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Exhibit 10.03
 
SUBSCRIPTION AGREEMENT
 
THIS SUBSCRIPTION AGREEMENT (this “Agreement”) made as of the Effective Date of
the Note referred to below between Paxton Energy, Inc., a Nevada corporation
(the “Company”), and What Happened LLC, a limited liability company (the
“Subscriber”).
 
RECITALS
A.      The Company is conducting a private offering (the “Offering”) of 8%
unsecured convertible promissory notes (each a “Note,” collectively, the
“Notes”), initially convertible into shares of the Company’s common stock par
value $0.001 per share (the “Common Stock”), pursuant to Section 4(2) of the
Securities Act of 1933, as amended (the “Securities Act”) and Rule 506
promulgated thereunder; and
 
B. Subscriber desires to purchase such amount of Note as set forth on the
signature page hereof on the terms and conditions hereinafter set forth.
 
NOW, THEREFORE, in consideration of the premises and the mutual representations
and covenants hereinafter set forth, the parties hereto do hereby agree as
follows:
 
I.           SUBSCRIPTION FOR SECURITIES AND REPRESENTATIONS BY SUBSCRIBER
 
1.1             Subject to the terms and conditions hereinafter set forth,
Subscriber hereby subscribes for and agrees to purchase from the Company, and
the Company agrees to sell to the Subscriber, such aggregate face amount of Note
for the aggregate purchase price as is set forth on the signature page
hereof.  The purchase price is payable by wire transfer to Paxton Energy, Inc..
 
1.2             The Securities will be offered for sale until November 30, 2011.
 
1.3             Subscriber recognizes that the purchase of the Securities
involves a high degree of risk including, but not limited to, the following: (a)
the Company has a limited operating history and requires substantial funds in
addition to the proceeds of the Offering; (b) an investment in the Company is
highly speculative, and only investors who can afford the loss of their entire
investment should consider investing in the Company and the Securities; (c)
Subscriber may not be able to liquidate its investment; (d) transferability of
the Securities is extremely limited; (e) in the event of a disposition,
Subscriber could sustain the loss of its entire investment; (f) the Company has
not paid any dividends since its inception and does not anticipate paying any
dividends; and (g) the other risks associated with the Company’s business,
financial situation and the Offering set forth on Exhibit A annexed hereto.
 
1.4        At the time Subscriber was offered the Securities, it was, and as of
the date hereof it is, and on each date on which it converts the Notes and/or
exercises any Warrants it will be an “accredited investor” as defined in Rule
501(a) under the Securities Act, as indicated by the
 

 
 

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Subscriber’s responses to the questions contained in Article VII hereof, and
that the Subscriber is able to bear the economic risk of an investment in the
Securities.
 
1.5             Subscriber hereby acknowledges and represents that: (a)
Subscriber has knowledge and experience in business and financial matters, prior
investment experience, including investment in securities that are non-listed,
unregistered and/or not traded on a national securities exchange or the
Subscriber has employed the services of a “purchaser representative” (as defined
in Rule 501 of Regulation D), attorney and/or accountant to read all of the
documents furnished or made available by the Company both to Subscriber and to
all other prospective investors in the Securities to evaluate the merits and
risks of such an investment on Subscriber’s behalf; (b) Subscriber recognizes
the highly speculative nature of this investment; and (c) Subscriber is able to
bear the economic risk that Subscriber hereby assumes.
 
1.6             Subscriber hereby acknowledges receipt and careful review of
this Agreement the Note and all other exhibits thereto (collectively referred to
as the “Transaction Documents”) and hereby represents that Subscriber has been
furnished by the Company during the course of the Offering with all information
regarding the Company, including the Company’s Annual Report on Form 10-K for
the fiscal year ended December 31, 2010 (the “Form 10-K”), the terms and
conditions of the Offering and any additional information that Subscriber has
requested or desired to know, and has been afforded the opportunity to ask
questions of and receive answers from duly authorized officers or other
representatives of the Company concerning the Company and the terms and
conditions of the Offering; provided, however that no investigation performed by
or on behalf of Subscriber shall limit or otherwise affect its right to rely on
the representations and warranties of the Company contained herein.
 
1.7                (a)  In making the decision to invest in the Securities
Subscriber has relied solely upon the information provided by the Company in the
Transaction Documents.  To the extent necessary, Subscriber has retained, at its
own expense, and relied upon appropriate professional advice regarding the
investment, tax and legal merits and consequences of this Agreement and the
purchase of the Securities hereunder.  Subscriber disclaims reliance on any
statements made or information provided by any person or entity in the course of
Subscriber’s consideration of an investment in the Securities other than the
Transaction Documents.
 
(b)       Subscriber represents that (i) Subscriber was contacted regarding the
sale of the Securities by the Company (or another person whom the Subscriber
believed to be an authorized agent or representative thereof) with whom
Subscriber had a prior substantial pre-existing relationship and (ii) it did not
learn of the offering of the Securities by means of any form of general
solicitation or general advertising, and in connection therewith, Subscriber did
not (A) receive or review any advertisement, article, notice or other
communication published in a newspaper or magazine or similar media or broadcast
over television or radio, whether closed circuit, or generally available; or (B)
attend any seminar meeting or industry investor conference whose attendees were
invited by any general solicitation or general advertising.
 
1.8         Subscriber hereby acknowledges that the Offering has not been
reviewed by the United States Securities and Exchange Commission (the “SEC”) nor
any state regulatory authority since the Offering is intended to be exempt from
the registration requirements of Section 5 of the Securities Act, pursuant to
Regulation D.  Subscriber understands that the Securities have not
 

 
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been registered under the Securities Act or under any state securities or “blue
sky” laws and agrees not to sell, pledge, assign or otherwise transfer or
dispose of the Securities unless they are registered under the Securities Act
and under any applicable state securities or “blue sky” laws or unless an
exemption from such registration is available.
 
1.9              Subscriber understands that the Securities have not been
registered under the Securities Act by reason of a claimed exemption under the
provisions of the Securities Act that depends, in part, upon Subscriber’s
investment intention.  In this connection, Subscriber hereby represents that
Subscriber is purchasing the Securities for Subscriber’s own account for
investment and not with a view toward the resale or distribution to others;
provided, however, that nothing contained herein shall constitute an agreement
by Subscriber to hold the Securities for any particular length of time and the
Company acknowledges that Subscriber shall at all times retain the right to
dispose of its property as it may determine in its sole discretion, subject to
any restrictions imposed by applicable law.  Subscriber, if an entity, further
represents that it was not formed for the purpose of purchasing the Securities.
 
1.10           Subscriber consents to the placement of a legend on any
certificate or other document evidencing the Securities and, when issued, the
shares of Common Stock issuable upon conversion of the Notes (the “Conversion
Shares”) have not been registered under the Securities Act or any state
securities or “blue sky” laws and setting forth or referring to the restrictions
on transferability and sale thereof contained in this Agreement. Subscriber is
aware that the Company will make a notation in its appropriate records with
respect to the restrictions on the transferability of such Securities or the
Shares.
 
1.11           Subscriber hereby represents that the address of Subscriber
furnished by Subscriber herein is the Subscriber’s principal business address.
 
1.12           Subscriber understands that the Securities are “restricted
securities” and have not been registered under the Securities Act or any
applicable state securities law and is acquiring the Securities as principal for
its own account and not with a view to or for distributing or reselling such
Securities or any part thereof in violation of the Securities Act or any
applicable state securities law, has no present intention of distributing any of
such Securities in violation of the Securities Act or any applicable state
securities law and has no direct or indirect arrangement or understandings with
any other persons to distribute or regarding the distribution of such Securities
in violation of the Securities Act or any applicable state securities
law.  Furthermore, such Subscriber is not purchasing the Securities as a result
of any advertisement, article, notice or other communication regarding the
Securities published in any newspaper, magazine or similar media or broadcast
over television or radio or presented at any seminar or any other general
solicitation or general advertisement.
 
1.13           Subscriber represents that Subscriber has full power and
authority (corporate, statutory and otherwise) to execute and deliver this
Agreement and to purchase the Securities.  This Agreement constitutes the legal,
valid and binding obligation of Subscriber, enforceable against the Subscriber
in accordance with its terms.
 
1.14           If Subscriber is a corporation, partnership, limited liability
company, trust, employee benefit plan, individual retirement account, Keogh
Plan, or other tax-exempt entity, it is
 

 
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authorized and qualified to invest in the Company and the person signing this
Agreement on behalf of such entity has been duly authorized by such entity to do
so.
 
1.15           Subscriber acknowledges that if he or she is a Registered
Representative of a Financial Industry Regulatory Authority (“FINRA”) member
firm, he or she must give such firm the notice required by the FINRA’s Rules of
Fair Practice, receipt of which must be acknowledged by such firm in Section 7.4
below.
 
1.16           Subscriber agrees not to issue any public statement with respect
to the Subscriber’s investment or proposed investment in the Company or the
terms of any agreement or covenant between them and the Company without the
Company’s prior written consent, except such disclosures as may be required
under applicable law or under any applicable order, rule or regulation.
 
1.17           Subscriber understands, acknowledges and agrees with the Company
that this subscription may be rejected, in whole or in part, by the Company, in
the sole and absolute discretion of the Company, at any time before any Closing
notwithstanding prior receipt by the Subscriber of notice of acceptance of the
Subscriber’s subscription.
 
1.18           Subscriber acknowledges that the information contained in the
Transaction Documents or otherwise made available to the Subscriber is
confidential and non-public and agrees that all such information shall be kept
in confidence by Subscriber and neither used by Subscriber for the Subscriber’s
personal benefit (other than in connection with this subscription) nor disclosed
to any third party for any reason, notwithstanding that Subscriber’s
subscription may not be accepted by the Company; provided, however, that (a)
Subscriber may disclose such information to its affiliates and advisors who may
have a need for such information in connection with providing advice to
Subscriber with respect to its investment in the Company so long as such
affiliates and advisors have an obligation of confidentiality, and (b) this
obligation shall not apply to any such information that (i) is part of the
public knowledge or literature and readily accessible at the date hereof, (ii)
becomes part of the public knowledge or literature and readily accessible by
publication (except as a result of a breach of this provision) or (iii) is
received from third parties without an obligation of confidentiality (except
third parties who disclose such information in violation of any confidentiality
agreements or obligations, including, without limitation, any subscription or
other similar agreement entered into with the Company).
 
1.19           Subscriber will indemnify and hold harmless the Company and,
where applicable, its directors, officers, employees, agents, advisors,
affiliates and shareholders, and each other person, if any, who controls any of
the foregoing from and against any and all loss, liability, claim, damage and
expense whatsoever (including, but not limited to, any and all fees, costs and
expenses whatsoever reasonably incurred in investigating, preparing or defending
against any claim, lawsuit, administrative proceeding or investigation whether
commenced or threatened) (a “Loss”) arising out of or based upon any
representation or warranty of Subscriber contained herein or in any document
furnished by Subscriber to the Company in connection herewith being untrue in
any material respect or any breach or failure by Subscriber to comply with any
covenant or agreement made by the Subscriber herein or therein; provided,
however, that  Subscriber shall not be liable for any Loss that in the aggregate
exceeds the Subscriber’s aggregate purchase price tendered hereunder.
 

 
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II.           REPRESENTATIONS BY AND COVENANTS OF THE COMPANY
 
The Company hereby represents and warrants to Subscriber that:
 
2.1             Organization, Good Standing and Qualification.  The Company is a
corporation duly organized, validly existing and in good standing under the laws
of the State of Nevada and has full corporate power and authority to own and use
its properties and its assets and conduct its business as currently
conducted.  Each of the Company’s subsidiaries (the “Subsidiaries”) is an entity
duly organized, validly existing and in good standing under the laws of the
jurisdiction of its incorporation with the requisite corporate power and
authority to own and use its properties and assets and to conduct its business
as currently conducted. Neither the Company, nor any of its Subsidiaries is in
violation of any of the provisions of their respective articles of
incorporation, by-laws or other organizational or charter documents, including,
but not limited to the Charter Documents (as defined below). Each of the Company
and its Subsidiaries is duly qualified to conduct business and is in good
standing as a foreign corporation in each jurisdiction in which the nature of
the business conducted or property owned by it makes such qualification
necessary, except where the failure to be so qualified or in good standing, as
the case may be, would not result in a direct and/or indirect (i) material
adverse effect on the legality, validity or enforceability of any of the
Securities and/or this Agreement, (ii) material adverse effect on the results of
operations, assets, business, condition (financial and other) or prospects of
the Company and its Subsidiaries, taken as a whole, or (iii) material adverse
effect on the Company’s ability to perform in any material respect on a timely
basis its obligations under the Transaction Documents (any of (i), (ii) or
(iii), a “Material Adverse Effect”).
 
2.2        Authorization; Enforceability.  The Company has all corporate right,
power and authority to enter into, execute and deliver this Agreement and each
other agreement, document, instrument and certificate to be executed by the
Company in connection with the consummation of the transactions contemplated
hereby, including, but not limited to Transaction Documents and to perform fully
its obligations hereunder and thereunder.  All corporate action on the part of
the Company, its directors and stockholders necessary for the (a) authorization
execution, delivery and performance of this Agreement and the Transaction
Documents by the Company; and (b) authorization, sale, issuance and delivery of
the Securities and upon issuance, the Shares contemplated hereby and the
performance of the Company’s obligations under this Agreement and the
Transaction Documents has been taken.  This Agreement and the Transaction
Documents have been duly executed and delivered by the Company and each
constitutes a legal, valid and binding obligation of the Company, enforceable
against the Company in accordance with its respective terms, subject to laws of
general application relating to bankruptcy, insolvency and the relief of debtors
and rules of law governing specific performance, injunctive relief or other
equitable remedies, and to limitations of public policy.  The Securities are
duly authorized and, when issued and paid for in accordance with the applicable
Transaction Documents, will be duly and validly issued, fully paid and
nonassessable, free and clear of all Encumbrances other than restrictions on
transfer provided for in the Transaction Documents.  The Shares, when issued in
accordance with the terms of the Transaction Documents, will be validly issued,
fully paid and nonassessable, free and clear of all Encumbrances imposed by the
Company other than
 

 
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restrictions on transfer provided for in the Transaction Documents.  The Company
has reserved a sufficient number of Conversion Shares and Warrant Shares for
issuance upon the conversion of the Notes, respectively, free and clear of all
Encumbrances, except for restrictions on transfer set forth in the Transaction
Documents or imposed by applicable securities laws.
 
2.3             Continuing Obligations. Company agrees that as long as any of
the Securities remain issued and outstanding, it will not consummate any
consolidation, merger, sale, transfer or other disposition of assets or shares,
including any form of share exchange, unless prior to, or simultaneously with,
the consummation thereof,  the successor corporation resulting from such
consolidation or merger (if other than the Company), or the corporation
purchasing or otherwise acquiring the assets of the Company, agrees to assume
the Company’s continuing obligations hereunder.
 
2.4             Disclosure.  The information set forth in the Transaction
Documents as of the date hereof and as of the date of each Closing contains no
untrue statement of a material fact nor omits to state a material fact necessary
in order to make the statements contained therein, in light of the circumstances
under which they were made, not misleading.
 
2.5              Brokers.  Except to the extent disclosed in writing, neither
the Company nor any of the Company's officers, directors, employees or
stockholders has employed or engaged any broker or finder in connection with the
transactions contemplated by this Agreement and no fee or other compensation is
or will be due and owing to any broker, finder, underwriter, placement agent or
similar person in connection with the transactions contemplated by this
Agreement.
 
2.6              No General Solicitation.   None of the Company, its
Subsidiaries, any of their affiliates, and any person acting on their behalf,
has engaged in any form of general solicitation or general advertising (within
the meaning of Regulation D under the Securities Act) in connection with the
offer or sale of the Securities.
 
2.7             No Integrated Offering.  Assuming the accuracy of the Subscriber
representations and warranties set forth in Article I hereunder, none of the
Company, its Subsidiaries, any of their affiliates, and any person acting on
their behalf has, directly or indirectly, made any offers or sales of any
security or solicited any offers to buy any security, under circumstances that
would require registration of any of the Securities under the Securities Act or
cause this offering of the Securities to be integrated with prior offerings by
the Company for purposes of the Securities Act or any applicable stockholder
approval provisions, including without limitation, under the rules and
regulations of any exchange or automated quotation system on which any of the
securities of the Company are listed or designated. Except as disclosed in the
SEC Reports, none of the Company, its Subsidiaries, their affiliates and any
person acting on their behalf,have taken any action or steps referred to in the
preceding sentence that would require registration of any of the Securities
under the Securities Act or cause the offering of the Securities to be
integrated with other offerings.
 
2.8        Listing and Maintenance Requirements.  The Common Stock is registered
pursuant to Section 12(b) or 12(g) of the Exchange Act, and the Company has
taken no action designed to, or which to its knowledge is likely to have the
effect of, terminating the registration of the Common Stock under the Exchange
Act nor has the Company received any notification that the
 

 
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SEC is contemplating terminating such registration.  The Company has not, in the
12 months preceding the date hereof, received notice from any trading market on
which the Common Stock is or has been listed or quoted to the effect that the
Company is not in compliance with the listing or maintenance requirements of
such trading market. The Company is, and has no reason to believe that it will
not in the foreseeable future continue to be, in compliance with all such
listing and maintenance requirements
 
2.9             Disclosure.  All disclosure furnished by or on behalf of the
Company to the Subscriber in the Transaction Documents regarding the Company,
its business and the transactions contemplated hereby, including the Disclosure
Schedules to this Agreement, is true and correct and does not contain any untrue
statement of a material fact or omit to state any material fact necessary in
order to make the statements made therein, in light of the circumstances under
which they were made, not misleading.
 
2.10           Private Placement. Assuming the accuracy of the Subscribers’
representations and warranties set forth in Section 1, no registration under the
Securities Act is required for the offer and sale of the Securities by the
Company to the Subscriber as contemplated hereby.
 
III.           TERMS OF SUBSCRIPTION
 
3.1            All funds representing the subscription amount referred to in
Section 1.1 hereof shall be wired to Company’s bank account in accordance with
wiring instructions to be provided Subscriber..
 
3.2             The Note or Notes purchased by Subscriber pursuant to this
Agreement will be prepared for delivery to the Subscriber as soon as practicable
(but in no event more than five (5) calendar days) following the wiring of the
funds and the Closing of the transaction..
 
IV.           CONDITIONS TO OBLIGATIONS OF SUBSCRIBER
 
4.1             Subscriber’s obligation to purchase the Securities at the
Closing at which such purchase is to be consummated is subject to the
fulfillment on or prior to such Closing of the following conditions, which
conditions may be waived at the option of each Subscriber to the extent
permitted by law:
 
(a)         Representations and Warranties; Covenants.  The representations and
warranties made by the Company in Section 2 hereof qualified as to materiality
shall be true and correct at all times prior to and on the Closing Date, except
to the extent any such representation or warranty expressly speaks as of an
earlier date, in which case such representation or warranty shall be true and
correct as of such earlier date, and, the representations and warranties made by
the Company in Section 2 hereof not qualified as to materiality shall be true
and correct in all material respects at all times prior to and on the Closing
Date, except to the extent any such representation or warranty expressly speaks
as of an earlier date, in which case such representation or warranty shall be
true and correct in all material respects as of such earlier date.  All
covenants, agreements and conditions contained in this Agreement to be performed
by the Company on or prior to the date of such Closing shall have been performed
or complied with in all material respects.
 

 
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(b)             No Legal Order Pending.  There shall not then be in effect any
legal or other order enjoining or restraining the transactions contemplated by
this Agreement.
 
(c)              No Law Prohibiting or Restricting Such Sale.  There shall not
be in effect any law, rule or regulation prohibiting or restricting such sale or
requiring any consent or approval of any person, which shall not have been
obtained, to issue the Securities (except as otherwise provided in this
Agreement).
 
(d)             Required Consents.  The Company shall have obtained any and all
consents, permits, approvals, registrations and waivers necessary or appropriate
for consummation of the purchase and sale of the Securities and the consummation
of the other transactions contemplated by the Transaction Documents, all of
which shall be in full force and effect.
 
(e)  Adverse Changes.  Since the date of execution of this Agreement, no event
or series of events shall have occurred that reasonably could have or result in
a Material Adverse Effect.
 
(f)        No Suspensions of Trading in Common Stock; Listing.  Trading in the
Common Stock shall not have been suspended by the SEC or any trading market
(except for any suspensions of trading of not more than one trading day solely
to permit dissemination of material information regarding the Company) at any
time since the date of execution of this Agreement, and the Common Stock shall
have been at all times since such date listed for trading on a trading market.
 
(g)       Blue Sky.  The Company shall have completed qualification for the
Securities and the Shares under applicable Blue Sky laws.
 
(h)        Disclosure Schedules.  The Company shall have delivered to the
Subscriber a copy of its Disclosure Schedules qualifying any of the
representations and warranties contained in Section 2.

V.           COVENANTS OF THE COMPANY
 
5.1              Transfer Restrictions.
 
(a)             The Securities may only be disposed of in compliance with state
and federal securities laws.  In connection with any transfer of Securities
other than pursuant to an effective registration statement or Rule 144
promulgated under the Securities Act, to the Company or to an affiliate of a
Subscriber or in connection with, the Company may require the transferor thereof
to provide to the Company an opinion of counsel selected by the transferor and
reasonably acceptable to the Company, the form and substance of which opinion
shall be reasonably satisfactory to the Company, to the effect that such
transfer does not require registration of such transferred Securities under the
Securities Act.  As a condition of transfer, any such transferee shall agree in
writing to be bound by the terms of this Agreement, and shall have the rights of
a Subscriber under this Agreement.
 
(b)        The Subscriber agrees to the imprinting, so long as is required by
this Section 5.1, of a legend on any of the Securities, including the Shares, in
the following form:
 

 
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[NEITHER] THIS SECURITY [NOR THE SECURITIES INTO WHICH THIS SECURITY IS
[EXERCISABLE] [CONVERTIBLE]] HAS [NOT] BEEN REGISTERED WITH THE SECURITIES AND
EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON
AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE
“SECURITIES ACT”), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT
TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO
AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE
REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH
APPLICABLE STATE SECURITIES LAWS AS EVIDENCED BY A LEGAL OPINION OF COUNSEL TO
THE TRANSFEROR TO SUCH EFFECT, THE SUBSTANCE OF WHICH SHALL BE REASONABLY
ACCEPTABLE TO THE COMPANY.  THIS SECURITY [AND THE SECURITIES ISSUABLE UPON
[EXERCISE] [CONVERSION] OF THIS SECURITY] MAY BE PLEDGED IN CONNECTION WITH A
BONA FIDE MARGIN ACCOUNT OR OTHER LOAN SECURED BY SUCH SECURITIES.
 

5.2             Listing of Securities.  The Company agrees, (i) if the Company
applies to have the Common Stock traded on any other trading market, it will
include in such application the shares of Common Stock and Shares, and will take
such other action as is necessary or desirable to cause the shares of Common
Stock and Shares to be listed on such other trading market as promptly as
possible, and (ii) it will take all action reasonably necessary to continue the
listing and trading of its Common Stock on a trading market and will comply in
all material respects with the Company’s reporting, filing and other obligations
under the bylaws or rules of the trading market.
 
5.3             Reservation of Shares.  The Company shall at all times while the
Note or Notes are outstanding maintain a reserve from its duly authorized shares
of Common Stock of a number of shares of Common Stock sufficient to allow for
the issuance of the Shares.
 
5.4              Replacement of Securities.  If any certificate or instrument
evidencing any Securities or the Shares is mutilated, lost, stolen or destroyed,
the Company shall issue or cause to be issued in exchange and substitution for
and upon cancellation thereof, or in lieu of and substitution therefor, a new
certificate or instrument, but only upon receipt of evidence reasonably
satisfactory to the Company of such loss, theft or destruction and customary and
reasonable indemnity, if requested.  The applicants for a new certificate or
instrument under such circumstances shall also pay any reasonable third-party
costs associated with the issuance of such replacement securities.  If a
replacement certificate or instrument evidencing any securities is requested due
to a mutilation thereof, the Company may require delivery of such mutilated
certificate or instrument as a condition precedent to any issuance of a
replacement.
 
5.5         Furnishing of Information.  Until the time that no Subscriber owns
Securities, the Company covenants to maintain the registration of the Common
Stock under Section 12(b) or 12(g) of the Exchange Act and to timely file (or
obtain extensions in respect thereof and file within the applicable grace
period) all reports required to be filed by the Company after the date hereof
pursuant to the Exchange Act.    As long as Subscriber owns Securities, if the
Company is not required to file reports pursuant to the Exchange Act, it will
prepare and furnish to Subscriber
 

 
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and make publicly available in accordance with Rule 144(c) such information as
is required for the Subscribers to sell the Securities under Rule 144.  The
Company further covenants that it will take such further action as any holder of
Securities may reasonably request, to the extent required from time to time to
enable such person to sell such Securities without registration under the
Securities Act within the requirements of the exemption provided by Rule 144.
 
5.6              Securities Laws; Publicity.  The Company shall, by 8:30 a.m.
(New York City time) on the second trading day immediately following a Closing
hereunder, issue a Current Report on Form 8-K disclosing the material terms of
the transactions contemplated hereby and including the Transaction Documents as
exhibits thereto.  The Company shall not publicly disclose the name of
Subscriber, or include the name of any Subscriber in any filing with the SEC or
any regulatory agency or trading market, without the prior written consent of
Subscriber, except: (a) as required by federal securities law in connection with
the filing of final Transaction Documents (including signature pages thereto)
with the SEC and (b) to the extent such disclosure is required by law, in which
case the Company shall provide the Subscriber with prior notice of such
disclosure permitted under this clause (b).
 
5.7             Form D; Blue Sky Filings.  The Company agrees to timely file a
Form D with respect to the Securities as required under Regulation D promulgated
under the Securities Act and to provide a copy thereof, promptly upon request of
the Subscriber. The Company shall take such action as the Company shall
reasonably determine is necessary in order to obtain an exemption for, or to
qualify the Securities for, sale to the Subscriber at the Closing under
applicable securities or “Blue Sky” laws of the states of the United States, and
shall provide evidence of such actions promptly upon request of any Subscriber.
 
5.8              Indemnification.
 
(a)           The Company agrees to indemnify and hold harmless Subscriber, its
affiliates and their respective officers, directors, employees, agents and
controlling persons (collectively, the “Indemnified Parties”) from and against ,
any and all loss, liability, damage or deficiency suffered or incurred by any
Indemnified Party by reason of any misrepresentation or breach of warranty by
the Company or,after any applicable notice and/or cure periods, nonfulfillment
of any covenant or agreement to be performed or complied with by the Company
under this Agreement, the Transaction Documents; and will promptly reimburse the
Indemnified Parties for all expenses (including reasonable fees and expenses of
legal counsel) as incurred in connection with the investigation of, preparation
for or defense of any pending or threatened claim related to or arising in any
manner out of any of the foregoing, or any action or proceeding arising
therefrom (collectively, “Proceedings”), whether or not such Indemnified Party
is a formal party to any such Proceeding.

(b)        If for any reason (other than a final non-appealable judgment finding
any Indemnified Party liable for losses, claims, damages, liabilities or
expenses for its gross negligence or willful misconduct) the foregoing indemnity
is unavailable to an Indemnified Party or insufficient to hold an Indemnified
Party harmless, then the Company shall contribute to the amount paid or payable
by an Indemnified Party as a result of such loss, claim, damage, liability or
expense in such proportion as is appropriate to reflect not only the relative
benefits received by the

 
10

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Company on the one hand and the Advisor on the other, but also the relative
fault by the Company and the Indemnified Party, as well as any relevant
equitable considerations.

5.9        Non-Public Information.  Except with respect to the material terms
and conditions of the transactions contemplated by the Transaction Documents,
the Company covenants and agrees that neither it, nor any other person acting on
its behalf, will provide Subscriber or its agents or counsel with any
information that the Company believes constitutes material non-public
information, unless prior thereto Subscriber shall have executed a written
agreement regarding the confidentiality and use of such information.  The
Company understands and confirms that Subscriber shall be relying on the
foregoing covenant in effecting transactions in securities of the Company.
 
5.10   Use of Proceeds.  Except as set forth on Schedule 5.10 attached hereto,
the Company shall use the net proceeds from the sale of the Securities hereunder
for working capital purposes and shall not use such proceeds for: (a) the
satisfaction of any portion of the Company’s debt (other than payment of trade
payables in the ordinary course of the Company’s business and prior practices),
(b) the redemption of any Common Stock or Common Stock equivalents or (c) the
settlement of any outstanding litigation.
 
VI.           MISCELLANEOUS
 
6.1            Any and all notices or other communications or deliveries
required or permitted to be provided hereunder shall be in writing and shall be
deemed given and effective on the earliest of: (a) the date of transmission, if
such notice or communication is delivered via facsimile or by electronic
communication at or prior to 5:30 p.m. (New York City time) on a day in which
the New York Stock Exchange is open for trading (a “Trading Day”), (b) the next
Trading Day after the date of transmission, if such notice or communication is
delivered via facsimile or electronic communication on a day that is not a
Trading Day or later than 5:30 p.m. (New York City time) on any Trading Day, (c)
the second (2nd) Trading Day following the date of mailing, if sent by U.S.
nationally recognized overnight courier service or (d) upon actual receipt by
the party to whom such notice is required to be given.  The address for such
notices and communications shall be addressed as follows:
 
if to the Company, to it at:
Paxton Energy, Inc.
Office & Delivery:
295 Highway 50, Suite 2
Stateline NV 89449

Mailing Address:
PO Box 1148
Zephyr Cove NV 89448-1148

 
11

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With a copy to (which shall not constitute notice):

Paxton Energy, Inc.
275 Battery St Ste 2600
San Francisco CA 94111-3356

 
to the Subscriber, to it as:
 
What Happened LLC
One Market Street 36th Floor
San Francisco CA 94105
.
 
6.2  Except as otherwise provided herein, this Agreement shall not be changed,
modified or amended except by a writing signed by the parties to be charged, and
this Agreement may not be discharged except by performance in accordance with
its terms or by a writing signed by the party to be charged.  No waiver of any
default with respect to any provision, condition or requirement of this
Agreement shall be deemed to be a continuing waiver in the future or a waiver of
any subsequent default or a waiver of any other provision, condition or
requirement hereof, nor shall any delay or omission of any party to exercise any
right hereunder in any manner impair the exercise of any such right.
 
6.3  This Agreement shall be binding upon and inure to the benefit of the
parties hereto and to their respective heirs, legal representatives, successors
and assigns.  The Company may not assign this Agreement or any rights or
obligations hereunder without the prior written consent of Subscriber (other
than by merger).  Subscriber may assign any or all of its rights under this
Agreement to any person to whom Subscriber assigns or transfers any Securities,
provided that such transferee agrees in writing to be bound, with respect to the
transferred Securities, by the provisions of the Transaction Documents
 
6.4   Upon the execution and delivery of this Agreement by Subscriber and the
Company, this Agreement shall become a binding obligation of Subscriber with
respect to the purchase of Securities as herein provided.
 
6.5   All questions concerning the construction, validity, enforcement and
interpretation of the Transaction Documents shall be governed by and construed
and enforced in accordance with the internal laws of the State of New York,
without regard to the principles of conflicts of law thereof.  Each party agrees
that all legal proceedings concerning the interpretations, enforcement and
defense of the transactions contemplated by this Agreement and any other
Transaction Documents (whether brought against a party hereto or its respective
affiliates, directors, officers, shareholders, employees or agents) shall be
commenced exclusively in the state and federal courts sitting in the City of New
York.  Each party hereby irrevocably submits to the exclusive jurisdiction of
the state and federal courts sitting in the City of New York, borough of
Manhattan for the adjudication of any dispute hereunder or in connection
herewith or with any transaction contemplated hereby or discussed herein
(including with respect to the enforcement of any of the
 

 
12

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Transaction Documents), and hereby irrevocably waives, and agrees not to assert
in any suit, action or proceeding, any claim that it is not personally subject
to the jurisdiction of any such court, that such suit, action or proceeding is
improper or is an inconvenient venue for such proceeding.
 
6.6  The holding of any provision of this Agreement to be invalid or
unenforceable by a court of competent jurisdiction shall not affect any other
provision of this Agreement, which shall remain in full force and effect.  If
any provision of this Agreement shall be declared by a court of competent
jurisdiction to be invalid, illegal or incapable of being enforced in whole or
in part, such provision shall be interpreted so as to remain enforceable to the
maximum extent permissible consistent with applicable law and the remaining
conditions and provisions or portions thereof shall nevertheless remain in full
force and effect and enforceable to the extent they are valid, legal and
enforceable, and no provisions shall be deemed dependent upon any other covenant
or provision unless so expressed herein.
 
6.7   It is agreed that a waiver by either party of a breach of any provision of
this Agreement shall not operate, or be construed, as a waiver of any subsequent
breach by that same party.
 
6.8  The Company agrees to execute and deliver all such further documents,
agreements and instruments and take such other and further action as may be
necessary or appropriate to carry out the purposes and intent of this Agreement.
 
6.9  This Agreement may be executed in two or more counterparts each of which
shall be deemed an original, but all of which shall together constitute one and
the same instrument.  In the event that any signature is delivered by facsimile
transmission or by e-mail delivery of a “PDF” format data file, such signature
shall create a valid and binding obligation of the party executing (or on whose
behalf such signature is executed) with the same force and effect as if such
facsimile or “PDF” signature page were an original thereof.
 
6.10   Nothing in this Agreement shall create or be deemed to create any rights
in any person or entity not a party to this Agreement.
 
6.11  In addition to being entitled to exercise all rights provided herein or
granted by law, including recovery of damages, the Subscriber and the Company
will be entitled to specific performance under this Agreement.  The parties
agree that monetary damages may not be adequate compensation for any loss
incurred by reason of any breach of obligations described in the foregoing
sentence and hereby agrees to waive in any action for specific performance of
any such obligation the defense that a remedy at law would be adequate.
 
VII.
CONFIDENTIAL INVESTOR QUESTIONNAIRE

 
7.1           The Subscriber represents and warrants that he, she or it comes
within one category marked below, and that for any category marked, he, she or
it has truthfully set forth, where applicable, the factual basis or reason the
Subscriber comes within that category. ALL INFORMATION IN RESPONSE TO THIS
SECTION WILL BE KEPT STRICTLY CONFIDENTIAL. The undersigned agrees to furnish
any additional information which the Company deems necessary in order to verify
the answers set forth below.

 
13

--------------------------------------------------------------------------------

 

Category A  __
The undersigned is an individual (not a partnership, corporation, etc.) whose
individual net worth, or joint net worth with his or her spouse, presently
exceeds $1,000,000.

Explanation.  In calculating net worth you may NOT include equity in personal
property and real estate, including your principal residence.

Category B __
The undersigned is an individual (not a partnership, corporation, etc.) who had
an income in excess of $200,000 in each of the two most recent years, or joint
income with his or her spouse in excess of $300,000 in each of those years (in
each case including foreign income, tax exempt income and full amount of capital
gains and losses but excluding any income of other family members and any
unrealized capital appreciation) and has a reasonable expectation of reaching
the same income level in the current year.

Category C __
The undersigned is a director or executive officer of the Company which is
issuing and selling the Securities.

Category D __
The undersigned is a bank; a savings and loan association; insurance company;
registered investment company; registered business development company; licensed
small business investment company (“SBIC”); or employee benefit plan within the
meaning of Title 1 of ERISA and (a) the investment decision is made by a plan
fiduciary which is either a bank, savings and loan association, insurance
company or registered investment advisor, or (b) the plan has total assets in
excess of $5,000,000 or (c) is a self directed plan with investment decisions
made solely by persons that are accredited investors. (describe entity)

 
Category E __
The undersigned is a private business development company as defined in section
202(a)(22) of the Investment Advisors Act of 1940. (describe entity)

 
Category F __
The undersigned is either a corporation, partnership, Massachusetts business
trust, or non-profit organization within the meaning of Section 501(c)(3) of the
Internal Revenue Code, in each case not formed for the specific purpose of
acquiring the Securities and with total assets in excess of $5,000,000.
(describe entity)

 

 
14

--------------------------------------------------------------------------------

 

Category G __
The undersigned is a trust with total assets in excess of $5,000,000, not formed
for the specific purpose of acquiring the Securities, where the purchase is
directed by a “sophisticated investor” as defined in Regulation 506(b)(2)(ii)
under the Act.

 
Category H __
The undersigned is an entity (other than a trust) in which all of the equity
owners are “accredited investors” within one or more of the above
categories.  If relying upon this Category alone, each equity owner must
complete a separate copy of this Agreement.  (describe entity)

 
Category I __
The undersigned is not within any of the categories above and is therefore not
an accredited investor.

 
The undersigned agrees that the undersigned will notify the Company at any time
on or prior to the Closing in the event that the representations and warranties
in this Agreement shall cease to be true, accurate and complete.
 
7.2        SUITABILITY (please answer each question)
 
(a)           For an individual Subscriber, please describe your current
employment, including the company by which you are employed and its principal
business:
 
____________________________________________
____________________________________________
____________________________________________
____________________________________________
 
(b)           For an individual Subscriber, please describe any college or
graduate degrees held by you:
 
____________________________________________
____________________________________________
____________________________________________
____________________________________________
 
(c)           For all Subscriber, please list types of prior investments:
 
____________________________________________
____________________________________________
____________________________________________
____________________________________________
 
 
 
15

--------------------------------------------------------------------------------

 

(d)           For all Subscriber, please state whether you have participated in
other private placements before:
YES_______                                           NO_______

 
16

--------------------------------------------------------------------------------

 

(e)           If your answer to question (d) above was “YES”, please indicate
frequency of such prior participation in private placements of:
 

 
 
Public
Companies
 
Private
Companies
Public or Private Companies
with no, or insignificant,
assets and operations
 
Frequently
  ___________________ _______________________  _______________________ 
Occasionally
  ___________________ _______________________ _______________________ 
Never
  ___________________ _______________________  _______________________

(f)           For individual Subscriber, do you expect your current level of
income to significantly decrease in the foreseeable future:
 
YES_______                                           NO_______
(g)           For trust, corporate, partnership and other institutional
Subscriber, do you expect your total assets to significantly decrease in the
foreseeable future:
 
YES_______                                           NO_______
(h)           For all Subscriber, do you have any other investments or
contingent liabilities which you reasonably anticipate could cause you to need
sudden cash requirements in excess of cash readily available to you:
 
YES_______                                           NO_______
(i)           For all Subscriber, are you familiar with the risk aspects and the
non-liquidity of investments such as the securities for which you seek to
subscribe?
 
YES_______                                           NO_______
(j)            For all Subscriber, do you understand that there is no guarantee
of financial return on this investment and that you run the risk of losing your
entire investment?
 
YES_______                                           NO_______

 
17

--------------------------------------------------------------------------------

 

7.3        MANNER IN WHICH TITLE IS TO BE HELD.  (circle one)
 
(a)           Individual Ownership
(b)           Community or Shared Property
(c)           Joint Tenant with Right of
Survivorship (both parties
must sign)
(d)           Partnership*
(e)           Tenants in Common
(f)           Company*
(g)           Trust*
(h)           Other*
*If Securities are being subscribed for by an entity, the attached Certificate
of Signatory must also be completed.
 
7.4        FINRA AFFILIATION.
 
Are you affiliated or associated with an FINRA member firm? (please check one):
Yes _________                                           No __________
If Yes, please describe:
_____________________________________________________________________________________
_____________________________________________________________________________________
_____________________________________________________________________________________

*If Subscriber is a Registered Representative with an FINRA member firm, have
the following acknowledgment signed by the appropriate party:
 
The undersigned NASD member firm acknowledges receipt of the notice required by
Article 3, Sections 28(a) and (b) of the Rules of Fair Practice.
 
_________________________________
Name of FINRA Member Firm

By: ______________________________
Authorized Officer

Date: ____________________________

 
18

--------------------------------------------------------------------------------

 

7.5           The undersigned is informed of the significance to the Company of
the foregoing representations and answers contained in the Confidential Investor
Questionnaire contained in this Article VII and such answers have been provided
under the assumption that the Company will rely on them.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
 
 
 
 

 
 
19

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AGGREGATE PURCHASE PRICE OF THE NOTE = $20,000.00 (the “Purchase Price”)

AGGREGATE FACE AMOUNT OF THE NOTE = $20,000.00   (1.00 x Purchase Price)

/s/ Tim Hefferan       
Signature
 
Signature (if purchasing jointly)
          Tim Hefferan               
Name Typed or Printed
 
Name Typed or Printed
          Managing Partner       
Title (if Subscriber is an Entity)
 
Title (if Subscriber is an Entity)
          What Happened LLC      
Entity Name (if applicable)
 
Entity Name (if applicable
                         
Address
 
Address
                 
City, State and Zip Code
 
City, State and Zip Code
                 
Telephone-Business
 
Telephone-Business
                 
Telephone-Residence
 
Telephone-Residence
                 
Facsimile-Business
 
Facsimile-Business
                 
Facsimile-Residence
 
Facsimile-Residence
                 
Tax ID # or Social Security #
 
Tax ID # or Social Security #
                 
E-Mail Address
 
E-Mail Address
 

Name in which securities should be
issued:                                                                           

Delivery Address (if not to Placement Agent):
_________________________________________________

Dated:                                      , 2011

This Subscription Agreement is agreed to and accepted as of November 21, 2011.

 
PAXTON ENERGY, INC.
     
By:_/s/ CHARLES VOLK, JR.
 
Name:  Charles Volk, Jr.
 
Title: Chief Executive Officer

 
20

--------------------------------------------------------------------------------

 

CERTIFICATE OF SIGNATORY

(To be completed if Securities are
being subscribed for by an entity)

I, ____________________________, am the ____________________________ of
__________________________________________ (the “Entity”).

I certify that I am empowered and duly authorized by the Entity to execute and
carry out the terms of the Subscription Agreement and to purchase and hold the
Notes (and, upon issuance, the Shares), and certify further that the
Subscription Agreement has been duly and validly executed on behalf of the
Entity and constitutes a legal and binding obligation of the Entity.

IN WITNESS WHEREOF, I have set my hand this ________ day of _________________,
20__

_______________________________________
(Signature)

 
21

--------------------------------------------------------------------------------

 

 
Exhibit A

RISK FACTORS

An investment in the Securities in the Offering involves a high degree of risk.
You should carefully consider the risks below before making an investment
decision. Our business, financial condition or results of operations could be
materially adversely affected by any of these risks. In such case, the trading
price of our Common Stock could decline and you could lose all or part of your
investment.  Please refer to the other information contained in this Memorandum
(including the financial statements) for further details pertaining to the
Company’s business and financial condition.

RISKS RELATED TO OUR BUSINESS

We are currently in default under certain Bridge Notes and other Promissory
Notes. If we are unable to raise funds in this Offering, or if the holders of
the Old Notes do not convert their Old Notes into Notes in this Offering, we may
be unable to satisfy our liquidity requirements and continue our operations as a
going concern.
 
In May 2011, we issued the Bridge Notes in the face amount of $2,550,000 to 34
accredited investors in a private placement transaction pursuant to Rule 506 of
Regulation D.  The Bridge Notes bear interest at 9% per annum, which is payable
quarterly in arrears, mature one year from the date of issuance, and are
convertible at the holder’s option at any time into Common Stock at a conversion
price of $0.15 per share.  As of July 26, 2011, all of the Bridge Notes are
outstanding and in default because we have not made the interest payment on July
1, 2011 in the aggregate amount of $34,669.63.  We intend to pay the outstanding
interest on the Bridge Notes from this Offering.

The Bridge Note holders were granted a security interest in the form of a
Mineral Mortgage whereby the Bridge Note holders secured a first priority lien
on all assets we acquired from Montecito pursuant to the Montecito
Agreement.  As a result of the default, the Bridge Note holders may force us
into a foreclosure proceeding pursuant to which the assets could be sold in
order to satisfy the amounts due.

We have a history of losses which may continue and which may negatively impact
our ability to achieve our business objectives.

We had minimal revenues and incurred net losses of $4,154,493 for the year ended
December 31, 2010 and $337,516 for the year ended December 31, 2009.  In
addition, we incurred a net loss of $714,003 for the three months ended March
31, 2011.  At December 31, 2010 and March 31, 2011, we had an accumulated
deficit of $12,237,724 and $12,951,727 respectively. We expect to continue
incurring net losses in the near term. We cannot assure you that we can achieve
or sustain profitability on a quarterly or annual basis.  Our operations are
subject to the risks and competition inherent in the establishment of a business
enterprise. There can be no assurance that future operations will be profitable,
and will depend upon various factors, including whether we will be able to
continue expansion of our revenue. We may not achieve our business objectives
and the failure to achieve such goals would have an adverse impact on us.
 
We received a modified report from our independent registered public accounting
firm with an emphasis of matter paragraph for the year ended December 31, 2010
with respect to our ability to continue as a going concern.  The existence of
such a report may adversely affect our stock price and our ability to raise
capital.  There is no assurance that we will not receive a similar emphasis of
matter paragraph for our year ended December 31, 2011.
 

 
A-1

--------------------------------------------------------------------------------

 

In their report dated April 1, 2011, our independent registered public
accounting firm expressed substantial doubt about our ability to continue as a
going concern as we have incurred losses from operations, negative cash flows
from operating activities and a working capital deficiency. Our ability to
continue as a going concern is subject to our ability to generate a profit
and/or obtain necessary funding from outside sources, including obtaining
additional funding from the sale of our securities, increasing sales or
obtaining loans and grants from various financial institutions where possible.
Our continued net operating losses increase the difficulty in meeting such goals
and there can be no assurances that such methods will prove successful.

If we are unable to obtain additional funding, our business operations will be
harmed and if we do obtain additional financing, our then existing shareholders
may suffer substantial dilution.

We will require additional funds beyond this Offering to implement our proposed
business plan, including drilling operations on the VM 179 well, covering
expenditures in excess of our current commitments for our share of costs related
to the exploration and development of our current and future leasehold interests
and for current working capital.  We anticipate that we will require up to
approximately $9,700,000 to fund our drilling program on VM 179 and continue
operations for the next twelve months from the date of this Memorandum,
depending on revenues from operations.  There can be no assurance that financing
will be available in amounts or on terms acceptable to us, if at all. The
inability to obtain additional capital will restrict our ability to grow and may
reduce our ability to continue to conduct business operations. If we are unable
to obtain additional financing, we will likely be required to curtail our
drilling plans and possibly cease our operations. While we have had discussions
for debt financing to fund any additional amounts required for exploration and
development or possible acquisition of additional prospect interests, including
amounts necessary to pursue development of VM179 and acquire additional
producing properties, we may have to obtain such funds through the sale of
additional equity securities.  Any additional equity financing may involve
substantial dilution to our then existing shareholders. Our board of directors
can authorize the sale of additional equity securities without stockholder
consent. The unavailability of adequate financing on acceptable terms could have
a material adverse effect on our financial condition and on our continued
operation. Even if we do receive additional financing, it may not be sufficient
to sustain or expand our development operations or continue our business
operations.

Although we have the option of being the operator or engaging a third-party
operator at our oil and gas lease sites located in the Vermillion 179 tract
where no drilling or production has commenced as of yet, we are not the operator
of our Texas properties, so we have no control and limited influence over our
current exploration, development, and production activities over our Texas
working interests.

We are not the operator of the Texas properties in which we have an interest, so
we are dependent on the financial and technical resources, initiative, and
management of the operator, Bayshore.  In addition, while we have the option of
being the operator on the recently acquired property from Montecito, we may
elect to have a third-party operator since we do not have any experience
operating oil and gas sites.  As the operator initiates drilling and other
activities, we only have the right to elect whether to participate in specific
proposed activities by bearing our working-interest share of expenses or to
withhold participation, in which case we would not bear related costs or share
in any resulting revenues.  We have very limited rights to propose drilling or
other activities.  We rely to a significant extent on the initiative, expertise,
and financial capabilities of the operators of our wells.  The failure of an
operator to proceed with exploration and development or to perform its
obligations under contracts with us could prevent us from continuing to drill in
an effort to establish production and reserves and recover our current or future
investment in our properties.  In addition, operators typically have oil and gas
interests in which we do not participate.  If an operator’s separately held
interests should become more promising to them than interests held with us, such
operator may focus its efforts, funds, expertise,

 
A-2

--------------------------------------------------------------------------------

 

and other resources elsewhere.  In addition, should our relationship with an
operator deteriorate or terminate, our oil and gas exploratory programs may be
delayed significantly.

If we default under the Bridge Notes, Montecito Note or Mineral Mortgage, the
investors have the right to take possession of all our VM 179 Assets.

In connection with the issuance of the Bridge Notes, we granted in favor of the
Bridge Note holders a first priority security interest in all of the assets of
Montecito acquired pursuant to the Montecito Agreement.  In connection with the
Montecito Agreement, we issued to Montecito the Montecito Note, which provides a
second priority security interest in all of the assets of Montecito acquired
pursuant to the Montecito Agreement, subordinated to the security interests of
the Bridge Notes.  The Montecito Note matures on September 3, 2011 and the
Bridge Notes mature on May 5, 2012.  We currently do not have the ability to pay
either the Montecito Note or the Bridge Notes, although the Montecito Note will
be repaid with funds from this Offering.  In the event of a default, including
not paying either the Montecito Note or the Bridge Notes when due, the Bridge
Note Investors have the right to take possession of the collateral, to operate
the VM 179 business using the collateral, and have the right to assign, sell,
lease or otherwise dispose of and deliver all or any part of the collateral, at
public or private sale or otherwise to satisfy our obligations under these
agreements.  

Our ability to monitor Bayshore and the competitiveness of the rates we pay to
it are limited.

We do not have sufficient personnel to audit Bayshore or the services it
provides to us, so we have not completed an internal administrative or third
party review of Bayshore’s field activities or expenditures.  We also have
little or no basis by which to determine whether we are being charged
competitive rates for the services provided to us by Bayshore.  We have not, and
in the future, may not, obtain competitive bids for the services provided to us
by Bayshore.  We do not know if the quantity and quality of services we receive
from Bayshore are as beneficial to us as we could obtain from competitor
negotiations.

Particularly in Texas, where our operations are concentrated in a geographical
area, a single disaster could halt all or a substantial part of our operations.

Except for the 160 gross-acre Nome prospect in Jefferson County, Texas, on which
we drilled the McDermand No. 1 dry hole, and our assets in the Vermillion 179
tract, where no drilling or production has commenced, our operations are
currently concentrated in La Salle County, Texas.  So all or a substantial part
of our operations may be temporarily disrupted or permanently halted in the case
of a natural or other disaster in that geographical area.  Such a disaster could
result in the loss of our assets and termination of our activities.  Similarly,
if operations in our interests in the Vermilion 179 tract commence, a
substantial part of our operations may be temporarily disrupted or permanently
halted in the case of a natural or other disaster in that geographical area.

Our lack of diversification will increase the risk of an investment in us, and
our financial condition and results of operations may deteriorate if we fail to
diversify.

Our current business focus is on the oil and gas industry in a limited number of
properties, currently in Texas and the Gulf of Mexico. Larger companies have the
ability to manage their risk by diversification. However, we currently lack
diversification, in terms of both the nature and geographic scope of our
business. As a result, we will likely be impacted more acutely by factors
affecting our industry or the regions in which we operate, than we would if our
business were more diversified, enhancing our risk profile.

 
A-3

--------------------------------------------------------------------------------

 

Because we are small and have limited access to additional capital, we may have
to limit our exploration activity, which may result in a loss of investment.

We have a small asset base and limited access to additional capital.
Accordingly, we must limit our exploration activity. As such, we may not be able
to complete an exploration program that is as thorough as our management would
like. In that event, existing reserves may go undiscovered. Without finding
reserves, we cannot generate revenues and investors may lose their investment.

We face strong competition from other oil and gas companies.

We encounter competition from other oil and gas companies in all areas of our
operations, including the acquisition of exploratory prospects and proven
properties. Our competitors include major oil and gas companies and numerous
independent oil and gas companies, individuals and drilling and income programs.
Many of our competitors have been engaged in the oil and gas business much
longer than we have and possess substantially larger operating staffs and
greater capital resources than us. These companies may be able to pay more for
exploratory projects and productive oil and gas properties and may be able to
define, evaluate, bid for and purchase a greater number of properties and
prospects than our financial or human resources permit. In addition, these
companies may be able to expend greater resources on the existing and changing
technologies that we believe are and will be increasingly important to attaining
success in the industry. Such competitors may also be in a better position to
secure oilfield services and equipment on a timely basis or on favorable terms.
We may not be able to conduct our operations, evaluate and select suitable
properties and consummate transactions successfully in this highly competitive
environment.

Current global financial conditions have been characterized by increased
volatility, which could have a material adverse effect on our business,
prospects, liquidity and financial condition.

Current global financial conditions and recent market events have been
characterized by increased volatility and the resulting tightening of the credit
and capital markets has reduced the amount of available liquidity and overall
economic activity. There can be no assurance that debt or equity financing, the
ability to borrow funds or cash generated by operations will be available or
sufficient to meet or satisfy our initiatives, objectives or requirements. Our
inability to access sufficient amounts of capital on terms acceptable to us for
our operations could have a material adverse effect on our business, prospects,
liquidity and financial condition.

The potential profitability of oil and gas properties depends upon factors
beyond our control.

The potential profitability of oil and gas properties is dependent upon many
factors beyond our control. For instance, world prices and markets for oil and
gas are unpredictable, highly volatile, potentially subject to governmental
fixing, pegging, controls, or any combination of these and other factors, and
respond to changes in domestic, international, political, social, and economic
environments. Additionally, due to worldwide economic uncertainty, the
availability and cost of funds for production and other expenses have become
increasingly difficult, if not impossible, to project. These changes and events
may materially affect our financial performance. In addition, a productive well
may become uneconomic in the event that water or other deleterious substances
are encountered which impair or prevent the production of oil and/or gas from
the well. In addition, production from any well may be unmarketable if it is
impregnated with water or other deleterious substances. These factors cannot be
accurately predicted and the combination of these factors may result in us not
receiving an adequate return on investment.

 
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The marketability of natural resources will be affected by numerous factors
beyond our control.

The markets and prices for oil and gas depend on numerous factors beyond our
control. These factors include demand for oil and gas, which fluctuate with
changes in market and economic conditions, and other factors, including:

 
·
worldwide and domestic supplies of oil and gas;
 
·
actions taken by foreign oil and gas producing nations;
 
·
political conditions and events (including instability or armed conflict) in
oil-producing or gas-producing regions;
 
·
the level of global and domestic oil and gas inventories;
 
·
the price and level of foreign imports;
 
·
the level of consumer demand;
 
·
the price and availability of alternative fuels;
 
·
the availability of pipeline or other takeaway capacity;
 
·
weather conditions;
 
·
domestic and foreign governmental regulations and taxes; and
 
·
the overall worldwide and domestic economic environment.

Significant declines in oil and gas prices for an extended period may have the
following effects on our business:

 
·
adversely affect our financial condition, liquidity, ability to finance planned
capital expenditures and results of operations;
 
·
cause us to delay or postpone some of our capital projects;
 
·
reduce our revenues, operating income and cash flow; and
 
·
limit our access to sources of capital.

 
We may have difficulty distributing our oil and gas production, which could harm
our financial condition.

In order to sell the oil and gas that we are able to produce, we may have to
make arrangements for storage and distribution to the market. We will rely on
local infrastructure and the availability of transportation for storage and
shipment of our products, but infrastructure development and storage and
transportation facilities may be insufficient for our needs at commercially
acceptable terms in the localities in which we operate. This situation could be
particularly problematic to the extent that our operations are conducted in
remote areas that are difficult to access, such as areas that are distant from
shipping and/or pipeline facilities. These factors may affect our ability to
explore and develop properties and to store and transport our oil and gas
production and may increase our expenses.

Furthermore, weather conditions or natural disasters, actions by companies doing
business in one or more of the areas in which we will operate, or labor disputes
may impair the distribution of oil and/or gas and in turn diminish our financial
condition or ability to maintain our operations.

Oil and gas operations are subject to comprehensive regulation, which may cause
substantial delays or require capital outlays in excess of those anticipated,
causing an adverse effect on us.

Oil and gas operations are subject to federal, state, provincial and local laws
relating to the protection of the environment, including laws regulating removal
of natural resources from the ground and the discharge of materials into the
environment. Oil and gas operations are also subject to federal, state,
provincial and local laws and regulations which seek to maintain health and
safety standards by regulating the design and use of drilling methods and
equipment. Various permits from government

 
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bodies are required for drilling operations to be conducted; no assurance can be
given that such permits will be received.  

Exploration activities are subject to certain environmental regulations, which
may prevent or delay the commencement or continuance of our operations.

In general, our exploration activities are subject to certain federal, state and
local laws and regulations relating to environmental quality and pollution
control. Such laws and regulations increase the costs of these activities and
may prevent or delay the commencement or continuance of a given operation.
Compliance with these laws and regulations has not had a material effect on our
operations or financial condition to date. Specifically, we are subject to
legislation regarding emissions into the environment, water discharges and
storage and disposition of hazardous wastes. In addition, legislation has been
enacted which requires well and facility sites to be abandoned and reclaimed to
the satisfaction of state authorities. However, such laws and regulations are
frequently changed and we are unable to predict the ultimate cost of compliance.
Generally, environmental requirements do not appear to affect us any differently
or to any greater or lesser extent than other companies in the industry.

We believe that our operations comply, in all material respects, with all
applicable environmental regulations. Our operating partners generally maintain
insurance coverage customary to the industry; however, we are not fully insured
against all possible environmental risks.

Exploratory drilling involves many risks and we may become liable for pollution
or other liabilities, which may have an adverse effect on our financial
position.

Drilling operations generally involve a high degree of risk. Hazards such as
unusual or unexpected geological formations, power outages, labor disruptions,
blow-outs, sour gas leakage, fire, inability to obtain suitable or adequate
machinery, equipment or labor, and other risks are involved. We may become
subject to liability for pollution or hazards against which we cannot adequately
insure or for which we may elect not to insure. Incurring any such liability may
have a material adverse effect on our financial position and operations.
 
Any change in government regulation and/or administrative practices may have a
negative impact on our ability to operate and on our profitability.

The laws, regulations, policies or current administrative practices of any
government body, organization or regulatory agency in the U.S. or any other
jurisdiction may be changed, applied or interpreted in a manner which will
fundamentally alter our ability to carry on our business. The actions, policies
or regulations, or changes thereto, of any government body or regulatory agency,
or other special interest groups, may have a detrimental effect on us. Any or
all of these situations may have a negative impact on our ability to operate
and/or our profitability.

No assurance can be given that defects in our title to natural gas and oil
interests do not exist.

Title to natural gas and oil interests is often not possible to determine
without incurring substantial expense. An independent title review was completed
with respect to certain of the more valuable natural gas and oil rights acquired
by us and the interests in natural gas and oil rights owned by us. Also, legal
opinions have been obtained with respect to the spacing units for the wells that
have been drilled to date and which we have operated. However, no assurance can
be given that title defects do not exist. If a title defect does exist, it is
possible that we may lose all or a portion of the properties to which the title
defect relates. Our actual interest in certain properties may therefore vary
from our records.

 
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We have limited internal controls due to our small size and limited number of
people, which may keep us from preventing or detecting waste or fraud.

Currently, we have four directors, two of whom are also executive officers.  We
rely on manual systems without independent officers and employees to implement
full, formal, internal control systems.  Accordingly, we do not have separate
personnel that provide dual signatures on checks, separate accounts receivable
and cash receipts, accounts payable and check writing, or other functions that
frequently are divided among several individuals as a method of reducing the
likelihood of improper activity.  This reliance on a few individuals and the
lack of comprehensive internal control systems may impair our ability to detect
and prevent internal waste and fraud.

If we are unable to identify and complete future acquisitions, we may be unable
to grow.  There is no assurance that any future acquisitions will be a
profitable venture.

We intend to expand our operations through targeted strategic acquisitions, such
as the acquisition of VM 179.  However, we may not be able to identify
additional suitable acquisition opportunities. The process to identify and
conduct due diligence on possible acquisitions requires significant time,
attention, and resources of management, which may not result in any benefits to
us.  Moreover, there is no guarantee that we can acquire properties which we may
identify in the future on reasonable terms or at all. For example, the Merger
Agreement with Virgin recently terminated as a result of our inability to obtain
financing, which was a condition to closing.  Furthermore, if acquired, there is
no assurance the venture will prove profitable. If we are unable to complete
attractive acquisitions, our growth may slow or decline in the future.

Future acquired companies could be difficult to assimilate, disrupt our
business, diminish stockholder value and adversely affect our operating results.

Completing acquisitions may require significant management time and financial
resources because we may need to assimilate widely dispersed operations with
distinct corporate cultures. Our failure to manage future acquisitions
successfully could seriously harm our operating results. Also, acquisitions
could cause our quarterly operating results to vary significantly. Furthermore,
our stockholders would be diluted if we financed the acquisitions by issuing
equity securities. In addition, acquisitions expose us to risks such as
undisclosed liabilities, increased indebtedness associated with an acquisition
and the potential for cash flow shortages that may occur if anticipated
financial performance is not realized or is delayed from such acquired
companies.

Operational hazards for which we do not maintain insurance are inherent in the
exploration, drilling, and production of oil and gas.

Usual operational hazards incident to our industry include blowouts, cratering,
explosions, uncontrollable flows of oil, natural gas or well fluids, fires,
pollution, releases of toxic gas, and other environmental hazards and
risks.  These hazards can cause personal injury and loss of life, severe damage
to and destruction of property and equipment, pollution or environmental damage,
and suspension of operations.  We do not maintain insurance to cover operational
hazards, but rely on our agreements that require the operator of the properties
in which we have an interest to maintain $1.0 million workers’ compensation,
$1.0 employer’s and general liability, $2.0 million aggregate general liability,
$5.0 million well control, and $5.0 million bodily injury and property damage
insurance coverage.  The insurance policies purchased under this covenant
include us as the owner of a non-operating working interest as an insured under
such policies.  We cannot assure that we could obtain or that Bayshore or our
contractors will be able to continue to obtain insurance coverage for current or
future activities.  Further, we cannot assure that any insurance obtained will
provide coverage customary in the industry, be comparable to the insurance now
maintained, or be on favorable terms or at premiums that are reasonable.  The
insurance maintained by Bayshore or our contractors does not cover all of the
risks involved in oil and gas exploration, drilling, and production, and if
coverage does exist, may not be sufficient to pay the full amount of such
liabilities.  We may not be insured against all losses or liabilities that may
arise from all hazards because such insurance may not be available at economical
rates; the respective insurance policies may have limited coverage, and other
factors.  For example, insurance against risks related to violations of
environmental laws is not maintained.  The occurrence of a significant adverse
event that is not fully covered by insurance or for which the coverage is
insufficient to cover aggregate losses could expose us to liability because we
may be responsible for our working interest share of the damages in excess of
any related insurance coverage.  Further, we cannot assure that adequate levels
of insurance will be maintained for our benefit in the future at rates we
consider reasonable.  The occurrence of any of these risks could lead to a
reduction in our value and the loss of investments made by purchasers of our
stock.

 
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Although the Company has obtained an independent reserve report relating to
proven and probable reserves in the Vermillion 179 area, we cannot predict
whether production or reserves will be established on the Vermillion 179 area or
on other properties in which we have an interest.
 
The decision to develop, exploit, purchase, or explore a property will depend,
in part, on our assessment of the information we are provided by an independent
reserve report (as it pertains to the potential recoverable reserves in our
interests in the Vermillion 179 tract), the information we are provided by
Bayshore (as it pertains to our potential recoverable reserves in our Texas
properties), future oil and natural gas prices and operating costs, potential
environmental and other liabilities risks, and other factors that are beyond our
control.  Such assessments are necessarily inexact, and their accuracy is
inherently uncertain.  Results from previous exploration and production in the
Cooke Ranch area by others do not assure that hydrocarbons in commercial
quantities exist in the areas in which we have or may obtain an interest or that
we may discover or recover any reserves in place.  Although we have obtained an
independent reserve report relating to proven and probable reserves in the
Vermillion 179 areas, there can be no assurance that our development,
exploitation, acquisition, or exploration activities will be successful in
drilling productive wells.
 
In general, the volume of production from oil and natural gas properties
declines as reserves are depleted.  Except to the extent we conduct successful
development, exploitation, and exploration activities or acquire properties
containing proved reserves, or both, any reserves we establish will decline as
reserves are produced.

We have no proved reserves on some of our properties and any future estimates we
may make of quantities of proved oil and gas reserves, projected rates of
production, and the timing and results of development expenditures may prove
inaccurate because of numerous uncertainties.

We are testing geological formations that have not previously been explored or
produced widely in the Cooke Ranch area, so our wells should be considered
exploratory unless and until there is greater drilling experience.  Because of
the limited drilling of the geological formations that we are drilling, we
cannot forecast the anticipated results of drilling, even though a particular
drilling site may be adjacent to or nearby a producing well.

Although we have an independent report of proven and probable reserves in the
Vermillion 179 areas, we currently have no proved reserves in our Texas
properties and will be able to establish reserves only if the results of
drilling provide sufficient engineering and geological data to demonstrate with
reasonable certainty that our properties contain hydrocarbons that may be
recoverable in future years from known reservoirs under existing economic and
operating conditions.  We can establish reserves respecting an individual well
only after, if ever, we have sustained production from such well over several
months and have related engineering and geological data to demonstrate the
existence and recoverability of hydrocarbons.  We cannot assure that we will be
able to establish proved reserves in any well we drill.  We will be unable to
estimate precisely any reserves we may establish.  Oil and gas reserve
engineering is a subjective process of estimating underground accumulations of
oil and gas that cannot be measured in an exact way, and estimates of other
engineers might differ.  The accuracy of any reserve estimate is a function of
the quality of available data and of engineering and geological interpretation
and judgment.  Results of drilling, testing, and production subsequent to the
date of an estimate may justify revision of such estimate.  Accordingly, reserve
estimates are often significantly different from the quantities of oil and gas
that are ultimately recovered.  In addition, estimates of our future net
revenues from any future proved reserves and the present value thereof are based
on certain assumptions regarding future oil and gas prices, production levels,
and operating and development costs that may not prove to be correct.  Any
significant variance in these assumptions could materially affect our estimated
quantity of reserves and future net revenues therefrom.

 
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RISKS RELATED TO THIS OFFERING

There will be restrictions on resale of the Securities and there is no assurance
of the registration of the securities.
 
None of the Securities offered hereby may be resold unless, at the time of such
intended sale, there is a current registration statement covering the resale of
the Securities or there exists an exemption from registration under the
Securities Act, and such Securities have been registered, qualified, or deemed
to be exempt under applicable securities or “blue sky” laws in the state of
residence of the seller or in the state where sales are being effected.  No
assurance can be given when, if ever, the registration of the Securities will be
filed or declared effective by the SEC.  If the SEC does not approve a
registration statement covering the resale of the Securities, investors will be
precluded from disposing of such Securities unless such Securities may become
eligible to be disposed of under the exemptions provided by Rule 144 under the
Securities Act without restriction.

The offering price for the Securities has been determined by the Company

The offering and conversion price of the Notes was determined by us.  These
prices do not necessarily accurately reflect the actual value of the shares or
the price that may be realized upon disposition of the Securities.

 
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An investment in the Securities is speculative and there can be no assurance of
any return on any such investment.

An investment in the Securities is speculative and there is no assurance that
investors will obtain any return on their investment.  Investors will be subject
to substantial risks involved in an investment in the Company, including the
risk of losing their entire investment.

RISKS RELATED TO OUR COMMON STOCK

If we fail to remain current on our reporting requirements, we could be removed
from the OTC Bulletin Board, which would limit the ability of broker-dealers to
sell our securities and the ability of stockholders to sell their securities in
the secondary market.
 
Companies trading on the Over-The-Counter Bulletin Board must be reporting
issuers under the Securities Exchange Act of 1934, as amended, and must be
current in their reports under Section 13, in order to maintain price quotation
privileges on the OTC Bulletin Board. The lack of resources to prepare and file
our reports, including the inability to pay our independent registered public
accounting firm, could result in our failure to remain current on our reporting
requirements, which could result in our being removed from the OTC Bulletin
Board. As a result, the market liquidity for our securities could be severely
adversely affected by limiting the ability of broker-dealers to sell our
securities and the ability of stockholders to sell their securities in the
secondary market.   In addition, we may be unable to get re-approved for
quotation on the OTC Bulletin Board, which may have an adverse material effect
on our company.

There has been a limited trading market for our common stock.

It is anticipated that there will be a limited trading market for our Common
Stock on the NASD’s Over-the-Counter Bulletin Board for the foreseeable
future.  The lack of an active market may impair your ability to sell your
shares at the time you wish to sell them or at a price that you consider
reasonable. The lack of an active market may also reduce the fair market value
of your shares. An inactive market may also impair our ability to raise capital
by selling shares of capital stock and may impair our ability to acquire other
companies or technologies by using common stock as consideration.
 
You may have difficulty trading and obtaining quotations for our common stock.

Our common stock is not actively traded, and the bid and asked prices for our
common stock on the NASD Over-the-Counter Bulletin Board may fluctuate widely.
As a result, investors may find it difficult to dispose of, or to obtain
accurate quotations of the price of, our securities. This severely limits the
liquidity of the common stock, and would likely reduce the market price of our
common stock and hamper our ability to raise additional capital.

Our common stock is not currently traded at high volume, and you may be unable
to sell at or near ask prices or at all if you need to sell or liquidate a
substantial number of shares at one time.

Our common stock is currently traded, but with very low, if any, volume, based
on quotations on the “Over-the-Counter Bulletin Board”, meaning that the number
of persons interested in purchasing our common stock at or near bid prices at
any given time may be relatively small or non-existent.  This situation is
attributable to a number of factors, including the fact that we are a small
company which is still relatively unknown to stock analysts, stock brokers,
institutional investors and others in the investment community that generate or
influence sales volume, and that even if we came to the attention of such
persons, they tend to be risk-averse and would be reluctant to follow an
unproven company such as ours or purchase or recommend the purchase of our
shares until such time as we became more seasoned and viable.  As a consequence,
there may be periods of several days or more when trading activity in our shares
is minimal or non-existent, as compared to a seasoned issuer which has a large
and steady volume of trading activity that will generally support continuous
sales without an adverse effect on share price.  We cannot give you any
assurance that a broader or more active public trading market for our common
stock will develop or be sustained, or that trading levels will be sustained.

 
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Shareholders should be aware that, according to Commission Release No. 34-29093,
the market for “penny stocks” has suffered in recent years from patterns of
fraud and abuse.  Such patterns include (1) control of the market for the
security by one or a few broker-dealers that are often related to the promoter
or issuer; (2) manipulation of prices through prearranged matching of purchases
and sales and false and misleading press releases; (3) boiler room practices
involving high-pressure sales tactics and unrealistic price projections by
inexperienced sales persons; (4) excessive and undisclosed bid-ask differential
and markups by selling broker-dealers; and (5) the wholesale dumping of the same
securities by promoters and broker-dealers after prices have been manipulated to
a desired level, along with the resulting inevitable collapse of those prices
and with consequent investor losses.  Our management is aware of the abuses that
have occurred historically in the penny stock market.  Although we do not expect
to be in a position to dictate the behavior of the market or of broker-dealers
who participate in the market, management will strive within the confines of
practical limitations to prevent the described patterns from being established
with respect to our securities. The occurrence of these patterns or practices
could increase the future volatility of our share price.

The market price of our Common Stock may, and is likely to continue to be,
highly volatile and subject to wide fluctuations.

The market price of our Common Stock is likely to be highly volatile and could
be subject to wide fluctuations in response to a number of factors that are
beyond our control, including:

 
·
dilution caused by our issuance of additional shares of Common Stock and other
forms of equity securities, which we expect to make in connection with future
capital financings to fund our operations and growth, to attract and retain
valuable personnel and in connection with future strategic partnerships with
other companies;

 

 
·
quarterly variations in our revenues and operating expenses;

 

 
·
changes in the valuation of similarly situated companies, both in our industry
and in other industries;

 
·
changes in analysts’ estimates affecting our company, our competitors and/or our
industry;

 
·
changes in the accounting methods used in or otherwise affecting our industry;

 
·
additions and departures of key personnel;

 
·
announcements of technological innovations or new products available to the
personal protective equipment industry;

 
·
fluctuations in interest rates and the availability of capital in the capital
markets; and

 
·
significant sales of our common stock.

 
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These and other factors are largely beyond our control, and the impact of these
risks, singly or in the aggregate, may result in material adverse changes to the
market price of our Common Stock and/or our results of operations and financial
condition.

We have not paid dividends in the past and do not expect to pay dividends in the
future. Any return on investment may be limited to the value of our common
stock.
 
We have never paid cash dividends on our common stock and do not anticipate
paying cash dividends in the foreseeable future. The payment of dividends on our
common stock will depend on earnings, financial condition and other business and
economic factors affecting it at such time as the Board of Directors may
consider relevant.

Legislative actions, higher insurance costs and potential new accounting
pronouncements may impact our future financial position and results of
operations.

There have been regulatory changes, including the Sarbanes-Oxley Act of 2002,
and there may potentially be new accounting pronouncements or additional
regulatory rulings that will have an impact on our future financial position and
results of operations. The Sarbanes-Oxley Act of 2002 and other rule changes as
well as proposed legislative initiatives following the Enron bankruptcy are
likely to increase general and administrative costs and expenses. In addition,
insurers are likely to increase premiums as a result of high claims rates over
the past several years, which we expect will increase our premiums for insurance
policies. Further, there could be changes in certain accounting rules.  These
and other potential changes could materially increase the expenses we report
under generally accepted accounting principles, and adversely affect our
operating results.

Efforts to comply with recently enacted changes in securities laws and
regulations will increase our costs and require additional management resources.
 
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted
rules requiring public companies to include a report of management on their
internal controls over financial reporting in their annual reports on Form 10-K.
In addition, in the event we are no longer a smaller reporting company, the
independent registered public accounting firm auditing our financial statements
would be required to attest to the effectiveness of our internal controls over
financial reporting. Such attestation requirement by our independent registered
public accounting firm would not be applicable to us until the report for the
year ended December 31, 2011 at the earliest, if at all.  If we are unable to
conclude that we have effective internal controls over financial reporting or if
our independent registered public accounting firm is required to, but is unable
to provide us with a report as to the effectiveness of our internal controls
over financial reporting, investors could lose confidence in the reliability of
our financial statements, which could result in a decrease in the value of our
securities.

Our common stock is subject to the "penny stock" rules of the SEC and the
trading market in our securities is limited, which makes transactions in our
stock cumbersome and may reduce the value of an investment in our stock.

The SEC has adopted Rule 15g-9 which establishes the definition of a "penny
stock," for the purposes relevant to us, as any equity security that has a
market price of less than $5.00 per share or with an exercise price of less than
$5.00 per share, subject to certain exceptions. For any transaction involving a
penny stock, unless exempt, the rules require:
 

 
·
that a broker or dealer approve a person's account for transactions in penny
stocks; and
 
·
the broker or dealer receive from the investor a written agreement to the
transaction, setting forth the identity and quantity of the penny stock to be
purchased.

 
 
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In order to approve a person's account for transactions in penny stocks, the
broker or dealer must:
 

 
·
obtain financial information and investment experience objectives of the person;
and
 
·
make a reasonable determination that the transactions in penny stocks are
suitable for that person and the person has sufficient knowledge and experience
in financial matters to be capable of evaluating the risks of transactions in
penny stocks.

 
The broker or dealer must also deliver, prior to any transaction in a penny
stock, a disclosure schedule prescribed by the SEC relating to the penny stock
market, which, in highlight form:
 

 
·
sets forth the basis on which the broker or dealer made the suitability
determination; and
 
·
that the broker or dealer received a signed, written agreement from the investor
prior to the transaction.

 
Generally, brokers may be less willing to execute transactions in securities
subject to the "penny stock" rules. This may make it more difficult for
investors to dispose of our common stock and cause a decline in the market value
of our stock.

Disclosure also has to be made about the risks of investing in penny stocks in
both public offerings and in secondary trading and about the commissions payable
to both the broker-dealer and the registered representative, current quotations
for the securities and the rights and remedies available to an investor in cases
of fraud in penny stock transactions. Finally, monthly statements have to be
sent disclosing recent price information for the penny stock held in the account
and information on the limited market in penny stocks.

FINRA sales practice requirements may also limit a shareholder’s ability to buy
and sell our stock.

In addition to the “penny stock” rules described above, FINRA has adopted rules
that require that in recommending an investment to a customer, a broker-dealer
must have reasonable grounds for believing that the investment is suitable for
that customer. Prior to recommending speculative low priced securities to their
non-institutional customers, broker-dealers must make reasonable efforts to
obtain information about the customer’s financial status, tax status, investment
objectives and other information. Under interpretations of these rules, FINRA
believes that there is a high probability that speculative low priced securities
will not be suitable for at least some customers. The FINRA requirements make it
more difficult for broker-dealers to recommend that their customers buy our
common stock, which may limit your ability to buy and sell our stock and have an
adverse effect on the market for our shares.

Penny Stock Regulations may affect the ability of broker-dealer to sell our
common stock, thereby limiting the liquidity of our common stock.

Our stock is presently regulated as a penny stock, and broker-dealers will be
subject to regulations that impose additional requirements on us and on
broker-dealers that want to publish quotations or make a market in our common
stock.  The Securities and Exchange Commission has promulgated rules governing
over-the-counter trading in penny stocks, defined generally as securities
trading below $5.00 per share that are not quoted on a securities exchange or
Nasdaq or which do not meet other substantive criteria.  Under these rules, our
common stock is currently classified as a penny stock.  As a penny stock, our
common stock is currently subject to rules promulgated by the Securities and
Exchange Commission that impose additional sales practice requirements on
broker-dealers that sell such securities to persons other than established
customers and institutional accredited investors.  For transactions covered by
the rule, the broker-dealer must make a special suitability determination for
the purchaser and receive the purchaser’s written consent to the transaction
prior to sale.  Further, if the price of the stock is below $5.00 per share and
the issuer does not have $2.0 million or more net tangible assets or is not
listed on a registered national securities exchange or Nasdaq, sales of such
stock in the secondary trading market are subject to certain additional rules
promulgated by the Securities and Exchange Commission.  These rules generally
require, among other things, that brokers engaged in secondary trading of penny
stocks provide customers with written disclosure documents, monthly statements
of the market value of penny stocks, disclosure of the bid and asked prices, and
disclosure of the compensation to the broker-dealer and the salesperson working
for the broker-dealer in connection with the transaction.  These rules and
regulations may affect the ability of broker-dealers to sell our common stock,
thereby effectively limiting the liquidity of our common stock.  These rules may
also adversely affect the ability of persons that acquire our common stock to
resell their securities in any trading market that may exist at the time of such
intended sale.
 
 
 
 
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