** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

##### **Form 10-Q**

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

**Forthe quarterly period ended March 31, 2007**

**or**

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

**Forthe transition period from                       to                  **

**Commissionfile number: 001-33457**

**PinnacleGas Resources, Inc.******(Exact name of registrant asspecified in its charter)

| **Delaware**                                                    |   | **30-0182582**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **1 E.  Alger Street**                                          |   | **82801**                             |
| **Sheridan,  WY**                                               |   | (Zip code)                            |
| (Address of  principal executive offices)                       |   |                                  |

 

**(307)673-9710**(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes £ No x

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Act. (Check one):

Large AcceleratedFiler £       Accelerated Filer £       Non-Accelerated Filer x

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

28,928,301 shares of the registrant’s Common Stockwere outstanding as of May 30, 2007.

 

 

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**PINNACLEGAS RESOURCES, INC.**

Index to Form 10-Q
|                                                                                                     | ** ** | **Page** |
|-----------------------------------------------------------------------------------------------------|------------|----------|
| Cautionary Statement Concerning Forward-looking  Statements                                         | ** ** | 1        |
| Part  I. FINANCIAL INFORMATION                                                                      | ** ** | 3        |
| Item  1. Financial Statements                                                                       |       | 3        |
| Balance  Sheets as of December 31, 2006 and March 31, 2007                                          |       | 3        |
| Statements  of Operations for the three months ended March 31, 2006 and 2007                        |       | 4        |
| Statements  of Cash Flows for the three months ended March 31, 2006 and 2007                        |       | 5        |
| Statements of Redeemable Preferred Stock and  Stockholders’ Equity at March 31, 2007           |       | 6        |
| Notes  to Financial Statements (unaudited)                                                          |       | 7        |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations |       | 17       |
| Overview                                                                                            |       | 17       |
| Recent  Developments                                                                                |       | 17       |
| Critical  Accounting Policies                                                                       |       | 18       |
| Trends  Affecting Our Business                                                                      |       | 21       |
| Results of Operations for the Three Months Ended March  31, 2007                                    |       | 22       |
| Liquidity and Capital Resources                                                                     |       | 23       |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                 |       | 27       |
| Item 4T. Controls and Procedures                                                                    |       | 28       |
| Part  II. OTHER INFORMATION                                                                         |       | 28       |
| Item  1. Legal Proceedings                                                                          |       | 28       |
| Item 1A. Risk Factors                                                                               |       | 29       |
| Item 2. Unregistered Sales of Equity Securities and Use  of Proceeds                                |       | 29       |
| Item 3. Defaults Upon Senior Securities                                                             |       | 29       |
| Item 4. Submission of Matters to a Vote of Security  Holders                                        |       | 29       |
| Item  5. Other Information                                                                          |       | 29       |
| Item 6. Exhibits                                                                                    |       | 30       |

 

 

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**CAUTIONARYSTATEMENT CONCERNING FORWARD-LOOKING STATEMENTS**

We are including the following discussion to inform youof some of the risks and uncertainties that can affect our company and to takeadvantage of the “safe harbor” protection for forward-looking statements thatapplicable federal securities law affords. Various statements in thisprospectus, including those that express a belief, expectation, or intention,as well as those that are not statements of historical fact, are forward-lookingstatements. These include statements relating to such matters as:

·                  projectionsand estimates concerning the timing and success of specific projects;

·                  our financial position or operatingresults;

·                  our business strategy;

·                  our budgets;

·                  the amount, nature and timing ofcapital expenditures;

·                  the drilling of wells;

·                  the development of recently acquirednatural gas and oil properties;

·                  the timing and amount of futureproduction of natural gas and oil;

·                  our operating costs and otherexpenses;

·                  our estimated future net revenuesfrom natural gas and oil reserves and the present value thereof;

·                  our cash flow and anticipatedliquidity; and

·                  ourother plans and objectives for future operations.

When we use the words “believe,” “intend,” “expect,” “may,”“should,” “anticipate,” “could,” “estimate,” “plan,” “predict,” “project,”their negatives, or other similar expressions, the statements which includethose words are usually forward-looking statements. When we describestrategy that involves risks or uncertainties, we are making forward-lookingstatements. The forward-looking statements in this quarterly report onForm 10-Q speak only as of the date of this report. We disclaim any obligationto update these statements unless required by securities law, and we caution younot to rely on them unduly. We have based these forward-lookingstatements on our current expectations and assumptions about future events.While our management considers these expectations and assumptions to bereasonable, they are inherently subject to significant business, economic,competitive, regulatory and other risks, contingencies and uncertainties, mostof which are difficult to predict and many of which are beyond our control.These risks, contingencies and uncertainties relate to, among other matters,the following:

·                  our ability to implement our businessstrategy;

·                  the extent of our success indiscovering, developing and producing reserves, including the risks inherent inexploration and development drilling, well completion and other developmentactivities;

·                  fluctuations in the commodity pricesfor natural gas and crude oil;

·                  engineering, mechanical ortechnological difficulties with operational equipment, in well completions andworkovers, and in drilling new wells;

·                  the effects of government regulationand permitting and other legal requirements;

·                  labor problems;

·                  environmental-related problems;

·                  the uncertainty inherent inestimating future natural gas and oil production or reserves;

·                  production variances fromexpectations;

1

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·                  the substantial capital expendituresrequired for construction of pipelines and the drilling of wells and therelated need to fund such capital requirements through commercial banks and/orpublic securities markets;

·                  disruptions, capacity constraints inor other limitations on our or others’ pipeline systems;

·                  our ability to effectively market ourproduction;

·                  land issues and the costs associatedwith perfecting title for natural gas rights in some of our properties;

·                  our ability to develop and replacereserves;

·                  dependence upon key personnel;

·                  the lack of liquidity of our equitysecurities;

·                  operating hazards attendant to thenatural gas and oil business, including down-hole drilling and completion risksthat are generally not recoverable from third parties or insurance;

·                  potential mechanical failure or under-performanceof significant wells;

·                  climatic conditions or naturaldisasters;

·                  acts of terrorism;

·                  the availability and cost ofmaterials and equipment;

·                  delays in anticipated start-up dates;

·                  our ability to find and retainskilled personnel;

·                  the availability of capital;

·                  competition from, and the strengthand financial resources of, our competitors; and

·                  generaleconomic conditions.

When you considerthese forward-looking statements, you should keep in mind these factorsand the other factors discussed under “Risk Factors.”

 

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**PART I. FINANCIAL INFORMATION**

**ITEM 1.FINANCIAL STATEMENTS**

**PINNACLE GAS RESOURCES, INC.Balance Sheets**
| ** **                                                                                                                                                                | ** ** | **March 31,  2007**                                                       | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                | ** ** | **(unaudited)**                                                                | ** ** | ** **                  | ** ** |
| ** **                                                                                                                                                                | ** ** | **(in thousands, except  share and  per share data)** | ** ** |
| Assets                                                                                                                                                                    |       |                                                                           |       |                        |       |
| Current assets                                                                                                                                                            |       |                                                                           |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                |       | $                                                                              | 1,590      |                        | $          | 4,762 |   |
| Receivables                                                                                                                                                               |       |                                                                           |       |                        |       |
| Accrued gas  sales                                                                                                                                                        |       | 2,547                                                                          |       | 2,364                       |       |
| Joint interest  receivables, net of $100 allowance for doubtful accounts                                                                                                  |       | 6,731                                                                          |       | 9,237                       |       |
| Derivative  instruments                                                                                                                                                   |       | 2,220                                                                          |       | 2,856                       |       |
| Inventory of  material for drilling and completion                                                                                                                        |       | 155                                                                            |       | 271                         |       |
| Prepaid expenses                                                                                                                                                          |       | 499                                                                            |       | 394                         |       |
| Total current  assets                                                                                                                                                     |       | 13,742                                                                         |       | 19,884                      |       |
| Property and equipment,  at cost, net of accumulated depreciation                                                                                                         |       | 2,129                                                                          |       | 2,107                       |       |
| Oil and gas properties,  using full cost accounting, net of accumulated depletion and impairment                                                                          |       |                                                                           |       |                        |       |
| Proved                                                                                                                                                                    |       | 26,676                                                                         |       | 39,988                      |       |
| Unproved                                                                                                                                                                  |       | 86,521                                                                         |       | 85,094                      |       |
| Inventory of material  for drilling and completion                                                                                                                        |       | 860                                                                            |       | 944                         |       |
| Deposits                                                                                                                                                                  |       | 529                                                                            |       | 520                         |       |
| Restricted certificates  of deposit                                                                                                                                       |       | 1,800                                                                          |       | 1,795                       |       |
| Total assets                                                                                                                                                              |       | $                                                                              | 132,257    |                        | $          | 150,332 |   |
| Liabilities and Stockholders’  Equity                                                                                                                                |       |                                                                           |       |                        |       |
| Current liabilities                                                                                                                                                       |       |                                                                           |       |                        |       |
| Long term debt-current  portion                                                                                                                                           |       | $                                                                              | 22         |                        | $          | 21 |   |
| Trade accounts  payable                                                                                                                                                   |       | 11,675                                                                         |       | 17,567                      |       |
| Revenue  distribution payable                                                                                                                                             |       | 7,974                                                                          |       | 7,301                       |       |
| Drilling  prepayments from joint interest owners                                                                                                                          |       | 256                                                                            |       | 289                         |       |
| Accrued liabilities                                                                                                                                                       |       | 2,523                                                                          |       | 2,375                       |       |
| Total current  liabilities                                                                                                                                                |       | 22,450                                                                         |       | 27,553                      |       |
| Asset retirement  obligations                                                                                                                                             |       | 2,438                                                                          |       | 2,321                       |       |
| Production taxes, non-current                                                                                                                                             |       | 1,249                                                                          |       | 843                         |       |
| Long term debt-net  of current portion                                                                                                                                    |       | 5,281                                                                          |       | 786                         |       |
| Total  liabilities                                                                                                                                                        |       | 31,418                                                                         |       | 31,503                      |       |
|                                                                                                                                                                      |       |                                                                           |       |                        |       |
| Commitment and  contingencies                                                                                                                                             |       | —                                                                         |       | —                      |       |
|                                                                                                                                                                      |       |                                                                           |       |                        |       |
| Series A Redeemable  Preferred stock, $0.01 par value; 25,000,000 authorized, 0 shares issued and  outstanding at March 31, 2007 and December 31, 2006, respectively      |       | —                                                                         |       | —                      |       |
| Stockholders’ equity                                                                                                                                                 |       |                                                                           |       |                        |       |
| Common stock,  $0.01 par value; 100,000,000 authorized and 25,178,301 and 25,131,301 shares  issued and outstanding at March 31, 2007 and December 31, 2006, respectively |       | 251                                                                            |       | 251                         |       |
| Additional paid-in  capital                                                                                                                                               |       | 119,514                                                                        |       | 119,354                     |       |
| Accumulated  deficit                                                                                                                                                      |       | (18,926                                                                        | )          | (776                        | )          |
| Total stockholders’  equity                                                                                                                                          |       | 100,839                                                                        |       | 118,829                     |       |
| Total liabilities and stockholders’ equity                                                                                                                           |       | $                                                                              | 132,257    |                        | $          | 150,332 |   |

 

See Notes to FinancialStatements (unaudited)

 

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**PINNACLE GASRESOURCES, INC.Statements of Operations(unaudited)**
| ** **                                             | ** ** | **For the Three Months  Ended March 31,**                 | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2007**                                                                           | ** ** | **2006** | ** ** |
| ** **                                             | ** ** | **(in thousands, except  share and per share data)** | ** ** |
| Revenues                                               |       |                                                                               |       |   |   |
| Gas sales                                              |       | $                                                                                  | 3,654      |   | $ | 3,627 |   |
| Earn-in  joint venture                                 |       | —                                                                             |       | 379 |   |
| Total revenues                                         |       | 3,654                                                                              |       | 4,006 |   |
| Cost of revenues and  expenses                         |       |                                                                               |       |   |   |
| Lease operating  expenses                              |       | 917                                                                                |       | 515 |   |
| Production taxes                                       |       | 401                                                                                |       | 415 |   |
| Marketing and  transportation                          |       | 786                                                                                |       | 406 |   |
| General and  administrative, net                       |       | 1,107                                                                              |       | 770 |   |
| Depreciation,  depletion, amortization and accretion   |       | 1,485                                                                              |       | 1,472 |   |
| Impairment of  oil and gas properties                  |       | 17,003                                                                             |       | — |   |
| Total cost of  revenues and expenses                   |       | 21,699                                                                             |       | 3,578 |   |
| Operating (loss)/income                                |       | (18,045                                                                            | )          | 428 |   |
| Other income(expense)                                  |       |                                                                               |       |   |   |
| (Loss)/gain on  derivatives                            |       | (199                                                                               | )          | 1,886 |   |
| Interest income                                        |       | 48                                                                                 |       | 9 |   |
| Other income                                           |       | 110                                                                                |       | 50 |   |
| Unrealized  derivative loss                            |       | —                                                                             |       | (26 | ) |
| Interest expense                                       |       | (64                                                                                | )          | (35 | ) |
| Total other  income(expense)                           |       | (105                                                                               | )          | 1,884 |   |
| Net (loss)/income  before income taxes                 |       | (18,150                                                                            | )          | 2,312 |   |
| Income taxes                                           |       | —                                                                             |       | — |   |
| Net (loss)/income                                      |       | (18,150                                                                            | )          | 2,312 |   |
| Preferred dividends                                    |       | —                                                                             |       | (1,245 | ) |
| Net (loss)/income  attributable to common shareholders |       | $                                                                                  | (18,150    | ) | $ | 1,067 |   |
| Basic net (loss)/income  per share                     |       | $                                                                                  | (0.72      | ) | $ | 0.18 |   |
| Diluted net  (loss)/income per share                   |       | $                                                                                  | (0.72      | ) | $ | 0.07 |   |
| Weighted average shares  outstanding — basic      |       | 25,151,179                                                                         |       | 5,800,000 |   |
| Weighted average shares outstanding — diluted     |       | 25,151,179                                                                         |       | 14,269,540 |   |

 

See Notes to FinancialStatements (unaudited)

 

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**PINNACLE GASRESOURCES, INC.Statements of Cash Flows(unaudited)**
| ** **                                                                                          | ** ** | **For the Three  Months ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **March 31,**                             | ** ** |
| ** **                                                                                          | ** ** | **2007**                                       | ** ** | **2006** | ** ** |
| Cash flows from  operating activities                                                               |       |                                           |       |   |   |
| Net income/(loss)                                                                                   |       | $                                              | (18,150    | ) | $ | 2,312 |   |
| Adjustments to  reconcile net income/(loss) to net cash (used in)/provided by operating  activities |       |                                           |       |   |   |
| Impairment of  oil and gas properties                                                               |       | 17,003                                         |       | — |   |
| Depreciation,  depletion, amortization and accretion                                                |       | 1,485                                          |       | 1,472 |   |
| (Gain)loss on  derivatives                                                                          |       | 199                                            |       | (1,860 | ) |
| Allowance for  doubtful accounts                                                                    |       | —                                         |       | 100 |   |
| Stock-based  compensation                                                                           |       | 160                                            |       | 33 |   |
| Changes in  assets and liabilities                                                                  |       |                                           |       |   |   |
| Decrease in  receivables                                                                            |       | 2,323                                          |       | 479 |   |
| Decrease in  inventory of material for drilling and completion                                      |       | —                                         |       | 13 |   |
| Increase in  prepaid expenses                                                                       |       | (105                                           | )          | (169 | ) |
| (Decrease)  increase in accounts payable and accrued liabilities                                    |       | (9,277                                         | )          | 1,019 |   |
| Increase in  revenue distribution payable                                                           |       | 673                                            |       | 157 |   |
| (Decrease)  increase in drilling prepayments                                                        |       | (33                                            | )          | 545 |   |
| Net cash (used  in)/provided by operating activities                                                |       | (5,722                                         | )          | 4,101 |   |
| Cash flows from investing  activities                                                               |       |                                           |       |   |   |
| Capital  expenditures — exploration and production                                             |       | (2,221                                         | )          | (5,859 | ) |
| Capital  expenditures — property and equipment                                                 |       | (230                                           | )          | (172 | ) |
| Purchase of  restricted certificate of deposit                                                      |       | (5                                             | )          | (606 | ) |
| Decrease in  inventory held for exploration and development                                         |       | 84                                             |       | 36 |   |
| Deposits                                                                                            |       | (9                                             | )          | — |   |
| Realized  gain/(loss) on derivatives                                                                |       | 437                                            |       | (318 | ) |
| Proceeds from  the sale of assets held for sale                                                     |       | —                                         |       | 394 |   |
| Net cash used in  investing activities                                                              |       | (1,944                                         | )          | (6,525 | ) |
| Cash flows from  financing activities                                                               |       |                                           |       |   |   |
| Principal  payments on note payable and capital leases                                              |       | (6                                             | )          | (18 | ) |
| Proceeds from  long-term debt                                                                       |       | 4,500                                          |       | — |   |
| Net cash  provided/(used in) by financing activities                                                |       | 4,494                                          |       | (18 | ) |
| Net decrease in  cash and cash equivalents                                                          |       | (3,172                                         | )          | (2,442 | ) |
| Cash and cash equivalents  at beginning of year                                                     |       | 4,762                                          |       | 2,672 |   |
| Cash and cash  equivalents at end of year                                                           |       | $                                              | 1,590      |   | $ | 230 |   |
| Noncash investing and  financing activities                                                         |       |                                           |       |   |   |
| Capital  expenditures included in trade accounts payable                                            |       | $                                              | 3,940      |   | $ | 1,293 |   |
| Asset retirement  obligation included in oil and gas properties                                     |       | 69                                             |       | 156 |   |
| Accrued offering  costs                                                                             |       | 419                                            |       | 1,012 |   |
| Dividend paid in  kind with the issuance of additional preferred stock                              |       | —                                         |       | 1,214 |   |
| Derivative  liability related to preferred stock                                                    |       | —                                         |       | 6 |   |
| Inventory used  in oil and gas properties                                                           |       | 116                                            |       | — |   |
| Supplemental cash flow  information                                                                 |       |                                           |       |   |   |
| Cash payments for  interest, net of amount capitalized                                              |       | $                                              | 64         |   | $ | 35 |   |

 

See Notes to FinancialStatements (unaudited)

 

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**PINNACLE GASRESOURCES, INC.Statements of Redeemable Preferred Stock and Stockholders’ Equity**
| ** **                            | ** ** | ** **                                                  | ** ** | **Stockholders’ Equity** | ** ** |
|---------------------------------------|------------|-------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                            | ** ** | **Redeemable  Preferred Stock**                        | ** ** | **Common Stock**              | ** ** | **Warrants  and** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Shares**                                                  | ** ** | **Amount**                         | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Options** | ** ** | **Capital** | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| ** **                            | ** ** | **(in thousands except share amounts)** | ** ** |
| Balance at December 31,  2006         |       | —                                                      |       | $                                  | —     |   | 25,131,301 |   | $ | 251 |   | — |   | $ | 119,354 |   | $ | (776 | ) | $ | 118,829 |   |
| Issuance of restricted  shares        |       | —                                                      |       | —                             |       | 47,000 |   | — |   | — |   | 49 |   | — |   | 49 |   |
| Stock-based compensation              |       | —                                                      |       | —                             |       | — |   | — |   | — |   | 111 |   | — |   | 111 |   |
| Net loss                              |       | —                                                      |       | —                             |       | — |   | — |   | — |   | — |   | (18,150 | ) | (18,150 | ) |
|                                  |       |                                                        |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at March 31, 2007 (unaudited) |       | —                                                      |       | —                             |       | 25,178,301 |   | $ | 251 |   | — |   | $ | 119,514 |   | $ | (18,926 | ) | $ | 100,839 |   |
|                                       |            |                                                             |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See Notes to FinancialStatements (unaudited)

 

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**Notes to Financial StatementsUnaudited**

**Note 1 — Organization and Nature of Operations**

Pinnacle Gas Resources, Inc., (the “Company”) wasformed as a Delaware corporation in June 2003 through a contribution of cash byfunds affiliated with DLJ Merchant Banking and oil and gas reserves andleasehold interests by subsidiaries of Carrizo Oil & Gas, Inc. and U.S.Energy Corporation.

Pinnacle’s primary business is the exploration for,and the acquisition, development and production of, coalbed methane natural gasin the United States. The Company is also engaged in gas property operationsand the construction of low pressure gas collection systems which providetransportation for the Company’s coalbed methane production.

**Note 2 — Basis of Presentation**

The accompanying unaudited financial statementsinclude Pinnacle’s proportionate share of assets, liabilities, income andexpenses from the properties in which Pinnacle has a participatinginterest.  Pinnacle has no subsidiariesor affiliates with which intercompany transactions are recorded.

The accompanying financial statements are unaudited,and in the opinion of management, reflect all adjustments that are necessaryfor a fair presentation of the financial position and results of operations forthe periods presented.  All suchadjustments are of a normal and recurring nature. The following notes describeonly the material changes in accounting policies, account details, or financialstatement notes during the first three months of 2007.  The results for the quarterly period are notnecessarily indicative of the results expected for the entire year.  These financial statements should be read inconjunction with the audited financial statements and the summary ofsignificant accounting policies for prior years contained in the Company’sRegistration Statement on Form S-1/A which was filed April 27, 2007 anddeclared effective May 10, 2007.

*Use of Estimates*

The preparation of the Company’s financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions thataffect the reported amount of assets and liabilities, disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from these estimates. Significant estimates with regard to thefinancial statements include the estimated carrying value of unprovedproperties, the estimate of proved oil and gas reserve volumes and the relatedpresent value of estimated future net cash flows and the ceiling test appliedto capitalized oil and gas properties, the estimated cost and timing related toasset retirement obligations, the estimated fair value of derivative assets andliabilities and the realizability of deferred tax assets.

*Oil and Gas Properties*

Pinnacle utilizes the full cost method of accountingfor oil and gas producing activities. Under this method, all costs associatedwith property acquisition, exploration and development, including costs ofunsuccessful exploration, costs of surrendered and abandoned leaseholds, delaylease rentals and the fair value of estimated future costs of site restoration,dismantlement and abandonment activities are capitalized within a cost center.The Company’s oil and gas properties are all located within the United States,which constitutes a single cost center. The Company has not capitalized anyoverhead costs. No gain or loss is recognized upon the sale or abandonment ofundeveloped or producing oil and gas properties unless the sale represents asignificant portion of gas properties and the gain significantly alters therelationship between capitalized costs and proved gas reserves of the costcenter. Expenditures for maintenance and repairs are charged to lease operatingexpense in the period incurred.

7

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**Note 2 — Basis of Presentation (continued)**

Depreciation,depletion and amortization of oil and gas properties (“DD&A”) is computedon the units-of-production method based on proved reserves. Amortizable costsinclude estimates of future development costs of proved undeveloped reservesand asset retirement obligations. Pinnacle invests in unevaluated oil and gasproperties for the purpose of exploration for proved reserves. The costs ofsuch assets, including exploration costs on properties where a determination ofwhether proved oil and gas reserves will be established is still underevaluation, and any capitalized interest are included in unproved oil and gas propertiesat the lower of cost or estimated fair market value and are not subject toamortization. On a quarterly basis, such costs are evaluated for inclusion inthe costs to be amortized resulting from the determination of proved reserves,impairments, or reductions in value. To the extent that the evaluationindicates these properties are impaired, the amount of the impairment is addedto the capitalized costs to be amortized. Abandonment of unproved properties isaccounted for as an adjustment to capitalized costs related to proved oil andgas properties, with no losses recognized. The Company recorded an impairmentof unevaluated properties of approximately $740,000 during the period endedMarch 31, 2007. Substantially all of the remaining unproved property costs areexpected to be developed and included in the amortization base over the nextthree to five years. Salvage value is taken into account in determiningdepletion rates and is based on the Company’s estimate of the value ofequipment and supplies at the time the well is abandoned.

Underfull cost accounting rules, capitalized costs less accumulated depletion andrelated deferred income taxes may not exceed the sum of (1) the present valuediscounted at ten percent of estimated future net revenue using current pricesand costs, including the effects of derivative instruments designated as cashflow hedges but excluding the future cash outflows associated with settlingasset retirement obligations that have been accrued on the balance sheet, lessany related income tax effects;  plus (2)the cost of properties not being amortized, if any; plus (3) the lower of costsor estimated fair value of unproved properties; less (4) the income tax effectsrelated to differences in the book to tax basis of oil and gas properties. Thisis referred to as the “full cost ceiling limitation.” If capitalized costsexceed the limit, the excess must be charged to expense. The expense may not bereversed in future periods. At the end of each quarter, the Company calculates thefull cost ceiling limitation.  At March31, 2007, the carrying amount of oil and gas properties exceeded the full costceiling limitation by approximately $17.0 million, based upon a naturalgas price of approximately $4.37 per Mcf in effect at that date.  The impairment of the Company’s oil and gasproperties resulted from low commodity prices at March 31, 2007. Based on subsequent price decreases toapproximately $3.05 per Mcf of gas at May 30, 2007, the carrying amount of theCompany’s oil and gas properties exceeded the full cost ceiling limitation byapproximately $26.5 million.  Adecline in gas prices or an increase in operating costs subsequent to themeasurement date or reductions in the economically recoverable quantities couldresult in the recognition of an additional ceiling write-down of our oiland gas properties in a future period.

*Per Share Information*

Basic earnings(loss) per share is computed by dividing net income (loss) from continuingoperations attributable to common stock by the weighted average number ofshares of common stock outstanding during each period. Diluted earnings pershare is computed by adjusting the average number of shares of common stockoutstanding for the dilutive effect, if any, of common stock equivalents suchas stock options and warrants. For the quarter ended March 31, 2007, commonstock equivalents of 964,000 were antidilutive as a result of the loss incurredand have been excluded from the calculation of earnings per share.

All per share information for common stock has beenretroactively restated for all periods to reflect the 25-for-1stock split which took place on March 31, 2006.

*Income Taxes*

The Company uses the asset and liability method ofaccounting for income taxes, in accordance with Statement of FinancialAccounting Standard (SFAS) No. 109, “Accounting for Income Taxes.”Deferred tax assets and liabilities are recognized for the expected future taxconsequences of temporary differences between the financial statements and taxbases of assets and liabilities. If appropriate, deferred tax assets arereduced by a valuation allowance which reflects expectations of the extent towhich such assets will be realized. As of March 31, 2007 and December 31,2006, the Company had recorded a full valuation allowance for its net deferredtax asset.

8

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**Note 2 — Basis of Presentation (continued)**

On January 1, 2007, the Company adopted FinancialAccounting Standards Board Interpretation No. 48, “Accounting for Uncertaintyin Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 prescribes a measurement process forrecording in the financial statements uncertain tax positions taken or expectedto be taken in a tax return. Additionally, FIN 48 provides guidance regarding uncertain tax positionsrelating to derecognition, classification, interest and penalties, accountingin interim periods, disclosure and transition. At March 31, 2007, the Company had no material uncertain tax positions.

*Recent Accounting Pronouncements*

In September 2006, the FASB issued SFAS No. 157, “FairValue Measurements,” which defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles, and expandsdisclosures about fair value measurements. SFAS No. 157 applies underother accounting pronouncements that require or permit fair value measurements.Accordingly, SFAS No. 157 does not require any new fair value measurements.However, for some entities, the application of SFAS No. 157 will changecurrent practice. The provisions of SFAS No. 157 are effective as ofJanuary 1, 2008. The Company is currently evaluating the impact ofadopting SFAS No. 157 on its financial statements.

In September 2006, the Securities and Exchange Commissionissued Staff Accounting Bulletin (SAB) No. 108 which provides interpretiveguidance on how the effects of the carryover or reversal of prior yearmisstatements should be considered in quantifying a current year misstatement.SAB No. 108 is effective for us as of January 1, 2007. The Companyhas completed its evaluation of the impact of SAB No. 108 on its financialstatements and noted no material impact.

In February 2007, the FASB issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities.” SFASNo. 159 permits entities to choose to measure eligible financialinstruments and certain other items at fair value. The objective is to improvefinancial reporting by providing entities with the opportunity to mitigatevolatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accountingprovisions. The Statement will be effective as of January 1, 2008 for us.The Statement offers various options in electing to apply the provisions ofthis Statement, and at this time the Company has not made any decisions in itsapplication to its financial position or results of operations.

**Note 3 — Asset Retirement Obligations**

The Company follows the provisions of SFASNo. 143, “Accounting for Asset Retirement Obligations” (“SFAS No. 143”).  SFAS No. 143 generally applies to legalobligations associated with the retirement of long-lived assets that result fromthe acquisition, construction, development and/or normal operation of along-lived asset. SFAS No. 143 requires the Company to recognize anestimated liability for costs associated with the abandonment of its oil andgas properties. A liability for the fair value of an asset retirementobligation with a corresponding increase to the carrying value of the relatedlong-lived asset is recorded at the time a well is completed or acquired. Theincreased carrying value is depleted using the units-of-production method, andthe discounted liability is increased through accretion over the remainingeconomic life of the respective oil and gas properties.

The estimated liability is based on historical gasindustry experience in abandoning wells, including estimated economic lives,external estimates as to the cost to abandon the wells in the future andfederal and state regulatory requirements. The Company’s liability isdiscounted using Pinnacle’s best estimate of its credit-adjusted riskfree rate. Revisions to the liability could occur due to changes in estimatedabandonment costs or changes in well economic lives or if federal or stateregulators enact new requirements regarding the abandonment of wells.

The following is a summary of the Company’s assetretirement obligation activity for the three months ended March 31, 2007  (in thousands):

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**Note 3 — Asset Retirement Obligations - continued**

|                                                 | ** ** | **For the Three  Months Ended  March 31** | ** ** | **For the Year  Ended  December 31** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                                      | ** ** | **2006**                                            | ** ** |
| Beginning balance  asset retirement obligations |       | $                                                             | 2,321      |                                                | $          | 1,277 |   |
| Additional  obligation added during the period  |       | 69                                                            |       | 953                                                 |       |
| Obligations  settled during the period          |       | —                                                        |       | (2                                                  | )          |
| Revisions in  estimates                         |       | —                                                        |       | (69                                                 | )          |
| Accretion  expense                              |       | 48                                                            |       | 162                                                 |       |
| Ending balance of asset  retirement obligations |       | $                                                             | 2,438      |                                                | $          | 2,321 |   |

 

**Note 4 — Restricted Assets (certificates of deposit)and Deposits**

*Certificates of deposit.*TheCompany holds a certificate of deposit (“CD”), which expires in July 2007,totaling $144,000. The CD is collateral on bonding requirements. Because theCompany intends to renew the CD in order to maintain its bonding requirements,the Company has included the CD in other non-current assets as of March 31,2007.  Additionally, the Company holds acertificate of deposit for $627,000 which was issued in February 2006 andexpires in February 2008.  This CDcollateralizes a letter of credit in favor of Powder River Energy Corporation,a local rural electric association, in order to secure power lines to the Kirbyand Deer Creek areas. The Company has included this amount in non-currentassets as of March 31, 2007 because the Company also intends to renew the CD inorder to maintain a power supply on a long-term basis. In April 2006, theCompany issued a $1,029,000 letter of credit that expires in April 2008 infavor of Bitter Creek Pipelines, LLC to secure the construction of a highpressure pipeline and related compression facilities to the Company’s DeerCreek and Kirby areas.  The Company hasincluded this amount in non-current assets as of March 31, 2007 because theCompany anticipates it will be required to renew the CD because construction ofthe pipeline and compression facility is expected to take over a year tocomplete.

*Deposits.* In addition, the Company has prepaidapproximately $500,000 to EMIT Technologies, Inc. for the construction of awater treatment plant near the Cabin Creek drilling area.  The Company has also included $20,000 indeposits related to royalty payments and $9,000 related to the construction ofa reservoir.  These amounts are includedin Deposits in the accompanying balance sheet at March 31, 2007.

**Note 5 — Derivatives**

The Company accounts for derivative instruments orhedging activities under the provisions of SFAS No. 133, “Accounting forDerivative Instruments and Hedging Activities.” SFAS No. 133 requires theCompany to record derivative instruments at their fair value. If the derivativeis designated as a fair value hedge, the changes in the fair value of thederivative and of the hedged item attributable to the hedged risk arerecognized in earnings. If the derivative is designated as a cash flow hedge,the effective portions of changes in the fair value of the derivative arerecorded in other comprehensive income (loss) and are recognized in the statementof operations when the hedged item affects earnings. Ineffective portions ofchanges in the fair value of cash flow hedges, if any, are recognized inearnings. Changes in the fair value of derivatives that do not qualify forhedge treatment are recognized in earnings.

The Company periodically hedges a portion of its oiland gas production through swap and collar agreements. The purpose of thehedges is to provide a measure of stability to the Company’s cash flows in anenvironment of volatile oil and gas prices and to manage the exposure tocommodity price risk. Management of the Company decided not to use hedgeaccounting for these agreements. Therefore, in accordance with the provisionsof SFAS No. 133, the changes in fair market value are recognized inearnings.

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**Note 5 — Derivatives- continued**

As of March 31, 2007 and 2006, the Company had naturalgas hedges in place as follows:
| **Product and Type of  Hedging Contract** | ** ** | ** ** | ** ** | **MMbtu Per  Day** | ** ** | **Fixed Price  Range  CIG Index Price** | ** ** | **Time  Period** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|-------------------------|------------|--------------------------------------------------------|------------|------------------|------------|
| March 31, 2007                                                |       |       |       |                    |       |                                                   |       |
| Natural Gas—Collar                                       |       | 1,000      |       | $5.00-$5.20             |       | 10/04-9/07                                             |       |
| Natural Gas—Collar                                       |       | 1,000      |       | $6.50-$10.50            |       | 9/06-12/07                                             |       |
| Natural Gas—Collar                                       |       | 3,000      |       | $7.00-$9.05             |       | 1/07-12/07                                             |       |
| March 31, 2006                                                |       |       |       |                    |       |                                                   |       |
| Natural Gas—Collar                                       |       | 1,000      |       | $5.00-$5.20             |       | 10/04-9/07                                             |       |
| Natural Gas—Collar                                       |       | 750        |       | $5.00-$5.50             |       | 10/04-9/06                                             |       |
| Natural  Gas—Collar                                      |       | 1,750      |       | $6.70-$7.90             |       | 1/06-12/06                                             |       |

 

As a result of the change in the fair value of thecommodity derivatives, the Company had an unrealized loss of $636,000 for thequarter ended March 31, 2007 and an unrealized gain of $2,203,000 for thequarter ended March 31, 2006.  TheCompany realized a hedging gain of $437,000 and a hedging loss of $318,000 forthe quarters ending March 31, 2007 and 2006, respectively.  Unrealized and realized gains and losses are includedin gains or losses on derivatives in the statements of operations.  As the Company’s derivative contracts werenot accounted for as cash flow hedges, the Company classifies the realizedgains and losses in the investing activities in the statements of cash flows.

The Company is exposed to credit risk to the extent ofnonperformance by the counterparties in the derivative contracts discussedabove; however, the Company does not anticipate such nonperformance.

**Note 6 — Stock Based Compensation**

*Options under Employee Option Plans*

The Company has adopted stock option plans containingboth incentive and non-statutory stock options. All options allow for thepurchase of common stock at prices not less than the fair market value of suchstock at the date of grant. If the option holder owns more than 10% of thetotal combined voting power of all classes of the Company’s stock, the exerciseprice cannot be less than 110% of the fair market value of such stock at thedate of grant.

Options granted under the plans become vested asdirected by the Company’s Board of Directors and generally expire seven or tenyears after the date of grant, unless the option holder owns more than 10% ofthe total combined voting power of all classes of the Company’s stock, in whichcase the non-statutory stock options must be exercised within five years of thedate of grant. At March 31, 2007, there were 964,000 shares granted underthe plans.

Theoptions granted since formation in June 2003 all vest as follows:

| Year 1 |   | 20  | % |
|--------|--------|-----|---|
| Year 2 |   | 30  | % |
| Year 3 |   | 50  | % |
|   |   | 100 | % |

 

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**Note 6 — Stock Based Compensation (continued)**

*Stock-Based Compensation*

At March 31, 2007, the Company had unvested options topurchase 668,750 shares with a weighted average grant date fair value of $1.3million.  During the three months endedMarch 31, 2007, the Company granted 75,000 employee options and recognizedcompensation expense of approximately $111,000. The Company will recognizecompensation expense relating to nonvested options granted after January 1,2006 of approximately $1.9 million ratably over the next 3 years.

The following table summarizes stock option activityfor the three months ended March 31, 2007:
| ** **                                                        | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Exercise Price  Per Share** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Aggregate  Intrinsic value** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding,  December 31, 2006                                   |       | 1,035,000                  |       | $                                                              | 6.68       |                                                    |       |                                |       |   |
| Granted                                                           |       | 75,000                     |       | 11.00                                                          |       |                                                    |       |                                |       |
| Canceled or  forfeited                                            |       | (146,000                   | )          | 6.68                                                           |       |                                                    |       |                                |       |
|                                                              |       |                       |       |                                                           |       |                                                    |       |                                |       |
| Outstanding,  March 31, 2007                                      |       | 964,000                    |       | $                                                              | 7.02       |                                                    | 5.39       |                                | $          | 3,840,800 |   |
|                                                              |       |                       |       |                                                           |       |                                                    |       |                                |       |
| Exercisable,  March 31, 2007                                      |       | 295,250                    |       | $                                                              | 4.46       |                                                    | 4.30       |                                | $          | 1,931,550 |   |
| Weighted average fair  value of options granted during the period |       |                       |       | $                                                              | 11.00      |                                                    |       |                                |       |   |

 

The following table summarizes information about stockoptions outstanding at March 31, 2007:

|                     | ** ** | **Options Outstanding**            | ** ** | **Options Exercisable**                       | ** ** | ** **              | ** ** |
|---------------------|------------|-----------------------------------------|------------|----------------------------------------------------|------------|-------------------------|------------|
| **Exercise Prices** | ** ** | **Number of  shares  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Fair Value  Determination** | ** ** |
| $4.00               |       | 137,500                                 |       | 3.5 years                                          |       | 137,500                 |       | $ | 4.00 |   | Black-Scholes  (minimum value) |   |
| $4.80               |       | 359,000                                 |       | 5.1 years                                          |       | 135,250                 |       | $ | 4.80 |   | Black-Scholes  (minimum value) |   |
| $5.20               |       | 112,500                                 |       | 5.8 years                                          |       | 22,500                  |       | $ | 5.20 |   | Black-Scholes |   |
| $11.00              |       | 355,000                                 |       | 6.3 years                                          |       | —                  |       | — |   | Black-Scholes |   |
|                |       | 964,000                                 |       |                                               |       | 295,250                 |       |   |   |   |   |

 

*RestrictedStock*

The Company has an incentive program whereby grants ofrestricted stock have been awarded to members of the Board of Directors andcertain employees.  Restrictions and vesting periods for the awards aredetermined at the discretion of the Board of Directors and are set forth in theaward agreements.

Effective February 12, 2007, the Company granted andissued an aggregate of 12,000 shares of restricted common stock to itsnon-employee directors and 25,000 shares of restricted common stock to certainemployees pursuant to the Company’s stock incentive plan.  In addition, on March 26, 2007 the Companygranted an additional 10,000 shares of restricted common stock to certainemployees pursuant to the stock incentive plan. The restricted shares issued to the non-employees directors will vest100% over the next year.  Restrictedshares issued to employees will vest according to the option vestingschedule.  The company recognized anexpense of approximately $49,000 for the quarter ended March 31, 2007 based onthe fair value of the vested shares during the period.

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**Note 6 — Stock Based Compensation (continued)**

A summary of thestatus and activity of the restricted stock for the three months ended March31, 2007 is presented below.

|                                  | ** ** | **Shares** | ** ** | **Weighted-Average  Grant-Date  Fair Value** | ** ** |
|----------------------------------|------------|------------|------------|---------------------------------------------------|------------|
| Non-vested at  December 31, 2006 |       | 36,360     |       | $                                                 | 11.00      |   |
| Granted                          |       | 47,000     |       | $                                                 | 11.00      |   |
| Forfeited                        |       | (9,090     | )          | $                                                 | 11.00      |   |
| Vested                           |       | —     |       | $                                                 | 11.00      |   |
| Non-vested at March 31,  2007    |       | 74,270     |       | $                                                 | 11.00      |   |

 

As of March 31,2007, the Company had approximately $817,000 of unrecognized share-basedcompensation expense related to non-vested stock awards, which is expected tobe amortized over the remaining vesting period of 3 years.

**Note 7 —Long-Term Debt**

*RevolvingCredit Facility*

Effective February 12, 2007, the Companyentered into a new $100 million credit facility (the “New Credit Agreement”)with The Royal Bank of Scotland (“RBS”), with an initial commitment of $27million which permits borrowings up to the borrowing base as designated by theadministrative agent.  As of March 31,2007, the borrowing base under the New Credit Agreement was $22 millionalthough the borrowing availability is less than the initial borrowing base dueto covenant limitations. As of March 31, 2007, the borrowing availability was$16.7 million. The borrowing base is determined on a semi-annual basis and atsuch other times as may be requested by the borrower or administrativeagent.  Based on the Company’s reservereport as of February 28, 2007, management expects that the borrowing base willbe reduced below the initial level. Borrowing under the New Credit Agreement bears interest either: (i) at adomestic bank rate plus an applicable margin between 0.25% and 1.25% per annumbased on utilization or (ii) on a sliding scale from the one, two, three, orsix month LIBOR rate plus 1.25% to 2.25% per annum based on utilization. TheNew Credit Agreement matures February 12, 2011 and replaced the Company’sprevious credit facility.  The New CreditAgreement with RBS is collateralized by substantially all of the Company’sproducing assets.  At March 31,2007, the Company had $4.5 million outstanding under the New CreditAgreement.  On April 20, 2007, theCompany borrowed an additional $2.5 million under the New Credit Agreementwhich brought the total debt outstanding to $7.0 million as of May 30,  2007. The Company intends to use a portion of the net proceeds from itsinitial public offering to pay down all of the outstanding indebtedness under theNew Credit Agreement.

The New CreditAgreement contains covenants that, among other things, restrict the Company’sability, subject to certain exceptions, to do the following:

·      incur liens;

·      incur debt;

·      make investments in otherpersons;

·      declare dividends or redeemor repurchase stock;

·      engage in mergers,acquisitions, consolidations and asset sales or amend our organizationaldocuments;

·      enter into certain hedgingarrangements;

·      amend material contracts;and

·      enter into related partytransactions.

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**Note 7 —Long-Term Debt - continued**

With regard tohedging arrangements, the New Credit Agreement provides that acceptablecommodity hedging arrangements cannot be greater than 80 to 85% depending onthe measurement date of the Company’s monthly production from its hydrocarbonproperties that are used in the borrowing base determination and that the fixedor floor price of the Company’s hedging arrangements must be equal to orgreater than the gas price used by the lenders in determining the borrowingbase.

The New CreditAgreement also requires that the Company satisfy certain affirmative covenants,meet certain financial tests, maintain certain financial ratios and makecertain customary indemnifications to lenders and the administrative agent. Thefinancial covenants include requirements to maintain: (i) earnings beforeincome taxes, depreciation, depletion, amortization and accretions (“EBITDA”)to cash interest expense of not less than 3.00 to 1.00, (ii) current ratio ofnot less than 1.00 to 1.00, (iii) total debt to annualized EBITDA of not morethan 3.0 to 1.0, (iv) quarterly total senior debt to annualized EBITDA equal toor less than 3.0 to 1.0 until June 30, 2007 and 2.00 to 1.0 thereafter, and (v)total proved PV-10 value of reserves to total debt of at least 1.50 to1.00.  The “New Credit Agreement”contains customary events of default, including, without limitation, paymentdefaults, covenant defaults, certain events of bankruptcy and insolvency,defaults in the payment of other material debt, judgment defaults, breaches ofrepresentations and warranties, loss of material permits and licenses and achange in control.  In addition, theCompany is required to eliminate scheduled title defects within periods specifiedon or prior to August 12, 2007, and the failure to eliminate all of thesedefects could result in an event of default. On March 9, 2007, the Company notified the lenders that it would beunable to comply with the initial deadline for the first phase of the curativetitle work and received a waiver from the lenders until April 30, 2007.  On April 30, 2007, the initial deadline forthe first phase of initial curative title work was further extended to May 31,2007 by a waiver received from the lenders. Such curative title work had not been completed as of May 30, 2007, butthe Company expects to receive an additional extension of the waiver.  Failure to obtain an additional extensionwould result in an event of default under the New Credit Agreement. Except forthose covenants the compliance with which was waived, the Company was incompliance with the covenants under the New Credit Agreement as of March 31,2007.

*Office Building Loan*

On November 15, 2005, the Company entered into amortgage loan secured by our office building in Sheridan, Wyoming in theaggregate principal amount of $829,000. The promissory note provides formonthly payments of principal and interest in the initial amount of $6,400, andunpaid principal bears interest at 6.875% during the first three years, at avariable base rate thereafter and at 18% upon a default. The variable base rateis based on the lender’s base rate. The maturity date of this mortgage isNovember 15, 2015, at which time a principal and interest payment of $615,400will become due. As of March 31, 2007, the Company had $803,000 outstanding inprincipal and interest on this mortgage.

**Note 8 —Equity**

*Common Stock*. In April 2006, theCompany completed a private placement of 12,835,230 shares of common stock at aprice of $11.00 per share.  The Companyreceived net proceeds of approximately $130.6 million, before out of pocketoffering costs of $0.7 million,  whichwere used as follows: (i) approximately $53.6 million to redeem all of theoutstanding shares of Series A Redeemable Preferred Stock, including thepayment of all accrued and unpaid dividends and a redemption premium,(ii) approximately $27.0 million for the acquisition of the Green RiverBasin assets, (iii) approximately $16.3 million to repurchase an aggregateof 1,593,783 shares of common stock at a price of $10.23 per share from certainshareholders, and (iv) approximately $33.7 million to fund the Company’sdevelopment drilling program, additional out of pocket offering costs and forgeneral corporate purposes.

In May 2007, the Company completed an initial publicoffering of an aggregate of 3,750,000 shares of common stock at a price pershare of $9.00, or $8.37 net of the underwriters’ discounts and commissions.

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**Note 8 —Equity — continued**

*Series A Redeemable Preferred Stock.*Asof March 31, 2007, there were no shares of Series A RedeemablePreferred Stock issued and outstanding. In April 2006, following the initialclosing of the Company’s private placement discussed above, the Companyredeemed all of the outstanding shares of Series A Redeemable Preferred Stockwith a portion of the proceeds from the private placement including the paymentof accrued and unpaid dividends of $1.4 million.  The difference between the redemption priceand the carrying value of the Series A Redeemable Preferred Stock resulted in a$19.6 million redemption premium that was recorded as a dividend expense in theaccompanying statement of operations in 2006.

*Warrants.*As of December 30,2005, there were Series A warrants outstanding to purchase an aggregate10,530,725 shares of common stock with an exercise price of $4.00 pershare. However, immediately prior to the initial closing of the privateplacement, all outstanding warrants and 1,168,204 escalating options were exchangedin a cashless transaction into an aggregate of 8,062,584 shares of commonstock.

**Note 9 — Contingencies**

From time to time, the Company may be involved inlitigation that arises in the ordinary course of business operations. As of thedate of this report, the Company is not a party to any litigation that itbelieves could reasonably be expected to have a material adverse effect on itsfinancial position, results of operations or cash flows.

The Company iscurrently a defendant in two lawsuits whereby the plaintiff, among otherthings, is seeking to permanently enjoin the State of Montana and itsadministrative bodies from issuing licenses or permits to drill on, or fromauthorizing the removal of ground water from under, the plaintiff’s property.Based on the information available to date, the Company believes the claims arewithout merit and intends to defend the cases vigorously. Additionally, theCompany’s oil and gas operations are subject to various Federal, state andlocal laws and regulations. The Company could incur significant expense tocomply with the new or existing laws and non-compliance could have a materialadverse effect on the Company’s operations.

**Note 10 — Earn-In joint VentureAgreement**

As part of theconsideration related to the acquisition of the properties at formation,Pinnacle signed an Earn-In Joint Venture (“EIJV”) agreement whereby Pinnaclecommitted to spend $14,500,000 (“Spending Commitment”) to develop properties inan area of mutual interest on behalf of the Company and the seller.  Additionally, once the Spending Commitmentwas met under the EIJV, the Company could recoup $2,417,000 of the amountexpended under the Spending Commitment. The EIJV entitled the Company to receive 60% of all monthly pre-tax cashflows from the acquired properties until the entire $2,417,000 isrealized.  As of March 31, 2006, theCompany had fully recouped the $2,417,000 and therefore, realized no additionalgas revenues during the quarter ended March 31, 2007.

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**Note 11 — Subsequent Events**

InApril 2007, the Company hedged 3,000 MMBtu per day from January 2008 throughDecember 2008 at a floor price of $6.50 per MMBtu and a ceiling price of $8.20per MMBtu based on the CIG Inside FERC published price.

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**ITEM2. MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS****OF OPERATIONS**

*The discussion and analysis thatfollows should be read together with the accompanying financial statements andnotes related thereto that are included elsewhere in this quarterly report onForm 10-Q. It includes forward-looking statements that may reflect ourestimates, beliefs, plans and expected performance. The forward-lookingstatements are based upon events, risks and uncertainties that may be outsideour control. Our actual results could differ significantly from those discussedin these forward-looking statements. Factors that could cause orcontribute to these differences include, but are not limited to, market pricesfor natural gas and oil, regulatory changes, estimates of proved reserves,economic conditions, competitive conditions, development success rates, capitalexpenditures and other uncertainties, as well as those factors discussed belowand elsewhere in this quarterly report on Form 10-Q, including in “Risk Factors”and “Cautionary Statement Concerning Forward-Looking Statements,” all ofwhich are difficult to predict. As a result of these assumptions, risks anduncertainties, the forward-looking matters discussed may not occur.*

**Overview**

We are an independent energy company engaged in theacquisition, exploration and development of domestic onshore natural gasreserves. We were formed in June 2003 as a Delaware corporation by fundsaffiliated with DLJ Merchant Banking III, Inc., which we refer to collectivelyas DLJ Merchant Banking, and subsidiaries of Carrizo Oil & Gas, Inc., orCarrizo, and U.S. Energy Corporation, or U.S. Energy.  We primarily focus our efforts on thedevelopment of CBM properties located in the Powder River Basin in northeasternWyoming and southern Montana. In addition, in April 2006, we acquiredproperties located in the Green River Basin in southern Wyoming. As ofMarch 31, 2007, we owned natural gas and oil leasehold interests inapproximately 454,000 gross (308,000 net) acres, approximately 90% of which areundeveloped. As of March 31, 2007, our estimated net proved reserves werelocated on approximately 10% of our net acreage. We drilled 20 gross (11 net)wells and completed 39 gross (22 net) wells during the three months endedMarch 31, 2007, and we operated 100% of those wells. We incurred capitalexpenditures of $2.3 million during the three months ended March 31,2007 related to drilling, completion and infrastructure costs on ourundeveloped acreage in our Kirby, Deer Creek, Cabin Creek and Green River Basinareas.

**Recent Developments**

As of March 31, 2007, we had $4.5 million outstandingunder our new credit facility.  On April20, 2007, we borrowed an additional $2.5 million under our credit facility, andas of May 30, 2007, we had $7.0 million of outstanding borrowings under ourcredit facility.  We intend to use aportion of the net proceeds from our initial public offering to pay down all ofthe outstanding indebtedness under our credit facility.  Please see “—Liquidity and CapitalResources—Credit Facility” for further information regarding our creditfacility.

In April 2007, we hedged 3,000 MMBtu per day from January2008 through December 2008 at a floor price of $6.50 per MMBtu and a ceilingprice of $8.20 per MMBtu based on the CIG Inside FERC published price.

On April 30, 2007,the initial deadline for the first phase of initial curative title workrequired under our credit facility was further extended to May 31, 2007 by awaiver received from the lenders.  Suchcurative title work had not been completed as of May 30, 2007, but we expect toreceive an additional extension of the waiver. Failure to obtain an extension would result in an event of default underour credit facility.

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In May 2007, we completed an initial public offering of an aggregate of3,750,000 shares of our common stock at a price per share of $9.00, or $8.37net of the underwriters’ discounts and commissions.

**Critical Accounting Policies**

The most subjective and complex judgments used in the preparationof our financial statements are:

·                  Reserveevaluation and determination.

·                  Estimatesof the timing and cost of our future drilling activity.

·                  Estimatesof the fair valuation of hedges in place.

·                  Estimatesof timing and cost of asset retirement obligations.

·                  Estimatesof the expense and timing of exercise of stock options.

·                  Accrualsof operating costs, capital expenditures and revenue.

·                  Estimatesfor litigation.

***Oiland Gas Properties***

We use the full cost method of accounting for oil and gasproducing activities. Under this method, all costs associated with propertyacquisition, exploration and development, including costs of unsuccessfulexploration, costs of surrendered and abandoned leaseholds, delay lease rentalsand the fair value of estimated future costs of site restoration, dismantlementand abandonment activities, are capitalized within a cost center. Our oil andgas properties are all located within the United States, which constitutes asingle cost center. We have not capitalized any overhead costs. No gain or lossis recognized upon the sale or abandonment of undeveloped or producing oil andgas properties unless the sale represents a significant portion of gasproperties and the gain significantly alters the relationship between capitalizedcosts and proved gas reserves of the cost center. Expenditures for maintenanceand repairs are charged to lease operating expense in the period incurred.

Depreciation, depletion and amortization of oil and gasproperties is computed on the unit-of-production method based on provedreserves. Amortizable costs include estimates of future development costs ofproved undeveloped reserves and asset retirement obligations. We invest inunevaluated oil and gas properties for the purpose of exploration for provedreserves. The costs of such assets, including exploration costs on propertieswhere a determination of whether proved oil and gas reserves will beestablished is still under evaluation, and any capitalized interest, areincluded in unproved oil and gas properties at the lower of cost or estimatedfair market value and are not subject to amortization. On an annual basis, suchcosts are evaluated for inclusion in the costs to be amortized resulting fromthe determination of proved reserves, impairments, or reductions in value. Tothe extent that the evaluation indicates these properties are impaired, theamount of the impairment is added to the capitalized costs to be amortized.Abandonment of unproved properties are accounted for as an adjustment to capitalizedcosts related to proved oil and gas properties, with no losses recognized.Substantially all remaining unproved property costs are expected to bedeveloped and included in the amortization base ratably over the next three tofive years. Salvage value is taken into account in determining depletion ratesand is based on our estimate of the value of equipment and supplies at the timethe well is abandoned. As of March 31, 2007 and December 2006, the estimatedsalvage value was $5,925,000 and $5,736,000, respectively.

Under the full cost method of accounting, capitalized oiland gas property costs, net of accumulated depreciation, depletion andamortization and related deferred income taxes, may not exceed a “ceiling”value comprised of the total of the present value of future net revenues fromproved reserves, using current costs and prices, including the effects ofderivative instruments accounted for at the fair value but excluding the futurecash outflow associated with settling asset retirement obligations that havebeen accrued on the balance sheet, discounted at 10%, plus the lower of cost ormarket value of unproved properties and unevaluated properties excluded fromcosts being 

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amortized, net of related income tax effects related to differences inthe book and tax basis of oil and gas properties. During the three months endedMarch 31, 2007 and 2006, we recorded impairment of unevaluated propertiesof approximately $740,000 and $0, respectively. At March 31, 2007, the capitalized cost of gas properties exceededthe ceiling value by approximately $17.0 million based upon a natural gasprice of approximately $4.37 per Mcf in effect at that date. Based onsubsequent price decreases to approximately $3.05 per Mcf of gas at May 30,2007, the carrying amount of our oil and gas properties exceeded the full costceiling limitation by approximately $26.5 million. A decline in gas pricesor an increase in operating costs subsequent to the measurement date orreductions in the economically recoverable quantities could result in therecognition of an additional ceiling write-down of our oil and gasproperties in a future period.

***GasSales***

We use the sales method for recording natural gas sales.Sales of gas applicable to our interest in producing natural gas and oil leasesare recorded as revenues when the gas is metered and title transferred pursuantto the gas sales contracts covering our interest in gas reserves. During suchtimes as our sales of gas exceed our pro rata ownership in a well, such salesare recorded as revenues unless total sales from the well have exceeded ourshare of estimated total gas reserves underlying the property at which timesuch excess is recorded as a gas imbalance liability. At March 31, 2007 andDecember 31, 2006, there was no such liability recorded. Although therewas no such liability recorded for prior periods, gas reserves are an estimateand are updated on an annual and interim basis. Gas pricing, expenses andproduction may impact future gas reserves remaining which in turn, could impactthe recording of liabilities in the future. Gas sales accrual at March 31, 2007and December 31, 2006 were based on the actual volume statements from ourpurchasers and distribution process. If accruals were to change by 10% at March31, 2007 and December 31, 2006, the impact would have been a $261,000 and$319,000 change, respectively.

***AssetRetirement Obligations***

We follow the provisions of Statement of FinancialAccounting Standards (SFAS) No. 143, “Accounting for the Asset RetirementObligations.” SFAS No. 143 generally applies to legal obligationsassociated with the retirement of long-lived assets that result from the acquisition,construction, development and/or the normal operation of a long-lived asset.SFAS No. 143 requires us to recognize an estimated liability for costsassociated with the abandonment of our oil and gas properties.

A liability for the fair value of an asset retirementobligation with a corresponding increase to the carrying value of the relatedlong-lived asset is recorded at the time a well is completed or acquired. Theincreased carrying value is depleted using the units-of-productionmethod, and the discounted liability is increased through accretion over theremaining life of the respective oil and gas properties.

The estimated liability is based on historical gasindustry experience in abandoning wells, including estimated economic lives,external estimates as to the cost to abandon the wells in the future andfederal and state regulatory requirements. Our liability is discounted usingour best estimate of our credit-adjusted risk-free rate. Revisions to theliability could occur due to changes in estimated abandonment costs, changes inwell economic lives or if federal or state regulators enact new requirementsregarding the abandonment of wells. For example, a 10% change in our estimatedretirement costs would have a $242,000 effect on our asset retirementobligation liability.

***Inventory***

We acquired inventory of oil and gas equipment, primarilytubulars, in 2006 and 2005, to take advantage of quantity pricing and to securea readily available supply. Inventory is valued at the lower of average cost ormarket. Inventory is used in the development of gas properties and to theextent it is estimated that it will be billed to other working interest ownersduring the next year, it is included in current assets. Otherwise, it isrecorded in other assets. The price of steel is a primary factor in valuing ourinventory. Under the valuation method of lower of average cost or market, a 10%reduction in the price of steel would cause a $54,000 reduction in ourinventory valuation as of March 31, 2007. The market price of steel isevaluated each quarter using prices quoted by authorized vendors in the area.

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***Propertyand Equipment***

Property and equipment is comprised primarily of abuilding, computer hardware and software, vehicles and equipment, and isrecorded at cost. Renewals and betterments that substantially extend the usefullives of the assets are capitalized. Maintenance and repairs are expensed whenincurred. Depreciation and amortization are provided using the straight-linemethod over the estimated useful lives of the assets, ranging as follows:buildings—30 years, computer hardware and software—3 to 5 years,machinery, equipment and vehicles—5 years, and office furniture andequipment—3 to 5 years.

***Long-LivedAssets***

Long-lived assets to be held and used in our business arereviewed for impairment whenever events or changes in circumstances indicatethat the related carrying amount may not be recoverable. When the carryingamounts of long-lived assets exceed the fair value, which is generally based ondiscounted expected future cash flows, we record an impairment. No impairmentswere recorded during the year ended December 31, 2006 or the three monthsended March 31, 2007.

***Generaland Administrative Expenses***

General and administrative expenses are reported net ofamounts allocated and billed to working interest owners of gas propertiesoperated by us. The administrative expenses billed to working interest ownersmay change in accordance with the terms of the joint operating agreements.Administrative expenses are charged to working interest owners based onproductive well counts. A 10% change in well counts for the three months endedMarch 31, 2007 would have increased or decreased our expenses billed toworking interest owners by approximately $38,000. As we operate and drilladditional wells in the future, additional administrative expenses will becharged to the working interest owners when the wells become productive.

***IncomeTaxes***

We use the asset and liability method of accounting forincome taxes, in accordance with SFAS No. 109, “Accounting for IncomeTaxes.” Deferred tax assets and liabilities are recognized for the expectedfuture tax consequences of temporary differences between the financialstatement and tax bases of assets and liabilities. If appropriate, deferred taxassets are reduced by a valuation allowance which reflects expectations of theextent to which such assets will be realized. As of March 31, 2007 andDecember 31, 2006 we had recorded a full valuation allowance for our netdeferred tax asset.

***Derivatives***

We use derivative instruments to manage our exposure tofluctuating natural gas prices through the use of natural gas swap and optioncontracts. We account for derivative instruments or hedging activities underthe provisions of SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities.” SFAS No. 133 requires us to record derivativeinstruments at their fair value. If the derivative is designated as a fairvalue hedge, the changes in the fair value of the derivative and of the hedgeditem attributable to the hedged risk are recognized in earnings. If thederivative is designated as a cash flow hedge, the effective portions ofchanges in the fair value of the derivative are recorded in other comprehensiveincome (loss) and are recognized in the statement of operations when the hedgeditem affects earnings. Ineffective portions of changes in the fair value ofcash flow hedges, if any, are recognized in earnings. Changes in the fair valueof derivatives that do not qualify for hedge treatment are recognized inearnings. Please see Note 5 of unaudited Notes to Financial Statements foradditional discussions of derivatives.

We periodically hedge a portion of our oil and gasproduction through swap and collar agreements. The purpose of the hedges is toprovide a measure of stability to our cash flows in an environment of volatileoil and gas prices and to manage the exposure to commodity price risk. Ourmanagement decided not to use hedge accounting for these agreements. Therefore,in accordance with the provisions of SFAS No. 133, the changes in fairmarket value are recognized in earnings.

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***Stock-BasedCompensation***

Effective January 1, 2006, we adopted SFASNo. 123(R), “Share-Based Payments,” which requires companies torecognize compensation expense for share-based payments based on theestimated fair value of the awards.

SFAS No. 123(R) also requires that the benefits oftax deductions in excess of compensation cost recognized for stock awards andoptions (“excess tax benefits”) be presented as financing cash inflows in theStatement of Cash Flows. Prior to January 1, 2006, we accounted for share-basedpayments under the recognition and measurement provisions of APB OpinionNo. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations, as permitted by SFAS No. 123, “Accounting for Stock-BasedCompensation.” In accordance with APB No. 25, no compensation cost wasrequired to be recognized for options granted that had an exercise price equalto or greater than the market value of the underlying common stock on the dateof the grant.

***AccountsReceivable***

Our revenue producing activities are conducted primarilyin Wyoming. We grant credit to qualified customers, which potentially subjectsus to credit risk resulting from, among other factors, adverse changes in theindustry in which we operate and the financial condition of our customers. Wecontinuously monitor collections and payments from our customers and, ifnecessary, record an allowance for doubtful accounts based upon historicalexperience and any specific customer collection issues identified. We recorded$100,000 at March 31, 2007 and December 31, 2006, respectively.

***TransportationCosts***

We account for transportation costs under Emerging IssuesTask Force Issues 00-10, “Accounting for Shipping and Handling Fees and Costs,”whereby amounts paid for transportation are classified as operating expenses.

***PerShare Information***

Basic earnings per share is computed by dividing net(losses)/income from continuing operations attributable to common stock by theweighted average number of common shares outstanding during each period.Diluted earnings per share is computed by adjusting the average number ofcommon shares outstanding for the dilutive effect, if any, of common stockequivalents such as stock options and warrants. Common stock equivalents of964,000 at March 31, 2007 were excluded because they were anti-dilutivedue to the loss incurred in the period. For the three months endedMarch 31, 2006, common stock equivalents of 707,500 were included in thediluted calculation.

***NewAccounting Pronouncements***

For information regarding new accounting pronouncements,please see note 2 included in the accompanying unaudited Notes to FinancialStatements.

**Trends Affecting Our Business**

We have experienced increasing costs since our inceptionin 2003 due to increased demand for oilfield products and services. Thecyclical nature of the natural gas industry causes fluctuations in demand forgoods and services from oilfield companies, suppliers and others associatedwith the industry, which in turn affects the prices for those goods andservices. Typically, as prices for natural gas increase, so do all the costsassociated with natural gas production. Recently, we have seen increases in the cost of tubulars, drilling rigsand cement in particular. We expect that increased demand for the goods andservices we use in our business will continue to put pressure on prices in thenear to medium term.

Historically, natural gas prices have been extremelyvolatile, and we expect that volatility to continue. For example, during thethree months ended March 31, 2007, the NYMEX natural gas index price rangedfrom a high of $7.83 per MMBtu to a low of $6.16 per MMBtu, while theCIG natural gas index price ranged from a high of $7.11 per MMBtu to a lowof $3.37 per MMBtu. During the year ended December 31, 2006, theNYMEX natural gas index price 

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ranged from a high of $11.23 per MMBtu to a low of $4.20 perMMBtu, while the CIG natural gas index price ranged from a high of$7.90 per MMBtu to a low of $1.30 per MMBtu. Changes in natural gaspricing have impacted our revenue streams, production taxes, prices used inreserve calculations, borrowing base calculations and the valuation ofpotential property acquisitions. During the three months ended March 31, 2007,estimated future gas prices had an impact on both our revenues and the costsattributable to our future operations. We expect that changing natural gasprices will continue to impact our operations and financial results in thefuture.

Transportation of natural gas and access to throughputcapacity have a direct impact on natural gas prices in the Rocky Mountainregion, where our operations are concentrated. As drilling activity increases throughout the Rocky Mountain region,additional production may come on line, which could cause bottlenecks orcapacity constraints. Generally speaking, a surplus of natural gas productionrelative to available transportation capacity has a negative impact on prices.Conversely, as capacity increases, and bottlenecks are eliminated, pricesgenerally increase. Although there is currently adequate transportationcapacity out of the Powder River Basin, a surplus of natural gas arriving atkey marketing hubs from the Powder River Basin and elsewhere relative toavailable takeaway capacity from these hubs has caused Rocky Mountain gas totrade at a discount to the Henry Hub Index. Two major projects that are expected to be completed in 2008 willincrease takeaway capacity from these hubs, and we expect that they willtherefore help reduce the differential between gas produced in the RockyMountain region and the Henry Hub Index.

**Results of Operations for the ThreeMonths Ended March 31, 2007**

Net loss attributable to stockholders for the threemonths ended March 31, 2007 was $18.1 million, or $0.72 per dilutedshare, on total revenue of $3.7 million. Net loss attributable tostockholders for the three months ended March 31, 2007 included a$0.6 million unrealized loss associated with the change in the fairvaluation of our natural gas hedges in place in accordance with the provisionsof SFAS No. 133. Absent such a change in the valuation, we would haveshown a net loss attributable to stockholders of $17.5 million on totalrevenues of $3.7 million. This compares to net income attributable tostockholders of $1.1 million for the three months ended March 31, 2006 ontotal revenue of $4.0 million. Adjusted for an unrealized gain in the fairvaluation of our natural gas hedges in place of $2.2 million, our resultsfor the three months ended March 31, 2006 would have been a net lossattributable to stockholders of $1.1 million on total revenues of$4.0 million.

*Gas sales volume.*

Gas sales volume increased 27% from 565 MMcf in the threemonths ended March 31, 2006 to 717 MMcf in the three months ended March 31,2007. Daily sales volume was 8.0 MMcf for the three months ended March 31, 2007as compared to 6.3 MMcf for the three months ended March 31, 2006, a 1.7 MMcfper day increase. The increase was primarily due to production coming online inour Cabin Creek project area.

*Gas sales revenue.*

Revenue from gas sales increased $0.02 million in thethree months ended March 31, 2007 to $3.7 million, a 1% increase comparedto the three months ended March 31, 2006. This increase was primarily due to anincrease in gas sales volume which was partially offset by a decrease in theaverage realized price per Mcf.  Theaverage realized price per Mcf decreased 21% from $6.42 per Mcf in the threemonths ended March 31, 2006 to $5.10 per Mcf in the three months ended March31, 2007.

*Derivatives.*

For the three months ended March 31, 2007, we had anunrealized loss of $0.6 million compared to an unrealized gain of$2.2 million for the three months ended March 31, 2006. The unrealizedloss is a noncash expense based primarily on the Black-Scholes model forvaluing future cash flows utilizing price volatility with a normal discount rate.Hedges settled in the three months ended March 31, 2007 resulted in a realizedgain of $0.4 million compared to hedge losses of $0.3 million in thethree months ended March 31, 2006. The hedge gains were primarily due to thefact that gas prices were lower than our weighted average floor price.

*Lease operating expenses.*

Lease operating expenses increased $0.4 million inthe three months ended March 31, 2007 to $0.9 million, a 78% increasecompared to the three months ended March 31, 2006. This increase resulted froman increase in the number of wells in the productive cycle during the threemonths ended March 31, 2007. On an Mcf basis, lease operating expensesincreased 41% from $0.91 per Mcf in the three months ended March 31, 2006 to$1.28 per Mcf in the three months ended March 31, 2007. The increase per Mcfwas primarily due to a number of wells being in the 

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early stages of their productive life cycle as production did notincrease proportionately to the number of wells coming online.

*Production taxes.*

Production taxes decreased $0.01 million in thethree months ended March 31, 2007 to $0.4 million, a 3% decrease from thethree months ended March 31, 2006. Production taxes correlate to gross salesrevenue because production taxes in Wyoming are based on a percentage of salesvalue. The percentage averages 11% to 13%, depending on rates in effect for therespective year. The decrease in production taxes for the quarter ended March31, 2007 is primarily due to reduced rates for Montana production taxes. On anMcf basis, production taxes were $0.56 per Mcf for the three months ended March31, 2007 and $0.73 per Mcf for the three months ended March 31, 2006, a 23%decrease, which correlates to the decrease in the price per Mcf received in thethree months ended March 31, 2007 from the three months ended March 31, 2006.

*Marketing and transportation.*

Marketing and transportation expenses increased $0.4 millionin the three months ended March 31, 2007 to $0.8 million, a 94% increasefrom the three months ended March 31, 2006. The increase related primarily tothe increased sales volume in the three months ended March 31, 2007 togetherwith a slight increase in transportation fees and compression due toinflationary adjustments in the contracts along with fees paid for compressiondesign capacity which was not used.  Onan Mcf basis, marketing and transportation expenses increased 53% to $1.10 perMcf in the three months ended March 31, 2007 from $0.72 per Mcf in the threemonths ended March 31, 2006.

*General and administrative expenses,net.*

General and administrative expenses are offset byoperating income from drilling and production activities for which we cancharge an overhead fee to nonoperating working interest owners. These welloperating overhead fees increased 44% in the three months ended March 31,2007, from $0.3 million to $0.4 million, due to increased productivewells which we operate and for which we charge an overhead fee. General andadministrative expenses, net increased $0.3 million in the three monthsended March 31, 2007 to $1.1 million from $0.8 million in thethree months ended March 31, 2006. This increase during the three monthsended March 31, 2007 was due primarily to an increase in payroll expensesdue to the hiring of additional employees. On an Mcf basis, general and administrative expenses, net increased 13%from $1.36 per Mcf in the three months ended March 31, 2006 to $1.54 perMcf in the three months ended March 31, 2007.

*Depreciation, depletion, amortizationand accretion.*

Depreciation, depletion, amortization and accretionexpense increased $0.1 million for the three months ended March 31, 2007to $1.5 million, a 1% increase compared to the three months endedMarch 31, 2006. This increase was due to an increase in capitalexpenditures that were added into the full cost pool used for the computationof depletion, as well as increased production coupled with lower quarter-endreserves due to lower quarter-end pricing. On an Mcf basis, the depreciation,depletion, amortization and accretion rate decreased 21% to $2.07 per Mcf inthe three months ended March 31, 2007 from $2.61 per Mcf in the threemonths ended March 31, 2006.

*Impairment.*

AtMarch 31, 2007, the carrying amount of oil and gas properties exceeded the fullcost ceiling limitation by approximately $17.0 million, based upon anatural gas price of approximately $4.37 per Mcf in effect at that date.  The impairment of our oil and gas propertiesresulted from low commodity prices at March 31, 2007.  For further informationregarding this impairment, please see note 2 included in the accompanyingunaudited Notes to Financial Statements.

**Liquidity and Capital Resources**

Our primary source of liquidity since our formation hasbeen the sale of our equity. During the period from our formation in June 2003through September 2005, DLJ Merchant Banking contributed $44.1 millioncash in exchange for shares of our common stock, shares of our Series ARedeemable Preferred Stock and detachable warrants 

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to purchase additional shares of common stock. The proceeds were used tofund our acquisitions and capital expenditures. In April 2006, wecompleted a private placement of an aggregate of 12,835,230 shares of ourcommon stock at a price per share of $11.00, or $10.23 net of the initialpurchaser’s discount and placement fee. In May 2007, we completed an initialpublic offering of an aggregate of 3,750,000 shares of our common stock at a priceper share of $9.00, or $8.37 net of the underwriters’ discounts andcommissions.  Please see “—Cash Flow fromFinancing Activities—Sales and Issuances of Equity.”

*Credit Facility.*  EffectiveFebruary 12, 2007, we entered into a new $100 million credit facilitywith an initial commitment of $27 million which permits borrowings up tothe borrowing base as designated by the administrative agent. As ofMarch 31, 2007, the initial borrowing base was $22 million althoughour borrowing availability is less than our initial borrowing base due tocovenant limitations. As of March 31, 2007, the actual borrowingavailability was $16.7 million. The borrowing base is determined on asemi-annual basis and at such other additional times, up to twice yearly, asmay be requested by either the borrower or the administrative agent and isdetermined by the administrative agent in accordance with customary practicesand standards for loans of a similar nature; provided that such determinationis at the administrative agent’s discretion as the credit agreement does notprovide a specific borrowing base formula. Based on our reserve report as ofDecember 31, 2006 and February 28, 2007, we expect that our borrowing basewill be further reduced below its initial level. Borrowings under this creditfacility may be used solely to acquire, explore or develop oil and gasproperties and for general corporate purposes. The credit facility maturesFebruary 12, 2011. At March 31, 2007 and May 30, 2007, we had$4.5 million and $7.0 million, respectively, of indebtedness outstandingunder our credit facility.

Our obligations under the credit facility are secured byliens on (i) no less than 90% of the net present value of the oil and gasto be produced from our oil and gas properties that are included in theborrowing base determination, calculated using a discount rate of 10% per annumand reserve estimates, prices and production rates and costs, (ii) optionsto lease, seismic options, permits, and records related to such properties, and(iii) seismic data.

Borrowings under our credit facility may be either (i) adomestic bank rate plus an applicable margin between 0.25% and 1.25% per annumbased on utilization, or (ii) the London interbank offered rate, or LIBOR, plusan applicable margin between 1.25% and 2.25% per annum based on utilization.The credit agreement provides for various fees, including a quarterlycommitment fee of 1¤2 of 1.00% per annum and engineering fees to theadministrative agent in connection with a borrowing base determination. Inaddition, the credit agreement provides for an up front fee of $27,000, whichwas paid on the closing date of the credit agreement, and an additionalarrangement fee of up to 1% based on utilization. Borrowings under this creditfacility may be prepaid without premium or penalty, except on Eurodollaradvances. If an event of default exists, the default rate shall be equal to 2%plus the floating rate.

The credit agreement contains covenants that, among otherthings, restrict our ability, subject to certain exceptions, to do thefollowing:

·                  incurliens;

·                  incurdebt;

·                  makeinvestments in other persons;

·                  declaredividends or redeem or repurchase stock;

·                  engagein mergers, acquisitions, consolidations and asset sales or amend ourorganizational documents;

·                  enterinto certain hedging arrangements;

·                  amendmaterial contracts; and

·                  enterinto related party transactions.

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With regard to hedging arrangements, the credit facility provides thatacceptable commodity hedging arrangements cannot be greater than 80 to 85%depending on the measurement date of our monthly production from ourhydrocarbon properties that are used in the borrowing base determination andthat the fixed or floor price of our hedging arrangements must be equal to orgreater than the gas price used by the lenders in determining the borrowingbase.

The credit agreement also requires that we satisfycertain affirmative covenants, meet certain financial tests, maintain certainfinancial ratios and make certain customary indemnifications to lenders and theadministrative agent. The financial covenants include requirements to maintain:(i) EBITDA to cash interest expense of not less than 3.00 to 1.00, (ii) currentratio of not less than 1.00 to 1.00, (iii) total debt to annualized EBITDAof not more than 3.0 to 1.0, (iv) quarterly total senior debt to annualizedEBITDA equal to or less than 3.0 to 1.0 until June 30, 2007 and 2.00 to 1.0thereafter, and (v) total proved PV-10 value to total debt of at least1.50 to 1.00.

The credit agreement contains customary events of default, including,without limitation, payment defaults, covenant defaults, certain events ofbankruptcy and insolvency, defaults in the payment of other material debt,judgment defaults, breaches of representations and warranties, loss of materialpermits and licenses and a change in control. In addition, we are required toeliminate scheduled title defects within periods specified on or prior toAugust 12, 2007, and the failure to eliminate all of these title defectswould result in an event of default under the credit facility. We cannotguarantee that we will be able to eliminate all of these title defects withinthe specified periods. On March 9, 2007, we notified the lenders that wewould be unable to comply with the initial deadline for the first phase of thecurative title work and received a waiver from the lenders until April 30,2007.  Certain phase one curative titlework was not completed by April 30, 2007 and we received an additional extensionof the waiver until May 31, 2007. Such curative title work had not been completed as of May 30, 2007, butwe expect to receive an additional extension of the waiver.  Failure to obtain an additional extensionwould result in an event of default under the credit facility.  Except for those covenants the compliancewith which was waived, we were in compliance with the covenants under ourcredit agreement as of March 31, 2007.

The credit agreement requires all of our wholly ownedsubsidiaries to guarantee the obligations under the credit agreement.

*Office Building Loan.*  OnNovember 15, 2005, we entered into a mortgage loan secured by our officebuilding in Sheridan, Wyoming in the aggregate principal amount of $829,000.The promissory note provides for monthly payments of principal and interest inthe initial amount of $6,400, and unpaid principal bears interest at 6.875%during the first three years, at a variable base rate thereafter and at 18%upon a default. The variable base rate is based on the lender’s base rate. Thematurity date of this mortgage is November 15, 2015, at which time aprincipal and interest payment of $615,400 will become due. As ofMarch 31, 2007, we had $781,000 outstanding in principal and interest onthis mortgage.

*Capital Expenditure Budget.*  For 2007,we have a total capital expenditure budget of approximately $52.6 millionto drill and complete approximately 260 gross (207 net) wells, to constructrelated gas and water infrastructure, to fund plans of development costs forfuture wells, to fund undeveloped leasehold acquisition costs carried over from2006, to recomplete certain wells, and to fund infrastructure and completioncosts related to wells drilled in 2006. We incurred capital expenditures of $2.3 million during the threemonths ended March 31, 2007,  whichwere primarily related to drilling, completion and infrastructure costs on ourundeveloped acreage in our Kirby, Deer Creek, Cabin Creek and Green River Basinareas. While we believe we have adequate resources from our credit facility andcash flows from operations to implement our 2007 drilling plan, our ability todevelop future projects will depend on access to additional capital.  The CIG index price has been extremelyvolatile since March 31, 2007 and has at times reached unusually lowlevels.  If prices remain low, it wouldcause our cash flows from operations to decrease and could result in areduction of the borrowing base under our credit facility, and if we could notobtain capital through our credit facility or otherwise, our ability to executeour development and acquisition plans, replace our reserves and maintainproduction levels could be greatly limited.

We participated in the drilling of 20 gross (11 net)wells during the three months ended March 31, 2007 and we are activelydeveloping the Kirby, Deer Creek and Cabin Creek areas of our undevelopedacreage. We are also actively developing our Green River Basin acreage.

 

25

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***Cash Flow fromOperating Activities***

Net cash used by operating activities was$5.7 million for the three months ended March 31, 2007, compared tonet cash provided by operating activities of $4.1 million for the threemonths ended March 31, 2006 due to a reduction in our accounts payablebalance.

While we believe that cash flows from operations andborrowings under our credit facility will be sufficient to meet our plannedcapital expenditures and our other cash needs during the year endingDecember 31, 2007, the CIG index price has been extremely volatile sinceMarch 31, 2007 and has at times reached unusually low levels. If pricesremain low, it would cause our cash flows from operations to decrease and couldresult in a reduction of the borrowing base under our credit facility.

***Cash Flow fromInvesting Activities***

Net cash used in investing activities was$1.9 million for the three months ended March 31, 2007. Net cash usedin investing activities decreased by approximately $4.5 million comparedto the three months ended March 31, 2006 due to a decrease in capitalexpenditures primarily related to wildlife stipulations and weather delays.

***Cash Flow fromFinancing Activities***

During the period from our formation in June 2003 throughSeptember 2005, DLJ Merchant Banking contributed $44.1 million in cash inexchange for shares of our common stock, shares of our Series A RedeemablePreferred Stock and detachable warrants to purchase additional shares of commonstock.  As of March 31, 2006 andMarch 31, 2007, we had 5,800,000 and 25,178,301 shares of common stockissued and outstanding, respectively, of which 0 and 74,270 shares,respectively, were shares of restricted stock issued to employees anddirectors.

In April 2006, we completed a private placement, exemptfrom registration under the Securities Act, of 12,835,230 shares of our commonstock to qualified institutional buyers, non-U.S. persons and accreditedinvestors at a price of $11.00 per share, or $10.23 per share net of theinitial purchaser’s discount and placement fee. Out of the aggregate ofapproximately $129.9 million of net proceeds (after the initial purchaser’sdiscount and placement fee and offering expenses) we received in the privateplacement, we used (i) approximately $53.6 million to redeem all ofthe outstanding shares of our Series A Redeemable Preferred Stock,including the payment of all accrued and unpaid dividends and a redemptionpremium, (ii) approximately $27.0 million for our acquisition of theGreen River Basin assets, (iii) approximately $16.3 million torepurchase an aggregate of 1,593,783 shares of common stock at a price of$10.23 per share from DLJ Merchant Banking and Gary W. Uhland, our formerPresident, and (iv) approximately $33.0 million to fund our developmentdrilling program and pay additional offering expenses and for general corporatepurposes.

Immediately prior to the initial closing of our privateplacement, DLJ Merchant Banking exchanged all of its outstanding warrants for6,894,380 shares of our common stock in a tax-free reorganization based on theprivate placement price of $11.00 per share. As of March 31, 2007, we hadno warrants or escalating options issued and outstanding.

In April 2006, following the initial closing of ourprivate placement, we redeemed all of the outstanding shares of Series ARedeemable Preferred Stock with a portion of the proceeds from our privateplacement including the payment of accrued and unpaid dividends of$1.4 million. The difference between the redemption price and the carryingvalue of the Series A Redeemable Preferred Stock resulted in a$19.6 million redemption premium that was recorded as a dividend expensein our statement of operations for the three months ended June 30, 2006.As of March 31, 2007, we had no shares of Series A RedeemablePreferred Stock issued and outstanding.

In May 2007, we completed an initial public offering of3,750,000 shares of our common stock at a price of $9.00 per share, or $8.37per share net of underwriters’ discounts and commissions.  Out of the approximately $30.7 million of netproceeds (after underwriters’ discounts and commissions and offering expenses)we received in our initial public offering, we intend to use $7.0 million topay down all of the outstanding indebtedness under our credit facility.  We intend to use the remainder of the netproceeds for accelerated capital expenditures, infrastructure development andgeneral corporate purposes.

26

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***ContractualObligations***

The following table summarizes by period our contractualobligations as of March 31, 2007:
| ** **                                     | ** ** | **Total**               | ** ** | **2007** | ** ** | **2008-2009** | ** ** | **2010-2011** | ** ** | **Thereafter** | ** ** |
|------------------------------------------------|------------|-------------------------|------------|----------|------------|---------------|------------|---------------|------------|----------------|------------|
| ** **                                     | ** ** | **(in thousands)** | ** ** |
| Credit facility                                |       | $                       | 4,500      |     | —     |          | —     |          | $          | 4,500          |       | — |   |
| Notes payable in  connection with the mortgage |       | 803                     |       | 22       |       | 41            |       | 42            |       | 698            |       |
| Asset retirement  obligations                  |       | 2,438                   |       | —   |       | 209           |       | 513           |       | 1,716          |       |
| Non-current  production and property taxes     |       | 1,249                   |       | —   |       | 1,249         |       | —        |       | —         |       |
| Total                                          |       | $                       | 8,990      |     | $          | 22            |       | $             | 1,499      |           | $          | 5,055 |   | $ | 2,414 |   |
|                                                |            |                         |            |          |            |               |            |               |            |                |            |  |  |  |  |  |

 

At March 31, 2007, the commodity derivatives assetwas valued at $ 2,220,000, which represents a current receivableattributable to 2007.

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

The primary objective of the following information is toprovide forward-looking quantitative and qualitative information aboutour potential exposure to market risk. The term “market risk” refers to therisk of loss arising from adverse changes in natural gas prices. This forward-lookinginformation provides indicators of how we view and manage our ongoing marketrisk exposure. All of our market risk sensitive instruments were entered intofor purposes other than speculative trading.

***Commodity Price Risk***

Our major market risk exposure is in the pricingapplicable to our natural gas production. The prices we receive for ourproduction depend on many factors beyond our control. We seek to reduce ourexposure to unfavorable changes in natural gas prices, which are subject tosignificant and often volatile fluctuation, through the use of fixed-pricecontracts. The fixed-price contracts are comprised of energy swaps andcollars. These contracts allow us to predict with greater certainty theeffective natural gas prices to be received for hedged production and benefitoperating cash flows and earnings when market prices are less than the fixedprices provided by the contracts. However, we will not benefit from marketprices that are higher than the fixed prices in the contracts for hedgedproduction. Collar structures provide for participation in price increases anddecreases to the extent of the ceiling prices and floors provided in thosecontracts.

The following table summarizes the estimated volumes,fixed prices, fixed price sales and fair value attributable to the fixed pricecontracts as of March 31, 2007. At March 31, 2007, we had no hedgedvolumes beyond December 2007. However, in April 2007, we hedged anadditional 3,000 MMBtu per day from January 2008 through December 2008 at afloor price of $6.50 per MMBtu and a ceiling price of $8.20 per MMBtu based onthe CIG Inside FERC published price. Please see Note 5 included in the accompanying unaudited Notes toFinancial Statements.

|                                             | ** ** | **Year Ending  December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                | ** ** |
| ** **                                  | ** ** | **(Unaudited)**                         | ** ** |
| **Natural  Gas Collars:**                   |       |                                    |       |
| Contract volumes  (MMBtu):                  |       |                                    |       |
| Floor                                       |       | 1,283,000                               |       |
| Ceiling                                     |       | 1,283,000                               |       |
| Weighted-average  fixed price per MMBtu(1): |       |                                    |       |
| Floor                                       |       | $                                       | 6.61       |   |
| Ceiling                                     |       | $                                       | 8.81       |   |
| Fixed-price  sales(2)                       |       | $                                       | 8.81       |   |
| Fair value, net  (thousands)(3)             |       | $                                       | 2,220      |   |

 

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|                                            | ** ** | **Year Ending  December 31,** | ** ** |
|--------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                 | ** ** | **2007**                                | ** ** |
| ** **                                 | ** ** | **(Unaudited)**                         | ** ** |
| **Total  Natural Gas Contracts:**          |       |                                    |       |
| Contract volumes  (MMBtu)                  |       | 1,283,000                               |       |
| Weighted-average  fixed price per MMBtu(1) |       | $                                       | 6.61       |   |
| Fixed-price  sales(2)                      |       | $                                       | 8.81       |   |
| Fair value, net  (thousands)(3)            |       | $                                       | 2,220      |   |

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(1)                                  Volumes hedged using the CIG index price publishedin the first issue of Inside FERC’s Gas Market Report for each calendar monthof the derivative transaction.

(2)                                  Assumes ceiling prices for natural gas collarvolumes.

(3)           Fair value based on CIG index price in effect for eachmonth as of Mach 31, 2007.

**ITEM 4T. CONTROLS AND PROCEDURES**

**Disclosure Controls and Procedures**

Based on their evaluation as of the end of the periodcovered by this report, our principal executive officer and principal financialofficer have concluded that our disclosure controls and procedures (as definedin Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, asamended (the Exchange Act)) are effective to ensure that information requiredto be disclosed in reports that we file or submit under the Exchange Act arerecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms.

**Changes in Internal Control OverFinancial Reporting**

During the most recent fiscal quarter, there have beenno changes in our internal control over financial reporting that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

**PART II. OTHER INFORMATION**

**ITEM 1. LEGAL PROCEEDINGS**

For a discussion of certain of our current legalproceedings, please read note 9 included in the accompanying unaudited Notes toFinancial Statements in Item 1 of this quarterly report on Form 10-Q.

We were named as defendants intwo related lawsuits (Civil Action No. 06CV0047J) filed on March 30,2006 in the United States District Court, Wyoming by Burning Rock Energy, LLCand (Case No. 06-CV-01627-MDM-MEH) filed onApril 25, 2006 in the United States District Court for the District ofColorado by John R. Behrmann, et al. claiming various contract and tortclaims against us relating to a like-kind exchange between us and theplaintiffs of approximately 1,000 acres of leased acreage in January 2004.The plaintiffs claimed, in part, that the leases transferred by us to BurningRock did not terminate upon nonpayment of shut-in rentals and further,that we trespassed by releasing from the original lessors the propertiesoriginally transferred to Burning Rock under the exchange agreement. In April2007, we settled these claims with the plaintiffs and both lawsuits have beendismissed. The settlement arrangement included a $500,000 payment by us toBurning Rock together with an assignment by us to Burning Rock of a 69.5%carried working interest in the disputed leased acreage.

From time to time, we are subjectto legal proceedings and claims that arise in the ordinary course of ourbusiness.  While the outcome of theseproceedings cannot be predicted with certainty, we do not expect them to have amaterial adverse effect on the financial statements.

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**ITEM 1A. RISK FACTORS**

There have been no material changes to the riskfactors disclosed in our amended registration statement on Form S-1 (File No.333-139556), filed April 27, 2007.

**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIESAND USE OF PROCEEDS**

On May 10, 2007, our registration statement on FormS-1 (File No. 333-139556), as amended, relating to our initial public offeringwas declared effective by the Securities and Exchange Commission.  The managing underwriters of the offeringwere Friedman, Billings, Ramsey & Co., Inc., RBC Capital MarketsCorporation, A.G. Edwards & Sons, Inc. and Johnson Rice & CompanyL.L.C.  The closing date of our initialpublic offering was May 18, 2007, and on that date we sold 3,750,000 shares ofour common stock, par value $0.01 per share, ata price per share of $9.00, or $8.37 net of the underwriters’ discounts andcommissions. Out of the approximately $30.7 million of net proceeds (afterunderwriters’ discounts and commissions of approximately $2.3 million andestimated offering expenses of approximately $750,000) we received in ourinitial public offering, we intend to use $7.0 million to pay down all of theoutstanding indebtedness under our credit facility.  We intend to use the remainder of the netproceeds for accelerated capital expenditures, infrastructure development andgeneral corporate purposes.

**ITEM 3. DEFAULTS UPON SENIORSECURITIES**

Not applicable.

**ITEM 4. SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

On March 30, 2007, we heldour annual meeting of stockholders.  Ofthe 25,131,301 shares of common stock of record, 20,237,471 were represented inperson or by proxy.  At the meeting, thestockholders voted on the election of two Class I directors to serve until theend of their terms in 2010.  Thefollowing is a summary of the vote on this matter:

|                      | ** ** | **Votes For** | ** ** | **Votes  Withheld** | ** ** |
|----------------------|------------|--------------------|------------|---------------------|------------|
| Jeffrey P. Gunst     |       | 18,947,001         |       | 1,290,470           |       |
| Peter G. Schoonmaker |       | 18,947,001         |       | 1,290,470           |       |

 

The terms of directorsSteven A. Webster, Robert L. Cabes, Sylvester P. Johnson IV, F. Gardner Parkerand  Susan C. Schnabel continuedthrough and after the meeting.

**ITEM 5. OTHER INFORMATION**

Not applicable.

 

29

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**ITEM 6. EXHIBITS**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                  |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1         |       | —Second Amended and Restated Certificate of  Incorporation of Pinnacle Gas Resources, Inc. (incorporated herein by  reference to Exhibit 3.1 to the Registration Statement on Form S-1 (File No.  333-133983) filed by Pinnacle Gas Resources, Inc. on May 10, 2006).                                                                                                                                                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 3.2         |       | —Amended and Restated Bylaws of Pinnacle Gas  Resources, Inc. (incorporated herein by reference to Exhibit 3.2 to the  Registration Statement on Form S-1 (File No. 333-133983) filed by Pinnacle  Gas Resources, Inc. on May 10, 2006).                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.1         |       | —Amended and Restated Securityholders Agreement,  dated February 16, 2006 (incorporated herein by reference to Exhibit 4.1 to  the Registration Statement on Form S-1 (File No. 333-133983) filed by  Pinnacle Gas Resources, Inc. on May 10, 2006).                                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.2         |       | —Registration Rights Agreement, dated April 11, 2006  (incorporated herein by reference to Exhibit 4.2 to the Registration  Statement on Form S-1 (File No. 333-133983) filed by Pinnacle Gas Resources,  Inc. on May 10, 2006).                                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.1        |       | —Credit Agreement, dated February 12, 2007, by and  among Pinnacle Gas Resources, Inc., as Borrower, the Lenders from time to  time party thereto and Royal Bank of Scotland plc, individually and as  Administrative Agent (incorporated herein by reference to Exhibit 10.2 to  Amendment No. 1 to the Registration Statement on Form S-1 (File No.  333-139556) filed by Pinnacle Gas Resources, Inc. on April 3, 2007). |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.2        |       | —Letter regarding Waiver and Amendment of Credit Agreement,  dated March 9, 2007 (incorporated herein by reference to Exhibit 10.3 to  Amendment No. 1 to the Registration Statement on Form S-1 (File No.  333-139556) filed by Pinnacle Gas Resources, Inc. on April 3, 2007).                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| †10.3  |       | —Term Sheet and Summary regarding New Employment  Agreement and Equity Awards for Ronald T. Barnes (incorporated by reference  to Exhibit 10.17 to Amendment No. 2 to the Registration Statement on Form S-1  (File No. 333-139556) filed by Pinnacle Gas Resources, Inc. on April 23,  2007).                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| *31.1       |       | —Certification of President and Chief Executive  Officer of Pinnacle Gas Resources, Inc. pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| *31.2       |       | —Certification of Senior Vice President, Chief  Financial Officer and Secretary of Pinnacle Gas Resources, Inc. pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| *32.1       |       | —Certification of President and Chief Executive  Officer of Pinnacle Gas Resources, Inc. pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| *32.2       |       | —Certification of Senior Vice President, Chief  Financial Officer and Secretary of Pinnacle Gas Resources, Inc. 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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*              Filedherewith

†              Managementcontract or compensatory plan or arrangement

 

30

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
|        |   | PINNACLE GAS  RESOURCES, INC. |
|--------|--------|-------------------------------|
|   |   | ** **                    |
|        |   | By:                           | /s/ Peter G.  Schoonmaker |
|   |   | Name:                         | Peter G. Schoonmaker |
|   |   | Title:                        | *President, Chief Executive* |
|   |   |                          | *Officer and Director* |
|   |   |                          | (Principal Executive Officer) |
|   |   |                          |   |
|   |   | Date:                         | May 30, 2007 |
|   |   |                          |   |
|        |   | By:                           | /s/ Ronald T.  Barnes |
|   |   | Name:                         | Ronald T. Barnes |
|   |   | Title:                        | *Senior Vice President, Chief  Financial* |
|   |   |                          | *Officer and Secretary* |
|   |   |                          | (Principal Financial Officer and |
|   |   |                          | Principal Accounting Officer) |
|   |   |                          |   |
|   |   | Date:                         | May 30, 2007 |

 

31

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| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                  |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1         |       | —Second Amended and Restated Certificate of  Incorporation of Pinnacle Gas Resources, Inc. (incorporated herein by  reference to Exhibit 3.1 to the Registration Statement on Form S-1 (File No.  333-133983) filed by Pinnacle Gas Resources, Inc. on May 10, 2006).                                                                                                                                                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 3.2         |       | —Amended and Restated Bylaws of Pinnacle Gas  Resources, Inc. (incorporated herein by reference to Exhibit 3.2 to the  Registration Statement on Form S-1 (File No. 333-133983) filed by Pinnacle  Gas Resources, Inc. on May 10, 2006).                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.1         |       | —Amended and Restated Securityholders Agreement,  dated February 16, 2006 (incorporated herein by reference to Exhibit 4.1 to  the Registration Statement on Form S-1 (File No. 333-133983) filed by  Pinnacle Gas Resources, Inc. on May 10, 2006).                                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.2         |       | —Registration Rights Agreement, dated April 11, 2006  (incorporated herein by reference to Exhibit 4.2 to the Registration  Statement on Form S-1 (File No. 333-133983) filed by Pinnacle Gas Resources,  Inc. on May 10, 2006).                                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.1        |       | —Credit Agreement, dated February 12, 2007, by and  among Pinnacle Gas Resources, Inc., as Borrower, the Lenders from time to  time party thereto and Royal Bank of Scotland plc, individually and as  Administrative Agent (incorporated herein by reference to Exhibit 10.2 to  Amendment No. 1 to the Registration Statement on Form S-1 (File No.  333-139556) filed by Pinnacle Gas Resources, Inc. on April 3, 2007). |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.2        |       | —Letter regarding Waiver and Amendment of Credit Agreement,  dated March 9, 2007 (incorporated herein by reference to Exhibit 10.3 to  Amendment No. 1 to the Registration Statement on Form S-1 (File No.  333-139556) filed by Pinnacle Gas Resources, Inc. on April 3, 2007).                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| †10.3  |       | —Term Sheet and Summary regarding New Employment  Agreement and Equity Awards for Ronald T. Barnes (incorporated by reference  to Exhibit 10.17 to Amendment No. 2 to the Registration Statement on Form S-1  (File No. 333-139556) filed by Pinnacle Gas Resources, Inc. on April 23, 2007).                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| *31.1       |       | —Certification of President and Chief Executive  Officer of Pinnacle Gas Resources, Inc. pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| *31.2       |       | —Certification of Senior Vice President, Chief  Financial Officer and Secretary of Pinnacle Gas Resources, Inc. pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| *32.1       |       | —Certification of President and Chief Executive  Officer of Pinnacle Gas Resources, Inc. pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| *32.2       |       | —Certification of Senior Vice President, Chief  Financial Officer and Secretary of Pinnacle Gas Resources, Inc. 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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*              Filedherewith

†              Managementcontract or compensatory plan or arrangement

 

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