**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

Washington, D.C. 20549

 

**FORM 10-Q/A**

**Amendment No. 1**

 

þ  QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended **March 31, 2010**

 

o TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE EXCHANGE ACT

 

For the transition period from _________ to _________

 

Commission File Number: **000-28305**

 

**ENERGY QUEST, INC.**

(Name of Small Business Issuer in its charter)

 

|  

 

**Nevada**

**91-1880015**

(state or other jurisdiction of incorporation or organization)

(I.R.S. Employer I.D. No.)

 

 

**850 South Boulder Hwy, Suite 169**

**Henderson, Nevada**

**89015-7564**

(Address of principal executive offices)

(Zip Code)

**(702) 568-4131**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was require to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  **Yes  ******** ****þ**    No o

 

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

Large accelerated filer   o      Accelerated filer   o     Non-accelerated filer   o     **Smaller reporting company********þ**

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes **   **o      **No   ********þ**

 

**APPLICABLE ONLY TO CORPORATE ISSUERS**

 

As of**May 14, 2010** the registrant had**13,818,294** shares of common stock outstanding.

 

 

                                   
**EXPLANATORY NOTE**

This Form 10-Q/A amends the Form 10-Q for the three months ended March 31, 2010 filed by Energy Quest Inc. (“we”, “us”, “our” or the “Company”) with the Securities and Exchange Commission on May 24, 2010, and restates its unaudited financial statements for the three months ended March 31, 2010, the notes thereto and related disclosure, to reflect an adjustment to the accounting and disclosure of the convertible note issued by us on January 29, 2010. As a result, the unaudited interim financial statements included in the originally filed Form 10-Q should not be relied upon.

On January 29, 2010, the Company completed a financing agreement for $50,000 with a private investor (the “Investor”) and issued a callable convertible note totaling $50,000 (the “Note”). The embedded conversion option contains a reset provision that can cause an adjustment to the conversion price if the Company sells or issues an equity instrument at a price lower than the initial conversion price.  Due to this provision, the embedded conversion option qualifies for derivative accounting.  The Company should have recorded the fair value of this derivative liability on the date of issuance of the Note as well as the change in fair value for each subsequent balance sheet date.  The unaudited financial statements and the notes thereto included herein have been restated to reflect this adjustment, and disclosure of the adjustment has been made to the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. 

Except as stated above, no other information has been changed from the originally filed Form 10-Q and this Form 10-Q/A does not reflect events occurring after the filing of the Form 10-Q.

The Company has included new certifications of its officers pursuant to Sections 302 and 906 of the Sarbanes Oxley Act with this Form 10-Q/A.

**Table of Contents**

**PART I - FINANCIAL INFORMATION**

**3**

ITEM 1. FINANCIAL STATEMENTS.

3

ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION / PLAN OF OPERATIONS.

4

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS.

8

ITEM 4. CONTROL AND PROCEDURES.

9

ITEM 4T. CONTROL AND PROCEDURES.

9

 

 

**PART II – OTHER INFORMATION**

**10**

ITEM 1. LEGAL PROCEEDINGS.

10

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES.

10

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

10

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

10

ITEM 5. OTHER INFORMATION.

10

ITEM 6. EXHIBITS.

11

 

 

 

2
                               **PART I - FINANCIAL INFORMATION**
**ITEM 1.  Financial Statements.**

Our unaudited interim consolidated financial statements are stated in US dollars and are prepared in accordance with United States Generally Accepted Accounting Principles.  All dollar amounts in this report refer to US dollars unless otherwise indicated.  When we refer to Energy Quest, we, our or us, we are referring to Energy Quest Inc.

 

 

**Energy Quest Inc.**

** **

**(A Development Stage Company)**

 

 

 

 

 

March 31, 2010

 

 

 

 

Index

Consolidated Balance Sheets (Unaudited)

F-1

 

 

Consolidated Statements of Operations and Other Comprehensive Loss (Unaudited)

F-2

 

 

Consolidated Statements of Cash Flows (Unaudited)

F-3

 

 

Notes to the Consolidated Financial Statements

F-4

 

 

 

3
                               
**Energy Quest Inc.**

**(A Development Stage Company)**

**Consolidated Balance Sheets**

**(Unaudited)**

 

March 31,

2010 

(Restated)

December 31,

2009 

Assets

 

 

 

 

 

Current Assets 

 

 

 

 

 

Cash 

$               181 

$             816 

Deferred Financing Cost 

2,033 

– 

 

 

 

Total Current Assets 

2,214 

816 

 

 

 

Intangible Assets, net 

2,744,594 

2,781,224 

 

 

 

Total Assets 

2,746,808 

2,782,040 

 

 

 

 

 

 

Liabilities and Stockholders' Equity 

 

 

 

 

 

Current Liabilities 

 

 

 

 

 

Accounts payable and accrued liabilities 

37,395 

36,294 

Amounts due to related parties 

561,582 

516,881 

Notes payable– related parties 

35,722 

35,298 

Convertible note, net 

11,111 

– 

Derivative liabilities

140,413

– 

 

 

 

Total Liabilities 

786,223 

588,473 

 

 

 

Stockholders' Equity 

 

 

 

 

 

Preferred Stock 

 

 

Authorized: 1,000,000 shares, with a $0.01 par value;

none issued or outstanding 

– 

– 

 

 

 

Common Stock 

 

 

Authorized:  200,000,000 shares, with a $0.001 par value;

Issued:  13,818,294 shares 

13,818 

13,818 

 

 

 

Additional Paid-in Capital 

8,663,596 

8,663,596 

 

 

 

Accumulated Other Comprehensive Income 

4,820 

3,946 

 

 

 

Deficit Accumulated During the Development Stage 

(6,721,649)

(6,487,793)

 

 

 

Total Stockholders’ Equity 

1,960,585 

2,193,567 

 

 

 

Total Liabilities and Stockholders’ Equity 

$     2,746,808 

$    2,782,040 

  

 

 

 

 

F-1
                               
**Energy Quest Inc.**

**(A Development Stage Company)**

**Consolidated Statements of Operations and Other Comprehensive Loss**

**(Unaudited)**

 

 

For the Three

Months Ended

March 31,

2010 

(Restated)

 

For the Three

Months Ended

March 31,

2009 

Period from

December 14, 2004

(Date of Inception) to

March 31,

2010 

(Restated)

Revenue

 

$               – 

 

$               – 

$              5,164 

 

 

 

 

 

 

Expenses 

 

 

 

 

 

 

 

 

 

 

 

Consulting and management fees 

 

75,000 

 

102,875 

5,216,394 

General and administrative 

 

6,263 

 

7,088 

430,550 

Professional fees 

 

10,385 

 

16,720 

451,333 

Research and development 

 

1,500 

 

– 

266,494 

Depreciation, depletion, and impairment 

 

37,500 

 

37,500 

285,577 

Loss on theft of cash 

 

– 

 

– 

80,000 

 

 

 

 

 

 

 

 

130,648 

 

164,183 

6,730,348 

 

 

 

 

 

 

Loss from operations: 

 

(130,648)

 

(164,183)

(6,725,184)

 

 

 

 

 

 

Interest income 

 

– 

 

– 

2,089 

Interest expense 

 

(1,217)

 

(573)

(12,644)

Gain on settlement of former shareholder advances 

 

– 

 

– 

310,003 

Accretion of convertible debt discount 

 

(11,111)

 

– 

(11,111)

Loss on derivative financial instruments

(90,413)

– 

(90,413)

Financing Cost 

 

(467)

 

– 

(467)

Loss on write-off of loan receivable 

 

– 

 

– 

(193,922)

 

 

 

 

 

 

Net loss 

 

(233,856)

 

(164,756)

(6,721,649)

 

 

 

 

 

 

Other comprehensive income 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment 

 

874 

 

20 

4,820 

 

 

 

 

 

 

Total Comprehensive Loss 

 

$  (232,982)

 

$  (164,736)

$      (6,716,829)

 

 

 

 

 

 

Net Loss Per Share– Basic and Diluted 

 

$        (0.02)

 

$        (0.02)

 

 

 

 

 

 

 

Weighted Average Shares Outstanding–

Basic and Diluted 

 

13,818,000 

 

9,555,000 

 

 

 

 

 

 

 

 

 

F-2
                               
**Energy Quest Inc.**

**(A Development Stage Company)**

**Consolidated Statements of Cash Flows**

**(Unaudited)**

 

For the Three

Months Ended

March 31,

2010 

(Restated)

For the Three

Months Ended

March 31,

2009 

Accumulated from

December 14, 2004

(Date of Inception) to

March 31,

2010 

(Restated)

Cash Flows Used In Operating Activities 

 

 

 

Net loss 

$        (233,856)

$    (164,756)

$ (6,721,649)

 

 

 

 

Adjustments to reconcile net loss to net cash used in operating activities: 

 

 

 

Accretion of convertible debt discount 

11,111 

– 

11,111 

Shares issued for services 

– 

60,375 

4,571,306 

Loss on shares issued for amounts due related parties 

– 

– 

15,976 

Loss on theft of cash 

– 

– 

80,000 

Loss on write-off of loan receivable 

– 

– 

193,922 

Loss on derivatives

90,413

– 

90,413

Amortization of intangible assets 

37,500 

37,500 

285,577 

Gain on settlement of former shareholder advances 

– 

– 

(310,003)

Amortization of deferred financing cost 

467 

– 

467 

 

 

 

 

Changes in operating assets and liabilities: 

 

 

 

Accounts payable and accrued liabilities 

1,525 

4,902 

24,010 

Due to related parties 

44,701 

38,970 

876,002 

 

 

 

 

Net Cash Used in Operating Activities 

(48,139)

(23,009)

(882,868)

 

 

 

 

Investing Activities 

 

 

 

Loan receivable 

– 

– 

(193,922)

Net cash acquired on business acquisition 

– 

– 

565 

Change in restricted cash 

– 

– 

(80,000)

Purchase of intangible assets 

– 

– 

(25,000)

 

 

 

 

Net Cash Used In Investing Activities 

– 

– 

(298,357)

 

 

 

 

Financing Activities 

 

 

 

Proceeds from issuance of common stock 

– 

– 

644,307 

Payment of deferred financing cost 

(2,500)

_ 

(2,500)

Proceeds from convertible note 

50,000 

– 

50,000 

Proceeds from notes payable 

– 

29,649 

518,214 

Re-payment of note payable 

– 

(6,808)

(28,005)

 

 

 

 

Net Cash Provided By Financing Activities 

47,500 

22,841 

1,182,016 

 

 

 

 

Effect of Exchange Rate Changes on Cash 

4 

– 

(610)

 

 

 

 

Increase (decrease) in Cash and Cash Equivalents 

(635)

(168)

181 

 

 

 

 

Cash and Cash Equivalents, beginning 

816 

792 

– 

 

 

 

 

Cash and Cash Equivalents, end 

$                 181 

$             624 

$        181 

 

 

 

 

 

 

 

 

Supplemental Disclosures 

 

 

 

 

 

 

 

Cash paid for taxes 

$                     – 

$                 – 

$                  – 

Cash paid for interest 

– 

– 

– 

 

 

 

 

Non-Cash Activities 

 

 

 

 

 

 

 

Common stock issued for intangible assets 

$                    – 

$                 – 

$    3,000,204 

Common stock issued for stock payable 

– 

– 

161,550 

Common stock issued for amounts due to related parties 

– 

– 

360,954 

Debt Discount 

50,000 

- 

50,000

 

 

 

F-3
                               
**Energy Quest Inc.**

**(A Development Stage company)**

**Notes to the Unaudited Consolidated Financial Statements**

1.    Basis of Presentation

The accompanying unaudited interim consolidated financial statements of Energy Quest, Inc. (“Energy Quest”), have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission, and should be read in conjunction with the audited consolidated financial statements and notes thereto contained in Energy Quest’s Annual Report filed with the SEC on Form 10-K.  In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein.  The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.  Notes to the consolidated financial statements which substantially duplicate the disclosure contained in the audited consolidated financial statements for fiscal 2009 as reported in the Form 10-K have been omitted.

 

2.    Going Concern

These consolidated financial statements have been prepared on the assumption that the company is a going concern, meaning it will continue in operation for the foreseeable future and will be able to realize assets and discharge liabilities in the ordinary course of operations.  Different bases of measurement may be appropriate when a company is not expected to continue operations for the foreseeable future.  The company’s continuation as a going concern is dependent upon its ability to attain profitable operations and generate funds there-from, and/or raises equity capital or borrowings sufficient to meet current and future obligations.  Management plans to raise equity financings over the next twelve months to finance operations.  There is no guarantee that the company will be able to complete any of these objectives.  The company has incurred losses from operations since inception and at March 31, 2010, has a working capital deficiency and an accumulated deficit that creates substantial doubt about the company’s ability to continue as a going concern.

 

3.    Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2010-06, Improving Disclosures about Fair Value Measurements (ASU 2010-06).  This update provides amendments to Subtopic 820-10 and requires new disclosures for 1) significant transfers in and out of Level 1 and Level 2 and the reasons for such transfers and 2) activity in Level 3 fair value measurements to show separate information about purchases, sales, issuances and settlements.  In addition, this update amends Subtopic 820-10 to clarify existing disclosures around the disaggregation level of fair value measurements and disclosures for the valuation techniques and inputs utilized (for Level 2 and Level 3 fair value measurements).  The provisions in ASU 2010-06 are applicable to interim and annual reporting periods beginning subsequent to December 15, 2009, with the exception of Level 3 disclosures of purchases, sales, issuances and settlements, which will be required in reporting periods beginning after December 15, 2010.  The adoption of ASU 2010-06 did not impact the Company’s operating results, financial position or cash flows, but did impact the Company’s disclosures on fair value measurements.  See Note 6, “Fair Value Measurements.”

In February 2010, FASB issued ASU No. 2010-09, Amendments to Certain Recognition and Disclosure Requirements (ASU 2010-09).  This update amends Subtopic 855-10 and gives a definition to SEC filer, and requires SEC filers to assess for subsequent events through the issuance date of the financial statements.  This amendment states that an SEC filer is not required to disclose the date through which subsequent events have been evaluated for a reporting period.  ASU 2010-09 becomes effective upon issuance of the final update.  The Company adopted the provisions of ASU 2010-09 for the period ended March 31, 2010.

In April 2010, the FASB issued ASU No. 2010-12, Accounting for Certain Tax Effects of the 2010 Health Care Reform Acts (ASU 2010-12).  This update clarifies questions surrounding the accounting implications of the different signing dates of the Health Care and Education Reconciliation Act (signed March 30, 2010) and the Patient Protection and Affordable Care Act (signed March 23, 2010).  ASU 2010-12 states that the FASB and the Office of the Chief Accountant at the SEC would not be opposed to view the two Acts together for accounting purposes.  The Company is currently assessing the impact, if any, the adoption of ASU 2010-12 will have on the Company’s disclosures, operating results, financial position and cash flows.

 

 

 

F-4
                               
**Energy Quest Inc.**

**(A Development Stage company)**

**Notes to the Unaudited Consolidated Financial Statements**

 

 

4.     Restatements

On May 18, 2010, the Company identified an error in its financial statements included in the Company’s Form 10-K filed with the SEC on April 14, 2009.The error related to an extinguishment of debt recorded in the fourth quarter of 2008.The extinguishment was recorded in connection with an agreement with a related party. Pursuant to the agreement, the Company agreed to issue 2,982,021 shares of common stock in relief of debt and accrued consulting fees of $241,120 and $86,903, respectively. However, the shares were issued and delivered to the related party subsequent to December 31, 2008.Consequently, the debt was not extinguished as of December 31, 2008 and the 2008 Consolidated Balance Sheet and Consolidated Statement of Changes in Stockholders’ Equity (Deficit), both of which were included in the Company’s Annual Report on Form 10-K filed with the SEC on April 14, 2009, were misstated. In addition, the 2009 Consolidated Statement of Changes in Stockholders’ Equity (Deficit), which was included in the Company’s Annual Report on Form10-K filed with the SEC on April 12, 2010, was misstated. The December 31, 2009 ending balance sheet included in the Company’s Annual Report on Form 10-K, as well as the 2009 balance sheet presented in this filing, were unaffected by the restatements.

The Company identified an error relating to the accounting for the convertible note described in Note 6 in its financial statements included in the Company’s Form 10-Qs filed with the SEC on May 24, 2010 and August 16, 2010.  The Company had previously recognized a beneficial conversion feature as additional paid-in capital.  After further review, the Company has determined that the conversion feature should have been classified as derivative liability pursuant to ASC 815-15, Determining Whether an Instrument (or Embedded Feature) is indexed to an Entity’s Own Stock.  The Company intends to restate its financial results for the interim fiscal periods ending March 31, 2010 and June 30, 2010 to reflect the derivative liability.

The Company is restating the March 31, 2010 financial statements due to an error in the accounting for the conversion features embedded in the convertible note described in Note 6. The Company had previously recognized a beneficial conversion feature as additional paid-in capital.  After further review, the Company has determined that the conversion feature should have been classified as derivative liability.   The Company has corrected the accounting and recorded the fair value of the derivative liability on the date of issuance and the change in fair value for each subsequent balance sheet date.

The following tables reflect the adjustment and restated amounts: 

 

March 31, 2010

As Previously

Reported

$

Adjustment

$

 

March 31, 2010

As Restated

$

Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

Convertible note, net

21,090

(9,979)

(c)

11,111

Derivative liabilities

–

81,995

(a)

 

 

 

58,418

(b)

140,413

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

 

 

 

 

Additional Paid-in Capital

8,696,929

(33,333)

(a)

8,663,596

 

 

 

 

 

Retained Earnings

(6,624,548)

(97,101)

(a)

(6,721,649)

 

 

 

 

 

 

 

Period from

December 14, 2004

(Date of Inception) to

March 31, 2010

As Previously

Reported

$

Adjustment

$

 

Period from

December 14, 2004

(Date of Inception) to

March 31, 2010

As Restated

$

Consolidated Statements of Operations and Other Comprehensive Loss

 

 

 

 

 

 

 

 

 

Accretion of convertible debt discount

(4,423)

(6,688)

(c)

(11,111)

Loss on derivative financial instruments

–

(31,995)

(a)

 

 

 

(58,418)

(b)

(90,413)

 

 

 

 

 

Net Loss

(6,624,548)

(6,688)

(c)

 

 

 

(31,995)

(a)

 

 

 

(58,418)

(b)

(6,721,649)

 

 

 

 

 

Total Comprehensive Loss

(6,619,728)

(6,688)

(c)

 

 

 

(31,995)

(a)

 

 

 

(58,418)

(b)

(6,716,829)

 

 

 

 

 

 

 

For the Three Months

Ended

March 31, 2010

As Previously

Reported

$

Adjustment

$

 

For the Three Months

Ended

March 31, 2010

As Restated

$

Consolidated Statements of Operations and Other Comprehensive Loss

 

 

 

 

 

 

 

 

 

Accretion of convertible debt discount

(4,423)

(6,688)

(a)

(11,111)

Loss on derivative financial instruments

–

(31,995)

(a)

 

 

 

(58,418)

(b)

(90,413)

 

 

 

 

 

Net Loss

(136,755)

(6,688)

(c)

 

 

 

(31,995)

(a)

 

 

 

(58,418)

(b)

(233,856)

 

 

 

 

 

Total Comprehensive Loss

(135,881)

(6,688)

(c)

 

 

 

(31,995)

(a)

 

 

 

(58,418)

(b)

(232,982)

 

 

 

 

 

Loss per share

(0.01)

(0.01)

 

(0.02)

 

(a)   To record fair value of derivative liabilities upon issuance of convertible notes.

(b)   To record change in fair value of the derivative liability.

(c)   To adjust discount and accretion.  

5.     Related Party Transactions

The following details amounts due to related parties at March 31, 2010:

a)    At March 31, 2010, the Company owes its Secretary $132,618 (December 31, 2009 - $152,916).

b)    During the three months period ended March 31, 2010, the Company recorded $75,000 (2009 - $37,500) for management services provided by its President. At March 31, 2010, $428,964 (December 31, 2009 - $363,964) is included in due to related parties.

The following details Notes payable – related parties:

c)     During the three month period ended March 31, 2010, the Company received an advance of $Nil (2009 - $14,722) from a related party consultant. At March 31, 2010, this amount is included in note payable – related party, and the related accrued interest of $238 (2009 - $39) is included in accrued liabilities.

d)    On November 5, 2007, the Company received $21,000 in exchange for a promissory note payable. The note bears interest at 6% per annum, calculated annually, and is due on demand. At March 31, 2010, accrued interest of $311 (2009 - $311) is included in accrued liabilities.

6.     Convertible Debt

On January 29, 2010, the Company completed a financing agreement for $50,000 with a private investor (the “Investor”) and issued a callable convertible note totaling $50,000 with 8% interest rate, 22% interest rate upon default and a maturity of nine months (the “Note”). The Company paid a finders’ fee of $2,500. The note is convertible into shares of common stock at 55% of the average of the lowest three closing prices for the Company’s shares of common stock during the ten trading day period ending one trading day prior to the date the conversion notice is sent by the investor to the borrower.

The embedded conversion option contains a reset provision that can cause an adjustment to the conversion price if the Company sells or issues an equity instrument at a price lower than the initial conversion price.  Due to this provision, the embedded conversion option qualifies for derivative accounting under ASC 815-15 (See Note 8 below).  This fair value of the derivative liability at issuance of $81,995 resulted in a full discount to the note payable and a loss on the fair value of derivatives of $31,995.  

The carrying value of the convertible note is to be accreted over the term of the convertible note up to their face value of $50,000. As at March 31, 2010, the carrying values of the convertible note and accrued convertible interest payable thereon were $11,111 and $669, respectively.

For the three months ended March 31, 2010, the Company recorded $11,111 as the accretion of interest expense on the convertible note and recorded the cost associated with obtaining the convertible note as deferred financing cost of $2,500 on February 8, 2010. As of March 31, 2010, the Company recorded $467 on amortization of deferred financing cost.

 

 

 

F-5
                               
**Energy Quest Inc.**

**(A Development Stage company)**

**Notes to the Unaudited Consolidated Financial Statements**

 

 

7.     Fair Value Measurements

ASC 825 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.

Fair Value Hierarchy

ASC 825 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. ASC 825 establishes three levels of inputs that may be used to measure fair value.

Level 1 applies to assets and liabilities for which there are quoted prices in active markets for identical assets or liabilities. Valuations are based on quoted prices that are readily and regularly available in an active market and do not entail a significant degree of judgment.

Level 2 applies to assets and liabilities for which there are other than Level 1 observable inputs such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets), or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data. Level 2 instruments require more management judgment and subjectivity as compared to Level 1 instruments. For instance: determining which instruments are most similar to the instrument being priced requires management to identify a sample of similar securities based on the coupon rates, maturity, issuer, credit rating and instrument type, and subjectively select an individual security or multiple securities that are deemed most similar to the security being priced; and determining whether a market is considered active requires management judgment.

Level 3 applies to assets and liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities. The determination of fair value for Level 3 instruments requires the most management judgment and subjectivity.

Pursuant to ASC 825, the fair values of the cash equivalents and investment securities are determined based on “Level 1” inputs, which consist of quoted prices in active markets for identical assets. Convertible notes payable are valued based on “Level 2” inputs, consisting of quoted prices in less active markets. Embedded derivatives are carried at fair value. The fair value amounts in current period earnings associated with the Company’s derivatives resulted from Level 2 fair value methodologies; that is, the Company is able to value the assets and liabilities based on observable market data for similar instruments. This observable data includes the quoted market prices and estimated volatility factors. The Company believes that the recorded values of all of the other financial instruments approximate their current fair values because of their nature and respective relatively short maturity dates or durations.

 

8.     Derivative Liability

ASC 815-15lays out a procedure to determine if an equity linked financial instrument (or embedded feature) is indexed to its own common stock.

Convertible Debt - The embedded conversion option in the Company’s $50,000 note described in Note 6 contains a reset provision that can cause an adjustment to the conversion price if the Company sells or issues an equity instrument at a price lower than the initial conversion price. The fair value of these liabilities will be re-measured at the end of every reporting period and the change in fair value will be reported in our consolidated statement of operations as a gain or loss on derivative financial instruments.

The following table summarizes the change in derivative liabilities for the three months ended March 31, 2010:

Derivative Liabilities at December 31, 2009

$–

Addition of new derivative liabilities 

81,995

Change in fair value of embedded conversion option

58,418

Derivative Liabilities at March 31, 2010

$      140,413

The following table summarizes the loss on derivatives for the three months ended March 31, 2010:

Fair value of derivative liabilities in excess of note proceeds received 

$         31,995

Change in fair value of derivative liabilities at March 31, 2010

58,418

Loss on derivative liabilities

$          90,413

The Company used the Black-Scholes option pricing model to value the embedded conversion feature using the following assumptions: number of options as set forth in the convertible note agreements; no expected dividend yield; expected volatility ranging from 428% - 534%; risk-free interest rates ranging from 0.15% - 0.24% and expected terms based on the contractual term.

 

 

 

F-6
                               
**ITEM 2.  Management Discussion and Analysis of Financial Condition and Results of Operations.  **

**Safe Harbor Statement**

This report on Form 10-Q contains certain forward-looking statements.  All statements other than statements of historical fact are “forward-looking statements” for purposes of these provisions, including any projections of earnings, revenues, or other financial items; any statements of the plans, strategies, and objectives of management for future operation; any statements concerning proposed new products, services, or developments; any statements regarding future economic conditions or performance; statements of belief; and any statement of assumptions underlying any of the foregoing. Such forward-looking statements are subject to inherent risks and uncertainties, and actual results could differ materially from those anticipated by the forward-looking statements.

These forward-looking statements involve significant risks and uncertainties, including, but not limited to, the following: competition, promotional costs, and risk of declining revenues.  Our actual results could differ materially from those anticipated in such forward-looking statements as a result of a number of factors.  These forward-looking statements are made as of the date of this filing, and we assume no obligation to update such forward-looking statements.  The following discusses our financial condition and results of operations based upon our consolidated financial statements which have been prepared in conformity with accounting principles generally accepted in the United States.  It should be read in conjunction with our financial statements and the notes thereto included elsewhere herein.

The following discussion should be read in conjunction with our consolidated financial statements, including the notes thereto, appearing elsewhere in this Form 10-Q.  The discussions of results, causes and trends should not be construed to imply any conclusion that these results or trends will necessarily continue into the future.

**Restatements**

On May 18, 2010, the Company identified an error in its financial statements included in the Company’s Form 10-K filed with the SEC on April 14, 2009. The error related to an extinguishment of debt recorded in the fourth quarter of 2008. The extinguishment was recorded in connection with an agreement with a related party. Pursuant to the agreement, the Company agreed to issue 2,982,021 shares of common stock in relief of debt and accrued consulting fees of $241,120 and $86,903, respectively. However, the shares were issued and delivered to the related party subsequent to December 31, 2008. Consequently, the debt was not extinguished as of December 31, 2008 and the 2008 Consolidated Balance Sheet and Consolidated Statement of Changes in Stockholders’ Equity (Deficit), both of which were included in the Company’s Annual Report on Form 10-K filed with the SEC on April 14, 2009, were misstated. In addition, the 2009 Consolidated Statement of Changes in Stockholders’ Equity (Deficit), which was included in the Company’s Annual Report on Form 10-K filed with the SEC on April 12, 2010, was misstated. The December 31, 2009 ending balance sheet included in the Company’s Annual Report on Form 10-K, as well as the 2009 balance sheet presented in this filing, were unaffected by the restatements.

The Company identified an error relating to the accounting for the convertible note described in Note 6 in its financial statements included in the Company’s Form 10-Qs filed with the SEC on May 24, 2010 and August 16, 2010.  The Company had previously recognized a beneficial conversion feature as additional paid-in capital.  After further review, the Company has determined that the conversion feature should have been classified as derivative liability pursuant to ASC 815-15, Determining Whether an Instrument (or Embedded Feature) is indexed to an Entity’s Own Stock.  The Company intends to restate its financial results for the interim fiscal periods ending March 31, 2010 and June 30, 2010 to reflect the derivative liability.

 

**Overview**

 

We are engaged in the development and production of hydrogen-enriched alternative fuels.  We plan to employ gasification technologies and catalytic conversion processes to produce clean fuels.  We design, build, lease and in some cases operate the gasification technologies with broad potential application within the energy field.  Our various technologies allow for the use of steam for reformation of coal and other carbonaceous feedstocks, conversion of waste solid fuel sources into gaseous form and allow for incineration of waste in an environmentally friendly manner.

 

We have one wholly-owned subsidiary, Syngas Energy Corp., and its principal business involves an integrated gasification production system technology that combines modern gasification with turbine technologies to produce synthetic gas, hydrogen or electricity.

 

 

 

4
                               
**Liquidity and Capital Resources**

As of March 31, 2010, we had cash of $181 and a working capital deficiency of $784,009.  As of March 31, 2010 our accumulated deficit was $6,721,649.  For the three months ended March 31, 2010 our net loss was $233,856 compared to $164,756 during the same period in 2009. 

Our loss was funded by proceeds from shareholder loans.  During the three months ended March 31, 2010, we raised in net proceeds $50,000 through financing activities and our cash position decreased by $635. 

We used net cash of $48,139 in operating activities for the three months ended March 31, 2010 compared to net cash of $23,009 in operating activities for the same period in 2009.  We did not use any money in investing activities for the three months ended March 31, 2010 nor did we use any money for investing activities during the same period in 2009.  The effect of exchange rates on cash was an increase in cash of $4 for the three months ended March 31, 2010 compared to an increase of $nil during three months ended March 31, 2009.

During the three months ended March 31, 2010 our monthly cash requirement was approximately $16,046, compared to approximately $7,670 for the same period in 2009.  We expect to require a total of approximately $26,585,000 to fully carry out our business plan over the next twelve months beginning June 2010 as set out in this table: 

 

 

**Description**  

**Estimated Expense**

Marketing our gasification technologies 

$200,000

Continued improvement of our PyStRTM and other technologies 

$1,200,000

Further commercializing our gasification technologies 

$400,000

Manufacturing of Modular Bio-energy units 

$400,000

Payment of accounts payable and accrued liabilities   

$250,000

General and administrative expenses 

$500,000

Professional fees 

$100,000

Consulting fees 

$200,000

Investor relations expenses 

$100,000

Patent application costs (including legal fees) 

$100,000

Heavy Oil Upgrader Plant (Northern Alberta Oil)

$23,135,000

**Total**  

**$26,585,000**

 

 

 

5
                               
We intend to meet our cash requirements for the next 12 months through external sources: a combination of debt financing and equity financing through private placements.  We are currently not in good short-term financial standing.  We anticipate that we may not generate any revenues in the near future and we will not have enough positive internal operating cash flow until we can generate substantial revenues, which may take the next few years to fully realize.  There is no assurance we will achieve profitable operations.  We have historically financed our operations primarily by cash flows generated from the sale of our equity securities and through cash infusions from officers and outside investors in exchange for debt and/or common stock.

These consolidated financial statements have been prepared on the assumption that the company is a going concern, meaning it will continue in operation for the foreseeable future and will be able to realize assets and discharge liabilities in the ordinary course of operations.  Different bases of measurement may be appropriate when a company is not expected to continue operations for the foreseeable future.  The company’s continuation as a going concern is dependent upon its ability to attain profitable operations and generate funds there-from, and/or raises equity capital or borrowings sufficient to meet current and future obligations.  Management plans to raise equity financings over the next twelve months to finance operations.  There is no guarantee that the company will be able to complete any of these objectives.  The company has incurred losses from operations since inception and at March 31, 2010, have a working capital deficiency and an accumulated deficit that creates substantial doubt about the company’s ability to continue as a going concern.

We intend to raise the funds to meet our cash requirements (approximately $26,585,000) from private placements, loans, or possibly a registered public offering (either self-underwritten or through a broker-dealer) within the next few months.  At this time we do not have any commitments from any broker-dealer to provide us with financing.  There is no guarantee that we will be successful in raising any capital.  There is no assurance that we will be able to obtain such additional funds on favorable terms, if at all.  If we fail in raising capital, our business may fail and we may curtail or cease our operations.   

 

**Results of Operations for the three months ended March 31, 2010 compared to the three months ended March 31, 2009 and from inception to March 31, 2010.**

 

*Limited Revenues*

 

Since our inception on December 14, 2004 to March 31, 2010, we have earned limited revenue of $5,164.  As of March 31, 2010, we have an accumulated deficit of $6,721,649 and we did not earn any revenues during the three months ending on March 31, 2010.  At this time, our ability to generate any significant revenues continues to be uncertain.  Our financial statements contain an additional explanatory paragraph in Note 2, which identifies issues that raise substantial doubt about our ability to continue as a going concern.  Our financial statements do not include any adjustment that might result from the outcome of this uncertainty.

 

 

 

6
                               
*Net Loss*

We incurred a net loss of $233,856 for the three months ended March 31, 2010, compared to a net loss of $164,756 for the same period in 2009.  From inception on December 14, 2004 to March 31, 2010, we have incurred a net loss of $6,721,649.  Our basic and diluted loss per share was $0.02 for the three months ended March 31, 2010, and $0.02 for the same period in 2009. 

*Expenses*

Our total operating expenses decreased from $164,183 to $130,648 for the three months ended March 31, 2010 compared to the same period in 2009.  This decrease in expenses is mostly due to lower consulting and management fees.  Since our inception on December 14, 2004 to March 31, 2010, we have incurred total operating expenses of $6,730,348.

 

Our consulting and management fees decreased $27,875 from $102,875 to $75,000 for the three months ended March 31, 2010 compared to the same period in 2009.  Since our inception on December 14, 2004 until March 31, 2010 we have spent $5,216,394 on consulting and management fees.

 

Our general and administrative expenses consist of bank charges, travel, meals and entertainment, office maintenance, communication expenses (internet, fax, and telephone), courier, postage costs, office supplies.  Our general and administrative expenses decreased $825 from $7,088 to $6,263 for the three months ended March 31, 2010 compared to the same period in 2009.  Since our inception on December 14, 2004 until March 31, 2010 we have spent $430,550 on general and administrative expenses.

 

We spent $1,500 on research and development expenses for the three months ended March 31, 2010 compared to $nil spent on research and development during the three months ended March 31, 2009.  Since our inception on December 14, 2004 until March 31, 2010 we have spent $266,494 on research and development.  Going forward, we anticipate that we will spend approximately $1,600,000 on research and development during the next 12 months. 

* *

Our professional fees, consisting primarily of legal, accounting and auditing fees, decreased by $6,335 to $10,385 for the three months ended March 31, 2010 from $16,720 for the same period in 2009, mainly due to decreased legal and auditing services provided in the three month periods ended March 31, 2010.

We incurred $11,111 of interest expense relating to the convertible note during the three month period ended March 31, 2010 compared to $nil during the three months ended March 31, 2009.  We also incurred a loss of $90,413on the change in the fair value of derivative liabilities during the three month period ended March 31, 2010 compared to $nil during the three months ended March 31, 2009.

**Inflation**

The amounts presented in the financial statements do not provide for the effect of inflation on our operations or financial position.  The net operating losses shown would be greater than reported if the effects of inflation were reflected either by charging operations with amounts that represent replacement costs or by using other inflation adjustments.

 

 

 

7
                               
**Off-Balance Sheet Arrangements**

As of March 31, 2010, we had no off-balance sheet transactions that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

**Recent Accounting Pronouncements**  

In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2010-06, Improving Disclosures about Fair Value Measurements (ASU 2010-06). This update provides amendments to Subtopic 820-10 and requires new disclosures for 1) significant transfers in and out of Level 1 and Level 2 and the reasons for such transfers and 2) activity in Level 3 fair value measurements to show separate information about purchases, sales, issuances and settlements. In addition, this update amends Subtopic 820-10 to clarify existing disclosures around the disaggregation level of fair value measurements and disclosures for the valuation techniques and inputs utilized (for Level 2 and Level 3 fair value measurements). The provisions in ASU 2010-06 are applicable to interim and annual reporting periods beginning subsequent to December 15, 2009, with the exception of Level 3 disclosures of purchases, sales, issuances and settlements, which will be required in reporting periods beginning after December 15, 2010. The adoption of ASU 2010-06 did not impact the Company’s operating results, financial position or cash flows, but did impact the Company’s disclosures on fair value measurements. See Note 6, “Fair Value Measurements.”

In February 2010, FASB issued ASU No. 2010-09, Amendments to Certain Recognition and Disclosure Requirements (ASU 2010-09). This update amends Subtopic 855-10 and gives a definition to SEC filer, and requires SEC filers to assess for subsequent events through the issuance date of the financial statements. This amendment states that an SEC filer is not required to disclose the date through which subsequent events have been evaluated for a reporting period. ASU 2010-09 becomes effective upon issuance of the final update. The Company adopted the provisions of ASU 2010-09 for the period ended March 31, 2010.

In April 2010, the FASB issued ASU No. 2010-12, Accounting for Certain Tax Effects of the 2010 Health Care Reform Acts (ASU 2010-12). This update clarifies questions surrounding the accounting implications of the different signing dates of the Health Care and Education Reconciliation Act (signed March 30, 2010) and the Patient Protection and Affordable Care Act (signed March 23, 2010). ASU 2010-12 states that the FASB and the Office of the Chief Accountant at the SEC would not be opposed to view the two Acts together for accounting purposes. The Company is currently assessing the impact, if any, the adoption of ASU 2010-12 will have on the Company’s disclosures, operating results, financial position and cash flows.

**Related Party Transactions**  

The following details amounts due to related parties at March 31, 2010:

a.      At March 31, 2010, the Company owes the Secretary of the Company $132,618 (December 31, 2009 - $152,916).

b.      During the three months period ended March 31, 2010, the Company recorded $75,000 (2009 - $37,500) for management services provided by the President of the Company. At March 31, 2010, $428,964 (December 31, 2009 - $363,964) is included in due to related parties. 

 

The following details Notes payable – related parties:

c.      During the three month period ended March 31, 2010, the Company received an advance of $Nil (2009 - $14,722) from a related party consultant. At March 31, 2010, this amount is included in note payable – related party, and the related accrued interest of $238 (2009 - $39) is included in accrued liabilities.

d.      On November 5, 2007, the Company received $21,000 in exchange for a promissory note payable. The note bears interest at 6% per annum, calculated annually, and is due on demand. At March 31, 2010, accrued interest of $311 (2009 - $311) is included in accrued liabilities.

**ITEM 3.  Quantitative and Qualitative Disclosure About Market Risks.**

Not applicable.

 

 

 

8
                               **ITEM 4.  Control and Procedures.**
 

Not applicable

**ITEM 4T.  Control and Procedures.**

Disclosure controls and procedures have been designed to ensure that information required to be disclosed by the Company is collected and communicated to management to allow timely decisions regarding required disclosures.  The Chief Executive Officer and the Chief Financial Officer have concluded, based on their evaluation as of March 31, 2010 that, as a result of the following material weaknesses in internal control over financial reporting as described further in our Annual Report on Form 10-K filed with the SEC on April 12, 2010, disclosure controls and procedures were not effective in providing reasonable assurance that material information is made known to them by others within the Company:

a)    We did not maintain sufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of generally accepted accounting principles commensurate with our complexity and our financial accounting and reporting requirements.  We have limited experience in the areas of financial reporting and disclosure controls and procedures.  Also, we do not have an independent audit committee.  As a result, there is a lack of monitoring of the financial reporting process and there is a reasonable possibility that material misstatements of the consolidated financial statements, including disclosures, will not be prevented or detected on a timely basis; and

b)    Due to our small size, we do not have a proper segregation of duties in certain areas of our financial reporting process.  The areas where we have a lack of segregation of duties include cash receipts and disbursements, approval of purchases and approval of accounts payable invoices for payment.  This control deficiency, which is pervasive in nature, results in a reasonable possibility that material misstatements of the financial statements will not be prevented or detected on a timely basis.

**Changes in Internal Control Over Financial Reporting**  

There were no changes in our internal control over financial reporting during the fiscal quarter ended March 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

9
                               
**Limitations On The Effectiveness Of Internal Controls**

Our management, including the CEO and CFO, does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error.  An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of the control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the internal control.  The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.  Over time, control may become inadequate because of changes in conditions, and/or the degree of compliance with the policies or procedures may deteriorate.

 

**PART II – OTHER INFORMATION**

**ITEM 1.  Legal Proceedings.**

As of May 14, 2010 there are no material pending legal proceedings, other than ordinary routine litigation incidental to our business, to which we or any of our subsidiaries are a party or of which any of our properties is the subject.  Also, our management is not aware of any legal proceedings contemplated by any governmental authority against us.

**ITEM 2.  Unregistered Sales of Equity Securities.**

None.

**ITEM 3.  Defaults Upon Senior Securities.**

None.

**ITEM 4.  Submission of Matters to a Vote of Security Holders.**

None.

**ITEM 5.  Other Information.**

None.

 

 

 

10
                               **ITEM 6.  Exhibits.**
 

 

**Number**

**Description**

31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 
  
31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
32.1

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
32.2 

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 
   
 

**SIGNATURES**

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

  

**ENERGY QUEST INC.**

 

 

(REGISTRANT)

  

 

Date:  September 30, 2010                                                                                                 

/s/ *Wilf Ouellette*

 

 

Wilf Ouellette

  

 

President, Chief Executive Officer, Director

 

 

(Authorized Officer for Registrant)

 

 

Date:  September 30, 2010

/s/ *Ronald Foster*

 

 

Ronald Foster

 

 

Chief Financial Officer, Director, Principal Accounting Officer

 

 
  
 

 

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