UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





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





For the
quarterly period ended June 30, 2009





OR





o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
transition period from ________________ to ________________.





Commission
File Number: 000-29463





VELOCITY
ENERGY INC.


(Exact
Name of Registrant as Specified in Its Charter)




Delaware
                  
                  51-0392750(State
      or Other Jurisdiction of
                  
                  (I.R.S.
      Employer Identification No.)Incorporation
      or Organization)523
      N. Sam Houston Pkwy. E.
                    Suite
      175
                    Houston,
      Texas 77060
                    (Address
      of Principal Executive Offices)




Registrant’s
telephone number, including area code: (713) 741-0610





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    ̈





Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit
and post such files).  YES ̈NO ̈





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




Large
      accelerated filer   o
                  Accelerated
      filer oNon-accelerated
      filer o(Do
      not check if a smaller reporting company)
                  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). YESoNOx





As of
August 14, 2009, the Registrant had 6,347,359 shares of its common stock, par
value $0.001 per share, issued and outstanding.









PART
I


FINANCIAL
INFORMATION




Item
1. Financial Statements


VELOCITY
ENERGY INC.


Unaudited
Consolidated Balance Sheets


June
      30,
                                            2009
                                          
                                          
                                          December
      31,
                                            2008ASSETSCurrent
      AssetsCash
      and cash equivalents
                                          
                                          $
                                          43,408
                                          
                                          
                                          $
                                          194,826Restricted
      cash
                                          
                                          
                                          1,629,931
                                          
                                          
                                          
                                          3,699,931Accounts
      receivable, net of $103,628 reserved for doubtful accounts
                                          
                                          
                                          31,400
                                          
                                          
                                          
                                          437,281Advances
      to operators
                                          
                                          
                                          161,124
                                          
                                          
                                          
                                          1,077,775Prepaid
      expenses
                                          
                                          
                                          5,007
                                          
                                          
                                          
                                          72,214Total
      current assets
                                          
                                          
                                          1,870,870
                                          
                                          
                                          
                                          5,482,027Property
      and EquipmentOil
      and gas properties, full cost methodUnproved
      properties
                                          
                                          
                                          698,549
                                          
                                          
                                          
                                          675,646Proved
      properties
                                          
                                          
                                          6,689,313
                                          
                                          
                                          
                                          5,199,116Pipelines
      and facilities
                                          
                                          
                                          778,418
                                          
                                          
                                          
                                          778,418Total
      oil and gas properties
                                          
                                          
                                          8,166,280
                                          
                                          
                                          
                                          6,653,180Less
      accumulated depreciation, depletion  and
      amortization
                                          
                                          
                                          (3,914,441
                                          )
                                          
                                          
                                          (2,056,397
                                          )4,251,839
                                          
                                          
                                          
                                          4,596,783Other
      property and equipment, net of accumulated depreciation of $106,044 at
      June 30, 2009 and $19,974 at December 31, 2008
                                          
                                          
                                          1,840,562
                                          
                                          
                                          
                                          1,925,611Total
      property and equipment, net
                                          
                                          
                                          6,092,401
                                          
                                          
                                          
                                          6,522,394Debt
      issuance costs, net of accumulated amortization of  $153,926 at
      June 30, 2009 and $86,432 at December 31, 2008
                                          
                                          
                                          308,983
                                          
                                          
                                          
                                          461,380Total
      Assets
                                          
                                          $
                                          8,272,254
                                          
                                          
                                          $
                                          12,465,801LIABILITIES
      AND SHAREHOLDERS' DEFICITCurrent
      LiabilitiesAccounts
      payable, trade
                                          
                                          $
                                          838,456
                                          
                                          
                                          $
                                          969,725Other
      payables and accrued liabilities
                                          
                                          
                                          479,553
                                          
                                          
                                          
                                          610,864Participant
      advances
                                          
                                          
                                          -
                                          
                                          
                                          
                                          966Current
      maturities of debt, net of discounts of  $8,575,729 at June 30,
      2009 and $-0- at December 31, 2008
                                          
                                          
                                          11,634,857
                                          
                                          
                                          
                                          1,735,822Interest
      payable
                                          
                                          
                                          1,064,226
                                          
                                          
                                          
                                          183,612Total
      current liabilities
                                          
                                          
                                          14,017,092
                                          
                                          
                                          
                                          3,500,989Noncurrent
      LiabilitiesLong-term
      debt, net of discounts of $9,923,615 at December 31, 2008
                                          
                                          
                                          -
                                          
                                          
                                          
                                          6,888,723Long-term
      debt – related party
                                          
                                          
                                          -
                                          
                                          
                                          
                                          2,210,551Asset
      retirement obligation
                                          
                                          
                                          130,523
                                          
                                          
                                          
                                          128,443Total
      noncurrent liabilities
                                          
                                          
                                          130,523
                                          
                                          
                                          
                                          9,227,717Shareholders'
      DeficitCommon
      stock, par value $0.001 per share, authorized 50,000,000 shares, issued
      and outstanding 26,347,359 and 21,846,559 shares
                                          
                                          
                                          26,351
                                          
                                          
                                          
                                          26,351Treasury
      stock
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Additional
      paid-in capital
                                          
                                          
                                          8,122,285
                                          
                                          
                                          
                                          7,223,851Accumulated
      deficit
                                          
                                          
                                          (14,023,997
                                          )
                                          
                                          
                                          (7,513,107
                                          )Total
      shareholders' deficit
                                          
                                          
                                          (5,875,361
                                          )
                                          
                                          
                                          (262,905
                                          )Total
      Liabilities and Shareholders' Deficit
                                          
                                          $
                                          8,272,254
                                          
                                          
                                          $
                                          12,465,801





See
notes to consolidated financial statements.


2




VELOCITY ENERGY INC.


Consolidated
Statements of Operations





For
      the three months ending June 30,
                      
                      
                      For
      the six months ending June 30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008RevenuesOil
      and gas sales
                      
                      $
                      -
                      
                      
                      $
                      122,390
                      
                      
                      $
                      -
                      
                      
                      $
                      238,149Gas
      gathering operations
                      
                      
                      -
                      
                      
                      
                      202,976
                      
                      
                      
                      75
                      
                      
                      
                      286,283Total
      revenues
                      
                      
                      -
                      
                      
                      
                      325,366
                      
                      
                      
                      75
                      
                      
                      
                      524,429Costs
      and ExpensesLease
      operating expenses
                      
                      
                      22,469
                      
                      
                      
                      155,024
                      
                      
                      
                      84,167
                      
                      
                      
                      458,982Production
      taxes
                      
                      
                      -
                      
                      
                      
                      10,271
                      
                      
                      
                      -
                      
                      
                      
                      18,418Drilling
      rig expenses
                      
                      
                      29,478
                      
                      
                      
                      -
                      
                      
                      
                      139,378
                      
                      
                      
                      -Depreciation,
      depletion and amortization
                      
                      
                      50,115
                      
                      
                      
                      58,784
                      
                      
                      
                      100,582
                      
                      
                      
                      124,568Impairment
      on oil & natural gas properties
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,842,510
                      
                      
                      
                      -Accretion
      on asset retirement obligation
                      
                      
                      1,061
                      
                      
                      
                      2,854
                      
                      
                      
                      2,080
                      
                      
                      
                      6,594General
      and administrative
                      
                      
                      804,451
                      
                      
                      
                      87,325
                      
                      
                      
                      1,718,157
                      
                      
                      
                      1,069,480Total
      costs and expenses
                      
                      
                      907,574
                      
                      
                      
                      317,258
                      
                      
                      
                      3,886,874
                      
                      
                      
                      1,678,042Income(Loss)
      from Operations
                      
                      
                      (907,574
                      )
                      
                      
                      8,108
                      
                      
                      
                      (3,886,799
                      )
                      
                      
                      (1,153,613
                      )Other
      ExpenseInterest
      expense
                      
                      
                      (1,229,516
                      )
                      
                      
                      (69,648
                      )
                      
                      
                      (2,558,265
                      )
                      
                      
                      (140,241
                      )Debt
      issuance cost amortization
                      
                      
                      (29,048
                      )
                      
                      
                      (10,326
                      )
                      
                      
                      (65,826
                      )
                      
                      
                      (27,327
                      )Other
      expense
                      
                      
                      (1,258,564
                      )
                      
                      
                      (79,974
                      )
                      
                      
                      (2,624,091
                      )
                      
                      
                      (167,568
                      )Net
      Loss
                      
                      $
                      (2,166,138
                      )
                      
                      $
                      (71,866
                      )
                      
                      $
                      (6,510,890
                      )
                      
                      $
                      (1,321,181
                      )Loss
      Per Common Share:Basic
                      
                      $
                      (.08
                      )
                      
                      $
                      (.003
                      )
                      
                      $
                      (0.25
                      )
                      
                      $
                      (0.05
                      )Diluted
                      
                      $
                      (.08
                      )
                      
                      $
                      (.003
                      )
                      
                      $
                      (0.25
                      )
                      
                      $
                      (0.05
                      )Weighted
      average number of common shares outstanding:Basic
                      
                      
                      26,267,359
                      
                      
                      
                      26,347,359
                      
                      
                      
                      26,267,359
                      
                      
                      
                      26,347,359Diluted
                      
                      
                      26,267,359
                      
                      
                      
                      26,347,359
                      
                      
                      
                      26,267,359
                      
                      
                      
                      26,347,359





See
notes to consolidated financial statements.


3




VELOCITY
ENERGY INC.


Consolidated
Statements of Cash Flows





For
      the six months ending,June
      30, 2009
                              
                              
                              June
      30, 2008Operating
      ActivitiesNet
      income (loss)
                              
                              $
                              (6,510,890
                              )
                              
                              $
                              (1,321,181
                              )Adjustments
      to reconcile net (loss) to net cash used in operating
      activities:Depreciation,
      depletion and amortization
                              
                              
                              100,582
                              
                              
                              
                              124,568Accretion
      on asset retirement obligation
                              
                              
                              2,080
                              
                              
                              
                              6,594Debt
      issuance costs amortization
                              
                              
                              65,825
                              
                              
                              
                              27,327Non-cash
      compensation expense
                              
                              
                              898,524
                              
                              
                              
                              30,433Accretion
      of discounted value of notes
                              
                              
                              1,386,334
                              
                              
                              
                              -Impairment
      on oil & gas properties
                              
                              
                              1,842,510
                              
                              
                              
                              -Changes
      in operating assets and liabilities:Accounts
      receivable
                              
                              
                              405,881
                              
                              
                              
                              2,549,034Prepaid
      expenses
                              
                              
                              983,858
                              
                              
                              
                              75,583Debt
      Issuance Costs
                              
                              
                              
                              
                              
                              
                              (95,000
                              )Accounts
      payable and accrued liabilities
                              
                              
                              (262,581
                              )
                              
                              
                              (2,596,599
                              )Accounts
      payable acquired in acquisition of  Sonterra Resources, Inc.,
      net
                              
                              
                              
                              
                              
                              
                              (642,308
                              )Participant
      advances received
                              
                              
                              (966
                              )
                              
                              
                              (947,528
                              )Interest
      payable
                              
                              
                              880,614
                              )
                              
                              
                              (199,845
                              )Net
      cash used in operating activities
                              
                              
                              (208,229
                              )
                              
                              
                              (2,988,922
                              )Investing
      ActivitiesReduction
      in Restricted Cash
                              
                              
                              2,070,000
                              
                              
                              
                              -Purchases
      and development of oil and gas properties
                              
                              
                              (1,513,189
                              )
                              
                              
                              (17,958
                              )Proceeds
      from sale of oil and gas properties
                              
                              
                              -
                              
                              
                              
                              162,000Change
      in other property and equipment
                              
                              
                              -
                              
                              
                              
                              28,154Net
      cash provided by investing activities
                              
                              
                              556,811
                              
                              
                              
                              172,196Financing
      ActivitiesProceeds
      from issuance of long term debt
                              
                              
                              1,500,000
                              
                              
                              
                              1,000,000Payment
      on long-term debt
                              
                              
                              (2,000,000
                              )Net
      cash provided  (used) from financing activities
                              
                              
                              (500,000
                              )
                              
                              
                              1,000,000Net
      Decrease in Cash and Equivalents
                              
                              
                              (151,418
                              )
                              
                              
                              (1,816,726
                              )Cash
      and cash equivalents at beginning of period
                              
                              
                              194,826
                              
                              
                              
                              2,195,899Cash
      and Cash Equivalents at End of Period
                              
                              $
                              43,408
                              
                              
                              $
                              379,173





See
notes to consolidated financial statements.




4


VELOCITY
ENERGY INC.


Notes
to Unaudited Consolidated Financial Statements


Period
Ended June 30, 2009





1.
            Basis
      of Presentation





The
accompanying unaudited consolidated financial statements report interim
financial information for Velocity Energy Inc., a Delaware corporation formerly
known as Sonterra Resources, Inc. (the “Company”), and its wholly owned
subsidiaries: Sonterra Oil & Gas, Inc., a Delaware corporation (“Sonterra
Oil & Gas”), which was merged into the Company on November 11, 2008;
Sonterra Operating, Inc., a Delaware corporation (“Sonterra Operating”);
Velocity Energy Inc, a Delaware corporation, which changed its name to Velocity
Energy Operating Inc. on March 4, 2009 (“Velocity Operating”); Velocity Energy
Offshore LP, a Delaware limited partnership (“Velocity Offshore”); Velocity
Energy Partners L.P., a Delaware limited partnership (“Velocity Partners”);
Velocity Energy Limited LLC, a Texas limited liability company (“Velocity
Limited”); North Texas Drilling Services, Inc., a Texas corporation (“NTDS”);
River Capital Holdings Limited, a Barbados corporation (“RCHL”); and River
Reinsurance Limited, a Barbados corporation (“River Re”). Collectively, all of
the subsidiaries are referred to as the “Subsidiaries”.  References to
“the Company” refer to Velocity Energy Inc., formerly known as Sonterra
Resources, Inc., and its Subsidiaries. Additionally, the terms “us,” “our,”
“we,” and “its” are sometimes used as abbreviated references to the
Company.





The
Company was originally incorporated in Florida effective as of June 17, 1997, as
Permastoprust International, Inc. and subsequently changed its name to Greystone
Credit Inc. on June 30, 1999. The current publicly traded entity was
incorporated in Delaware under the name whOOdoo.com, inc. on July 1, 1999. On
August 4, 1999, Greystone Credit Inc. acquired whOOdoo.com, inc. in a share
exchange, resulting in the Company’s state of incorporation being changed to
Delaware and the name of the Company becoming whOOdoo.com, inc.  On
July 17, 2000, the name of the Company was changed to Ballistic Ventures, Inc.
On June 5, 2004, the name of the Company was changed to River Capital Group,
Inc. (“River Capital”). River Capital intended to establish and grow a core
reinsurance business through two entities incorporated in Barbados, RCHL and
River Re, but was unable to raise equity or debt capital and River Capital
abandoned its efforts to establish a reinsurance business. These businesses of
RCHL and River Re are dormant, and the Company has reached an agreement to
divest both RCHL and River Re in the third quarter of 2009. Following the
closing of the Securities Exchange in February 2008 discussed below, the name of
the Company was changed to Sonterra Resources, Inc., and the Company emerged
from shell company status as an oil and gas exploration and production company.
On March 4, 2009, the name of the Company was changed to Velocity Energy
Inc.





On
February 14, 2008, the Company consummated the transactions (the “Securities
Exchange”) contemplated by a Securities Exchange and Additional Note Purchase
Agreement entered into on August 3, 2007 with The Longview Fund, L.P.
(“Longview”), together with an affiliated fund, which collectively owned
approximately 66.6% of the Company’s common stock. The Securities Exchange was
comprised of a series of transactions that occurred as part of the closing
including (i) Sonterra Resources’ 38,552,749 issued and outstanding shares of
common stock being combined into 3,855,275 shares of common stock in a 1-for-10
reverse stock split; (ii) the Company’s name being changed from River Capital
Group, Inc. to Sonterra Resources, Inc.; and (iii) Longview’s exchange of (a)
all of its shares of common stock of Sonterra Oil & Gas, Inc., (b) a
$5,990,010 equity note from Sonterra Oil & Gas, and (c) a warrant to
purchase 50 shares of Sonterra Oil & Gas common stock for 21,846,558 shares
of the Company’s common stock and a warrant to purchase 4,958,678 shares of the
Company’s common stock. Longview also exchanged its $2,000,000 non-equity note
from Sonterra Oil & Gas for a senior secured note from the Company in an
equal principal amount.





As a
result of the Securities Exchange, (i) 100% of the issued and outstanding
capital stock of Sonterra Oil & Gas, which was formerly known as Sonterra
Resources, Inc. prior to the Securities Exchange, was transferred to the
Company (known as River Capital Group, Inc. prior to the Securities Exchange);
(ii) the Company became engaged, through its Subsidiaries, in the operation
and development of oil and gas properties and related assets; and (iii) the
former stockholders of Sonterra Oil & Gas held approximately 95% of the
common stock of the Company. Although the Company was the legal acquirer of
Sonterra Oil & Gas and continues as the publicly traded entity, the
acquisition has been treated for accounting and financial reporting purposes as
a recapitalization of the Company with Sonterra Oil & Gas as the acquirer
(reverse acquisition).  The historical financials prior to February
14, 2008, are those of Sonterra Oil & Gas, which was subsequently merged
into the Company on November 7, 2008, and for SEC reporting purposes, the
Company presents the consolidated historical financial statements of the Company
and the Subsidiaries through the effective date of the Securities Exchange, and
the combined financial results thereafter.





On
November 13, 2008, the Company restructured its financing arrangements
(“Financial Restructuring”) by entering into two transactions with its
lenders.  Under the first transaction, the Company entered into a
Securities Exchange Agreement (the “New Securities Exchange Agreement”) with The
Longview Fund, L.P. (“Longview”) and Longview Marquis Master Fund, L.P.
(“Marquis”) under which Marquis acquired a warrant (the “Marquis Warrant”) to
acquire (a)(i) 1,000,000 shares of the Company’s common stock, par value $0.001
per share, subject to adjustment, at an initial exercise price per share of
$0.01, and (ii) an unsecured subordinated promissory note in the original
aggregate principal amount of $9,440,000 (the “Marquis Subordinated Note”),
bearing interest at 11% per annum; and Longview acquired (b)(i) an unsecured
promissory note in the original aggregate principal amount of $2,210,551 (the
“Longview Subordinated Note”), bearing interest at 11% per annum, and (ii)
$1,000,000 in cash as principal repayment of the Old Notes described
below.




5


As part
of the consideration to the Company under the New Securities Exchange Agreement,
Longview agreed to surrender to the Company warrants to acquire 3,000,000 shares
of the Company’s common stock at an exercise price of $0.30210709 per share (out
of  that certain Warrant to Purchase Common Stock dated February 14,
2008 to acquire up to 4,958,678 shares of the Company’s common stock that
Longview held prior to such transaction) (the “Old Longview Warrant”), and
Longview surrendered to the Company the following notes payable by the Company
in the aggregate outstanding principal amount of $3,000,000 (collectively, the
“Old Notes”): (i) that certain Amended and Restated Senior Secured Note dated
February 14, 2008 (amended and restated May 16, 2008); and (ii) that certain
Senior Secured Note dated May 22, 2008.





In
exchange for the Marquis Warrant and the Marquis Subordinated Note, the Company
acquired from Marquis all of the issued and outstanding shares of common stock,
par value $0.001 per share, of NTDS and that certain Ninth Amended and Restated
Senior Secured Note dated October 3, 2008, in the outstanding principal amount
of $8,575,000, plus accrued and unpaid interest of approximately $865,000,
issued by NTDS (the “North Texas Note”).  The North Texas Note was
cancelled upon delivery to the Company.





Contemporaneously
with the closing of the New Securities Exchange Agreement, the Company entered
into a second transaction pursuant to a Securities Purchase Agreement between
the Company and Marquis (the “Marquis Securities Purchase
Agreement”).  Under the Marquis Securities Purchase Agreement, the
Company issued and sold to Marquis, and Marquis purchased from the Company, for
consideration of $8,075,000, a senior secured promissory note in the principal
amount of $8,875,000, bearing interest at 13% per annum, subject to certain
adjustments (the “Senior Secured Note”), and a warrant to acquire 1,050,000
shares of common stock at an initial exercise price of $0.01 per
share.  As additional consideration under the Securities Purchase
Agreement, the Company also granted Marquis a limited conveyance of overriding
royalty interests (the “Overrides”) of 3% of the Company’s interest in the
hydrocarbon production from all of the Company’s (i) current oil and gas
properties (the “3% ORRI”) and (ii) oil and gas properties acquired in the
future with $5,000,000 of proceeds from the sale of the Senior Secured Note,
which sum has been deposited in the Acquisition Fund Account.  The
proceeds from the Securities Purchase Agreement were used in part to pay
$1,000,000 of principal under the existing indebtedness owed to Longview
pursuant to the Old Notes, to fund the Company’s share of the completion costs
of the State Tract 127-1 Unit and drilling and completion cost of the State
Tract 150-1 ST #1 Well, and for general corporate purposes.





Under the
Securities Purchase Agreement, from November 13, 2009 until November 12, 2010,
the Company has the right to purchase from Marquis all (but not less than all)
of the Overrides issued to Marquis prior to November 13, 2009 by delivering to
Marquis, at its election, either Override Warrants (as defined in the Securities
Purchase Agreement) or any combination of Common Override Exchange Shares (as
defined in the Securities Purchase Agreement) and Preferred Override Exchange
Shares (as defined in the Securities Purchase Agreement).  In
connection with the Securities Purchase Agreement, certain subsidiaries of the
Company guaranteed payment of the Senior Secured Note and the Company and
certain of its subsidiaries granted a security interest in substantially all of
their real and personal property to Summerline Asset Management, LLC, as
collateral agent for Marquis, as the secured party, and executed a security
agreement, a mortgage, guarantees and pledges to evidence the same.





These
financial statements have been prepared in accordance with U.S. generally
accepted accounting principles ("GAAP") for interim financial information and
with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by GAAP for
complete financial statements. The significant accounting policies followed by
the Company are described in Note 3 to the audited consolidated financial
statements for the year ended December 31, 2008.





In the
opinion of management, all normal recurring adjustments considered necessary for
the fair statement of the results for the interim period presented have been
included.  Certain reclassifications have been made to prior periods’
financial statements to conform to the current presentation.  These
reclassifications had no effect on total assets, total liabilities,
stockholders’ equity or net income.





2.
            Going
      Concern





The
accompanying financial statements have been prepared assuming the Company will
continue as a going concern.  The Company experienced a net loss of
$6.3 million for the year ended December 31, 2008, a net loss of $4.3 million in
the first quarter of 2009, and a net loss of $2.2 million in the second quarter
of 2009.  Furthermore, the Company has $20.2 million in debt, maturity
value, plus associated interest obligations, and virtually no current source of
revenue.  These factors raise substantial doubt about the Company’s
ability to continue as a going concern.


6


The
Company is pursuing acquisitions of producing properties in the Appalachian
Basin.  The management team has met with numerous providers of both
debt and equity, and is currently evaluating several potential acquisition
targets.  If successful with our Appalachian Basin acquisition
strategy, the Company expects to acquire a steady revenue stream from long-lived
assets.  On April 13, 2009, the Company executed a letter of intent to
acquire certain producing properties in southern West Virginia pursuant to the
Company’s Appalachian Basin acquisition strategy, but did not consummate this
acquisition in the second quarter of 2009 as anticipated.  The Company
remains in discussions with respect to that acquisition and other opportunities
in the Appalachian Basin.





3.
            Restricted
      Cash





As part
of the Financial Restructuring in November 2008, the Company established a
special controlled access account at Sterling Bank (“Acquisition Funds
Account”), which was intended to be used primarily for acquisitions or as
otherwise agreed by the Company and Summerline, the asset management company
representing Marquis, as Collateral Agent. The balance of the Acquisitions Fund
Account at December 31, 2008 was approximately $3.7 million.  To
access the funds (the “Acquisition Funds”), both the Company and Summerline, the
asset management company representing Marquis, have to agree on the use of such
funds and must submit written authorization to Sterling Bank to release these
funds.





On
December 4, 2008, the Company, Marquis, and Summerline entered into a letter
agreement whereby such parties agreed to release up to $1,300,000 of the
Acquisition Funds for payment directly to STO Operating Company (or another
third party) for operations related to the wellbore located at State Tract 150-1
ST #1 Well.  On December 8, 2008, $927,346 of the Acquisition Funds
was released from the Acquisition Funds Account for payment of drilling costs of
the State Tract 150-1 ST #1 Well.  Contemporaneously, the Company
delivered to Marquis an additional conveyance of an overriding royalty interest
of 7% (the “New ORRI”) of the Applicable Percentage (as defined in the New ORRI)
of the oil, gas, and other minerals in, under and that may be produced from the
State Tract 150-1 ST #1 Well.  When Marquis receives $250,000 from the
proceeds of the sale of the production of oil, gas and other minerals
attributable to the New ORRI, the New ORRI will be reduced to 3% of the
Applicable Percentage.  The New ORRI is in addition to, and not in
lieu, of the 3% ORRI with respect to the oil and gas leases upon which the State
Tract 150-1 ST #1 Well is located.  The balance of $1,300,000 of the
Acquisition Funds, being $372,654, was used primarily for completion costs of
the State Tract 150-1 ST #1 Well, as well as for miscellaneous costs related to
the Financial Restructuring in the first quarter of 2009.





On March
30, 2009, $700,000 was released from the Acquisition Funds Account for payment
of interest on the Senior Secured Debt and other corporate
purposes.  On April 1, 2009, the Company made an optional prepayment
on the Senior Secured Note in the amount of $2,000,000, at which time the
outstanding principal amount of the Senior Secured Note was reduced by
$2,195,000.  On May 7, 2009, $270,000 was released from the
Acquisition Funds Account to pay for general and administrative costs, leaving a
balance in the Acquisition Funds Account of $129,931.




On May
29, 2009, at which time the outstanding principal of the Senior Secured Note was
$6,682,500, Marquis and Summerview Marquis Fund, L.P. ("Summerview") entered
into a letter agreement whereby Marquis transferred to Summerview a portion of
the Senior Secured Note in the principal amount of $1,679,842, including all of
Marquis' right, title and interest with respect to the transferred portion of
the Senior Secured Note, and Summerview agreed to be bound by all of the terms
and conditions of the Securities Purchase Agreement. Marquis continued to hold a
note in the principal amount of $6,647,127, which represented the portion of the
Senior Secured Note (the "Marquis Secured Note") remaining after the transfer of
the portion to Summerview.




On June
17, 2009, the Company, Marquis, Summerview and certain subsidiaries of the
Company entered into an Amendment Agreement which amends the Marquis Secured
Note (the "Amendment"). Pursuant to the Amendment, Marquis paid the Company
$1,500,000 (the "Additional Payment"), and in consideration therefore, the
principal amount of the Marquis Senior Secured Note was increased by $1,644,375.
The Company has issued and delivered to Marquis a note in the same form as the
Senior Secured Note for the new principal amount of $6,647,127. The proceeds of
the Additional Payment are expected to be used primarily to fund an Agreed
Acquisition as defined in Section 4(d) of the Securities Purchase Agreement. The
terms and conditions of the Summerview Secured Note are not amended as a result
of or in connection with the amendment to the Marquis Secured Note pursuant to
the Amendment.  As a result of the Additional Payment, the balance in
the Acquisition Funds Account of June 30, 2009 was $1,629,931.





Subsequent
to June 30, 2009, $100,000 and $125,000 of the Acquisition Funds were released
on July 6, 2009 and July 28, 2009, respectively, to pay for general and
administrative expenses, leaving a current balance in the Acquisition Funds
Account of $1,404,931.




The
foregoing discussion of the Amendment is qualified in its entirety by reference
to the Amendment, a copy of which was filed as Exhibit 10.1 to the Form 8-K/A
filed on June 22, 2009, and is incorporated into this Item 1.01 by
reference.




4.
            Property
      and Equipment





The
Company follows the full cost method of accounting for its investments in oil
and natural gas properties.  Under this method, all costs associated
with acquisition, exploration, and development of oil and gas properties are
capitalized, including general and administrative costs that are directly
related with such acquisition, exploration and development
costs.  Specific capitalized costs include acquisition costs,
geological and geophysical expenditures, lease rentals on undeveloped
properties, and the costs of drilling and equipping productive and
non-productive wells.  Capitalized costs are categorized as either
being subject to amortization or not subject to amortization.




7


All
capitalized costs of oil and gas properties, including the estimated future
costs to develop proved reserves and estimated future costs to plug and abandon
wells and related costs of site restoration, are amortized on the
unit-of-production method using estimates of proved reserves as determined by
independent engineers.  Investments in unproved properties and major
development projects are not amortized until proved reserves associated with the
projects can be determined or until impairment occurs.  If the results
of an assessment indicate that the properties are impaired, the amount of the
impairment is added to the capitalized costs to be amortized.





In
addition, capitalized costs, less accumulated amortization and related deferred
income taxes, shall not exceed an amount (the full cost ceiling) equal to the
sum of:





1)
            The
      present value of estimated future net revenues computed by applying
      current prices of oil and gas reserves to estimated future production of
      proved oil and gas reserves, less estimated future expenditures (based on
      current costs) to be incurred in developing and producing the proved
      reserves computed using a discount factor of ten percent and assuming
      continuation of existing economic
conditions;





2)
            plus
      the cost of properties not being
amortized;





3)
            plus
      the lower cost of estimated fair value of unproven properties included in
      the costs being amortized; and





4)
            less
      income tax effects related to the differences between the book and tax
      basis of the properties.





We did
not recognize any impairment expense in the second quarter of 2009 compared to
the first quarter charge of $1,842,510.





5.
            Earnings
      (Loss) Per Common Share





Basic
loss per common share is calculated by dividing net loss by the weighted average
number of shares of common stock outstanding during the period. Diluted earnings
per common share considers the dilutive effect of the average number of common
stock equivalents, consisting of the Company’s common stock options and
warrants, that were outstanding during the period.  For the three and
six months ended June 30, 2009, a net loss of $2,166,138 and $6,510,890,
respectively, was incurred. Therefore, consideration of common stock equivalents
in the calculation of the weighted average number of shares outstanding was not
applicable because the effect would have been anti-dilutive.





For
purposes of calculating the weighted average number of shares of common stock
outstanding and earnings (loss) per share data, the number of common shares
issued by the Company in the Securities Exchange transaction is deemed to be
included in the number of common shares of the Company outstanding during the
interim period.





6.
            Stock
      Based Compensation





Concurrent
with the consummation of the Securities Exchange, the Company adopted the 2007
River Capital Group, Inc, Non-Qualified Stock Option Plan (the “2007 Stock
Option Plan”) to provide for the issuance of stock options as compensation to
key employees, officers and non-employee directors.





Stock
options issued to employees under the 2007 Stock Option Plan vest incrementally
over a period of three years and have a ten-year life. On February 14, 2008, a
total of 5,140,359 common stock options were issued. These options had exercise
prices that ranged from $0.332 to $0.453 per share, and were scheduled to expire
in February 2018.  These options were forfeited on June 23, 2008, when
the then management team resigned from the Company. A new management team was
employed on June 23, 2008, and a total of 2,459,087 new common stock options
were issued to the initial two members of the management team. An additional
1,141,719 new common stock options were issued to the third member of the
management team whose start date commenced July 1, 2008, and this third member
also received an additional 30,000 new common stock options in exchange for a
four-month deferral of salary.  These options have exercise prices
that range from $1.35 to $2.025 per share and will expire in June
2018.


8





Number
                        Outstanding
                      
                      
                      Weighted
                        Average
                        Exercise Price
                      
                      
                      Weighted Average
                        Contractual Term
                        in Years
                      
                      
                      Aggregate
                        Intrinsic
                        ValueOutstanding
      at June 30, 2009
                      
                      
                      3,630,806
                      
                      
                      $
                      1.707
                      
                      
                      
                      9.5
                      
                      
                      $
                      -Exercised
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      $
                      -Exercisable
      at June 30, 2009
                      
                      
                      30,000
                      
                      
                      $
                      1.35
                      
                      
                      
                      5.0
                      
                      
                      $
                      -





Effective
as of March 31, 2009, the Company adopted the 2008 Sonterra Resources, Inc.
Equity Compensation Plan (“2008 Equity Compensation Plan”). Under the 2008
Equity Compensation Plan, no employee participant may receive options to
purchase more than 400,000 shares of common stock in any given year, the total
number of options awarded to all employee participants shall not exceed
1,300,000 in any given year, and a maximum of 3,000,000 options may be awarded.
The 3,000,000 options available under the 2008 Equity Compensation Plan are in
addition to a maximum of 5,140,165 options available under the 2007 Stock Option
Plan. Equity compensation is intended to qualify as performance-based
compensation under Section 162(m) of the Code. The Corporate Compensation and
Nominating Committee has reviewed and discussed with the Company the 2008 Equity
Compensation Plan as well as the Company’s overall incentive-driven compensation
philosophy.  No options have been awarded under the 2008 Equity
Compensation Plan.





In
accordance with Statement of Financial Accounting Standard No. 123, the Company
determines the value of the stock-based compensation granted to its employees by
use of a Black-Scholes valuation model. That value is recognized as stock
compensation expense over the expected life of the underlying options. Total
stock-based compensation expense recognized for the three and six months ended
June 30, 2009 was $454,734 and $898,524, respectively.





The
following warrants are outstanding as of June 30, 2009:





Number
                      
                      
                      Exercise Price
                      
                      Expiration DateThe
      Longview Fund, L.P.
                      
                      
                      1,958,678
                      
                      
                      $
                      0.30
                      
                      February
      14, 2013Longview
      Marquis Master Fund, L.P. (1)
                      
                      
                      2,050,000
                      
                      
                      $
                      0.01
                      
                      November 13, 2013





(1)  Notwithstanding
the total of 2,050,000 shares of common stock issuable upon exercise of the
warrants held by Longview Marquis Master Fund, L.P., in no event shall
the total number of shares of common stock of the Company held by Longview
Marquis Master Fund, L.P. immediately following any such exercise exceed 4.99%
of the outstanding shares of the common stock of the Company.





7.   Debt




At June
30, 2009 and December 31, 2008, debt consisted of the following:




June
      30, 2009
                    
                    
                    December
      31, 2008Note
      payable to bank, interest rate of 8.75%, interest payable monthly,
      principal due July 2009, secured by trucks and vehicles owned by
      NTDS.
                    
                    $
                    150,000
                    
                    
                    $
                    150,000Marquis
      Senior Secured Note, net of unamortized discount of $990,687, interest
      rate of 13%, interest payable quarterly, principal amortized monthly over
      28 months beginning August 31, 2009, secured by oil and gas
      properties.
                    
                    
                    5,656,440
                    
                    
                    
                    7,109,533Summerview
      Senior Secured Note, net of unamortized discount of $250,350, interest
      rate of 13%, interest payable quarterly, principal amortized monthly over
      28 months beginning August 31, 2009, secured by oil and gas
      properties.
                    
                    
                    1,429,398
                    
                    
                    
                    -Marquis
      Subordinated Note, net of unamortized discount of $7,334,692, interest
      rate of 11%, interest payable quarterly, 25% of principal due November 13,
      2011 and 75% of principal due on November 13, 2012, secured by drilling
      rigs, owed by NTDS
                    
                    
                    2,105,308
                    
                    
                    
                    1,281,852Longview
      Subordinated Note – Related party, interest rate of 11%, interest payable
      quarterly, 25% of principal due November 13, 2011 and 75% of principal due
      on November 13, 2012 secured by oil and gas properties after
      retirement of Senior Secured Note
                    
                    
                    2,210,551
                    
                    
                    
                    2,210,551Subordinated
      note payable to related party, interest rate of 8%, compounded annually,
      all principal and interest payments will be deferred until repayment of
      any senior and subordinated debt
                    
                    
                    83,160
                    
                    
                    
                    83,160Total
      current debt
                    
                    
                    11,634,857
                    
                    
                    
                    10,835,096




On May
29, 2009, at which time the outstanding principal of the Senior Secured Note was
$6,682,500, Marquis and Summerview Marquis Fund, L.P. ("Summerview") entered
into a letter agreement whereby Marquis transferred to Summerview a portion of
the Senior Secured Note in the principal amount of $1,679,842, including all of
Marquis' right, title and interest with respect to the transferred portion of
the Senior Secured Note, and Summerview agreed to be bound by all of the terms
and conditions of the Securities Purchase Agreement. Marquis continued to hold a
note in the principal amount of $6,647,127, which represented the portion of the
Senior Secured Note (the "Marquis Secured Note") remaining after the transfer of
the portion to Summerview.




9


8.
            Subsequent
      Events





On July
27, 2009, the Company and Longview entered into a Share Exchange Agreement,
effective as of November 1, 2008 (the “Agreement”), pursuant to which the
parties, in part, acknowledged and effectuated their previous understandings and
agreements in connection with a financial restructuring of the Company on
November 13, 2008, wherein Longview accepted payment of $1,000,000 in exchange
for (i) the partial repayment of a senior secured note held by the Longview that
was previously issued in connection with a Securities Exchange Agreement dated
February 13, 2008 between the Company and the Longview; (ii) the agreement by
the Longview to subordinate its remaining indebtedness in the form
of  an unsecured subordinated promissory note in the original
aggregate principal amount of $2,210,551; and (iii) the cancellation by the
Longview of warrants to purchase 3,000,000 shares of Company common
stock.





Prior to
the Agreement, the Longview held 23,182,876 shares, or 87.99%, of the issued and
outstanding shares of the common stock of the Company. Pursuant to the
Agreement, Longview exchanged 20,000,000 shares of Company common stock (the
“Share Exchange”) for 20,000,000 shares of Series A Convertible Preferred Stock
issued by the Company (“Preferred Stock”). Under the Agreement, each share of
Preferred Stock is valued at $1.20 per share for an aggregate value of
$24,000,000 and is convertible into one share of common stock at a fixed rate of
$1.20 per share, which amount is also the Conversion Value and the Liquidation
Value as defined in the Certificate of Designations, Preferences and Rights of
Series A Convertible Preferred Stock filed with the Delaware Secretary of State
on March 4, 2009, as corrected by the Certificate of Correction filed with the
Delaware Secretary of State on April 9, 2009 (the “Certificate of Designation”).
The Preferred Stock does not receive dividends and has no voting rights, except
as otherwise provided in the Certificate of Designation. The Share Exchange
became effective upon the execution of the Agreement, effective as of November
1, 2008, at which time the 20,000,000 shares of common stock were retired
concurrently with the issuance of the Preferred Stock.





On July
13, 2009, one of the two rigs in North Texas Drilling Services, Inc. incurred
major damages while rigging down.  The damages have been reported to
the insurance carrier and appropriate agencies.  The Company is
providing a comprehensive damage assessment and like-kind and quality
comparative values for determining an insurance claim.  The rig was
insured for $375,000, and the Company expects to receive insurance proceeds in
excess of $300,000 in the third quarter.





9.   Recent Accounting
Pronouncements





FASB Statement of Accounting
Standards No. 160, "Noncontrolling Interests in Consolidated Financial
Statements - an amendment of Accounting Research Bulletin No. 51" ("SFAS
160"): SFAS 160, issued in December 2007, establishes accounting and
reporting standards for ownership interests in subsidiaries held by parties
other than the parent, the amount of consolidated net income attributable to the
parent and to the non-controlling interest, changes in a parent’s ownership
interest and the valuation of retained noncontrolling equity investments when a
subsidiary is deconsolidated. The Statement also establishes reporting
requirements that provide sufficient disclosures that clearly identify and
distinguish between the interests of the parent and the interests of the
non-controlling owners. SFAS 160 is effective for fiscal years beginning after
December 15, 2008. The Company does not currently have any non-controlling
interests in its subsidiaries and thus does not expect the adoption of SFAS 160
to impact its consolidated financial statements.




FASB Statement of Accounting
Standards No. 161, "Disclosures about Derivative Instruments and Hedging
Activities - an amendment of FASB Statement No. 133" ("SFAS 161"): SFAS
161, issued in March 2008, requires new and expanded disclosures regarding
hedging activities. These disclosures include, but are not limited to, a tabular
presentation of derivative data; financial statement presentation of fair values
on a gross basis, including those that currently qualify for netting under FASB
Interpretation No. 39; and a specific footnote narrative regarding how and
why derivatives are used. The disclosures are required in all interim and annual
reports. SFAS 161 is effective for fiscal and interim periods beginning after
November 15, 2008. The Company is not currently engaged in any hedging
activities and thus does not expect the application of SFAS 161 to impact its
consolidated financial statements.





On May
28, 2009, the FASB issued SFAS No. 165, Subsequent Events, which
provides guidance on management’s assessment of subsequent
events.  Historically, management had relied on U. S. auditing
literature for guidance on assessing and disclosing subsequent
events.  SFAS No. 165 represents the inclusion of guidance on
subsequent events in the accounting literature and is directed specifically to
management, since management is responsible for preparing an entity’s financial
statements.  SFAS No. 165 clarifies that management must evaluate, as
of each reporting period, events or transactions that occur after the balance
sheet date through the date that the financial statements are
issued.  SFAS No. 165 is effective prospectively for interim and
annual financial periods ending after June 15, 2009.  The Company has
adopted the provisions of SFAS No. 165 for its reporting period ending June 30,
2009.  The adoption of SFAS No. 165 did not have a material impact of
the Company’s financial condition or results of operations.  The
Company has evaluated subsequent events up through the date of the filing of
this report with the SEC.


10


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





Forward-Looking
Information





This Form
10-Q quarterly report of the Company for the three months ended June 30, 2009,
may contain certain forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, which are intended to be covered by the safe
harbors created thereby.  To the extent that there are statements that are
not recitations of historical fact, such statements constitute forward-looking
statements that, by definition, involve risks and uncertainties.  In any
forward-looking statement, where the Company expresses an expectation or belief
as to future results or events, such expectation or belief is expressed in good
faith and believed to have a reasonable basis, but there can be no assurance
that the statement of expectation or belief will be achieved or
accomplished.





The
following are factors that could cause actual results or events to differ
materially from those anticipated, and include, but are not limited to: general
economic, financial and business conditions; the Company’s ability to minimize
expenses; the Company’s ability to attract and retain key personnel to support
its present and planned operations; the Company’s ability to acquire additional
oil and gas properties and/or operations on acceptable terms, or at all; the
Company’s ability to obtain additional necessary financing from outside
investors and/or bank and mezzanine lenders; and the ability of the Company to
generate sufficient revenues to cover operating expenses and position it to
achieve positive cash flow.





Readers
are cautioned not to place undue reliance on the forward-looking statements
contained herein, which speak only as of the date hereof. The Company believes
the information contained in this Form 10-Q to be accurate as of the date
hereof.  Changes may occur after that date, and the Company will not update
that information except as required by law in the normal course of its public
disclosure practices.





Additionally,
the following discussion regarding the Company’s financial condition and results
of operations should be read in conjunction with the financial statements and
related notes contained in Item 1 of Part 1 of this Form 10-Q, as well as the
financial statements for the fiscal year ended December 31, 2008, as set forth
in the Company’s Form 10-K filed with the U.S. Securities and Exchange
Commission on May 8, 2009.  The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses. Our significant
accounting policies are described in Note 3 to the Financial Statements of
the Company’s Form 10-K for the fiscal year ended December 31, 2008. Certain of
these policies are of particular importance to the portrayal of our financial
position and results of operations, and require the application of significant
judgment by management. We analyze our estimates, including those related to
reserves, depletion and impairment of oil and gas properties, and the ultimate
utilization of the deferred tax asset, and base our estimates on historical
experience and various other assumptions that we believe to be reasonable under
the circumstances. Actual results may differ from these estimates under
different assumptions or conditions. We believe the following critical
accounting policies affect our more significant judgments and estimates used in
the preparation of our financial statements subsequent to the Securities
Exchange.





Critical
Accounting Policies





The
Company’s discussion and analysis of its financial condition and results of
operations are based upon its financial statements, which have been prepared in
accordance with accounting principles generally accepted in the U.S.  The
Company believes certain significant accounting policies affect its more
significant judgments and estimates used in the preparation of its financial
statements.  We believe the following accounting policies to be critical to
our operations:





Full Cost Method of
Accounting.  Oil and gas properties are stated at historical
cost using the full cost method of accounting.  Under this method, all
costs associated with the acquisition, exploration and development of oil and
gas properties are capitalized, including acquisition costs, geological and
geophysical expenditures, lease rentals on undeveloped properties, and the costs
of drilling and equipping productive and non-productive wells. Capitalized costs
are categorized as either being subject to amortization or not being subject to
amortization.





All
capitalized costs of oil and gas properties, including the estimated future
costs to develop proved reserves as well as estimated future costs to plug and
abandon wells and costs of site restoration, are amortized on the
unit-of-production method using estimates of proved reserves as determined by
independent engineers. Investments in unproved properties and major development
projects are not amortized until proved reserves associated with the projects
can be determined or until impairment occurs. If the results of an assessment
indicate that the properties are impaired, the amount of the impairment is added
to the capitalized costs to be amortized.





In
addition, capitalized costs, less accumulated amortization and related deferred
income taxes, shall not exceed an amount (the full cost ceiling) equal to the
sum of:




11


1) the
present value of estimated future net revenues computed by applying current
prices of oil and gas reserves to estimated future production of proved oil and
gas reserves, less estimated future expenditures (based on current costs) to be
incurred in developing and producing the proved reserves computed using a
discount factor of ten percent and assuming continuation of existing economic
conditions;





2) plus
the cost of properties not being amortized;





3) plus
the lower of cost or estimated fair value of unproven properties included in the
costs being amortized; and





4) less
income tax effects related to the differences between the book and tax basis of
the properties.





Given the
complexities associated with oil and gas reserve estimates and the history of
price volatility in the oil and gas markets, events may arise that would require
us to record an impairment of the recorded book values associated with oil and
gas properties.  We have recognized impairments in both for 2009 and
2008 and there can be no assurance that impairments will not be required in the
future.





Sales of
proved and unproved properties are accounted for as adjustments of capitalized
costs with no gain or loss recognized, unless such adjustments would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in
income.





Revenue
Recognition.   We recognize oil and gas revenue from our
interest in producing wells as the oil and gas is sold to third parties. Gas
gathering operations revenues are recognized upon delivery of the product to
third parties.





Reserve
Estimates.   Our estimates of oil and gas reserves, by
necessity, are projections based on geologic and engineering data, and there are
uncertainties inherent in the interpretation of such data as well as in the
projection of future rates of production and the timing of development
expenditures. Reserve engineering is a subjective process of estimating
underground accumulations of oil and gas that are difficult to measure. The
accuracy of any reserve estimate is a function of the quality of available data,
engineering and geological interpretation and judgment. Estimates of
economically recoverable oil and gas reserves and future net cash flows depend
upon a number of variable factors and assumptions, all of which may in fact vary
considerably from actual results. These factors and assumptions include
historical production from the area compared with production from other
producing areas, the assumed effects of regulations by governmental agencies and
assumptions governing future oil and gas prices, future operating costs,
severance taxes, development costs and workover costs. The future drilling costs
associated with reserves assigned to proved undeveloped locations may ultimately
increase to an extent that these reserves may be later determined to be
uneconomic. For these reasons, estimates of economically recoverable quantities
of oil and gas attributable to any particular group of properties,
classifications of such reserves based on risk of recovery, and estimates of
future net cash flows expected therefrom, may vary substantially. Any
significant variance in the assumptions could materially affect the estimated
quantity and value of the reserves, which could affect the carrying value of our
oil and gas properties and/or the rate of depletion of the oil and gas
properties. Actual production, revenues and expenditures, with respect to our
reserves, will likely vary from estimates and such variances may be material.
The reserve information contained in this report was developed internally, using
standard guidelines for reserve recognition and reporting.





Impairment of Oil & Gas
Properties and Other Property & Equipment.We review our
long-term assets and oil and gas properties for impairment at least annually and
whenever events and circumstances indicate a decline in the recoverability of
their carrying value.  We estimate the expected future cash flows of
our oil and gas properties and compare such future cash flows to the carrying
amount of the properties to determine if the carrying amount is
recoverable.  If the carrying amount exceeds the estimated
undiscounted future cash flows, we will adjust the carrying amount of the oil
and gas properties to their fair value. The factors used to determine fair value
include, but are not limited to, estimates of proved reserves, future commodity
pricing, future production estimates, anticipated capital expenditures, and a
discount rate commensurate with the risk associated with realizing the expected
cash flows projected.





General
Overview of Operations and Current Developments





Our oil
and gas assets consist of certain oil and gas properties and related assets that
we acquired in August 2007 from Cinco Natural Resources Corporation ("Cinco")
and Flash Gas & Oil Southwest, Inc. ("Flash") in two separate transactions
for an aggregate amount of approximately $5.9 million. Our wholly owned
subsidiary, Sonterra Operating, Inc., is the named operator of our oil and gas
properties, which are located in Matagorda Bay in Texas State Waters lying
offshore of the Texas coastal counties of Calhoun and Matagorda. In the Cinco
acquisition, for approximately $5.0 million, we purchased 60% of the interests
held by Cinco in the Texas State Tract 150 Wells No. 1 and No. 2 located in
Matagorda Bay, Texas, as well as a 320-acre oil and gas lease related to those
wells and certain other leases covering approximately 3,200 additional acres
located in Matagorda Bay. In the Flash acquisition, for approximately $1.2
million cash, we purchased all of the interests held by Flash in the Texas State
Tract 150 Wells No. 1 and No. 2 as well as a seven-mile pipeline connecting the
wells to the Keller Bay onshore facility located in Calhoun County, Texas. As
discussed below, the Texas State Tract 150 Well No. 2 has been shut-in as a
result of sand production and the Texas State Tract 150 Well No. 1 only produced
marginally in the third quarter of 2008.


12





In
December 2007, we acquired an additional 1,920 gross (960 net) offset acres for
one of the undrilled Matagorda Bay prospects, giving us combined total acreage
of approximately 5,500 gross (2,100 net) acres. On December 18, 2007, the Texas
State Tract 150 Well No. 2 was shut-in because it was producing sand. During the
first quarter of 2008, we worked over this well in an attempt to clean the sand
out of the wellbore. Following the workover, sand production again caused the
well to shut-in, and the well remains shut-in pending evaluation for future
utility. We have identified four additional drilling locations on our acquired
acreage and commenced drilling the first well location during the second quarter
of 2008.





The
Company commenced the drilling of the Matagorda Bay State Tract 127 No. 1 Unit
Well #1 (“State Tract 127-1 Unit Well”) at the end of the second quarter of
2008. The State Tract 127-1 Unit Well is the initial well in the Sydney/150 Deep
Prospect, the first of the four exploratory prospects in the Matagorda Bay 150
Field that have currently been identified as being prospective of oil and gas at
depths of between 8,500 feet and 12,000 feet total vertical depth (TVD). The
Company and South Texas Oil & Gas (“South Texas”) agreed that South Texas
would acquire 70% of the Company’s working interest, subject to a 25%
reversionary interest after payout, in the State Tract 127-1 Unit
Well.  The Company subsequently sold a 10% working interest to Vinland
Energy Capital I LLP on a promoted basis, including a 10% proportionate share of
the associated leasehold and geological and geophysical costs, and the Company
and South Texas subsequently entered into an amendment to the Matagorda Bay
Contract Operating Agreement to effectuate a 50%/50% split of the 10% working
interest sold to Vinland. The net result of the above transactions resulted in
the Company having approximately a 3.56% working interest before casing point, a
7.03% working interest after casing point, and an 11.36% working interest with
corresponding net revenue interests of 5.11%, 5.11%, and 8.27%, respectively,
after all well payout scenarios occur under various participation agreements and
related documentation. The State Tract 127-1 Unit Well reached total depth of
12,464 feet in late August 2008 and was cased, cemented, logged, and temporarily
suspended. Results of the logs indicate the well encountered productive pay in
the Bol Mex and Nodasaria #1 formations at depths between 8,500 feet and 11,700
feet. The attempted completion in the Nodasaria #2 formation encountered water
with no hydrocarbons.  The Nodasaria #1 formation was tested and found
hydrocarbons, but tests were terminated because formation sand plugged the
wellbore.  During the second quarter of 2009, the Company attempted to
run a through-tubing gravel pack to avoid sand accumulation in order to commence
production from the Nodasaria #1 formation.  This attempt was
unsuccessful in alleviating sand accumulation, and the Company has not been able
to establish production from the State Tract 127-1 Unit Well.





The State
Tract 150 Well No. 1 produced sporadically a few days a month throughout most of
the first three quarters of 2008, but also produced increasing volumes of water
and was shut-in in 2008.  The State Tract 150-1 ST #1 Well, a side
track development well, was commenced in November 2008. Diagnostic well analysis
indicated multiple gas and condensate pay zones in the Bol Mex Formation at
depths between 9,300 feet and 10,000 feet so we cased, cemented, and tested 785
thousand cubic feet per day (MCF/day) of gas and 120 barrels/day of condensate
at a flowing tubing pressure of 3,600 PSI on an 8/64 inch choke in a late
December 2008 production test at 9,950 feet. The State Tract 150-1 ST #1
subsequently encountered water from an uphole formation so we abandoned the zone
we had tested and then attempted to recomplete up hole, where we again
encountered water and sand along with as much as 563 MCF/day and 2.1 barrels/day
of condensate before this zone was also shut in.  Further testing and
wireline work in the second quarter of 2009 confirmed that a cement job failure
allowed sea water to invade the productive zones encountered in the wellbore,
with the only remaining alternatives being to either (i) pull the tubing and
attempt a new cement job or (ii) plug and abandon the well.  Further
study in the third and fourth quarters will be undertaken to evaluate these
options.





The
various technical and operational difficulties encountered by our contract
operator, South Texas Oil Company, with respect to both the State Tract 127-1
Unit Well and the State Tract 150-1 ST #1 Well resulted in cost overruns
of  approximately $2.9 million (a 31.4% variance to AFE) and $.7
million (a 17.8% variance to AFE), respectively. Various sums due and owing
under service contracts entered into with our contract operator or its operating
arm, STO Operating Company, for these two wells were not paid by our contract
operator, resulting in the filing of three liens totaling $299,178 against the
State Tract 127-1 Unit Well and six liens totaling $1,344,163 against the State
Tract 150-1 ST #1 Well for a total of $1,643,341. The proportionate share of the
liens filed on the State Tract 127-1 Unit Well and the State Tract 150-1 ST #1,
net to our working interest is $14,698 and $234,982, respectively, which are
recorded in our current liabilities.





Revenues. During the three
months ended June 30, 2009 and 2008, we reported total revenues of $-0-and $325,366,
respectively, with revenues in 2008 primarily from oil and gas sales and
contract operating income.  Revenues for the six-month period ending
June 30, 2009 and 2008 were $-0- and $524,429, respectively.  The
Matagorda Bay State Tract 150 #1 well ceased to produce in November
2008.  The well which was subsequently sidetracked, State Tract 150-1
ST #1, has not been productive.  Additional testing and further
remedial work commenced in the second quarter of 2009, but was unsuccessful in
restoring production to any of the Matagorda Bay wells.  The contract
operating agreement that generated contract operating income was terminated in
June, 2008.





Revenues
for the six month period ending June 30, 2009 and 2008 were $-0- and $524,429,
respectively.  Oil and gas production and contract operating income
accounted for the majority of the revenue during 2008.  The well
ceased to produce in November, 2008 and the contract operating agreement was
terminated in June, 2008.


13





Lease Operating Expenses.
During the three months ended June 30, 2009 and 2008, our lease operating
expenses were $22,469 and $158,024, respectively.  For the six month
period ending June 30, 2009, lease operating expenses were $84,167 compared to
$458,982 for the six month period ending June 30, 2008.  Normal field
monitoring and compliance visits were the most significant expense
incurred.  No other unusual operating expenses were incurred during
the three months ended June 30, 2009.  Wells in Matagorda Bay were
producing during the first half of 2008, increasing the lease operating expenses
during that period.





Impairment on Oil & Natural Gas
Properties. During the three months ended June 30, 2009, the
Company did not recognize any impairment on oil & natural gas properties
compared to the 2009 first quarter charge of $1,842,510.  Oil and
natural gas prices used in impairment valuation were $67.90/barrel and
$3.69/mcf.  The Company did not recognize an impairment charge in the
three or six months ended June 30, 2008.





General and Administrative
Expense.  General and administrative expenses for the three and six
months ended June 30, 2009 were $804,451 and $1,718,157, respectively compared
to the corresponding three and six month ended June 30, 2008 of $87,325 and
$1,069,480, respectively.  Non-cash stock compensation expenses for
the three months June 30, 2009 and 2008 were $443,790 and $30,433,
respectively.  Stock compensation expenses related to the prior
management team were reversed in the second quarter of 2008. All non-cash stock
compensation expense in 2009 relate to the common stock options of the current
management.





Total
payroll for the three and six month period ending June 30, 2009 was $175,929 and
$161,235, respectively. The Company’s corporate structure is to maintain as few
employees as needed and to outsource all administrative
functions.  Currently, we used PetroAcct L.P. for contract accounting
services; Hein & Associates LLP for audit and tax services; and Thompson and
Knight LLP and Duane Morris LLP for legal services.  Collectively, the
combined expenses for the second quarter of 2009 were $134,920 compared to the
first quarter expenses of $97,988. The increase in expenses incurred relate to
the audit, as well as the preparation and filing of the 2008 Annual Form 10-K.





Other (Expense).  During
the three months ended June 30, 2009, we had other expenses of $1,258,564,
consisting of interest expense, including accretion of debt discounts, in the
amount of $1,227,852 and debt issuance costs amortization of $29,048.
Corresponding expenses during the first three months of 2009 was $1,365,526,
consisting of interest expense, including accretion of debt discounts, in the
amount of $1,328,749 and debt issuance costs amortization of
$36,777.  During the three months ended June 30, 2008, we had other
expenses of $79,974, consisting of interest expense in the amount of $69,648 and
debt issuance costs amortization of $10,326.





Financial
Condition





Liquidity and Capital
Resources





Our
primary source of liquidity is intended to be cash flow from operations;
however, neither the two wells we acquired in the Matagorda Bay 150 Field nor
the two wells we drilled in the Matagorda Bay 150 Field were producing at
December 31, 2008, or at any time during the six months ending June 30,
2009.  In addition, all of our NTDS drilling rigs were idle during
both the first quarter and second quarters of 2009, although two of our rigs
have recently been utilized.  The documentation executed in connection
with the Financial Restructuring significantly restricts our ability to incur
indebtedness without seeking subordination from Marquis and Longview. If Marquis
is unwilling to waive or modify such conditions or subordinate the notes to
allow us to obtain project financing for future acquisitions, the Company
would likely be unable to raise the funds required to make acquisitions in the
future.




In the
absence of a significant acquisition, the Company does not believe that we will
have sufficient sources of capital to fund our operations for the next twelve
months because we were not able to establish production at commercial rates from
the aforementioned wells in the Matagorda Bay 150 Field, nor were we able to
generate any revenue from our NTDS subsidiary during the first two quarters of
2009. We were not able to consummate the acquisition of producing properties in
the Appalachian Basin as contemplated in the letter of intent we signed on April
13, 2009, but discussions continue with respect to that acquisition and other
opportunities in the Appalachian Basin. Our future funding requirements depend
on numerous factors, including ongoing costs associated with investigating and
acquiring potential oil and gas prospects, exploration and other development
costs of acquired oil and gas leases, and general administrative and operating
expenses.





The
Company experienced a net loss of $6.3 million for the year ended December 31,
2008, a net loss of $4.3 million in the first quarter of 2009, and a net loss of
$2.2 million in the second quarter of 2009.  Furthermore, the Company
has $20.2 million in debt, maturity value, plus associated interest obligations,
and has virtually no current source of revenue, and Nine liens have been filed
against our contract operator, South Texas Oil Company, and the other working
interest owners in the State Tract 127-1 Unit Well and the State Tract 150-1 ST
#1 Well.  All of these factors raise substantial doubt about the
Company’s ability to continue as a going concern.


14


The
Company did not make the interest payments of $336,044 that were due at the end
of the second quarter under the Senior Secured Note to Marquis and Summerview,
the Marquis Subordinated Note and the Longview Subordinated Note. The Company is
currently in default under each of these notes for lack of payment, and, in any
event, would be unable to satisfy any debt covenants under any of these notes
even if it had made, or was able to make, any such payments. The Company has not
renegotiated any deferral of payment, restructuring of debt repayment
obligations, or other arrangements to cure these events of default; and
therefore all debt has been reclassified as current.





Accordingly,
the Company is considering strategic alternatives to address the circumstances
that cast serious doubt on its ability to continue as a going concern, including
without limitation pursuing potential acquisitions in the Appalachian Basin,
evaluating its Matagorda Bay assets, restructuring its debt with Marquis and
Longview, and exploring its legal options, including bankruptcy.





The
current financial crisis and recession has continued to negatively impacted the
prices for our oil and natural gas production, limited access to the credit and
equity markets, increased the cost of capital.  It may also have other
negative consequences that we cannot predict.The
continued credit crisis and related turmoil in the global financial system and
economicrecession
in the U.S. create financial challenges that will grow if conditions do not
improve. Our cash flow from operations and cash onhand
historically have not been sufficient to fund all of our expenditures, and we
have relied on Longview and Marquis to provide us with additional capital. Our
ability to access the capital markets has beenrestricted
as a result of these crises and may continue to be restricted at a time when we
would like, orneed,
to raise capital. If our cash flow from operations is less than anticipated and
our access to capitalis
restricted, we may be required to reduce our operating and capital budget, which
could havea
material adverse effect on our results and future operations. The financial
crisis may also limit thenumber
of participants or reduce the values we are able to realize in asset sales or
other transactionswe
may engage in to raise capital, thus making these transactions more difficult to
consummate andless
economic. Additionally, the current economic situation has affected the demand
for natural gas andoil
and has resulted in lower prices for natural gas and oil, which could have a
negative impact on any possible futurerevenues
related to possible future oil and gas production.





Our
business model is based on growing the company by completing one or more
acquisitions of producing properties with upside proven locations to be drilled
and by participating in drilling prospects generated in-house and by third
parties. As discussed above, acquisitions and access to capital may be difficult
in the current economic environment. Acquisitions will have associated
production equipment. We currently have three senior management team members
focused on acquisitions. The number of acquisitions we complete and number of
prospects in which we participate, if any, will determine whether we will hire
additional consultants and/or employees. There is the potential for a
significant increase in the number of consultants and/or employees in the event
that we acquire or develop additional oil and gas properties and related
assets.





On March
30, 2009, $700,000 of the Acquisition Funds was released from the Acquisition
Funds Account for payment of interest on the Senior Secured Debt and other
corporate purposes.  On April 1, 2009, $2,000,000 of the Acquisition
Funds was released to prepay part of the Senior Secured Note, in exchange for a
reduction of $2,195,000 of the principal of the Senior Secured
Note.  On May 7, 2009, $270,000 of the Acquisition Funds was released
to pay for general and administrative costs, leaving a balance in the
Acquisition Funds Account of $129,931.





On June
17, 2009, the Company, Marquis, Summerview and certain subsidiaries of the
Company entered into that certain June 2009 Amendment Agreement which amends the
Marquis Secured Note (the "Amendment"). Pursuant to the Amendment, Marquis paid
the Company $1,500,000 (the "Additional Payment"), and in consideration
therefore, the principal amount of the Marquis Senior Secured Note was increased
by $1,644,375. The Company has issued and delivered to Marquis a note in the
same form as the Senior Secured Note for the new principal amount of
$6,647,126.98. The proceeds of the Additional Payment will be used solely to
fund an Agreed Acquisition as defined in Section 4(d) of the Securities Purchase
Agreement. The terms and conditions of the Summerview Secured Note are not
amended as a result of or in connection with the amendment to the Marquis
Secured Note pursuant to the Amendment.  As a result of the Additional
Payment, the balance in the Acquisition Funds Account of June 30, 2009 was
$1,629,931.





Subsequent
to June 30, 2009, $100,000 and $125,000 of the Acquisition Funds were released
on July 6, 2009 and July 28, 2009, respectively, to pay for general and
administrative expenses, leaving a current balance in the Acquisition Funds
Account of $1,404,931.





On April
13, 2009, the Company executed a letter of intent to acquire certain producing
properties in southern West Virginia pursuant to the Company’s Appalachian Basin
acquisition strategy, but did not consummate this acquisition in the second
quarter of 2009 as anticipated.  The Company remains in discussions
with respect to that acquisition and other opportunities in the Appalachian
Basin.


15


Senior
Secured Notes and Subordinated Notes





On
November 13, 2008, the Company restructured its financing arrangements
(“Financial Restructuring”) by entering into two transactions, as more fully
discussed in “Item 1. Financial Statements—Note 1.Basis
of Presentation”.  Under the first transaction, the Company entered
into a Securities Exchange Agreement (the “New Securities Exchange Agreement”)
with The Longview Fund, L.P. (“Longview”) and Longview Marquis Master Fund, L.P.
(“Marquis”) under which Marquis acquired a warrant (the “Marquis Warrant”) to
acquire (a)(i) 1,000,000 shares of the Company’s common stock, par value $0.001
per share (“Common Stock”), subject to adjustment, at an initial exercise price
per share of $0.01, and (ii) an unsecured subordinated promissory note in the
original aggregate principal amount of $9,440,000 (the “Marquis Subordinated
Note”), bearing interest at 11% per annum; and Longview acquired (b)(i) an
unsecured promissory note in the original aggregate principal amount of
$2,210,551 (the “Longview Subordinated Note”), bearing interest at 11% per
annum, and (ii) $1,000,000 in cash as principal repayment of the Old Notes
described below.





As part
of the consideration to the Company under the New Securities Exchange Agreement,
Longview agreed to surrender to the Company warrants to acquire 3,000,000 shares
of the Company’s Common Stock at an exercise price of $0.30210709 per share (out
of  that certain Warrant to Purchase Common Stock dated February 14,
2008 to acquire up to 4,958,678 shares of the Company’s Common Stock that
Longview held prior to such transaction) (the “Old Longview Warrant”), and
Longview surrendered to the Company the following notes payable by the Company
in the aggregate outstanding principal amount of $3,000,000 (collectively, the
“Old Longview Notes”): (i) that certain Amended and Restated Senior Secured note
dated February 14, 2008 (amended and restated May 16, 2008); and (ii) that
certain Senior Secured Note dated May 22, 2008.





In
exchange for the Marquis Warrant and the Marquis Subordinated Note, the Company
acquired from Marquis all of the issued and outstanding shares of common stock,
par value $0.001 per share, of NTDS and that certain Ninth Amended and Restated
Senior Secured Note dated October 3, 2008, in the outstanding principal amount
of $8,575,000, plus accrued and unpaid interest of approximately $865,000,
issued by NTDS (the “North Texas Note”).  The North Texas Note was
cancelled upon delivery to the Company.





Contemporaneously
with the closing of the New Securities Exchange Agreement, the Company entered
into a second transaction pursuant to a Securities Purchase Agreement (the
“Securities Purchase Agreement”) between the Company and
Marquis.  Under the Securities Purchase Agreement, the Company issued
and sold to Marquis, and Marquis purchased from the Company, for consideration
of $8,075,000, a senior secured promissory note in the principal amount of
$8,875,000, bearing interest at 13% per annum, subject to certain adjustments
(the “Senior Secured Note”), and a warrant to acquire 1,050,000 shares of Common
Stock at an initial exercise price of $0.01 per share.  As additional
consideration under the Securities Purchase Agreement, the Company also granted
Marquis a limited conveyance of overriding royalty interests (the “Overrides”)
of 3% of the Company’s interest in the hydrocarbon production from all of the
Company’s (i) current oil and gas properties (the “ORRI”) and (ii) oil and gas
properties acquired in the future with $5,000,000 of proceeds (the “Acquisition
Funds”) from the sale of the Senior Secured Note, which sum has been deposited
in the Acquisition Fund Account.  The proceeds from the Securities
Purchase Agreement were used in part to pay $1,000,000 of principal under the
existing indebtedness owed to Longview pursuant to the Old Notes, to fund the
Company’s share of the completion costs of the State Tract 127-1 Unit, and for
general corporate purposes.





Under the
Securities Purchase Agreement, from November 13, 2009 until November 12, 2010,
the Company has the right to purchase from Marquis all (but not less than all)
of the Overrides issued to Marquis prior to November 13, 2009 by delivering to
Marquis, at its election, either Override Warrants (as defined in the Securities
Purchase Agreement) or any combination of Common Override Exchange Shares (as
defined in the Securities Purchase Agreement) and Preferred Override Exchange
Shares (as defined in the Securities Purchase Agreement).  In
connection with the Securities Purchase Agreement, certain subsidiaries of the
Company guaranteed payment of the Senior Secured Note and the Company and
certain of its subsidiaries granted a security interest in substantially all of
their real and personal property to Summerline, as collateral agent for Marquis,
as the secured party, and executed a security agreement, a mortgage, guarantees
and pledges to evidence the same.





The
descriptions of the above agreements are qualified in each case, in their
entirety, by reference to the complete texts of such agreements, which have
previously been filed with the SEC.





Other
Notes





As part
of the acquisition of the Velocity entities, the Company assumed a $75,000
promissory note, plus accrued interest of $8,160, payable to our President and
Chief Executive Officer, which bears interest at 8%, compounded annually
(“Vandenberg Note”).  The Vandenberg Note has been subordinated to the
Senior Secured Note, the Marquis Subordinated Note, and the Longview
Subordinated Note.





Capital
Expenditures and Commitments





Our
commitment to drill an additional well in one of our Matagorda Bay prospects by
July 1, 2008, was met by the commencement of drilling operations of the State
Tract 127-1 Unit Well in late June 2008.  The well was drilled, cased
and temporarily suspended, awaiting completion.  Completion operations
commenced on November 1, 2008, and the well was expected to be on production by
year-end 2008. However, due to sand accumulation, a through tubing gravel pack
in order to produce said well was unsuccessful, and  production from
the State Tract 127-1 Unit Well was never established in either the first or
second quarters of 2009.  Cost overruns incurred by our contract
operator for the State Tract 127-1 Unit Well totaled $2,912,016. Liens totaling
$299,178 have been filed against that well, of which $14,698 would be the
proportionate share net to our working interest.


16





The State
Tract 150-1 ST #1 Well, a side track development well, was commenced in November
2008. Diagnostic well analysis indicated multiple gas and condensate pay zones
in the Bol Mex Formation at depths between 9,300 feet and 10,000 feet so we
cased, cemented, and tested 785 thousand cubic feet per day (MCF/day) of gas and
120 barrels/day of condensate at a flowing tubing pressure of 3,600 PSI on an
8/64 inch choke in a late December 2008 production test at 9,950 feet. The State
Tract 150-1 ST #1 subsequently encountered water from an uphole formation so we
abandoned the zone we had tested and then attempted to recomplete up hole, where
we again encountered water and sand along with as much as 563 MCF/day and 2.1
barrels/day of condensate before this zone was also shut in.  Further
testing and wire line work to determine any future remedial work in the second
quarter of 2009 was unsuccessful.  Cost overruns incurred by our
contract operator for the State Tract 150-1 ST #1 Well totaled
$719,752.  Liens totaling $1,344,163 have been filed against that
well, of which $234,982 would be the proportionate share net to our working
interest.





Off-Balance
Sheet Arrangements





We did
not have any off-balance sheet arrangements as of December 31, 2008, nor as of
June 30, 2009.





Inflation





We do not
believe that inflation has had a significant impact on our operations since
inception.





Item
3. Quantitative and Qualitative Disclosures about Market Risk.





Interest
Rate Risk





Our notes
have fixed interest rates so we are not exposed to changes in interest
rates.





Commodity
Price Risk





Our
revenues, profitability and future growth depend substantially on prevailing
prices for oil and natural gas. Prices also affect the amount of cash flow
available for capital expenditures and our ability to borrow and raise
additional capital, as, if and when needed. Lower prices may also reduce the
amount of oil and natural gas that we can economically produce. We may
periodically use derivative instruments to hedge our commodity price risk,
although we do not currently have any derivative instruments in
place.





Item
4T. Controls and Procedures.





Evaluation of Disclosure Controls
and Procedures





We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our filings with the Securities and
Exchange Commission are recorded, processed, summarized and reported within the
time period specified in the Securities and Exchange Commission’s rules and
forms, and that such information is accumulated and communicated to management,
including our chief executive and chief financial officer, as appropriate,
to allow timely decisions regarding required disclosure based on the definition
of “disclosure controls and procedures” as defined in Rule 13a-15(e) promulgated
under the Securities Exchange Act of 1934.





An
evaluation was carried out under the supervision and with the participation of
our management, including our chief executive officer and chief financial
officer, of the effectiveness of our disclosure controls and procedures as of
the end of the period covered by this report. Based on that evaluation, the
chief executive officer and the chief financial officer concluded that our
disclosure controls and procedures were not effective as of December 31,
2008, due to a material weakness regarding timely filing as reported in
Management’s Annual Report on Internal Control Over Financial Reporting, as of
December 31, 2008, which in management’s opinion has not been remediated as of
June 30, 2009.




Changes in Internal Control Over
Financial Reporting





There
have been no significant changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under
the Exchange Act) during the fiscal quarter to which this report relates that
have materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.





Part
II


OTHER
INFORMATION





Item
1. Legal Proceedings




We
currently are not aware of, or a party to, any legal proceedings. Additionally,
our officers and directors, in their capacity as such, are not a part to any
legal proceedings.


17




Item
1A. Risk Factors





Because
we are a smaller reporting company, we need not provide the information required
by this Item.




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




Not
Applicable.




Item
3. Default upon Senior Securities





The
Company did not make the interest payments of $336,044 that were due at the end
of the second quarter under the Senior Secured Note to Marquis and Summerview,
the Marquis Subordinated Note and the Longview Subordinated Note. The Company is
currently in default under each of these notes for lack of payment, and, in any
event, would be unable to satisfy any debt covenants under any of these notes
even if it had made, or was able to make, any such payments. The Company has not
renegotiated any deferral of payment, restructuring of debt repayment
obligations, or other arrangements to cure these events of default; and
therefore all debt has been reclassified as current.





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





Not
Applicable.





Item
5. Other Information





Not
Applicable





Item
6. Exhibits




Exhibit
                
                Description10.1
                
                June
      2009 Amendment Agreement among the Company, Longview Marquis Master Fund,
      L.P. and other parties named therein, dated as of June 17, 2009
      (incorporated by reference to our Form 8-K/A filed with the Securities and
      Exchange Commission on June, 2009).10.2
                
                Share
      Exchange Agreement between the Company and The Longview Fund, L.P. dated
      July 27, 2009, effective as of November 1, 2008 (incorporated by reference
      to our Form 8-K filed with the Securities and Exchange Commission on July
      29, 2009).31.1
                
                Certification
      of Chief Executive Officer pursuant to Securities Exchange Act of 1934
      Rule 13a-14(a) or 15d-14(a).31.2
                
                Certification
      of Chief Financial Officer pursuant to Securities Exchange Act of 1934
      Rule 13a-14(a) or 15d-14(a).32.1
                
                Joint
      Certification of Chief Executive Officer and Chief Financial Officer
      pursuant to Securities Exchange Act of 1934 Rule 13a-14(b) or 15d-14(b)
      and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002.


18


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.




Dated:
  August 14, 2009




VELOCITY
      ENERGY INC.By:
              /s/
      Donald J. SebastianDonald
      J. SebastianChief
      Financial Officer
                (Principal
      Financial and Accounting
Officer)


19




EXHIBIT
INDEX





Exhibit
                
                Description10.1
                
                June
      2009 Amendment Agreement among the Company, Longview Marquis Master Fund,
      L.P. and other parties named therein, dated as of June 17, 2009
      (incorporated by reference to our Form 8-K/A filed with the Securities and
      Exchange Commission on June, 2009).10.2
                
                Share
      Exchange Agreement between the Company and The Longview Fund, L.P. dated
      July 27, 2009, effective as of November 1, 2008 (incorporated by reference
      to our Form 8-K filed with the Securities and Exchange Commission on July
      29, 2009).31.1
                
                Certification
      of Chief Executive Officer pursuant to Securities Exchange Act of 1934
      Rule 13a-14(a) or 15d-14(a).31.2
                
                Certification
      of Chief Financial Officer pursuant to Securities Exchange Act of 1934
      Rule 13a-14(a) or 15d-14(a).32.1
                
                Joint
      Certification of Chief Executive Officer and Chief Financial Officer
      pursuant to Securities Exchange Act of 1934 Rule 13a-14(b) or 15d-14(b)
      and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002.