceeds**

 

Duringthe quarter ended June 30, 2005, the Company issued 11,045,676 shares of commonstock, via private placement.  TheCompany is seeking working capital and funds to service its debts and toupgrade and purchase equipment to increase its oil and natural gas productionand pipeline assets. The common stock was sold at prices ranging from $1.16 to$.54 per share. The gross proceeds of these sales amounted to $1,552,884.

 

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

 

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

 

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

 

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

 

Reports on Form 8-K.

 
| **Date of Filing**   | ** ** | **Subject**                                                                                                                                           |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
| April  19, 2005      |       | Membership  Interests Purchase Agreement between the Company and SW Energy Investments,  Inc.                                                         |
| June  20, 2005  |       | Letter  Agreement between the Company and H.C. Wainwright & Co.                                                                              |
| June  29, 2005       |       | Memorandum  of Understanding between the Company’s 50% owned subsidiary Earth Biofuels,  Inc. and Gulf Coast Fuels, Inc.                         |
|                 |       |                                                                                                                                                  |
| **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 22nd day of August, 2005.

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

 

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