UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C.  20549





(Mark One)


Form 10-Q





[√]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the quarterly period ended March 31, 2010





or





[ ]
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the transition period from __________________ to __________________________Commission file number: 0-27828





TN-K ENERGY GROUP INC.(Name of registrant as specified in its charter)





Delaware
13-3779546(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)





649 Sparta Highway, Suite 102, Crossville, TN
38555(Address of principal executive offices)
(Zip Code)





(931) 707-9601(Registrant's telephone number, including area code)








not applicable(Former name, former address and former fiscal year, if changed since last report)





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





Yes [√] No [ ]





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.





Large accelerated filer
[ ]
Accelerated filer
[ ]Non-accelerated filer
[ ]
Smaller reporting company
[√]





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)





Yes [ ] No [√]




Indicated the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.  41,131,178 shares of common stock are issued and outstanding as of May 13, 2010.











TABLE OF CONTENTS





Page No.PART I. - FINANCIAL INFORMATIONItem 1.
Financial Statements.
4Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
19Item 3.
Quantative and Qualitative Disclosures About Market Risk.
23Item 4T
Controls and Procedures.
23PART II - OTHER INFORMATIONItem 1.
Legal Proceedings.
23Item 1A.
Risk Factors.
23Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
24Item 3.
Defaults Upon Senior Securities.
24Item 4.
Submission of Matters to a Vote of Security Holders.
24Item 5.
Other Information.
24Item 6.
Exhibits.
24





CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION





This report contains forward-looking statements. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.  These forward-looking statements include, among others, the following:





•
our ability to continue as a going concern,


•
our business and growth strategies,


•
risks associated with the external factors that impact our operations,


•
our ability to satisfy our debt obligations which predate our existing business,


•
volatility in oil prices,


•
risks associates in general with oil and gas operations,


•
our ability to find additional reserves, and


•
the impact of government regulation and the impact of possible changes in tax laws.





Forward-looking statements are typically identified by use of terms such as “may”, “could”, “should”, “expect”, “plan”, “project”, “intend”, “anticipate”, “believe”, “estimate”, “predict”, “potential”, “pursue”, “target” or “continue”, the negative of such terms or other comparable terminology, although some forward-looking statements may be expressed differently.  The forward-looking statements contained in this report are largely based on our expectations, which reflect estimates and assumptions made by our management.  These estimates and assumptions reflect our best judgment based on currently known market conditions and other factors.  Although we believe such estimates and assumptions to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond our control.  In addition, management’s assumptions about future events may prove to be inaccurate.  Management cautions all readers that the forward-looking statements contained in this report are not guarantees of future performance, and we cannot assure any reader that such statements will be realized or the forward-looking events and circumstances will occur.  Actual results may differ materially from those anticipated or implied in the forward-looking statements due to a number of factors, including:





•
significant unforeseen events that have global or national impact such as major political disruptions, extended economic depression, and technological breakthroughs in producing oil and natural gas or in producing alternative forms of energy,


•
unanticipated future changes in oil or natural gas prices, and


•
other uncertainties inherent in the production of oil and natural gas.





2


You should consider the areas of risk described in connection with any forward-looking statements that may be made herein.  You should also consider carefully the statements under  Item 1A. Risk Factors appearing in our Annual Report on Form 10-K for the year ended December 31, 2009 which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements.  Readers are cautioned not to place undue reliance on these forward-looking statements and readers should carefully review this report in its entirety, including the risks described in Item 1A. - Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2009.  Except for our ongoing obligations to disclose material information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events.  These forward-looking statements speak only as of the date of this report, and you should not rely on these statements without also considering the risks and uncertainties associated with these statements and our business.





OTHER PERTINENT INFORMATION





Unless specifically set forth to the contrary, when used in this report the terms “TN-K", "we"", "our", the "Company" and similar terms refer to TN-K Energy Group Inc., a Delaware corporation formerly known as Digital Lifestyles Group, Inc..  In addition, when used herein and unless specifically set forth to the contrary, “2009” refers to the year ended December 31, 2009 and “2010” refers to the year ending December 31, 2010.





3





PART 1 - FINANCIAL INFORMATION





Item 1.                                Financial Statements.


TN-K Energy Group Inc


Balance Sheets


March 31,


December 31,2010


2009(Unaudited)


(Audited)ASSETS:CURRENT ASSETS:Cash and cash equivalents

$
106,720


$
7,148Accounts receivable


44,128



55,996Sale of well interest receivable


-



35,000TOTAL CURRENT ASSETS


150,848



98,144OIL AND GAS PROPERTY (Successful efforts method), at cost


1,165,003



734,397EQUIPMENT, net of depreciation


103,623



105,917OTHER ASSETS


10,000



10,000TOTAL ASSETS

$
1,429,474


$
948,458LIABILITIES AND STOCKHOLDERS' DEFICIT:CURRENT LIABILITIES:Accounts payable

$
6,448,479



6,403,527Accrued expenses


1,109,108



1,073,664Liquidated damages


553,314



526,684Deferred revenue


7,500



35,000Notes payable


550,000



550,000Note payable - related party


400,000



425,250Convertible - notes payable


600,000



600,000TOTAL CURRENT LIABILITIES


9,668,401



9,614,125Derivative and warrant liabilities


2,337,659



2,624,537STOCKHOLDERS' DEFICIT:Preferred stock, $.01 par value, 5,000,000 shares authorized,none issued, and outstanding


-



-Common stock, $.03 par value, 100,000,000 shares authorized,37,970,129 and 37,220,129 issued and outstanding, respectively


1,139,104



1,116,604Additional Paid - In Capital


18,103,560



17,635,992Unearned ESOP shares


(6,207,000
)


(6,207,000
)Accumulated deficit


(23,612,250
)


(23,835,800
)TOTAL STOCKHOLDERS' DEFICIT


(10,576,586
)


(11,290,204
)TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT

$
1,429,474


$
948,458


See accompanying  notes to financial statements.




4




TN-K Energy Group, Inc. Statement of Operations (Unaudited)


Three months ended March 31,2010


2009restatedRevenue:Oil sales

$
104,248


$
-Well Services


11,688



-Sale of oil and gas leases


105,000



-220,936



-Expense:Oil lease operating expense


93,203



-Sales, general and administrative


115,529



23,687Total operating expenses


208,732



23,687Income / (Loss) from operations


12,204



(23,687
)Other income (expense):Gain on derivatives


286,878



5,176Other income


-



7,000Liquidated damages


(26,630
)


(148,685
)Interest expense


(48,902
)


(42,997
)Total other income (expense)


211,346



(179,506
)Net income / (loss) before taxes


223,550



(203,193
)Income taxes


-



-Net Income / (loss )

$
223,550


$
(203,193
)Basic and Diluted loss per common share

$
0.01


$
(0.01
)Weighted average number of common shares outstanding -Basic


37,671,759



32,223,975Diluted


44,441,683



32,223,975


See accompanying notes to financial statements.




5




TN-K Energy Group Inc
 Statement of Cash Flows (Unaudited)


For the three months ended March 31,2010


2009restatedCash Flow From Operating Activities:Net income / (loss)

$
223,550


$
(203,193
)Adjustments to net loss:Depreciation and depletion


26,575



-Change in fair value of derivative and liquidating damages liabilities


(260,248
)


143,509Equity based compensation


5,068



-Adjustments to reconcile net loss to net cash used in operating activities:Changes in operating assets and liabilities:Accounts receivable


11,868



-Deposits


35,000



-Deferred revenue


(27,500
)


-Accounts payable and accrued expenses


80,396



59,497Net Cash Provided by / (Used in) Operating Activities


94,709



(187
)Cash Flow From Investing Activities:Purchase of oil and gas rights


(97,285
)


-Sale of oil and gas rights


63,998Purchases of fixed assets


(1,600
)


-Net Cash (Used in) Provided by  Investing Activities


(34,887
)


-Cash Flow From Financing Activities:Proceeds for excersise of warrants


65,000



-Repayments of notes payable - related party


(25,250
)


-Net Cash Provided by Financing Activities


39,750



-Net increase (decrease)  in cash


99,572



(187
)Cash and cash equivalents at beginning of period


7,148



22,997Cash and cash equivalents at end of period

$
106,720


$
22,810Supplemental cash flow information:Cash paid for interest

$
17,912


$
-Cash paid for taxes

$
-


$
-Non-cash financing activities:Common stock issued for oil and gas properties

$
410,000


$
-


See  accompanying notes to financial statements.




6




TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March  31, 2010 and December 31, 2009 and for the three months ended March 31, 2010 and 2009


(Unaudited)





NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION





Organization





TN-K Energy Group Inc. is an independent energy company engaged in the acquisition and development of crude oil and natural gas reserves and production in the Appalachian Basin and to conduct directly and indirectly through third parties, operations on the properties.  In these Notes, the terms “Company”, “TN-K”, “we”, “us”, “our” and terms of similar import refer to TN-K Energy Group Inc.





The Company made its first acquisition of oil and gas well partial interests in November 2009 and began drilling for oil and gas in December 2009, which resulted in locating oil in all of its drilling efforts in 2009.





Basis of Presentation





The accompanying reviewed financial statements are presented in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and item 310 under subpart A of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal occurring accruals) considered necessary in order to make the financial statements not misleading, have been included. Operating results for the three months ended March 31, 2010 are not necessarily indicative of results that may be expected for the year ending December 31, 2010. The financial statements are presented on the accrual basis.





Going Concern





The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. Going concern contemplates the realization of assets and the satisfaction of liabilities in the normal course of business over a reasonable length of time. The Company has incurred losses since inception and has negative cash flows from operations and a substantial portion of the debt is in default and has a stockholders’ deficit of $(10,576,586) as of March 31, 2010. The future of the Company is dependent upon its ability to obtain additional equity and/or debt financing and upon the continued development of commercially viable producing wells at levels which significantly increase the Company’s revenues and net income. Management cannot assure that the Company will be able to secure such financing or obtain financing on terms beneficial to the Company or that the Company will be able to significantly increase its revenues and net income. Failure to achieve these goals may result in the Company’s inability to continue as a going concern and the impairment of the recorded long-lived assets.





These financial statements do not include any adjustments relating to the recoverability and classifications of recorded assets, or the amounts and classification of liabilities that might be necessary in the event the Company cannot continue in existence.





NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Cash and Cash Equivalents— For purposes of reporting cash flows, we consider cash equivalents to be all highly liquid investments with a maturity of three months or less at the time of purchase. The Company typically has cash in banks in excess of federally insured amounts.





Use of Estimates - Our financial statements are prepared in accordance with United States generally accepted accounting principles, or GAAP.  Preparation in accordance with GAAP requires us to (1) adopt accounting policies within accounting rules set by the Financial Accounting Standards Board (“FASB”) and by the United States Securities and Exchange Commission (SEC) and (2) make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and other disclosed amounts.  This Note describes our significant accounting policies.  Our management believes the major estimates and assumptions impacting our financial statements are the following:





•

estimates of proven (i.e., reasonably certain) oil and gas reserve quantities, which affect the calculations of amortization and impairment of capitalized costs of oil and gas properties;•

estimates of the fair value of oil and gas properties we own, particularly properties that we have not yet explored, or fully explored, by drilling and completing wells;•

estimates of the fair value of stock options at date of grant;•

estimates of the fair value of the derivative liabilities;•

estimates as to the future realization of deferred income tax assets; and•

the assumption required by GAAP that proved reserves and generally proved reserve value for measuring capitalized cost impairment be based on the prices of oil and gas at the end of the reporting period.





7





The estimated fair values of our unevaluated oil and gas properties affect the calculation of gain on the sale of material properties and affect our assessment as to whether portions of unevaluated capitalized costs are impaired, which also affects the calculation of recorded amortization and impairment expense with regards to our capitalized costs of oil and gas properties.





The fair value of stock options at the date of grant to employees and members of our Board of Directors is based on judgment as to expected future volatility of our common stock and expected future choices by option holders as to when options are exercised.





Actual results may differ from estimates and assumptions of future events.  Future production may vary materially from estimated oil and gas proved reserves.  Actual future prices may vary significantly from price assumptions used for determining proved reserves and for financial reporting.





Fair Value— The carrying amounts reported in the balance sheets for cash, and accounts receivable approximate fair value because of the immediate or short-term maturity of these financial instruments. Predominately most of the payables are the results of operations and financings of our prior business which ceased operations in 2005, as a result of the undercapitalized nature of our Company and the age of these delinquent payables, we are unable to determine the fair value of these payables.





Accounts Receivable and Credit Policies— We have certain trade receivables consisting of oil and gas sales obligations due under normal trade terms.  Our management regularly reviews trade receivables and reduces the carrying amount by a valuation allowance that reflects management’s best estimate of the amount that may not be collectible.  At March 31, 2010 and December 31, 2009, management had determined no allowance for uncollectible receivables was necessary. At March 31, 2010 and December 31, 2009 we had accounts receivable and receivables from the sale of a partial interest in oil wells of $44,128, $0, $55,996 and $35,000, respectively.





Asset Retirement Obligations— When we incur an obligation for future asset retirement costs, we record as a liability and as a cost of the acquired asset the present value of the estimated future asset retirement obligation.  For example, when we drill a well, we record a liability and an asset cost for the present value of estimated costs we will incur at the end of the well’s life to plug the well, remove surface equipment and provide restoration of the well site’s surface.  Over time, accretion of the liability is recognized as an operating expense, and the capitalized cost is amortized over the expected useful life of the related asset.  Our asset retirement obligations (“ARO”) relate primarily to the plugging, dismantlement, removal, site reclamation and similar activities of our oil and gas properties. Due to the small amount of such monies related to the asset retirement obligations as of March 31, 2010 and December 31, 2009, this amount is included in accrued expenses on the balance sheet.





The following table reflects the change in ARO for the three months ended March 31, 2010:





Asset retirement obligation beginning of period

$
10,000Liabilities incurred


5,000Liabilities settled


-Accretion


-Revisions in estimated liabilities


-Asset retirement obligation end of period

$
15,000Current portion of obligation end of period

$
-





Oil and Gas Properties— We use the successful efforts method of accounting for oil and gas activities.  Under this method, subject to a limitation based on estimated value, all costs directly associated with property acquisition, exploration and development.    Internal costs that are capitalized at March 31, 2010 and December 31 2009, were nil as such costs have been limited to costs directly identifiable with acquisition, exploration and development activities for the Company’s account and exclude indirect costs and costs related to production or general corporate overhead.




The Company follows the successful efforts method of accounting for its oil and gas activities. Accordingly, costs associated with the acquisition, drilling and equipping of successful exploratory wells are capitalized. Geological and geophysical costs, delay and surface rentals and drilling costs of unsuccessful exploratory wells are charged to expense as incurred. Costs of drilling development wells are capitalized. Upon the sale or retirement of oil and gas properties, the cost and accumulated depreciation or depletion are removed from the accounts and any gain or loss is credited or charged to operations.





8


Capitalized costs of oil and gas properties evaluated as having, or not having, proved reserves are amortized in the aggregate by country using the unit-of-production method based upon estimated proved oil and gas reserves.  For amortization purposes, relative volumes of oil and gas production and reserves are converted at the energy equivalent conversion rate of six thousand cubic feet of natural gas to one barrel of crude oil.  Amortizable costs include estimates of future development costs of proved undeveloped reserves.  The costs of properties not yet evaluated are not amortized until evaluation of the property.  We make such evaluations for a well and associated lease rights when it is determined whether or not the well has proved oil and gas reserves.  Other unevaluated properties are evaluated for impairment as of the end of each calendar quarter based upon various factors at the time, including drilling plans, drilling activity, management’s estimated fair values of lease rights by project, and remaining lives of leases.





Capitalized costs of oil and gas properties (net of related deferred income taxes) may not exceed a ‘ceiling’ amount equal to the present value, discounted at 10% per annum, of the estimated future net cash flows from proved oil and gas reserves plus the cost of unevaluated properties (adjusted for related income tax effects).  Should capitalized costs exceed this ceiling, the excess is charged to earnings as an impairment expense, net of its related reduction of the deferred income tax provision.  The present value of estimated future net cash flows is computed by applying period-end oil and gas prices of oil and natural gas to estimated future production of proved oil and gas reserves as of period-end, less estimated future expenditures (at period-end rates) to be incurred in developing and producing the proved reserves and assuming continuation of economic conditions existing at period-end. SEC guidance allows the ceiling to be increased for subsequent events occurring reasonably before the filing date of the affected financial statements and indicative that capitalized costs were not impaired at period-end.  Such subsequent events are increased oil and gas prices and the proving up of additional reserves on properties owned at period-end.  The present value of proved reserves’ future net cash flows excludes future cash outflows associated with settling asset retirement obligations that have been accrued on the balance sheet.





Equipment— We record at cost any long-lived tangible assets that are not oil and gas property.  Depreciation is recorded using the straight-line method over the estimated useful lives of the related assets of three to seven years.  Expenditures for replacements, renewals, and betterments are capitalized.  Maintenance and repairs are charged to operations as incurred.  Long-lived assets, other than oil and gas properties, are evaluated for impairment to determine if current circumstances and market conditions indicate the carrying amount may not be recoverable.  We have not recognized any impairment losses on non oil and gas long-lived assets.





Impairment— The accounting guidance,Accounting for the Impairment and Disposal of Long-Lived Assets, requires that long-lived assets to be held and used be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Oil and gas properties accounted for using the successful efforts method of accounting (which we use) are excluded from this requirement but continue to be subject to the successful efforts method’s impairment rules.





Revenue Recognition and Gas Balancing— We recognize oil and gas revenues from our interests in producing wells when production is delivered to, and title has transferred to, the purchaser and to the extent the selling price is reasonably determinable.  We recognize the sale of the partial interests in our oil and gas wells once the terms of such contract have been fulfilled. We did not have any oil and gas production during the three months ended March 31, 2009.





Major Customers— During 2009 and the three months ended March 31, 2010, we had one major customer, accounting for 100% of oil and gas sales.  Because there are other purchasers that are capable of and willing to purchase our oil and gas and because we have the option to change purchasers on our properties if conditions so warrant, we believe that our oil and gas production can be sold in the market in the event that it is not sold to our existing customers, but in some circumstances a change in customers may entail significant transition costs and/or shutting in or curtailing production for weeks or even months during the transition to a new customer.





Derivative Financial Instruments- Our derivative financial instruments consist of embedded and free-standing derivatives related primarily to the Laurus notes entered into on November 30, 2004 and the Alloy note. The embedded derivatives include the conversion features, and liquidated damages clauses in the registration rights agreement. In addition, under the accounting provisions, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock ," the Company is required to classify certain other non-employee stock options and warrants (free-standing derivatives) as liabilities. The accounting treatment of derivative financial instruments requires that the Company record the derivatives and related warrants at their fair values as of the inception date of the agreement and at fair value as of each subsequent balance sheet date. The fair value of all derivatives at March 31, 2010 and December 31, 2009 totaled $2,337,659 and $2,624,537, respectively. Any change in fair value of these instruments will be recorded as non-operating, non-cash income or expense at each reporting date. If the fair value of the derivatives is higher at the subsequent balance sheet date, the Company will record a non-operating, non-cash charge. If the fair value of the derivatives is lower at the subsequent balance sheet date, the Company will record non-operating, non-cash income. At March 31, 2010 and December 31, 2009 derivatives were valued primarily using the Black-Scholes Option Pricing Model with the following assumptions: dividend yield of 0%, annual volatility of 179% - 364%, risk free interest rate of 2.11% - 4.83%, and expected life of 3-10 years.





9


The accounting guidance establishes a fair value hierarchy based on whether the market participant assumptions used in determining fair value are obtained from independent sources (observable inputs) or reflect the Company's own assumptions of market participant valuation (unobservable inputs). A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The accounting guidance establishes three levels of inputs that may be used to measure fair value:





•
Level 1—Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;•
Level 2—Quoted prices for identical assets and liabilities in markets that are inactive; quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly; or•
Level 3—Prices or valuations that require inputs that are both unobservable and significant to the fair value measurement.





The Company considers an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and views an inactive market as one in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. Where appropriate the Company's or the counterparty's non-performance risk is considered in determining the fair values of liabilities and assets, respectively.








Fair Value Measurements at Reporting Date UsingDescription
Quoted Prices in Active Markets for Identical Assets

(Level 1)


Significant Other Observable Inputs

(Level 2)

Significant Unobservable Inputs

(Level 3)Derivative securities – December 31, 2009

$
-


$
-


$
2,624,537Derivative securities – March 31, 2010

$
-


$
-


$
2,337,636





Net Income (Loss) Per Share— Basic net income (loss) per share is computed by dividing net income (loss) attributable to common stockholders by the weighted number of common shares outstanding during the period.  Diluted net income (loss) per share reflects per share amounts that would have resulted if dilutive potential common stock had been converted to common stock. The options and warrants excluded from the March 31, 2009  per share computation were 6,192,693 as if included it would have been anti-dilutive. There were dilutive securities of 6,769,924 at March 31, 2010.


Concentration of Credit Risk— Financial instruments which potentially subject the Company to concentrations of credit risk consist of cash.  We maintain substantially all cash assets at one financial institution.  We periodically evaluate the credit worthiness of financial institutions, and maintain cash accounts only in large high quality financial institutions. We believe that credit risk associated with cash is remote.  The Company is exposed to credit risk in the event of nonpayment by counter parties, a significant portion of which are concentrated in energy related industries. The creditworthiness of customers and other counter parties is subject to continuing review.





Share-Based Compensation— We adopted the accounting guidance for,Share-Based Payments, on a modified prospective basis. The accounting guidance requires publicly-held companies to recognize in their statements of operations the grant-date fair value of stock options and other equity-based compensation to employees, consistent with the rules for options to non-employees.





Reclassification— Certain amounts in the 2010 and 2009 consolidated financial statements have been reclassified to conform to the March 31, 2010 financial statement presentation.  Such reclassifications have had no effect on net income (loss).





Recent Accounting Pronouncements





On December 31, 2008, the SEC published changes to its rules and interpretations with regards to disclosures by oil and gas exploration companies, effective for annual reports for fiscal years ending on or after December 15, 2009.  Early adoption is not permitted. Key changes include changes to the oil and gas prices used to estimate proved reserves, permitting the disclosure of probable and possible reserves and the use of new technology for determining reserve classification.





In January 2010, the FASB issued Accounting Standards Update No 2010-03, Extractive Activities – Oil and Gas (Topic 932) – Oil and Gas Reserve Estimation and Disclosures. The objective of this amendment is to align the oil and gas reserve estimation and disclosure requirement of extractive activities – oil and gas Topic 932 with the requirements in the Securities and Exchange Commission’s rule, Modernization of the Oil and Gas Reporting Requirements issued on December 31, 2008. This new accounting guidance improves the reserve estimation and disclosure requirement. These amendments are effective for annual reporting periods ending on or after December 31, 2009. We have adopted these new reporting and disclosure requirements





All other newly issued but not yet effective accounting pronouncements have been deemed to either not be relevant or immaterial to the operations and reporting disclosures of the Company.





10





NOTE 3 — PRIOR PERIOD ADJUSTMENT





On April 12, 2010, the Board of Directors of TN-K Energy Group, Inc. determined that the balance sheet at December 31, 2008 and the statement of operations, statement of changes in stockholders’ deficit and statement of cash flows for the year ended December 31, 2008 included in its Annual Report on Form 10-K for the year ended December 31, 2008 as previously filed with the Securities and Exchange Commission could no longer be relied upon because of errors in these financial statements.  The errors related to (i) an error in the computation of the amount of liquidated damage resulting in an additional expense being recorded in the amount of $604,652, (ii) an error in the number of outstanding warrants at December 31, 2008, resulting in a decrease of warrants presented by 9,775,992, which impacted the related footnote disclosure, and (iii) an error in the number of issued and outstanding shares of our common stock at December 31, 2008, resulting in a decrease of 1,000,000 shares as being recorded as outstanding.  We determined that as a result of the net impact of the correction of these errors on our statement of operations, that we had underestimated the non-cash expense related to the liquidated damages and derivative liabilities by $604,652.  The error in the number of outstanding shares of our common stock at December 31, 2008 also resulted in a reclassification of amounts between paid in capital and additional paid in capital.





The effect of correcting these accounting errors on the statement of operations and the statement of cash flows for the three months ended March 31, 2009 previously included in the Form 10-Q for the three months ended March 31, 2009 are shown in the table below.  The balance sheet error was predominately the reclassification from common stock to additional paid in capital for the par value of the 1,000,000 shares not outstanding. The correction of these errors resulted in the corresponding changes within the statement of stockholders’ deficit for 2008. The balance sheet at March 31, 2009 and the statement of operations, statement of stockholders’ deficit and statement of cash flows for the three months ended March 31, 2009 have been restated to correct the 2008 accounting errors.





March 31, 2009As filed


Adjustment to Restate


RestatedStatement of Operations DataOther income (expense)Liquidated damages

$
-


$
(148,685
)

$
(148,685
)Total other income (expense)

$
(30,821)



(148,685
)

$
(179,506
)Net loss before taxes

$
(54,508
)


(148,685
)

$
(203.193
)Net Loss

$
(54,508
)


(148,685
)

$
(203,193
)





NOTE 4 — OIL AND GAS PROPERTY AND EQUIPMENT





Property and equipment at March 31, 2010 and December 31, 2009 consisted of the following:





March 31, 2010


December 31, 2009Oil and gas properties, successful efforts methodUnevaluated costs, not yet subject to amortization

$
689,192


$
225,905Evaluated costs


514,659



514,659Asset retirement costs


10,000



10,0001,213,851



750,564Furniture, equipment and software


110,100



108,500110,100



108,500Less accumulated depreciation, depletion and amortization


(45,325
)


(18,750
)Oil and gas property and equipment

$
1,278,626


$
840,314





11





Unevaluated Oil and Gas Properties





Costs directly associated with the acquisition and evaluation of unproved properties are excluded from the amortization computation.  The following table shows, by year incurred, the unevaluated oil and gas property costs (net of transfers to evaluated costs and net of sales proceeds) excluded from the amortization computation:





Net CostsYear Incurred

IncurredYear ended December 31, 2009

$
225,905Year ended December 31, 2008


-Prior to 2008


-$
225,905





Costs associated with unevaluated properties are primarily lease acquisition costs. No dry holes were drilled in 2009.  Costs of $33,905 for wells-in-progress were incurred in 2009.  There are no unevaluated costs relating to significant development activities.  We anticipate that all of the $33,905 of costs for wells-in-progress will be reclassified in 2010 as evaluated costs.  Reclassification of other unproved property costs to evaluated costs is largely dependent on (i) how quickly we drill on the unevaluated property, (ii) the results of such drilling, (iii) if third-parties pay drilling costs to earn a portion of our interest, and (iv) quarterly assessments of such costs for impairments.





Prospect leasing and acquisition normally require one to three years, and the subsequent evaluation normally requires an additional one to three years.





Acquisitions of oil and gas properties





In January 2010 we sold a 50% working interest in Todd Anderson Well #2 to an unrelated third party for $35,000 and the purchaser is responsible for 58% of the costs of the well.





In February 2010 we entered into a checkerboard well drilling location assignments covering the entire 738 acres of the JR and Pansy Clark Lease in Green County, Kentucky.  Under the terms of this agreement, we have a 27.5% net interest in each well location and we are responsible for paying 32% of the cost for drilling, completion, operation and permitting of these wells.  As consideration for this Assignment, we issued an aggregate of 425,000 shares of our common stock.





In February 2010 we acquired an 81.25% working interest in approximately 27 acres, which includes one existing producing well, and 100% of certain equipment necessary to operate and produce oil on the lease which is also located in Green County, Kentucky in exchange for 175,000 shares of our common stock.





In February 2010 we sold a 50% working interest in the Betty Hadley Well #1 to an unrelated third party for $35,000 and the purchaser is responsible for 58% of the costs of the well.





In January 2010 we completed a 10 well checkerboard lease acquisition in Green County, Kentucky with Americas Energy Company - AECo and the owners of the leased rights to these wells.  Under the terms of this latest agreement, we will receive a 20% net working interest in the 10 well acquisition at no initial cost per location to the company and we will be the operator of the wells.





Impairment of Oil and Gas Properties





We use the successful efforts-cost accounting method, which requires recognition of an impairment of oil and gas properties when the total capitalized costs (net of related deferred income taxes) exceed a “ceiling” as described in Note 3.





Our initial ceiling test calculation as of December 31, 2009, using oil and gas prices on that date indicated an impairment of our oil and natural gas properties of approximately $.375 million, net of income tax.





Amortization Rate





Amortization of oil and gas property is calculated quarterly based on the quarter’s production in barrels of oil equivalent (“BOE”) times an amortization rate.  The amortization rate is an amortization base divided by the BOE sum of proved reserves at the end of the quarter and production during the quarter.  The amortization base consists of (i) the capitalized evaluated oil and gas costs at the end of the quarter before recording any impairment at quarter’s end, plus (ii) estimated future development costs for the proved reserves, less (iii) accumulated amortization at the beginning of the quarter.  For the three months ended March 31, 2010, the annual average amortization rates were $14.05  per BOE.





The following table shows by type of asset the Depreciation, Depletion and Amortization (“DD&A”) expense for the years ended March 31, 2010:





March 31. 2010Amortization of costs for evaluated oil and gas properties

$
22,681Depreciation of office equipment, furniture and software


3,894Total DD&A expense

$
26,575





12


The resulting depletion and depreciation costs of $26,575 for the three months ended March 31, 2010, have been recorded under the caption heading “oil lease operating expense” on our Statement of Operations.





NOTE 5 - CONVERTIBLE NOTES PAYABLE





In September 2005 we executed a convertible promissory note with Mr. L.E. Smith under the terms of a convertible promissory which bears interest at 7% per annum and is convertible into shares of our common stock at a conversion price of $0.25 per share, was due in September 2006.   At March 31, 2010 and December 31, 2009 we owed Mr. Smith an aggregate of $ 658,507 and $649,877, respectively under this note, which includes principal and accrued but unpaid interest.  The principal and interest due under this note are convertible into shares of our common stock at the option of the holder at a conversion price of $0.25 per share.


In April 2007 we executed an agreement with Mr. Dan Page whereby we received $250,000 in funds to be advanced through a line of credit which was evidenced by a convertible promissory note.  The note bears interest at a rate of 7.5% per annum and had an original maturity date of April 23, 2008. The initial $250,000 advanced under the credit line is convertible at any time into shares of our common stock at a price per share equal to $0.35.  We pay interest only payments until the maturity date of the convertible note, unless it is converted or prepaid.  Upon maturity or the conversion of the initial $250,000 principal amount and interest due under the note, we also agreed to issue to Mr. Page a four year warrant to purchase shares of common stock with an exercise price of $0.35 per share in an amount equal to 20% of the total shares issued upon conversion of the note.  On September 27, 2007, Mr. Page amended the note to provide an additional $100,000 of working capital to us. Under the terms of the amendment, the additional $100,000 is convertible into shares of our common stock at a price per share equal to $0.18. As consideration for this increase of availability under the credit line, at such time as the note matures or he converts the additional $100,000 into common stock, we agreed to issue him a warrant to purchase shares of common stock equal to 20% of the total shares to be issued upon the conversion of that portion of the note with an exercise price of $0.18 per share.  On May 1, 2009 we entered into a second amendment of the note to provide for an additional $50,000 of working capital to us, bringing the total amount available under the credit line to $400,000. Under the terms of the amendment, the additional $50,000 is convertible into shares of our common stock at a price per share equal to $0.12. As consideration for this extension, upon maturity of the note or at such time as he converts the note we agreed to issue him a warrant to purchase shares of common stock equal to 20% of the total share amount issued upon conversion of the note, with an exercise price of $0.12 per share, solely as it relates to this additional $50,000.





On December 8, 2009 Mr. Page extended the due date of the note to June 30, 2010.  The warrants we will issue Mr. Page will expire four years from the date of issuance, which shall be deemed to be on the earlier of (i) the maturity date of the note; (ii) the date on which the funds are advanced in full and owing by us; or (iii) the date on which we elect to pay off the note in full during the term.  We agreed to register for resale the shares underlying the convertible note and warrants, but we have not filed the required registration statement. At March 31, 2010 and December 31, 2009 we owed Mr. Page $400,000 and $425,250, respectively of principal and approximately $3,077 and $13,278, respectively of accrued but unpaid interest under this credit line.  Mr. Dan Page, a principal shareholder of our Company, is the father of Mr. Ken Page, currently our sole officer and a member of our Board of Directors.





On November 30, 2004, we entered into a $7,500,000 secured credit facility with Laurus Master Fund, L.P. (“Laurus”). The facility consisted of a $4,750,000 convertible revolving note and a $2,750,000 convertible term note. We initially borrowed approximately $3,542,000 under this facility, for proceeds of $3,255,000 net of issuance costs of $287,000. The proceeds represented $2,750,000 under the convertible term note and $792,000 under the convertible revolving note. These funds were used to fund the repayment of existing short-term financing. The outstanding balance of the revolving note and the principal balance of the term note are convertible into shares of our common stock, subject to certain limitations set forth in the agreement based upon the stock's trading volume and Laurus' ownership position. The conversion price of the notes is $0.39 per share, which is a premium over the average closing price of our common stock over the ten trading days preceding the execution of the agreement, with conversion reset rights if we issue any shares for less than the initial conversion price. In connection with the credit facility, we also issued to Laurus warrants to purchase up to 3,846,154 shares of our common stock at $0.44 per share We agreed to file a registration statement with the Securities and Exchange Commission registering the resale of the shares of our common stock issuable to Laurus upon conversion of the term note and exercise of the warrants. Failure to file such a registration statement timely and to maintain its effectiveness will subject us to liquidated damages as defined in the registration rights agreement. Because we did not have a currently effective registration statement, in accordance with the accounting guidance we recorded a liability as liquidated damages for failure to register the underlying shares.





In April 2007, we reached an agreement with Laurus to extinguish $2.1 million in outstanding debt for $200,000 in cash. Under the terms of the agreement we paid $50,000 in cash in April 2007, and paid an additional $150,000 during the years ended December 31, 2007 and 2008. In addition to the cash consideration, we issued a warrant to Laurus to purchase one million shares of our common stock at $.40 per share. In connection with the agreement, we recognized a gain on debt relief of approximately $1,510,000 and a derivative liability of $358,612 during the year ended December 31, 2007.





13


On April 1, 2005, we issued to Alloy Marketing and Promotions, LLC ("Alloy") an unsecured subordinated convertible promissory note in the principal amount of approximately $600,000 in payment of services provided to us by Alloy in 2004. The note matured upon demand by Alloy and could have been converted into shares of our common stock at any time after April 1, 2005 at a conversion price equal to 75% of fair market value of the common stock, defined as the lesser of (i) the average of the closing prices of the common stock for the five trading days immediately prior to the first to occur of (A) the date on which we include the registration of the resale of the common stock issuable upon conversion of the note in a registration statement filed with the Securities and Exchange Commission and (B) any date on which Alloy delivers to us a notice of conversion, or (ii) the closing price of the common stock for the trading day immediately prior to the first to occur of such dates. The note is in default. In connection with the subordinated convertible promissory note, we entered into a registration rights agreement with Alloy, pursuant to which we agreed to use our commercially reasonable efforts to file with the SEC a registration statement for offerings to be made on a continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, with respect to the resale of the shares of common stock issuable upon the conversion of the note. We are obligated to pay Alloy a cash fee, as liquidated damages, equal to 1.50% of the original principal amount of the note for each thirty day period, beginning April 1, 2005, until the registration statement is declared effective. We would also have to make similar payments if the registration statement, after it is declared effective, ceases to be effective for more than twenty consecutive calendar days or more than thirty days in the aggregate during a year, or the common stock is not listed or quoted or is suspended from trading on any trading market for three consecutive trading days, and such suspension shall not have been lifted within thirty days or the common stock is not listed on another trading market.





Through March 31, 2010 and December 31, 2009, we had accrued $553,314 and $526,685, respectively of liquidated damages as interest expense under this agreement. Under the provisions of the accounting guidance for, “Accounting for Contingencies” and “Accounting for Registration Payment Arrangements ”.





Convertible notes payable are summarized as follows at March 31, 2010 and December 31, 2009:





March 31, 2010


December 31, 2009Convertible note payable to a third party with an interest rateof 7% per annum, due September 19, 2006, net of unamortizeddebt discount of $0

$
500,000


$
500,000Convertible note payable to a third party with an interest rateof 7% per annum, due October 27, 2006, net of unamortizeddebt discount of $0


50,000


$
50,000Convertible line of credit note payable to a third party with an interest rateof 7.5% per annum, due June 30, 2010


400,000



425,250Convertible note payable to Alloy, default interest rate of 18% per annum, payable upon demand


600,000



600,000$
1,550,000


$
1,575,250





NOTE 6 — STOCKHOLDERS’ EQUITY





Common Stock





In February 2010 we entered into a checkerboard well drilling location assignments covering the entire 738 acres of the JR and Pansy Clark Lease in Green County, Kentucky.  Under the terms of this agreement, we have a 27.5% net interest in each well location and we are responsible for paying 32% of the cost for drilling, completion, operation and permitting of these wells.  As consideration for this Assignment, we issued an aggregate of 425,000 shares of our common stock.





In February 2010 we acquired an 81.25% working interest in approximately 27 acres, which includes one existing producing well, and 100% of certain equipment necessary to operate and produce oil on the lease which is also located in Green County, Kentucky in exchange for 175,000 shares of our common stock.





Warrants





In October 2009, in connection with the sale of our common stock in private transactions, we issued the purchasers three year Series A Common Stock Purchase Warrants to purchase an aggregate of 39,231 shares of our common stock with an exercise price of $0.31 per share.





14


In February 2010 the holder of a warrant for 100,000 shares exercisable at $0.475 per share exercised the warrant resulting in cash proceeds to the company of $47,500.





In February 2010 the holder of a warrant for 50,000 shares exercisable at $0.35 per share exercised the warrant resulting in cash proceeds to the company of $17,500. The Company extended the holders remaining warrants till December 2010. The Company incurred an expense of $5,068.





Stock Options





On March 22, 2004 our Board of Directors adopted, subject to stockholder approval, the 2004 Stock Incentive Plan (the “2004 Plan”). The 2004 Plan was approved by our stockholder in May 2004.  No award could be granted under the 2004 Plan subsequent to the 10th anniversary of the date on which the plan was approved by our stockholders. The number of shares of our common stock available for issuance under the 2004 Plan was 3,500,000.  At March 31, 2010 there were outstanding options to purchase 405,000 shares of our common stock at an exercise prices ranging from $0.25 to $0.56 per share.





On September 29, 2009 our Board of Directors adopted our 2009 Equity Compensation Plan (the “2009 Plan”). The plan authorizes the grant of (i) options which qualify as incentive stock options under Section 422(b) of the Internal Revenue Code of 1986, as amended, (ii) non-qualified options which do not qualify as incentive stock options, (iii) awards of our common stock (iv) and rights to make direct purchases of our common stock which may be subject to certain restrictions. We have reserved 4,800,000 shares of our common stock for issuance upon grants made under the plan.





Compensation based stock option and warrant activity for warrants and qualified and unqualified stock options are summarized as follows:





Shares


Weighted

Average

Exercise PriceOutstanding at December 31, 2008


11,008,847


$
0.39Granted


727,231



0.12-0.31Exercised


-



-Expired or cancelled


(4,816,154
)


0.25-1.20Outstanding at December 31, 2009


6,919,924


$
0.31Granted


-Exercised


(150,000)



.44Expired or cancelled


-Outstanding at March 31, 2010


6,769,924


$
.30





We extended the term of 50,000 warrants expiring in June 2010 to December 2010.





NOTE 7 – EMPLOYEE STOCK OWNERSHIP PLAN





On December 1, 1999, we established a leveraged ESOP that covered all employees who completed 1,000 or more hours of service in a Plan year. To establish the plan, the ESOP borrowed $10,000,000 from Mr. Teng, then our majority stockholder, which we then used to purchase all of our outstanding preferred stock (a total of 1,350,000 shares) from Mr. Teng at the then estimated fair value, $7.41 per share. The preferred stock was convertible into common stock at an exchange rate of 1 share of preferred stock to 3.12828 shares of common stock, and in September 2004, the ESOP converted all of its preferred stock to common stock. We received no funds from the formation of the ESOP; however, we were required to record the ESOP's liability on our books as we had guaranteed the ESOP debt (see below), in accordance with the accounting guidance, "Employers' Accounting for Employee Stock Ownership Plans." Under the accounting guidance, we recorded an unearned employee benefit expense related to the cost basis of unreleased shares (determined based on the portion of the ESOP loan obligation not yet repaid by the ESOP – see below), and, as such, we recorded it as a reduction to stockholders' equity, "Unearned ESOP shares."





In the aftermath of a review by the Pension and Welfare Benefits Administration of the Department of Labor ("DOL"), in December 2003, Mr. Teng agreed to release the ESOP from its remaining obligations under the $10.0 million promissory note, thereby releasing us from our guarantee of the ESOP debt. In connection with Mr. Teng's release of the ESOP from its obligations under the promissory note, we eliminated the guarantee of ESOP loan and interest payable balances against additional paid-in capital, as this debt release was considered a contribution of capital to us by Mr. Teng.





15


In December 2003, since the ESOP was then under investigation by the DOL, Mr. Teng was not able to foreclose on the unreleased shares upon his release of our obligation under the promissory note, as was his right under the ESOP agreement. At that time, Mr. Teng notified us that while he was releasing us from our obligation under the promissory note, he was not waiving any rights he may have to foreclosure against the unreleased shares. Although the DOL investigation has been completed, we have not yet released the shares to the ESOP and Mr. Teng has not yet exercised any right he may have to foreclose on the unreleased shares. If Mr. Teng is able to foreclose on the ESOP shares, the value of the unearned ESOP shares will be eliminated against additional paid-in capital, which will reduce our additional paid-in capital balance by approximately $6,207,000, with no net change to our stockholders' deficit.





Common shares held by the ESOP as of March 31, 2010 and December 31, 2009 are as follows:





(in thousands)March 31, 2010


December 31, 2009Allocated shares


1,613



1,613Shares released from allocation


0



0Unreleased (unearned) shares


2,641



2,641Total ESOP shares


4,254



4,254





The fair value of unreleased (unearned shares) at March 31, 2010 and December 31, 2009  (based on closing price of our stock) was $1,914,300 and $1,280,885, respectively.





In the event a terminated ESOP participant desires to sell his or her shares of our common stock, or for certain employees who elect to diversify their account balances, we may be required to purchase the shares from the participant at their fair market value. During the three months ended March 31, 2010 and the year ended December 31, 2009 , we did not purchase any stock from ESOP participants nor did we have any obligation to do so at any time during this period. Our ESOP plan did not have an effect on our calculation of diluted earnings per share for the three months ended March 31, 2010 or the year ended December 31, 2009.





NOTE 8 — RELATED PARTY TRANSACTIONS





The Company purchased partial interests in oil and gas wells, in November and December 2009, through the issuance of 4,800,000 shares of common stock. The sellers of these partial interests also perform well drilling services for the exploration of new wells on an ongoing basis for the Company.





The Company has entered into a one year employment arrangement with its CEO, in September 2007, with automatic annual renewals. The employment arrangement required a monthly salary of $6,000 and a monthly expense allowance of $1,000, with 3,000,000 stock options issued. These stock options vest from March 2008 to September 2008 and have a $0.20 exercise price for three years. In September 2009, this employment agreement was amended to reduce the monthly salary to be $4,167.67 a month and an additional 120,000 options were issued with an exercise price of $0.25, vesting 10,000 options monthly commencing in September 2009.





In March 2010, the Company has entered into a one year consulting arrangement for services to be rendered from time to time by a related party who is also a principal shareholder of the Company and the father of the Company’s CEO for an annual fee of $25,000.





NOTE 9 — COMMITMENTS AND CONTINGENCIES





The Company may be subject to various possible contingencies, which are derived primarily from interpretations of federal and state laws and regulations affecting the oil and gas industry. Although management believes it has complied with the various laws and regulations, new rulings and interpretations may require the Company to make future adjustments.





The Company continually evaluates its leasehold interests, therefore certain leases may be abandoned by the Company in the normal course of business.





The Company has been involved in litigation from time to time as a result of the failure to make payments on certain of its past due debts. Overall management believes the net recorded value of its past due payables adequately cover the total financial exposure of the past due payables.





NOTE 10 ─ SUBSEQUENT EVENTS





On April 27, 2010 Mr. L.E. Smith converted the $500,000 principal amount convertible promissory note and all accrued but unpaid interest due under the note into an aggregate of 2,561,049 shares of our common stock based upon a conversion price of $0.25 per share in accordance with the terms of the note originally issued in September 2005.





16


On May 6, 2010 we entered into Assignments of Oil and Gas Lease with third parties covering 10 additional well locations on the checkerboard lease which were originally retained by them in the February 2010 transaction.  Under the terms of the Assignment of Oil and Gas Lease, we acquired these additional locations at $25,000 each.  We will have a 27.5% net interest in the 10 additional well locations and we are responsible to pay 32% of all costs for drilling, completion, operating and permitting of the wells.  We will be the operators of these wells.  As full and complete consideration for these interests, we issued the assignors an aggregate of 500,000 shares of our common stock valued at $0.50 per share for a total of $250,000.  In addition, we issued the assignors 100,000 shares of our common stock valued at $0.50 per share as a prepayment for drilling, completion and operations costs at these well locations in the amount of $50,000.





We have evaluated the subsequent events through May 13, 2010 for disclosure purposes.





17


Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.





The following discussion of our financial condition and results of operationfor the first quarter of 2010 and the first quarter of 2009 should be read in conjunction with the unaudited financial statements and the notes to those statements that are included elsewhere in this report. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Item 1A. Risk Factors appearing in our Annual Report on Form 10-K for the year ended December 31, 2009 as previously filed with the Securities and Exchange Commission.  e use words such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions to identify forward-looking statements.





Overview





We are an independent oil and gas exploration and production company, engaged in acquiring oil and gas leases and exploring and developing crude oil and natural gas reserves and production in the Appalachian basin.  While we have acquired working interests in existing wells in an effort to balance our revenue sources, we primarily focus our efforts on acreage acquisitions in which we will the operator of the wells which we believe gives us the greatest ability to maximize our revenues over the long term.  We concentrate our operations in Kentucky and Tennessee primarily in the Murfreesboro, Knox and Wells Creek formations, although we also have assets located in the Granville, Stones River and Sunbrook formations.  All of these formations are primary known producing formations.





Our growth strategy is to focus on our operational growth in our core area, to convert our unproved reserves to proved reserves and to continue our acreage acquisitions while maintaining balanced, prudent financial management.  Our drilling and exploration efforts are primarily centered around two checkerboard leases on the JR and Pansy Clark Lease in Clinton County, Kentucky which when we acquired the leases during the first quarter of 2010 provided an estimated 65 net unproved drilling locations based upon an four acre well spacing.  During the second quarter of 2010 we acquired 10 additional well locations on the checkerboard that the assignors had originally retained.  As of May 11, 2010, we have a total of nine wells with some level of producing operations on locations in which we are the well operator and working interests in an additional 15 wells.  In addition, our current lease holdings have an additional estimated 75 net unproved drilling locations.  During the remainder of 2010 we plan to continue to expand our acreage position in our core area, focusing on acreage we will operate.





To date, we have experienced a high success rate in our exploration and drilling efforts while maintaining low drilling and development costs.  There are no assurances, however, that we will be able to continue this trend.  There are also no assurances that our existing wells will continue to produce at their initial levels. To date, while our oil exploration and drilling locations have also located natural gas deposits in quantities which may be commercially viable.




In addition to the challenges faced by small independent oil and gas companies, we also face a number of challenges in executing our business model which are particular to our company.  At March 31, 2010 our balance sheet includes approximately $6.9 million of past due debt and liquidated damages that relates to the prior business of our company before those operations were discontinued in 2005.  Subsequent to March 31, 2010 the holder of a $500,000 convertible note converted that note, together with the accrued interest of approximately $142,000, into 2,562,049 shares of our common stock in accordance with the original terms of the note.  None of these remaining obligations represent secured debt, although a number of the creditors have obtained judgments against our company.  We do not have the resources to satisfy these obligations.  If one or more of these judgment creditors should seek to enforce the judgment, our ability to continue our operations as they are presently conducted is in jeopardy.





While we have been able to acquire participating interests in producing wells, as well leasing unproven acreage for our drilling operations, using minimal amounts of cash by leveraging our common stock, it is possible that the value of the shares we have issued have exceeded the price we would have paid for the same assets had we been negotiating a cash transaction.  In 2009 we recognized an impairment of $375,000 net of income tax on various properties we acquired as the value of the reserves was less than the value of the shares we issued as consideration in the transaction.  Given our limited cash resources, it is likely that we will continue to use equity to expand our holdings during 2010 which will further dilute our existing stockholders and possibly result in additional one-time impairments of the assets acquired.





18


We also face the challenge of limited personnel and diversion of our management’s time and attention.  We only have one employee, our CEO.  We utilize the services of contract drillers and outsource our accounting functions.  As our company continues to grow, we need hire additional staff to handle the increasing needs of our company, including from an administrative standpoint, and we need to invest in internal systems to ensure that our financial statements are properly prepared.  Lastly, we need to raise additional capital to fund these necessary infrastructure increases and our continued expansion, as well as to provide adequate funds to satisfy our obligations.  We have been relying on funding available to us under a line of credit extended by a related party which matures in June 2010.  At March 31, 2010, $400,000 is outstanding under this facility.  The holder of the note has orally agreed to extend the note for an additional one year period.  We will enter into an extension agreement with him prior to the current maturity date.  The amount is convertible into shares of our common stock at various prices, but there are no assurances the holder will convert the obligation at maturity.  Given the small size of our company, the early stage of our operations and our limited revenues, we may find it difficult to raise sufficient capital to meet our needs.  If we are unable to access capital as needed, our ability to grow our company is in jeopardy and absent a significant increase in our revenues we may be unable to continue as a going concern.





Going Concern





We only began generating revenues from our operations in the fourth quarter of 2009.  While we reported a net loss of $1,360,939 for 2009 and we have incurred net losses of approximately $23.6 million since inception through March 31, 2010, we reported net income of $223,550 for the first quarter of 2010.  The report of our independent registered public accounting firm on our financial statements for the year ended December 31, 2009 contains an explanatory paragraph regarding our ability to continue as a going concern based upon our operating losses and need to raise additional capital.  These factors, among others, raise substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty.  There are no assurances we will be successful in our efforts to increase our revenues and report profitable operations or to continue as a going concern, in which event investors would lose their entire investment in our company.





Results of Operations





We exited shell status and began our operations in the energy industry in the fourth quarter of 2009.  Our revenue in the first quarter of 2010 includes revenues from oil sales generated both from wells in which we are the operator as well as those in which we have a working interest.  During the first quarter of 2010 the average sales price (including transfers) per unit of oil extracted from wells drilled by us was approximately $65.00.  Our revenues from oil sales were adversely impacted during the first quarter of 2010 as a result of inclement weather with hindered our drilling operations.  Given the location of our wells, we anticipate that winter weather conditions may impact our drilling operations during the first quarter of our fiscal years in future periods as well.





During the first quarter of 2010 we also recognized revenue related to the sale of revenues interests in one oil well.  We anticipate that we will continue to sell revenue interest to third parties during 2010 as a means to fund our drilling operations and to partially offset the costs of operating the wells.





Our total operating expenses in the first quarter of 2010 increased approximately 781% from the comparable quarter in 2009.  This increase includes oil lease operating expense for which there were no comparable expenses in the 2009 period.  We anticipate that these expenses will continue to increase in future periods as we expand our drilling operations.  During the first quarter of 2010 our sales, general and administrative expenses increased approximately 387% from the comparable period in 2009.  This increase is primarily attributable to professional fees and expenses associated with expanding our lease holdings and our reporting obligations under federal securities laws, as well as our general overhead expenses which have increased as a result of our operations.  Included in sales, general and administrative expenses during the first quarter of 2010 is a one-time non-cash expense of approximately $5,000 related to our extension of the expiration period of an outstanding warrant.  We anticipate our operating expenses will continue to increase in the balance of 2010 which will be reflective of our increased operations.  We are not able at this time, however, to quantify the amount of the expected increase.





19


Included in our total other income during the first quarter of 2010 is a gain on derivatives of approximately $287,000 as compared to a loss on derivatives of approximately $5,200 during the first quarter of 2009.  Gain (loss) on derivatives consists of income or expense associated with the change in the fair value of derivative liabilities as a result of the application of EITF Issue No. 07-05 to our financial statements. The difference in fair value of the derivative liabilities between the date of their issuance and their measurement date has been recognized as other income in those periods.





Other income in the first quarter of 2009 represented royalties received for the use of our name under a marketing and license agreement which expired in January 2009 for which there was no comparable income in the comparable 2010 period.





Liquidated damages are related to registration rights granted by our prior management and while they decreased in the first quarter of 2010 as compared to the first quarter of 2009 as a result of the expiration of certain of the instruments under which the registration rights were granted, these expenses continue to have a material impact on our company.





Our interest expense as increased as a result of the increased amounts outstanding under the line of credit provided by a related party which provides funding for our operations.





Liquidity and Capital Resources





Liquidity is the ability of a company to generate sufficient cash to satisfy its needs for cash.  At March 31, 2010 we had a working capital deficit of $9,517,553 as compared to $9,515,982 at December 31, 2009.  Our current liabilities includes approximately $6.4 million of accounts payable and approximately $1.1 million of accrued expenses, almost all of which relates to obligations incurred before our company discontinued its previous operations in 2005.  The increase in liquidated damages reflects the accruals for the first quarter of 2010.





Cash flows





Net cash provided by operating activities in the first quarter of 2010 was $94,709 as compared to net cash used in operating activities of $187 in the first quarter of 2009.  The change reflects the commencement of our operations during the fourth quarter of 2009.  We used cash in the first quarter of 2010 to reduce our accounts receivables which was offset by an increase in deferred revenue and accounts payable and accrued expenses.   In the first quarter of 2009, we offset our loss from operations with an increase in accrued expenses and a reduction in our derivative liabilities.





Net cash used in investing activities in the first quarter of 2010 reflects the purchase of oil and gas leases and fixed assets, net of the sale of working interest in certain of our wells.





Net cash provided by financing activities in the first quarter reflects proceeds from the exercise of outstanding warrants offset by a repayment of a portion of the balance due under the credit line with Mr. Dan Page which is described below.





Line of Credit





In April 2007 we executed an agreement with Mr. Dan Page whereby we received $250,000 in funds to be advanced through a line of credit which was evidenced by a convertible promissory note.  The note bears interest at a rate of 7.5% per annum and had an original maturity date of April 23, 2008. The initial $250,000 advanced under the credit line is convertible at any time into shares of our common stock at a price per share equal to $0.35.  We pay interest only payments until the maturity date of the convertible note, unless it is converted or prepaid.  Upon maturity or the conversion of the initial $250,000 principal amount and interest due under the note, we also agreed to issue to Mr. Page a four year warrant to purchase shares of common stock with an exercise price of $0.35 per share in an amount equal to 20% of the total shares issued upon conversion of the note.  On September 27, 2007, Mr. Page amended the note to provide an additional $100,000 of working capital to us. Under the terms of the amendment, the additional $100,000 is convertible into shares of our common stock at a price per share equal to $0.18. As consideration for this increase of availability under the credit line, at such time as the note matures or he converts the additional $100,000 into common stock, we agreed to issue him a warrant to purchase shares of common stock equal to 20% of the total shares to be issued upon the conversion of that portion of the note with an exercise price of $0.18 per share.  On May 1, 2009 we entered into a second amendment of the note to provide for an additional $50,000 of working capital to us, bringing the total amount available under the credit line to $400,000. Under the terms of the amendment, the additional $50,000 is convertible into shares of our common stock at a price per share equal to $0.12. As consideration for this extension, upon maturity of the note or at such time as he converts the note we agreed to issue him a warrant to purchase shares of common stock equal to 20% of the total share amount issued upon conversion of the note, with an exercise price of $0.12 per share, solely as it relates to this additional $50,000.





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On December 8, 2009 Mr. Page extended the due date of the note to June 30, 2010.  The warrants we will issue Mr. Page will expire four years from the date of issuance, which shall be deemed to be on the earlier of (i) the maturity date of the note; (ii) the date on which the funds are advanced in full and owing by us; or (iii) the date on which we elect to pay off the note in full during the term.  We agreed to register for resale the shares underlying the convertible note and warrants for resale, but we have not filed the required registration statement. At March 31, 2010 we owed Mr. Page $400,000 of principal and approximately $3,077 of accrued but unpaid interest under this credit line, net of repayments.  As set forth above, we will enter into an agreement with Mr. Page prior to the maturity date to extend the note term for an additional year. Mr. Dan Page is the father of Mr. Ken Page, currently our sole officer and a member of our Board of Directors.





Past Due Notes at March 31, 2010





Our liabilities at March 31, 2010 reflect a number of past due obligations which were incurred by us under our former management, including:





•           $600,000 principal amount due Alloy Marketing and Promotions, LLC under the terms of an unsecured convertible promissory note issued to it in April 2005 in payment to Alloy for marketing and promotional services rendered to us.  Under the terms of this demand note which originally bore interest at the rate of 10% per annum, the principal and interest could be converted into shares of our common stock at any time after April 1, 2005 at a conversion price equal to 75% of the fair market value of our common stock providing that the underlying shares were covered by an effective registration statement.  In connection with the issuance of the note we entered into a registration rights agreement with Alloy whereby we agreed to file a registration statement with the SEC to cover the resale of the shares of common stock into which the note could be converted.  We agreed to pay Alloy liquidated damages if we did not file the registration statement within a specified period, if we failed to maintain an effective registration statement or if our common stock was suspended from trading on any market.  We have not filed the registration statement and at March 31, 2010 we have accrued liquidated damages in the amount of $553,314 which were due Alloy.  This note remains outstanding and interest is now being accrued at the default rate of 15% per annum, with a late payment fee of 6% per month.  At March 31, 2010 we owed Alloy an aggregate of $1,153,515 under this note, which includes principal and accrued but unpaid interest, liquidated damages and late fees; and





•           $50,000 principal amount due Mr. Robert Wood under the terms of a convertible promissory note issued in October 2005.  This note, which bears interest at 7% per annum and is convertible into shares of our common stock at a conversion price of $0.25 per share, was due in October 2006.  The purchaser was also issued corresponding five warrants to purchase 40,000 shares of our common stock common stock at an exercise price of $0.25 per share which expire in October 2010.  In connection with both the convertible note and the warrants, we entered into a registration rights agreement with the purchaser whereby we agreed to register for resale the shares underlying the convertible note and warrants.  This note is in default and we did not register the shares underlying either the note or the warrant.  At March 31, 2010 we owed Mr. Wood an aggregate of $65,851 under this note, which includes principal and accrued but unpaid interest.





While we had a past due note in the amount of $500,000 to Mr. L.E. Smith at March 31, 2010, this note has subsequently been converted into equity as described elsewhere herein.





Recent Accounting Pronouncements





On December 31, 2008, the SEC published changes to its rules and interpretations with regards to disclosures by oil and gas exploration companies, effective for annual reports for fiscal years ending on or after December 15, 2009.  Early adoption was not permitted. Key changes include changes to the oil and gas prices used to estimate proved reserves, permitting the disclosure of probable and possible reserves and the use of new technology for determining reserve classification.





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In January 2010, the FASB issued Accounting Standards Update No 2010-03, Extractive Activities – Oil and Gas (Topic 932) – Oil and Gas Reserve Estimation and Disclosures. The objective of this amendment is to align the oil and gas reserve estimation and disclosure requirement of extractive activities – oil and gas Topic 932 with the requirements in the SEC’s rule, Modernization of the Oil and Gas Reporting Requirements issued on December 31, 2008. This new accounting guidance improves the reserve estimation and disclosure requirement. These amendments are effective for annual reporting periods ending on or after December 31, 2009. We have adopted these new reporting and disclosure requirements





Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.





Item 3.                         Quantitative and Qualitative Disclosures About Market Risk.





Not applicable for a smaller reporting company.





Item 4T.                      Controls and Procedures.





Evaluation of Disclosure Controls and Procedures.  We maintain “disclosure controls and procedures” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934.  In designing and evaluating our disclosure controls and procedures, our management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of disclosure controls and procedures are met.  Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures.  The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.  Based on his evaluation as of the end of the period covered by this report, our Chief Executive Officer who also serves as our principal financial and accounting officer has concluded that our disclosure controls and procedures were not effective such that the information relating to our company, required to be disclosed in our Securities and Exchange Commission reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) is accumulated and communicated to our management, including our Chief Executive Officer, to allow timely decisions regarding required disclosure.





Our management concluded that our disclosure controls and procedures were not effective as a result of a material weakness in our disclosure controls and procedures. The material weakness identified was that our accounting resources are not adequate to allow sufficient time to (i) perform a review of the consolidation and supporting financial statement disclosure schedules independent of the preparer (ii) adequately prepare for our quarterly reviews and annual audit and (iii) research all applicable accounting pronouncements as they relate to our financial statements and underlying disclosures. Due to this material weakness, in preparing our financial statements for the period ended March 31, 2010, 2009 we performed additional analysis and other post close procedures to ensure that such financial statements were stated fairly in all material respects in accordance with U.S. generally accepted accounting principles.  We do not expect our disclosure controls and procedures to be effective until such time as we hire sufficient, experienced accounting personnel.





Changes in Internal Control over Financial Reporting.There have been no changes in our internal control over financial reporting during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.





PART II - OTHER INFORMATION





Item 1.                         Legal Proceedings.





None.





Item 1A.                      Risk Factors.





Not applicable for a smaller reporting company.





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Item 2.                                Unregistered Sales of Equity Securities and Use of Proceeds.





None.





Item 3.                                Defaults Upon Senior Securities.





None.





Item 4.                                Submission of Matters to a Vote of Security Holders.





None.





Item 5.                                Other Information.





On April 27, 2010 the holder of a $500,000 principal amount convertible promissory note converted the principal and all accrued but unpaid interest due under the note into an aggregate of 2,561,049 shares of our common stock based upon a conversion price of $0.25 per share in accordance with the terms of the note originally issued in September 2005.





Item 6.                                Exhibits.





No.
Description31.1
Rule 13a-14(a)/ 15d-14(a) Certification of Chief Executive Officer31.2
Rule 13a-14(a)/ 15d-14(a) Certification of principal financial and accounting officer32.1
Section 1350 Certification of Chief Executive Officer and principal financial and accounting officer





SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


TN-K ENERGY GROUP INC.May 13, 2010
By:
/s/ Ken PageKen Page, Chief Executive Officer, principal financial and accounting officer