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, 2011





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 x No o





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
o
Accelerated filer
oNon-accelerated filer
o
Smaller reporting company
x





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





Yes o No x





Indicate 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 11, 2011.











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.
23Item 3.
Quantative and Qualitative Disclosures About Market Risk.
27Item 4.
Controls and Procedures.
27PART II - OTHER INFORMATIONItem 1.
Legal Proceedings.
27Item 1A.
Risk Factors.
28Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
28Item 3.
Defaults Upon Senior Securities.
28Item 4.
(Removed and Reserved).
28Item 5.
Other Information.
28Item 6.
Exhibits.
28





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, 2010.  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, “First Quarter 2011” refers to the three months ended March 31, 2011, “First Quarter 2010” refers to the three months ended March 31, 2010, “2010” refers to the year ended December 31, 2010, and “2011” refers to the year ending December 31, 2011.





3





PART 1 - FINANCIAL INFORMATION





Item 1.                                Financial Statements.





TN-K Energy Group IncBalance SheetsMarch 31,


December 31,2011


2010(Unaudited)


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

$
131,214


$
166,501Accounts receivable-related party


43,675



58,656Accounts receivable


119,840



21,453TOTAL CURRENT ASSETS


294,729



246,610OIL AND GAS PROPERTY (Successful efforts method), at cost


2,702,149



2,870,438EQUIPMENT, net of depreciation


216,602



158,212OTHER ASSETS


64,000



64,000TOTAL ASSETS

$
3,277,480


$
3,339,260LIABILITIES AND STOCKHOLDERS' DEFICIT:CURRENT LIABILITIES:Accounts payable

$
4,718,162


$
4,658,253Accrued expenses


1,328,032



1,295,280Liquidated damages


661,314



634,684Loan Payable


839,511



1,012,622Notes payable


50,000



50,000Note payable - related party


400,000



400,000Convertible - notes payable


600,000



600,000TOTAL CURRENT LIABILITIES


8,597,019



8,650,839Derivative and warrant liabilities


849,261



1,454,035STOCKHOLDERS' 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,41,131,178 and 41,131,178 issued and outstanding, respectively


1,233,935



1,233,935Additional Paid - In Capital


19,398,984



19,398,984Unearned ESOP shares


(6,207,000
)


(6,207,000
)Accumulated deficit


(20,594,719
)


(21,191,533
)TOTAL STOCKHOLDERS' DEFICIT


(6,168,800
)


(6,765,614
)TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT

$
3,277,479


$
3,339,260See accompanying notes to financial statements.




4




TN-K Energy Group, Inc.Statement of Operations(Unaudited)For the Three Months Ended March 31,2011


2010Revenue:Oil sales

$
312,199


$
104,248Well Services


24,582



11,688Sale of oil and gas leases


44,000



105,000380,782



220,936Expense:Oil lease operating expense


99,436



29,205Cost of oil and gas leases sold


13,229



63,998Sales, general and administrative


71,629



115,529Impairment of developed properties


142,928



-Total operating expenses


327,222



208,732Income from operations


53,560



12,204Other income (expense):Gain on derivatives


604,774



286,878Liquidated damages


(26,630
)


(26,630
)Interest expense


(34,890
)


(48,902
)Total other income


543,254



211,346Net income before taxes


596,814



223,550Income taxes


-



-Net Income

$
596,814


$
223,550Basic income per common share

$
0.01


$
0.01Diluted income per common share

$
0.01


$
0.01Weighted average number of common shares outstanding -Basic


40,032,020



37,671,759Diluted


40,095,263



44,441,683See accompanying notes to financial statements.




5




TN-K Energy Group IncStatement of Cash Flows(Unaudited)For the Three Months Ended March 31,2011


2010Cash Flow From Operating Activities:Net income

$
596,814


$
223,550Adjustments to net incomeDepreciation and depletion


95,993



26,575Impairment loss on developed oil property


142,928



-Change in fair value of derivative and liquidating damages liabilities


(578,144
)


(260,248
)Equity based compensation


-



5,068Adjustments to reconcile net loss to net cash used in operating activities:Changes in operating assets and liabilities:Accounts receivable


(83,406
)


11,868Deposits


-



35,000Deferred revenue


-



(27,500
)Accounts payable and accrued expenses


92,661



80,396Net Cash Provided by / (Used in) Operating Activities


266,846



94,709Cash Flow From Investing Activities:Purchase and improvement of oil and gas rights


(76,251
)


(97,285
)Sale of oil and gas rights


13,229



63,998Purchases of fixed assets


(66,000
)


(1,600
)Net Cash (Used in) Provided by  Investing Activities


(129,022
)


(34,887
)Cash Flow From Financing Activities:Proceeds for excersise of warrants


-



65,000Proceeds from related party


-



-Repayment of loan payable


(173,111
)


-Repayments of notes payable - related party


-



(25,250
)Net Cash Provided by Financing Activities


(173,111
)


39,750Net increase (decrease)  in cash


(35,288
)


99,572Cash and cash equivalents at beginning of period


166,501



7,148Cash and cash equivalents at end of period

$
131,214


$
106,720Supplemental cash flow information:Cash paid for interest

$
-


$
17,912Cash paid for taxes

$
-


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

$
-


$
410,000See accompanying notes to financial statements.




6





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION.





Organization




TN-K Energy GroupInc. is an independent energy company engaged in the acquisition and development of crude oil 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.




Basis of Presentation
 
 The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and the footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011.  The accompanying consolidated financial statements should be read in conjunction with the Company’s form 10-K for the fiscal year ended December 31, 2010 which was filed on April 13, 2011.


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 $(6,168,800) as of March 31, 2011. 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 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




TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued).





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 December 31, 2010 and 2009, management had determined no allowance for uncollectible receivables was necessary. At March 31, 2011 and December 31, 2010 we had accounts receivable and receivables from the completion costs owed in association with the sale of a partial interest in oil wells of $163,515, of which $43,675 was accounts receivable-related party, and $80,109, of which $58,656 was accounts receivable – related party, 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, 2011 and December 31, 2010, this amount is included in accrued expenses on the balance sheet.





The following table reflects the change in ARO at:





March 31, 2011


December 31, 2010Asset retirement obligation beginning of period

$
46,590


$
10,000Liabilities incurred


-



35,600Liabilities settled


-



-Accretion


990



990Revisions in estimated liabilities


-



-Asset retirement obligation end of period

$
47,570


$
46,590Current portion of obligation end of period

$
-


$
-




8




TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued).





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 are capitalized directly associated with property acquisition, exploration and development.  Internal costs that are capitalized at March 31, 2011 and December 31 2010, 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.





Capitalized costs of oil and gas properties evaluated as having, or not having, proved reserves are amortized in the aggregate by using the unit-of-production method based upon estimated proved oil and gas reserves.  The Company currently does not have any gas production, which is sold, but we have developed policies to be inclusive of such production, if and when the Company becomes capable of selling such gas. 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 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 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 prices of oil to estimated future production of proved oil 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 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 properties.  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 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 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.





9





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued).





Revenue Recognition— We recognize oil 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 wells once the terms of such contract have been fulfilled.





Major Customers— During the three months ended March 31, 2011 and 2010, we had two customers and one customer, respectively accounting for 100% of oil sales.  Because there are other purchasers that are capable of and willing to purchase our oil and because we have the option to change purchasers on our properties if conditions so warrant, we believe that our oil 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, 2011 and December 31, 2010 totaled $849,261 and $1,454,035, 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, 2001 and December 31, 2010 derivatives were valued primarily using the Black-Scholes Option Pricing Model with the following assumptions: dividend yield of 0%, annual volatility of 179% to 234%, risk free interest rate of 1.00% to 3.39%, and expected life of three to 10 years.





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.





10





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued).





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, 2010

$
-


$
-


$
1,454,035Derivative securities – March 31,  2011

$
-


$
-


$
849,261





Net IncomePer Share— Basic net income per share is computed by dividing net income attributable to common stockholders by the weighted number of common shares outstanding during the period.  Diluted net income 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 included in the computation of diluted income per share for the quarter ended March 31, 2010 was 6,749,924. The options and warrants excluded from the diluted income per share for the quarter ended were 4,377,644, since the exercise price had exceeded the market price at March 31, 2011. There were 180,000 options with an exercise price below the market price at March 31, 2011, as a result there was 63,243 of additional shares recorded for the computation of diluted income per share for the quarter ended March 31, 2011.





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 2011 and 2010 consolidated financial statements have been reclassified to conform to the March 31, 2011 financial statement presentation.  Such reclassifications have had no effect on net income.





Recent Accounting Pronouncements





All 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.





NOTE 3 — OIL AND GAS PROPERTIES AND EQUIPMENT.





Oil and Gas Properties and equipment consisted of the following:





11





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 3 — OIL AND GAS PROPERTIES AND EQUIPMENT (continued).





March 31,2011


December 31, 2010Oil and gas properties, successful efforts methodUnevaluated costs, not yet subject to amortization

$
1,142,437


$
1,142,437Evaluated costs


1,765,359



1,845,265Asset retirement costs


39,600



39,6002,947,396



3,027,302Well equipment, furniture and software


260,358



194,3583,207,754



3,221,660Less accumulated depreciation, depletion and amortization


(289,003
)


(193,010
)Oil and gas property and equipment

$
2,918,751


$
3,028,650





Unevaluated Oil 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 Costs

IncurredYear IncurredThree months ended March 31, 2011

$
-Year ended December 31, 2010


916,532Year ended December 31, 2009


225,905Prior to 2009


-$
1,142,437





Costs associated with unevaluated properties are primarily lease acquisition costs. No dry holes were drilled in 2009. During 2010 we drilled seven dry holes and recorded an impairment expense of $67,837 associated with dry holes. During the three months ended March 31, 2011, we recorded an impairment expense of $142,928 as a result of well rework efforts and further evaluation of some wells plugged do to insufficient production. There are no unevaluated costs relating to significant development activities.  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 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.





12





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 3 — OIL AND GAS PROPERTIES AND EQUIPMENT (continued).





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.





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.





On June 23, 2010 the Company entered into an 87.5% working interest in 18 acres in Clinton County, Kentucky pursuant to the terms of an Oil and Gas Lease dated June 23, 2010 with Otis Wayne McClellan and Otis McClellan and his wife Peggy McClellan for an initial cost to the Company of $0.  In accordance with the agreement, the Company is responsible for 100% of all costs on the lease.





On July 8, 2010 the Company entered into an 87.5% working interest in 90 acres in Clinton County, Kentucky pursuant to the terms of an Oil and Gas Lease dated July 8, 2010, (the “Tompkins Lease”), with Tony Lynn Tompkins for an initial cost to the Company of $0.  In accordance with the agreement, the Company is responsible for 100% of the costs on the Tompkins Lease, subject to the further assignment of net working interest in wells drilled on the Tompkins Lease as described below.





On July 22, 2010 the Company entered into an assignment of an aggregate of a 50% net working interest in the Company’s interest in Tompkins Well #1 with seven assignees pursuant to the Assignments of Oil and Gas Leases each dated July 22, 2010 for an aggregate consideration of $37,000.  In accordance with the agreements , the assignees are responsible for 58% of the completion, operating, treatment and other costs for this well and the Company is be responsible for the remaining 42% of such costs.





On August 5, 2010 the Company entered into an agreement for a 87.5% working interest in 160 acres in Cumberland County, Kentucky pursuant to the terms an Oil and Gas Lease dated August 5, 2010, by and between the Company and Brenda Harden Capps and Jimmie Capps for an initial cost to the Company of $0.  In accordance with the agreement, the Company is responsible for 100% of the costs on the Capps Lease.





13





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 3 — OIL AND GAS PROPERTIES AND EQUIPMENT (continued).





On August 19, 2010 the Company entered into an assignment of an aggregate of a 50% net working interest in the Company’s interest in Tompkins Well #2 with seven assignees pursuant to the Assignments of Oil and Gas Leases each dated August 19, 2010 for an aggregate consideration of $37,000.  In accordance with the agreements , such assignees are be responsible for 58% of the completion, operating, treatment and related costs for this well and the Company is responsible for the remaining 42% of such costs.





On September 9, 2010 the Company entered into an assignment of a 50% working interest in the Company’s 87.5% interest in the McClellan Lease to Cool-Tooler, Inc. (“Cool-Tooler”), a company controlled by Mr. Dan Page, pursuant to the Assignment of Oil and Gas Lease effective September 9, 2010 for an aggregate consideration of $0.  In accordance with the agreement, Cool-Tooler is responsible for 50% of all costs on the McClellan Lease and the Company is responsible for the remaining 50% of such costs.





On September 9, 2010 the Company entered into an assignment of an 87.5% working interest in 42.288 acres in Clinton County, Kentucky pursuant to the terms of that certain Oil and Gas Lease dated September 9, 2010 by and between the Company and Timothy Brown and Jennifer L. Brown for an initial cost to the Company of $1,000.  In accordance with the agreement, the Company is responsible for 100% of the costs on the Brown Lease.





On September 17, 2010, the Company entered into a series of transactions which has resulted its acquisition of rights under the Charles and Lynda Anderson lease (the “Anderson Lease”) covering approximately 200 acres.   The Anderson Lease has three existing oil wells, one additional well location and provides the Company with the opportunity to drill an additional approximately 45 wells.





In the first transaction, the Company acquired an 85% interest in the Anderson Lease from Overton Oil & Gas Corp. for $1 million, including all existing wells on the leasehold and the related production equipment, subject to certain exceptions which included certain existing workings interests and overriding interests in the three existing wells.





In the second transaction, we entered into a Guaranteed Contract with King’s Oil, LLC under which it purchased an interest in the Anderson Lease from us for $1.2 million.  Under the terms of the Guaranteed Contract, we assigned our royalty interests in the production from the three existing wells up to a maximum of 50 barrels of oil per day average, with the average daily production rate based upon a 30 calendar day month, to King’s Oil LLC until such time as King’s Oil, LLC has received the return of the full $1.2 million investment.  During this time, we are entitled to 40% the proceeds from production from any of these three wells for any overage in this maximum daily production.  We have guaranteed King’s Oil, LLC that it will receive the $1.2 million within 18 months through the royalty interests in the existing wells and we are obligated to pay King’s Oil LLC any shortfall at the end of the 18 month period.  In addition, our President and CEO, Mr. Ken Page, has personally guaranteed the amount. We have agreed to pay 40% of the costs of any work on the three existing wells.  At such time as King’s Oil LLC has received the return of its investment, we will be entitled to receive 40% of King’s Oil’s royalty interests from production from the three existing wells.





Under the terms of the Guaranteed Contract, we also assigned King’s Oil, LLC 15% of our interest in the remaining portion of the Anderson Lease and granted King’s Oil LLC the right to purchase an additional 10% royalty interest in any future well site on a per site basis.  We are obligated to pay the costs of the drilling for any new wells on this lease.





On October 15, 2010 the Company entered into a 50% interest in an 87.5% working interest in Robbins Well #2 in Overton County, Tennessee pursuant to the terms of that certain Assignment of Interest in Oil and Gas Lease dated October 15, 2010 by and between the Company and Allen (Dan) Page a related party for an initial cost to the Company of $0.  The Company is responsible for 50% of the costs on this well and Allen (Dan) Page is responsible for the remaining 50% of such costs.





14





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 3 — OIL AND GAS PROPERTIES AND EQUIPMENT (continued).





On November 4, 2010 as contemplated by the terms of the Guaranteed Contract with King’s Oil, LLC, the Company sold a 10% net working interest in Charles and Lynda Anderson #8 to Kings Oil, LLC for $10,000; Company is responsible for costs of completion and operation.  The Company sold an additional 10% working interest in Charles and Lynda Anderson #8 to Kings Oil, LLC for $15,000 and Kings Oil, LLC is responsible for 25% of completion and operating costs.





On November 20, 2010 per a Memorandum of Understanding the Company sold 32.5% working and royalty interests to five individuals and/or entities in the Charles and Lynda Anderson Well # 7 for $42,000. Two of these purchasers are without any additional costs, while the other three are responsible for 36% of the future completion and operating costs.





On January 15, 2011 per a Memorandum of Understanding the Company sold 32.5% working and royalty interests to five individuals and/or entities in the Charles and Lynda Anderson Well # 10 for $42,000. Two of these purchasers are without any additional costs, while the other three are responsible for 36% of the future completion and operating costs.





Impairment of Oil 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. Our ceiling test calculations as of December 31, 2010, using oil and gas prices on that date did not indicate any impairment of our oil and natural gas properties.





During calendar 2010 and the three months ended March 31, 2011, we did record an impairment expense of $37,447 and $142,928, respectively, as a result of individual well drilling and well re-work efforts.





Amortization Rate





Amortization of oil 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 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.





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


2011

2010Amortization of costs for evaluated oil properties

$
88,383


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


7,610



3,894Total DD&A expense

$
95,993


$
26,575





The resulting depletion and depreciation costs of $95,993 and $26,575 for the three months ended March 31, 2011 and 2010, respectively, have been recorded under the caption heading “oil lease operating expense” on our Statement of Operations.





15





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 4 – LOAN PAYABLE, CONVERTIBLE NOTES PAYABLE, CONVERTIBLE NOTES PAYABLE – RELATED PARTY.





On September 17, 2010, the Company entered into a Guaranteed Contract with King’s Oil, LLC under which it purchased an interest in the Anderson Lease from us for $1.2 million.  Under the terms of the Guaranteed Contract, the Company assigned our royalty interests in the production from the three existing wells up to a maximum of 50 barrels of oil per day average, with the average daily production rate based upon a 30 calendar day month, to King’s Oil LLC until such time as King’s Oil, LLC has received the return of the full $1.2 million investment.  During this time, the Company is entitled to 40% the proceeds from production from any of these three wells for any overage in this maximum daily production.  The Company guaranteed King’s Oil, LLC that it will receive the $1.2 million within 18 months through the royalty interests in the existing wells and we are obligated to pay it any shortfall at the end of the 18 month period.  In addition, our President and CEO, Mr. Ken Page, has personally guaranteed the amount. The Company has agreed to pay 40% of the costs of any work on the three existing wells.  At such time as King’s Oil LLC has received the return of its investment, we will be entitled to receive 40% of King’s Oil’s royalty interests from production from the three existing wells. As of December 31, 2010 they received royalty payments of $187,378 reducing the amount owed to $1,012,622 as of December 31, 2010. As of March 31, 2011 they received royalty payments of $173,111 reducing the amount owed to $839,511 as of March 31, 2011.





Under the terms of the Guaranteed Contract, we also assigned King’s Oil, LLC 15% of our interest in the remaining portion of the Anderson Lease and granted King’s Oil LLC they right to purchase an additional 10% royalty interest in any future well site on a per site basis.  We are obligated to pay the costs of the drilling for any new wells on this lease.





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. On June 29, 2010 Mr. Page extended the due date of the note to December 31, 2010. Effective December 15, 2010 the Company entered into a Fifth Amendment to the Convertible Line of Credit Note with Mr. Dan Page pursuant to which he extended the due date of all amounts due under the Convertible Line of Credit from December 31, 2010 to December 31, 2011.





16





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 4 – LOAN PAYABLE, CONVERTIBLE NOTES PAYABLE, CONVERTIBLE NOTES PAYABLE – RELATED PARTY (continued).





At March 31, 2011 and December 31, 2010 we owed Mr. Page $400,000 and $400,000, respectively of principal and approximately $33,077 and $25,680, 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 SEC 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.





In the year ended December 31, 2009, these warrants issued to Laurus expired and as a result the Company was able to eliminate the related derivative liability attributed to these warrants and recorded a $2,393,630 gain on the reduction in the derivative liabilities recorded.





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





17





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 4 – LOAN PAYABLE, CONVERTIBLE NOTES PAYABLE, CONVERTIBLE NOTES PAYABLE – RELATED PARTY (continued).





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.





At March 31, 2011 and December 31, 2010, we had accrued $661,314 and $634,684, 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 and loans payable are summarized as follows:





March 31,

2011


December 31,

2009Loans payable – non interest bearing payable from production of certain oil wells

$
839,511


$
1,012,622Convertible note payable to a third party with an interest rate of 7% per annum due October 27, 2006


50,000



50,000Convertible line of credit note payable to a related party with an interest rate of

7.5% per annum, due December 31, 2010


400,000



400,000Convertible note payable to Alloy, default interest rate of 18% per annum, payable upon demand


600,000



600,000$
1,889,511


$
2,062,622





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 part of the consideration we received prepaid drilling costs of $50,000. As consideration for this Assignment and prepaid drilling costs, 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 April 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.





18





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 6 — STOCKHOLDERS’ EQUITY (continued).





In 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.





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.





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 until June 11, 2011. 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 December 31, 2010 there were outstanding options to purchase 355,000 shares of our common stock at 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.  As of December 31, 2010 there were outstanding options to purchase 2,188,000 shares of our common stock at exercise prices ranging from $0.12 to $0.30 per share.





In September 2010, 3,000,000 options exercisable at $0.20 a share held by Mr. Page, expired. On December 14, 2010 our Board of Directors granted Mr. Page five year non-qualified options to purchase 1,500,000 shares of our common stock at an exercise price of $0.30 per share. The Options were valued using the Black-Scholes Option Pricing Model with the following assumptions: dividend yield of 0%, annual volatility of 234%, risk free interest rate of 0%, and expected life of 4.5 years.





19





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 6 — STOCKHOLDERS’ EQUITY (continued).





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, 2009


6,919,924


$
0.31Granted


1,500,000



.30Exercised


(150,000)



.44Expired or cancelled


(3,712,280)



.20Outstanding at December 31, 2010


4,557,644


$
.31Granted


-



-Exercised


-



-Expired or cancelled


-



-Outstanding at March 31, 2011


4,557,644


$
.31





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.





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.





20





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





NOTE 7 – EMPLOYEE STOCK OWNERSHIP PLAN (continued).





Common shares held by the ESOP as of March 31, 2011 and December 31, 2010 are as follows:





(in thousands)March 31, 2011


December 31, 2010Allocated shares


1,011



1,011Shares released from allocation


-



-Unreleased (unearned) shares


3,243



3,243Total ESOP shares


4,254



4,254





The fair value of unreleased (unearned shares) at March 31, 2011 and December 31, 2010 (based on closing price of our stock) was $610,025 and $1,070,190, 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, 2011 and 2010, 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, 2011 and 2010.





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. On December 14, 2010 our Board of Directors granted Mr. Page five year non-qualified options to purchase 1,500,000 shares of our common stock at an exercise price of $0.30 per share. The Options were valued using the Black-Scholes Option Pricing Model with the following assumptions: dividend yield of 0%, annual volatility of 407%, risk free interest rate of 0%, and expected life of 4.5 years.





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.In March 2011, the Company extended its consulting agreement with Dan Page for an annual fee of $32,000 plus out of pocket expenses up to $1,000 per month.





In September 2010, the Company assigned a 50% working interest in its 87.5% interest in the McClellan lease to a company controlled by a related party for $0.  The company controlled by the related party is responsible for 50% of the costs on the lease.





On October 15, 2010 the Company entered into a 50% interest in an 87.5% working interest in Robbins Well #2 in Overton County, Tennessee pursuant to the terms of that certain Assignment of Interest in Oil and Gas Lease dated October 15, 2010 by and between the Company and Dan Page for an initial cost to the Company of $0.  The Company is responsible for 50% of the costs on this well and Dan Page is responsible for the remaining 50% of such costs.





21





TN-K ENERGY GROUP INC.


NOTES TO FINANCIAL STATEMENTS


as of March 31, 2011 and December 31, 2010 and three months ended March 31, 2011 and 2010





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.





22





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





The following discussion of our financial condition and results of operation for the First Quarter 2011 and the First Quarter 2010 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, 2010 as previously filed with the Securities and Exchange Commission.  We 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 exploration and production company, engaged in acquiring oil leases and exploring and developing crude oil reserves and production in the Appalachian basin.  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 Sunnybrook 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 operations are divided between leases in which we have a participation interest and leases in which we are the operator.  Interests owned by participation leases means we have a working or royalty interest in a property that is operated or maintained by another interest owner under an agreement. For participation leases, we receive payments for our oil sales from the operator and we are billed by the operator for a percentage of joint expenses relative to the costs of drilling and transporting the oil from the wells to the sales point.





For drilling operations on leases in which we are the operator, we hire third parties to provide contract drilling services to us on an as needed basis.  We have been able to reduce or eliminate our financial exposure in the initial drilling in our projects by creating joint venture arrangements that provide for others to pay for all or a disproportionate share of the initial drilling costs in exchange for a working or royalty interest in the well. To date we have sold working interests in 10 of our wells ranging from 30% to 50% per well, and we are responsible for completion and operating costs on those wells ranging from 25% to 58% per well. This has allowed us to move forward in drilling a greater number of wells than we would otherwise able to drill based upon our limited financial resources. We expect to continue to use these types of relationships to partially or completely fund initial drilling of future wells.





Our revenues increased 72% for the First Quarter 2011 from the First Quarter 2010, and our income from operations increased 339% from period to period.  During the balance of 2011 we plan to continue to expand our acreage position in our core area, focusing on acreage we will operate.  In addition to the challenges faced by small independent oil and gas companies, we continue to face a number of challenges in executing our business model which are particular to our company.  At March 31, 2011 our balance sheet includes approximately $7.3 million of past due debt, notes and liquidated damages that relates to the prior business of our company before those operations were discontinued in 2005, which is net of $1.8 million of aged payments which we wrote off during 2010.  None of the 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 the First Quarter 2011 we recognized an impairment of $142,928 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 and pay costs which will further dilute our existing stockholders and possibly result in additional one-time impairments of the assets acquired.




23




In September 2010 we entered into the guaranteed contract with Kings Oil, LLC under which we have guaranteed King’s Oil, LLC that it will receive the $1.2 million paid for the interests in the Anderson Lease within 18 months through the royalty interests in the existing wells.  We are obligated to pay it any shortfall at the end of the 18 month period and through March 31, 2011 it received $360,489 under this agreement.  While we reasonably believe the amounts will be paid to Kings Oil, LLC in accordance with the terms of the contract, if we were required to pay it any shortfall our liquidity would be adversely impacted and we could be forced to cease some of our operations.





We also face the challenge of limited personnel and diversion of our management’s time and attention.  While we hired a part-time accountant during the First Quarter 2011, as our company continues to grow, we still 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.  We also 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.  To date we have been relying on funding available to us under a line of credit extended by a related party which matures in December 2011; however, at March 31, 2011 the maximum amount available under this facility is outstanding.  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.  We do not presently have sufficient funds to satisfy this obligation.





Given the small size of our company, the low trading price of our stock, 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





While we reported net income of $596,814 for the First Quarter 2011, and net income of approximately $2.6 million for 2010, we have incurred net losses of approximately $20.6 million since inception through March 31, 2011.  The report of our independent registered public accounting firm on our financial statements for the year ended December 31, 2010 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





Our revenue in 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, as well as from non-recurring well services and sales of interest in oil and gas leases to third parties.  Our revenues from oil sales and well services were significantly higher in the First Quarter 2011 from the comparable period in 2010 which reflects the continued expansion of our company’s operations.  In addition, our revenues from oil sales during First Quarter 2010 were adversely impacted as a result of inclement weather with hindered our drilling operations. While our operations were not as adversely impacted during the First Quarter 2011 from weather related stoppages, given the location of our wells, it is likely that winter weather conditions may impact our drilling operations during the first quarter of our fiscal years in future periods.  During the First Quarter 2011 the average sales price (including transfers) per unit of oil extracted from wells drilled by us was approximately $84.00 as compared to approximately $65.00 for the First Quarter 2010.  Substantially all of the well service revenues in First Quarter 2011 were attributable to services rendered to a related party, which well service operations began the Third Quarter 2010.  Included in revenues in each of the periods were revenues attributable to the sales to third parties of various interests in wells.





Our total operating expenses in First Quarter 2011 increased approximately 57% from the First Quarter 2010.  Oil lease operating expenses, which included our portion of the cost of contract drillers, other expenses associated with the drilling operations and depletion expense, were 32% of revenues in First Quarter 2011 as compared to 28% in First Quarter 2010.  Due to our planned drilling program and treatment methods, we anticipate the total operating expenses to remain proportional to our current average and foresee our production increase in the second and third quarters of 2011. Historically, our fourth quarter production is difficult to anticipate as our production can be hindered by inclement weather.




24




Our cost of oil and gas leases sold in the First Quarter 2011 was 30% of revenue from the sale of the leases as compared to 25% in the First Quarter 2010.  We expect these margins will vary depending upon our costs in the underlying lease and its prospects for production which impact the prices at which we are able to sell interests in the leases.





During First Quarter 2011 our sales, general and administrative expenses decreased approximately 38% from the comparable period in 2010.  This decrease is primarily attributable to the hiring of an in-house accountant and the decrease of outsourcing professional services. We anticipate our operating expenses will increase during the balance of 2011 which will be reflective of our increased operations.  We are not able at this time, however, to quantify the amount of the expected increase.





During First Quarter 2011 we recognized an impairment expense of $142,928 related to impairment of developed properties for which there was no comparable expense in First Quarter 2010. However, given the nature of our operations is it likely we will recognize comparable expenses in future periods.





Included in our total other income during the First Quarter 2011 and the First Quarter 2010 are non-cash gains on derivatives of $604,774 and $286,878, respectively.  Gain on derivatives consists of income associated with the change in the fair value of derivative liabilities as a result of the application of derivative accounting rules 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.  These non-cash gains were material components of our net income in each of the periods and are not related to our operating performance.





Liquidated damages are related to registration rights granted by our prior management and these expenses continue to have a material impact on our company.





Our interest expense decreased in First Quarter 2011 as compared to First Quarter 2010 as a result of a decreased amount of outstanding notes payables accruing interest. Subsequently, an interest payment for approximately $17,000 was made in First Quarter 2011 to Mr. Dan Page, related party, which reduced the overall accruing interest on the outstanding notes payable-related party.





Liquidity and Capital Resources





Liquidity is the ability of a company to generate sufficient cash to satisfy its needs for cash.  At March 31, 2011 we had a working capital deficit of $8,302,291 as compared to a working capital deficit of $8,404,229 at December 31, 2010. Our current assets at March 31, 2011 include accounts receivable and receivables from the sale of a partial interest in oil wells of $163,515, which are due 30 days from invoicing.  Our current liabilities includes approximately $6.0 million of accounts payable and accrued expenses, together with $661,314 in liquidated damages and $650,000 of convertible notes payable related to financings which relates to obligations incurred before our company discontinued its previous operations in 2005.





Exclusive of these aged accounts payable, our accounts payable increased approximately $60,000, which is due to the purchase of a fixed asset.  Also included in our accrued expenses at March 31, 2011 is approximately $54,000 of accrued salary and consulting expenses, approximately $681,000 of accrued interest, approximately $33,000 in accrued interest due a related party under a credit line and approximately $154,000 of accrued taxes.





Our liabilities at March 31, 2011 includes $839,511 due King’s Oil, LLC under the guaranteed contract we entered into in September 2010.  As described earlier in this section, this amount, which is being paid through the sale of oil, must be paid in full by March 2012.





Net cash provided by operating activities for the First Quarter 2011 was $266,846 as compared to $94,709 for the First Quarter 2010.  During the First Quarter 2011, cash was provided by our net income and increases in our accounts payable offset by increased in accounts receivable.  During the First Quarter 2010, cash was provided by our net income and increases in our accounts payable and accrued expenses and deferred revenue, offset by decreases in accounts receivable and deposits. Net cash used in investing activities in the First Quarter 2011 reflects the purchase of oil and gas leases and fixed assets, as compared to net cash used in investment activities in First Quarter 2010 which also reflects the sale of oil and gas rights.  Net cash used in financing activities in the First Quarter 2011 reflects payments of the amounts due under the King’s Oil, LLC guarantee as compared to net cash provided by financing activities for the First Quarter 2010 which reflects proceeds from the exercise of outstanding warrants offset by a repayment notes payable under the credit line with Mr. Dan Page which is described below.




25




Line of Credit





In April 2007 we executed an agreement with Mr. Dan Page, a related party, 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.





We have entered into a number of extension agreements with Mr. Page and the line of credit is presently due on December 31, 2011.  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, 2011 we owed Mr. Page $400,000 of principal and approximately $33,077 of accrued but unpaid interest under this credit line, net of repayments.





Past Due Notes at March 31, 2011





Our liabilities at March 31, 2011 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, 2011 we have accrued liquidated damages in the amount of $661,314 which were due Alloy.  This note remains outstanding and interest is now being accrued at the default rate of 18% per annum, with a late payment fee of 1.5% per month; 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 expired 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.




26




Recent Accounting Pronouncements





The recent 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 4.                                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 as a result of continuing material weaknesses. The material weakness identified for the period ended December 31, 2010 were related to insufficient personnel and accounting resources are were 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 year ended December 31, 2010 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.  Subsequent to December 31, 2010 we have hired an experienced accountant which will mitigate to an extent these material weaknesses and are developing the necessary procedures ensure 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.  Until such time as these procedures have been fully developed and implemented, and we are able to devote a portion of our limited resources to expanding our personnel and providing greater resources to our accounting staff, we expect that the material weaknesses in our disclosure controls and procedures will continue.





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.




27




Item 1A.                             Risk Factors.





Not applicable for a smaller reporting company.





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





None.





Item 3.                                Defaults Upon Senior Securities.





None.





Item 4.                                (Removed and Reserved).





Item 5.                                Other Information.





None.





Item 6.                                Exhibits.





No.
Description31.1
Rule 13a-14(a)/ 15d-14(a) Certification of Chief Executive Officer *31.2
Rule 13a-14(a)/ 15d-14(a) Certification of principal financial and accounting officer *32.1
Section 1350 Certification of Chief Executive Officer and principal financial and accounting officer *





*           filed herewith





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, 2011
By: /s/ Ken PageKen Page, Chief Executive Officer, principal financial and accounting officer