UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549








FORM 10-Q/A
 (Amendment No. 1)


(Mark One)





x

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





FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011





OR





 ̈

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





FOR THE TRANSITION PERIOD FROM ____________ TO ____________





COMMISSION FILE NUMBER: 333-134568





PEGASI ENERGY RESOURCES CORPORATION


(Exact name of registrant as specified in its charter)





Nevada

20-4711443(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)





218 N. Broadway, Suite 204

Tyler, Texas 75702(Address of principal executive offices) (Zip Code)





Registrant’s telephone number, including area code: 903- 595-4139





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 small reporting company.  See definitions 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 oNon-accelerated filer o
Smaller reporting company x(Do not check if a smaller reporting company)





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





There were 33,660,801 shares of the registrant's common stock outstanding as of May 11, 2011.













1





EXPLANATORY NOTE
   The Company is filing this Amendment No. 1 on Form 10-Q/A (the “Amended Filing”) to its Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2011 (the “Original Filing”) filed with the Securities and Exchange Commission (“SEC”) on May 16, 2011 to amend and restate the consolidated financial statements and related disclosures for the fiscal quarter ended March 31, 2011 as discussed in Note 3 to the accompanying restated consolidated financial statements.
  1.           Background of the Restatement
  On August 4, 2011, the Company’s Board of Directors, serving its role as audit committee, concluded, based on the recommendation of management, that the previously issued consolidated financial statements for the year ended December 31, 2010 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 31, 2011, and the quarterly period ended March 31, 2011 included in Original Filing should not be relied upon because the Company failed to record a warrant derivative liability and to incorporate non-cash charges resulting from required adjustments to certain outstanding warrants issued in conjunction with an equity offering in 2007 (the “Warrants”).
  An explanation of the errors and their impact on the Company’s consolidated financial statements is contained in Note 3 to the consolidated financial statements contained in Item 1 of this report. The following is a brief summary of the accounting error:
  The Company assessed its Warrants  under the FASB Emerging Issues Task Force’s Issue No 07-5, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s own Stock” (“EITF 07-5”), now codified in ASC 815-40 which was effective January 1, 2009.   EITF 07-5 provides guidance as to assessing equity versus liability treatment and classification for equity-linked financial instruments, including stock purchase warrants. The Company did not properly assess the impact of certain anti-dilution provisions in the Warrants.    The anti-dilution provisions of the Warrants require an adjustment to the number of shares of common stock issuable upon exercise of the Warrants and the exercise price of the Warrants in the event the Company issues common stock, non-excluded options, or securities convertible into or exercisable for common stock, at a price per share lower than such exercise price, resulting in liability treatment and classification of such Warrants. The reset provision contained in these Warrants was triggered by the issuance of non-excluded stock options on December 24, 2010 and was reset again upon the issuance of common stock to a third party on March 1,  2011.  It was determined that the effect of these misstatements were material to the annual report on Form 10-K for the year ended December 31, 2010 and the quarterly report on Form 10-Q for the quarter ended March 31, 2011.
  2.           Internal Control Considerations
  Management determined that there was a deficiency in its internal control over financial reporting that constitutes a material weakness, as discussed in Part I — Item 4 of the Amended Filing. A material weakness in internal control over financial reporting is defined in Section 210.1-02(4) of Regulation S-X as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected on a timely basis..  For a discussion of management’s consideration of the Company’s disclosure controls and procedures and the material weakness identified, see Part I — Item 4 included in this Amended Filing.
 
 For the convenience of the reader, this Amended Filing sets forth the Original Filing as modified and superseded where necessary to reflect the restatement. The following items have been amended as a result of, and to reflect, the restatement:
  •
Part I — Item 1. Consolidated Financial Statements;
  •
Part I — Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations; and
  •
Part I — Item 4. Controls and Procedures.
  In accordance with applicable SEC rules, this Amended Filing includes certifications from our Chief Executive Officer and Chief Financial Officer dated as of the date of this filing.
  Except for the items noted above, no other information included in the Original Filing is being amended by this Amended Filing. The Amended Filing continues to speak as of the date of the Original Filing and we have not updated the filing to reflect events occurring subsequently to the Original Filing date other than those associated with the restatement of the Company’s consolidated financial statements. Accordingly, this Amended Filing should be read in conjunction with our filings made with the SEC subsequent to the filing of the Original Filing.





2





PEGASI ENERGY RESOURCES CORPORATION


CONSOLIDATED FINANCIAL STATEMENTS


FOR THE QUARTER ENDED MARCH 31, 2011





TABLE OF CONTENTS





PagePART I - FINANCIAL INFORMATIONItem 1. Financial Statements
4Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
17Item 3. Quantitative and Qualitative Disclosures About Market Risk
22Item 4. Controls and Procedures
22PART II - OTHER INFORMATIONItem 1. Legal Proceedings
24Item 1A. Risk Factors
24Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
24Item 3. Defaults Upon Senior Securities
24Item 4. (Removed and Reserved)
24Item 5. Other Information
24Item 6. Exhibits
24SIGNATURES
25








3


PART I - FINANCIAL INFORMATION





Item 1. Financial Statements.


PEGASI ENERGY RESOURCES CORPORATION


CONSOLIDATED BALANCE SHEETS





March 31,


December 31,2011


2010(Unaudited)AssetsCurrent assets:Cash and cash equivalents

$
651,711


$
249,802Accounts receivable, trade


375,846



186,669Accounts receivable, related parties


11,502



13,002Joint-interest billings receivable, related parties, net


15,669



192,700Joint-interest billing receivable, net


29,074



29,627Assets held for sale


300,347



300,347Other current assets


34,944



52,440Total current assets


1,419,093



1,024,587Property and equipment:Equipment


73,099



83,711Pipelines


722,809



722,937Leasehold improvements


7,022



7,022Vehicles


50,663



50,663Office furniture


135,689



135,689Website


15,000



15,000Total property and equipment


1,004,282



1,015,022Less accumulated depreciation


(341,952
)


(334,668
)Property and equipment, net


662,330



680,354Oil and gas properties:Oil and gas properties, proved


11,790,039



11,762,909Oil and gas properties, unproved


9,103,877



9,044,960Capitalized asset retirement obligations


219,040



219,040Total oil and gas properties


21,112,956



21,026,909Less accumulated depletion and depreciation


(1,061,917
)


(1,018,100
)Oil and gas properties, net


20,051,039



20,008,809Other assets:Restricted cash – leasing program


166,570



394,693Restricted cash – drilling program


723,910



793,611Certificates of deposit


78,049



77,947Total other assets


968,529



1,266,251Total assets

$
23,100,991


$
22,980,001





The accompanying notes are an integral part of these consolidated financial statements.




4





PEGASI ENERGY RESOURCES CORPORATION


CONSOLIDATED BALANCE SHEETS (CONTINUED)











March 31,


December 31,2011


2010(Unaudited)

(As Restated)


(As Restated)Liabilities and Stockholders' EquityCurrent liabilities:Cash overdraft

$
537,946


$
340,118Accounts payable


1,030,338



658,316Accounts payable, related parties


1,483,960



1,321,979Revenues payable


279,087



124,723Interest payable, related party


552,783



394,704Liquidated damages payable


181,751



173,802Other payables


31,881



27,893Current portion of notes payable


2,006



1,976Current portion of notes payable, related party


8,160,646



8,160,646Total current liabilities


12,260,398



11,204,157Lease program deposits


166,570



394,693Drilling prepayments


723,910



793,611Notes payable


2,313



2,826Asset retirement obligations


323,192



317,279Derivative warrant liability


4,519,514



3,638,311Total liabilities


17,995,897



16,350,877Commitments and contingencies ( Note 8 )Stockholders' equity:Preferred stock: $0.001 par value; 5,000,000 shares authorized;None issued and outstanding


-



-Common stock: $0.001 par value; 125,000,000 shares authorized; 33,660,801 shares issued and outstanding at March 31, 2011 and 33,610,801 shares at December 31,

2010


33,661



33,611Additional paid-in capital


19,923,354



19,903,404Accumulated deficit


(14,851,921
)


(13,307,891
)Total stockholders' equity


5,105,094



6,629,124Total liabilities and stockholders' equity

$
23,100,991


$
22,980,001




The accompanying notes are an integral part of these consolidated financial statements.




5




PEGASI ENERGY RESOURCES CORPORATION


CONSOLIDATED STATEMENTS OF OPERATIONS


(UNAUDITED)





Three Months Ended March 31,2011


2010(As Restated)Revenues:Oil and gas

$
201,166


$
177,716Condensate and skim oil


8,699



6,638Transportation and gathering


147,457



67,388Total revenues


357,322



251,742Operating expenses:Lease operating expenses


101,500



76,261Pipeline operating expenses


39,032



19,158Cost of gas purchased for resale


94,814



47,058Depletion and depreciation


61,713



41,195General and administrative


587,586



515,314Total operating expenses


884,645



698,986Loss from operations


(527,323
)


(447,244
)Other income (expenses):Interest income


102



191Interest expense


(161,178
)


(134,096
)Liquidated damages


(7,949
)


(5,126
)Other income


5,068



(5,723
)Changes in fair value of warrant derivative liability


(881,203
)


-Total other income (expenses)


(1,045,160
)


(144,754
)Loss from continuing operations before income

tax benefit


(1,572,483
)


(591,998
)Income tax benefit


9,959



-Loss from continuing operations


(1,562,524
)


(591,998
)Income (loss) from discontinued operations (net of tax expenses of $9,959 and $0, respectively)


18,494



(90,879
)Net loss

$
(1,544,030
)

$
(682,877
)Basic and diluted loss per share:

Loss from continuing operations


(0.05
)


(0.02
)Income (loss) from discontinued operations


0.00



(0.00
)Net loss

$
(0.05
)

$
(0.02
)Weighted average shares outstanding


33,627,468



33,610,801




The accompanying notes are an integral part of these consolidated financial statements.




6




PEGASI ENERGY RESOURCES CORPORATION


CONSOLIDATED STATEMENTS OF CASH FLOWS


(UNAUDITED)





Three Months Ended March 31,2011


2010(As Restated)Operating ActivitiesNet loss

$
(1,544,030
)

$
(682,877
)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depletion and depreciation


61,713



61,017Accretion of discount on asset retirement obligations


5,913



4,506Stock issued for consulting services


20,000



-Loss on abandonment of equipment


-



5,727Gain on sale of equipment


(4,872
)


-Changes in fair value of warrant derivative liability


881,203



-Changes in operating assets and liabilities:Accounts receivable, trade


(189,177
)


(30,709
)Accounts receivable, related parties


1,500



(1,272
)Joint-interest billing receivable, net


553



-Joint-interest billings receivable, related parties, net


177,031



(3,911
)Other current assets


17,496



24,974Accounts payable


372,022



98,793Accounts payable, related parties


161,981



66,850Revenues payable


154,364



14,376Interest payable, related party


158,079



131,046Liquidated damages payable


7,949



5,126Other payables


3,988



(11,942
)Net cash provided by (used in) operating activities


285,713



(318,296
)Investing ActivitiesAdditions to certificate of deposit


(102
)


(190
)Purchases of oil and gas properties


(86,047
)


(19,070
)Purchases of property and equipment


-



(84,920
)Proceeds from sale of property and equipment


5,000



-Net cash used in investing activities


(81,149
)


(104,180
)Financing ActivitiesPayments on notes payable


(483
)


(1,716
)Cash overdraft


197,828



-Proceeds from borrowing on notes payable, related party


-



623,000Net cash provided by financing activities


197,345



621,284Net increase in cash and cash equivalents


401,909



198,808Cash and cash equivalents at beginning of period


249,802



127,176Cash and cash equivalents at end of period

$
651,711


$
325,984Supplemental Disclosure of Cash Flow InformationCash paid during the period for interest

$
3,564


$
4,221Noncash disclosure - stock issued for consulting services

$
20,000


$
-





The accompanying notes are an integral part of these consolidated financial statements.




7


PEGASI ENERGY RESOURCES CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31, 2011 AND 2010





1.  NATURE OF OPERATIONS
 
 Pegasi Energy Resources Corporation (“PERC” or the “Company”) is engaged in the exploration and production of natural gas and oil through the development of a repeatable, low-geological risk, high-potential project in the active East Texas oil and gas region.  The Company's business strategy, which it designated as the “Cornerstone Project”, is to identify and exploit resources in and adjacent to existing or indicated producing areas within the Rodessa field area.  PERC’s principals spent over three years and invested over $3.5 million in equity for data harvesting, prospect evaluation and acreage acquisitions for the Cornerstone Project.
 
 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 a)  Basis of Presentation
 
 The accompanying unaudited interim consolidated financial statements of PERC have been prepared in accordance with accounting principles generally accepted (“GAAP”) in the United States of America and the rules of the Securities and Exchange Commission (the “SEC”), and should be read in conjunction with PERC’s audited consolidated financial statements for the year ended December 31, 2010, and notes thereto, which are included in the Company’s annual report on Form 10-K/A filed with the SEC on August 22 , 2011.  In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the Company’s consolidated financial position and the consolidated results of operations for the interim periods presented have been reflected herein.  The consolidated results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.  The notes to consolidated financial statements, which would substantially duplicate the disclosures required in the Company’s 2010 annual consolidated financial statements, have been omitted.
 
 b)  New Accounting Pronouncements
 
 In January 2010, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.  This standard requires reporting entities to provide information about movements of assets among Levels 1 and 2 of the three-tier fair value hierarchy established by SFAS No. 157 (FASB ASC 820).  The guidance is effective for any interim and annual reporting periods that begin after December 15, 2009.  The Company adopted ASU No. 2010-06 in the first quarter of 2010 and the adoption did not have a material impact on the Company’s disclosures.  The standard also requires entities to provide a reconciliation of purchases, sales, issuance, and settlements of anything valued with a Level 3 method.  This guidance is effective for fiscal years beginning after December 15, 2010, and for interim and periods within those fiscal years. The Company adopted the guidance in the first quarter of 2011 and the adoption did not have a material impact on the Company’s disclosures.
 
 c)  Reclassifications
 
 Certain reclassifications have been made to the comparative consolidated financial statements to conform to the current period’s presentation.
 
 d)  Derivative Instruments
 
 For derivative instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in fair value recognized in earnings each reporting period. For warrant derivative instruments, the Company uses the Black-Scholes model to value the derivative instruments at inception and subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as a liability or as equity, is re-assessed at the end of each reporting period, in accordance with FASB ASC Topic 815, Derivatives and Hedging. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not the net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.
 
 e)  Net Loss per Common Share
 
 Basic net loss per common share is calculated using the weighted average number of common shares outstanding during the period.  The Company uses the treasury stock method of calculating fully diluted per share amounts whereby any proceeds from the exercise of stock options or other dilutive instruments are assumed to be used to purchase common shares at the average market price during the period. The dilutive effect of convertible securities is reflected in diluted loss per share by application of the if-converted method. Under this method, conversion shall not be assumed for the purposes of computing diluted loss per share if the effect would be anti-dilutive. For the quarters ended March 31, 2011 and March 31, 2010, the diluted loss per share is the same as basic loss per share, as the effect of common stock equivalents are anti-dilutive.  For the quarters ended March 31, 2011 and March 31, 2010, the Company had potentially dilutive shares of , 28,056,477 and 11,446,415, respectively.
   8
  PEGASI ENERGY RESOURCES CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31, 2011 AND 2010


3. RESTATEMENT
 
 On August 10, 2011, the Company filed with the Securities and Exchange Commission (“SEC”) a Current Report on Form 8-K, to report management’s determination that the Company’s consolidated financial statements for the year ended December 31, 2010, included in its Annual Report on Form 10-K filed with the SEC on March 31, 2011 (the “2010 Form 10-K”),  should not  be relied upon due to an error in such consolidated financial statements with respect to the accounting for common stock purchase warrants in connection with its December 2007 private placement (the “2007 Warrants”).  The Company determined that the historical consolidated financial statements for the year ended December 31, 2010 included in the Company’s 2010 Form 10-K required restatement to properly record the 2007 Warrants as a derivative liability and to properly reflect the liability through an adjustment to Other Income/Expense in the Consolidated Statement of Operations.
 
 The Current Report on Form 8-K which the Company filed with the SEC on August 10, 2011 also reported management’s determination that the Company’s consolidated financial statements for the fiscal quarter ended March 31, 2011, included in its Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2011, filed with the SEC on May 16, 2011 (the “March 2011 Form 10-Q”) should not be relied upon due to an error in such financial statements with respect to the accounting for the 2007 Warrants.
 
 The Company has performed a complete assessment of its outstanding 2007 Warrants and has concluded that its outstanding 2007 Warrants are within the scope of Accounting Standards Codification 815-40, “Derivatives and Hedging – Contracts in Entity’s Own Equity” (“ASC 815-40”), formerly Emerging Issues Task Force Issue No. 07-05, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-05”), due to the inclusion in the Warrants of a provision requiring an adjustment to the number of shares and the exercise price of the 2007 Warrants in the event the Company issues common stock, non-excluded options or securities convertible into or exercisable for common stock, at a price per share lower than such exercise price.  Accordingly, ASC 815-40, formerly EITF 07-05, which was effective as of January 1, 2009, should have been applied resulting in a reclassification of the warrants as a liability, measured at fair value, with changes in fair value recognized as part of other income or expense for each reporting period thereafter.  The issuance of non-excluded stock options on December 24, 2010, and the issuance of stock to a third party in exchange for the fair value of  services on March 1, 2011, triggered the anti-dilution protection rights which reduced the exercise price of the Warrants and increased the number of shares of common stock issuable upon exercise of the Warrants.  As a result of the March 2011 adjustment the exercise price was adjusted from $0.42 to $0.40 and the number of shares issuable upon exercise of the Warrants increased from 19,182,350 to 20,141,468.
 
 This amended Quarterly Report on Form 10-Q/A for the fiscal quarter ended March 31, 2011 incorporates corrections made in response to the accounting errors described above by restating the Company’s consolidated financial statements presented herein for the fiscal quarter ended March 31, 2011.  The corrections to the quarterly information in this amended Form 10-Q/A had no impact on the Company’s previously reported operations from oil and gas activities or cash flows for the periods being restated.  However, a derivative liability has been recorded on the Consolidated Balance Sheet and a corresponding non-cash charge to Other Income/Expense has been reported on the Consolidated Statement of Operations.
 
 The following tables show the effects of the restatement on the Company's condensed consolidated balance sheet as of March 31, 2011, consolidated statements of operations and consolidated statements of cash flows for the three months ended March 31, 2011:
 
 PEGASI ENERGY RESOURCES CORPORATION
 CONDENSED CONSOLIDATED BALANCE SHEET
 
 As of March 31, 2011As Previously Reported


As RestatedDerivative warrant liability


-



4,519,514Total liabilities


13,476,383



17,995,897Accumulated deficit


(10,332,407
)


(14,851,921
)Total stockholders’ equity


9,624,608



5,105,094
   9
  PEGASI ENERGY RESOURCES CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31, 2011 AND 2010
 PEGASI ENERGY RESOURCES CORPORATION
 CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
 
 Three months ended March 31, 2011As Previously Reported


As RestatedChanges in fair value of warrant derivative liability

$
-


$
(881,203
)Total other income (expenses)


(163,957
)


(1,045,160
)Loss from continuing operations before income tax benefit


(691,280
)


(1,572,483
)Loss from continuing operations


(681,321
)


(1,562,524
)Net loss

$
(662,827
)

$
(1,544,030
)Basic and diluted loss per share

$
(0.02
)

$
(0.05
)
 
 The Company did not recognize any income tax benefits (expense) associated with the change in fair value of the warrant derivative liability in the three months ended March 31, 2011.  Therefore, the restatement did not have an effect on the Company’s taxable income for the three months ended March 31, 2011.
 
 PEGASI ENERGY RESOURCES CORPORATION
 CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
 
 Three months ended March 31, 2011As Previously Reported


As RestatedNet loss

$
(662,827
)

$
(1,544,030
)Changes in fair value of warrant derivative liability


-



(881,203
)Net cash provided by operating activities


285,713



285,713
 
 
 4.  NOTES PAYABLE, RELATED PARTY
 
 Notes payable, related party consisted of the following at:

March 31,

2011


December 31,

2010Note payable to Teton (the “Teton Renewal Note”) in the amount of $6,987,646 dated June 1, 2010, including interest at 8%, with all principal and  interest due on the maturity date of June 1, 2011 (however see third amendment below).    Renewed original note which matured May 21, 2010.  Secured by a stock pledge and security agreement.

$
6,987,646


$
6,987,646Original unsecured promissory note payable in the amount of $1 million dated October 14, 2009 to Teton (the “Teton Promissory”).  Additional funds added by amendment two to the note results in funds available of $1.5 million, including interest of 6.25%, with all interest and principal due on the maturity date of April 2, 2011 (however see fifth amendment below).


1,173,000



1,173,000Total notes payable, related party


8,160,646



8,160,646Less current portion


(8,160,646
)


(8,160,646
)Total long-term notes payable, related party

$
-


$
-
 
 
 10
 
 PEGASI ENERGY RESOURCES CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31, 2011 AND 2010
 On June 1, 2010, a Promissory (Teton Renewal Note) note was executed to renew and extend the original note payable (Teton Note) which matured May 21, 2010.  The renewal note’s principal balance of $6,987,646 is the total of the outstanding principal of $5,952,303 and accrued and unpaid interest of $1,035,343 on the original note.  Interest payments were due on the note on October 1, 2010; January12, 2011; and April 1, 2011. Effective October 1, 2010 an amendment to the Teton Renewal Note was executed to eliminate the October 1, 2010 interest payment.  Effective January 2, 2011, a second amendment was executed which eliminated the January 1, 2011 interest payment.  The final maturity date of the Teton Renewal Note was unchanged and remained June 1, 2011.  Teton has the right, but not the obligation to convert all or a portion of the indebtedness at any time after May 1, 2008, unless the debt is repaid before such date.  This option will continue in existence as long as any balance remains outstanding on the note.
 
 Effective April 1, 2011, a third amendment was executed which eliminated the April 1, 2011 interest payment and extended the maturity date of the note from June 1, 2011 to June 1, 2013 at which time all outstanding principal and accrued and unpaid interest of the note will be due.  The amendment also added an event of default whereby Teton may declare default on the note if the Company does not raise funds during or as a result of their engagement with a placement agent whom they initially engaged on March 25, 2011.
 
 The Teton Promissory was amended effective January 1, 2010 to eliminate the requirement of interest payments to be made on January 1, 2010; April 1, 2010; and October 1, 2010.  A second amendment was executed which increased the available balance to $1,500,000 effective March 2, 2010.  Effective July 1, 2010, a third amendment to the Teton Promissory was executed to eliminate the interest payment required on July 1, 2010 and to extend the maturity date of the note to January 2, 2011. Effective January 2, 2011, a fourth amendment was executed to extend the maturity date of the note from January 2, 2011, to April 2, 2011 at which time all outstanding principal and accrued  and unpaid interest will be due.
 
 Effective April 2, 2011, a fifth amendment was executed which eliminated the April 2, 2011 interest payment and extended the maturity of the note from April 2, 2011 to June 1, 2013 at which time all outstanding principal and accrued and unpaid interest of the note will be due.  The amendment also added an event of default whereby Teton may declare default on the note if the Company does not raise funds during or as a result of their engagement with a placement agent whom they initially engaged on March 25, 2011.   In addition, the amendment granted Teton the right, to convert the outstanding balance on the Promissory note into shares of PERC’s common stock at a fixed conversion price of $0.60 per share.
 
 On May 1, 2007, a “memorandum of Understanding” was executed to grant Teton the right to convert the outstanding balance on the Teton Note into shares of PERC’s common stock at a fixed conversion price of $1.20 per share.  Teton has the right, but not the obligation to convert all or a portion of the indebtedness at any time after May 1, 2008, unless the debt is repaid before such date.  This option will continue in existence as long as any balance remains outstanding on the note.
 
 On March 3, 2009, a “Second Amendment to Renewal Promissory Note and Loan Modification Agreement” (the “Second Amendment”) was executed, which amended the Teton Note.  This agreement added $550,000 of additional cash proceeds and $20,000 of advances payable to the outstanding balance of the Teton Note and pledged substantially all of the Company’s assets to secure repayment of the note.  The Second Amendment confirmed that the fixed conversion price of $1.20 per share would remain for the portion of the note payable balance that existed prior to its execution, and a fixed conversion price of $1.60 was agreed upon for conversion of the additional funds.
 
 In May 2009, the third and fourth amendments to the Teton Note were executed.  The third amendment deferred the May 21, 2009 interest payment to September 21, 2009 and the fourth amendment added $350,000 of additional funds to the outstanding balance of the Teton Note.  In September 2009, the fifth amendment was executed, which added $175,000 of additional funds to the outstanding balance of the Teton Note and deferred the interest payment due date from September 21, 2009 to October 21, 2009.  In February 2010, the seventh amendment to the Teton Note, dated May 21, 2007, was executed.  This amendment amended the sixth amendment, executed in October 2009, to defer the October 21, 2009 interest payment to February 21, 2010.  The seventh amendment eliminated the February 21, 2010 interest payment.  The final maturity date of the Teton Note was unchanged and remained May 21, 2010.  Upon maturity, the outstanding principal and accrued and unpaid interest on this note was renewed and extended to a maturity date of June 1, 2011.  See the Teton Renewal Note above.  The maturity date was subsequently extended to June 1, 2013.
  11
  PEGASI ENERGY RESOURCES CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31, 2011 AND 2010
  5.  WARRANTS OUTSTANDING
 
 In December 2007, the Company issued warrants to placement agents to purchase 837,850 shares of common stock, of which 346,850 could be exercised cashless and 491,000 exercised at a price of $1.60 per share until December 31, 2012, as part of a securities purchase offering.  On January 24, 2008, the Company issued an additional 9,615 warrants to a placement agent under the same terms as the original warrants.  Also in December 2007, the Company issued 8,375,784 warrants to purchase 4,187,901 shares of common stock exercisable until December 31, 2012 in connection with a securities purchase agreement.  The warrants had an exercise price of $1.60 per share.
 
 The 2007 Warrant Agreement contains anti-dilution protection rights (“ratchet provision”) which require an adjustment to the exercise price of the warrants and a proportional adjustment to the number of shares of common stock issuable upon exercise of the warrants in the event the Company issues common stock, stock options, or securities convertible into or exercisable for common stock, at a price per share lower than such exercise price.  On December 24, 2010, the Company issued non-excluded stock options to a third party with an exercise price of $0.42 which was below the original exercise of $1.60 contained in the agreement which triggered the ratchet provision.  The effect of the anti-dilution provision resulted in an adjustment to the number of shares of common stock issuable upon exercise of the warrants from 5,035,367 shares with an exercise price of $1.60 per share to 19,182,350 shares with an exercise price of $0.42 per share.. On March 1, 2011, the Company issued common shares at the then current market value of $0.40 to a consultant for the fair value of services rendered which also triggered the ratchet provision.  The effect of the anti-dilution provision  resulted in an adjustment to the number of shares of common stock issuable upon exercise of the warrants from 19,182,350 shares with an exercise price of $0.42 per share to 20,141,468 with an exercise price of $0.40 per share.
 
 A summary of warrant activity and shares issuable upon exercise of the warrants during the periods ended December 31, 2010 and March 31, 2011 is as follows:
 
 Warrants

Shares Issuable Under Warrants

Weighted Average Exercise PriceOutstanding at December 31, 2010


9,223,249

19,182,350

$
0.42Warrants issued


-

-


-Warrants exercised


-

-


-Shares issuable under anti-dilution adjustment on 3/1/11


-

959,114


0.40Outstanding at March 31, 2011


9,223,249

20,141,468

$
0.40
 
 No warrants were issued during the quarter ended March 31, 2011.
 
 6.  DERIVATIVE WARRANT LIABILITIY
 
 As of March 31, 2011 and December 31, 2010, the Company had derivative warrant liabilities of $4,519,514 and $3,638,311, respectively.
 
 The Company used the Black-Scholes valuation model to estimate the fair value of the derivative warrant liability.  Significant assumptions used at March 31, 2011 were as follows:
 
 March 31, 2011Market value of stock on reporting date (1)

$
0.38Risk-free interest rate (2)


0.65
%Dividend yield (3)


0.00
%Volatility factor


128.40
%Expected life (4)

1.71 years
   12
  PEGASI ENERGY RESOURCES CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31, 2011 AND 2010
 (1)  The market value of the stock on the data of reporting was based on reported public market prices.
 (2)  The risk-free interest rate was determined by management using the U.S. Treasury zero-coupon yield over the contractual term of the warrant on date of reporting.
 (3)  Management determined the dividend yield to be 0% based upon its expectation that there will not be earnings available to pay dividends in the near term.
 (4)  Expected life is remaining contractual life of the warrants.
 
 Upon issuance of shares on March 1, 2011, with an exercise price below the then-current exercise price, the anti-dilution provision was triggered.  Upon triggering the anti-dilution provision, the Company assessed its Warrants under ASC 815-40, which provides guidance as to assessing equity versus liability treatment, and it was determined that the Warrants should be classified as a derivative liability under ASC 815-40. As a result, the fair value of the warrants is recorded as a derivative liability.  Each reporting period, the derivative liability is fair valued with the non-cash gain or loss recorded in the period as Other Income/Expense.  Since the exercise price of the Warrants can be potentially decreased and the number of shares to settle the Warrants increased each time a trigger event occurs that results in a new adjusted exercise price below the adjusted exercise price then in effect, there could be a potentially infinite number of shares required to settle the warrant agreement.  However, the Company has the capability of limiting the occurrence of such events.
 
 7.  SEGMENT INFORMATION
 
 The following information is presented in accordance with FASB ASC Topic 280, Segment Reporting.  The Company is engaged in oil and gas exploration and production, saltwater disposal and pipeline transportation.  PERC is engaged in the exploration and production of natural gas and oil.  Pegasi Operating, Inc. (“POI”), a wholly-owned subsidiary of PERC, conducts the exploration and production operations.  TR Rodessa operates a 40-mile gas pipeline and gathering system which is used to transport hydrocarbons to market to be sold.  59 Disposal operates a saltwater disposal facility which disposes saltwater and flow-back waste into subsurface storage  and  also  sells  the  skim  oil  it  separates  from  the  saltwater.  The assets of this company are currently being held for sale and we have reported it as a discontinued operation ( see Note 11 ).  The Company identified such segments based on management responsibility and the nature of their products, services, and costs.  There are no major distinctions in geographical areas served as all operations are in the United States.  The Company measures segment profit (loss) as income (loss) from operations.  Business segment assets are those assets controlled by each reportable segment.  The following table sets forth certain information about the financial information of each segment as of March 31, 2011 and December 31, 2010 and for the three months ended March 31, 2011 and 2010.
 
 Three Months Ended

March 31,

2011


Three Months Ended

March 31,

2010Business segment revenue:Oil and gas

$
201,166


$
177,716Condensate and skim oil


8,699



6,638Transportation and gathering


147,457



67,388Total revenues

$
357,322


$
251,742Business segment profit (loss):Oil and gas

$
(95,487
)

$
15,633Condensate and skim oil


8,699



6,638Transportation and gathering


(4,197
)


(19,910
)General corporate


(436,338
)


(449,605
)Loss from operations

$
(527,323
)

$
(447,244
)Depletion and depreciation:Oil and gas

$
45,610


$
25,940Transportation and gathering


11,799



7,492Assets held for sale


-



19,822General corporate


4,304



7,763Total depletion and depreciation

$
61,713


$
61,017
   13
  PEGASI ENERGY RESOURCES CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31, 2011 AND 2010
 Three Months Ended

March 31,

2011


Three Months Ended

March 31,

2010Capital expenditures:Oil and gas

$
86,047


$
19,070Transportation and gathering


-



-Assets held for sale


-



84,920General corporate


-



-Total capital expenditures

$
86,047


$
103,990March 31,


December 31,2011



2010Business segment assets:Oil and gas

$
21,154,514


$
20,538,826Transportation and gathering


630,089



712,561Assets held for sale


300,347



300,347General corporate


1,016,041



1,428,267Total assets

$
23,100,991


$
22,980,001
 
 8. COMMITMENTS AND CONTINGENCIES
 
 Along with the Company's counsel, management monitors developments related to legal matters and, when appropriate, makes adjustments to record liabilities to reflect current facts and circumstances.  Management has recorded a liability related to its registration rights agreement with investors that provides for the filing of a registration statement for the registration of the shares issued in the offering in December 2007, as well as the shares issuable upon exercise of related warrants.  The Company failed to meet the deadline for the effectiveness of the registration statement and therefore was required to pay liquidated damages of approximately $100,000 on the first day of effectiveness failure, or July 18, 2008.  An additional $100,000 penalty was required to be paid by the Company every thirty days thereafter, prorated for periods totaling less than thirty days, until the effectiveness failure was cured, up to a maximum of 18% of the aggregate purchase price, or approximately $1,800,000.  The Company’s registration became effective on August 21, 2008.  At March 31, 2011, management reevaluated the status of the registration statement and determined an accrual of $181,751 was sufficient to cover any potential payments for liquidated damages.  The damages are reflected as liquidated damages payable of $181,751 and $173,802 in the accompanying consolidated balance sheets as of March 31, 2011 and December 31, 2010, respectively.
 
 9.  FAIR VALUE OF FINANCIAL INSTRUMENTS
 
 ASC Topic 825 requires certain disclosures regarding the fair value of financial instruments.  Fair value of financial instruments is made at a specific point in time, based on relevant information about financial markets and specific financial instruments.  As these estimates are subjective in nature, involving uncertainties and matters of significant judgment, they cannot be determined with precision. Changes in assumptions can significantly affect estimated fair values.
 ASC Topic 820 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.  When determining the fair value measurements 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.
 ASC Topic 820 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 Topic 820 establishes three levels of inputs that may be used to measure fair value:




14




PEGASI ENERGY RESOURCES CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010





Level 1 - Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.


Level 2 - Level 2 applies to assets or liabilities for which there are inputs other than quoted prices included within Level 1 that are observable for the asset or liability 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 3 - Level 3 applies to assets or 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 following table sets forth our estimate of fair value of our financial instruments that are liabilities as of March 31, 2011:
 
 Quoted Prices in Active Markets for Identical Assets


Significant Other Observable Inputs


Significant Unobservable Inputs(Level 1)


(Level 2)


(Level 3)


Total2007 Warrants

$
-


$
4,519,514


$
-


$
4,519,514
 
 The following table sets forth a summary of changes in fair value of our derivative liability for the three months ended March 31, 2011:
 
 Three months ended March 31,

2011Beginning Balance – December 31, 2010

$
3,638,311Expense included in net loss


881,203Balance at March 31

$
4,519,514
 
 The estimated fair values of accounts receivable, accounts payable and other current assets and accrued liabilities approximate their carrying amounts due to the relatively short maturity of these instruments.  The carrying value of long-term debt approximates market value due to the use of market interest rates.
 
 10.  RESTRICTED CASH – LEASING PROGRAM
 
 Leasing Program
 
 During the first quarter of 2010, the Company executed agreements with two independent oil and gas companies regarding leasing specific areas on the Cornerstone Project.  The agreements include both extensions and renewals of existing leaseholds that the Company currently holds and acquisitions of new leaseholds in order to expand the Company’s acreage position.  Funds received from these companies are restricted to the leasing programs and are considered released when they are spent in accordance with the agreements.  Total funds of $5,438,000 were received on these programs, $5,123,459 was spent on leasing activities and $147,971 was refunded leaving a balance of $166,570 in restricted cash and lease program deposits at March 31, 2011.
 
 Drilling Program
 
 During the last quarter of 2010, the Company executed participation and operating agreements with various independent oil and gas companies regarding the drilling of the Norbord and Swamp Fox wells.   Funds received from these companies are restricted to the drilling programs and are considered released when they are spent in accordance with the agreements.  Total funds of $2,249,980 were received on these programs and $1,526,070 was spent on drilling activities leaving a balance of $723,910 in restricted cash and drilling prepayments at March 31, 2011.
 
 
 15
  PEGASI ENERGY RESOURCES CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31, 2011 AND 2010
 11.  DISCONTINUED OPERATIONS
 
 The Company’s wholly-owned subsidiary, 59 Disposal Inc., operates a saltwater disposal facility which disposes saltwater and flow-back waste into subsurface storage.  The disposal activities have diminished over the past twelve months and in January 2011, the Company offered for sale certain assets of the subsidiary.  It held a letter of intent from a potential buyer for the purchase of certain of 59 Disposal’s assets which was valid for thirty days after its signing on March 1, 2011.   Although the letter of intent has expired, the Company is continuing negotiations with the potential purchaser with an anticipated closing of the sale in 2011.
 
 At March 31, 2011, assets of 59 Disposal to be included in the sale have a net book value of $300,347 and have been included in the consolidated balance sheets as assets held for sale.  The negotiated sales price is more than the net book value of the equipment so no impairment has been recorded.  Current assets and liabilities of 59 Disposal, including accounts receivable of $34,233, accounts payable of $51,641, related party payables of $111,679, interest payable of $1,550 and notes payable, related party, of $23,244  as of March 31, 2011, will be retained by the Company under the negotiated sale provisions.
 
 
 The following schedule details 59 Disposal’s property and equipment to be included in the sale as of March 31, 2011:
 
 Cost


Accumulated

Depreciation


March 31, 2011

Net Book ValueLease & well equipment

$
597,740


$
318,916


$
278,824Buildings


19,916



2,353



17,563Office furniture & equipment


6,550



2,590



3,960$
624,206


$
323,859


$
300,347
 
 Following is summarized information regarding the discontinued operations:
 
 Revenues of discontinued operations amounted to $82,650 and $36,504 for the three months ended March 31, 2011 and 2010.
 
  Three Months EndedMarch 31,


March 31,2011


2010Income (loss) from discontinued operations

$
28,453


$
(90,879
)Income tax expense – discontinued operations


(9,959
)


-Income (loss) from discounted operations, net of tax

$
18,494


$
(90,879
)
 
 12.  SUBSEQUENT EVENTS
 
 The notes payable, related party, were amended effective April 2011.  See Footnote 4 for details of such amendments.
 
 The Company is currently in negotiations to sell a 35% portion of a pipeline they own.  Negotiations are anticipated to close in approximately thirty to forty-five days.  Current plans are to use the proceeds to refurbish a pipeline near the Norbord well which is expected to potentially double production from that well.
   16
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
 Forward Looking Statements
 
 This Management's Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements that reflect management's current views with respect to future events and financial performance. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate” and “continue,” or similar words.  Those statements include statements regarding the intent, belief or current expectations of us and members of our management team as well as the assumptions on which such statements are based. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risk and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements.
 
 Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC.  The following Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Company should be read in conjunction with the Consolidated Financial Statements and notes related thereto included in this Quarterly Report on Form 10-Q/A. Important  factors not  currently  known  to management  could  cause  actual  results  to differ  materially  from  those in forward-looking  statements.  We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in the future operating results over time. We believe that our assumptions are based upon reasonable data derived from and known about our business and operations.  No assurances are made that actual results of operations or the results of our future activities will not differ materially from our assumptions.  Factors that could cause differences include, but are not limited to, expected market demand for our products, fluctuations in pricing for materials, and competition.
 
 Company Overview
 
 We are an independent energy company engaged in the exploration and production of natural gas and oil through the development of a repeatable, low-geological risk, high-potential project in the active East Texas oil and gas region.  We currently hold interests in properties located in Marion and Cass County, Texas, home to the Rodessa oil field.  The field has historically been the domain of small independent operators and is not a legacy field for any major oil company.
 
 Our business strategy, which we designated as the “Cornerstone Project”, is to identify and exploit resources in and adjacent to existing or indicated producing areas within the Rodessa field area. We intend to develop and produce reserves at a low cost and will take an aggressive approach to exploiting our contiguous acreage position through utilization of “best in class” drilling, (i.e. using the latest drilling techniques available and seismic technology).  We believe that we are uniquely familiar with the history and geology of the Cornerstone Project area based on our collective experience in the region as well as through our ownership of a large proprietary database which details the drilling history of the Cornerstone Project area since 1980.  We believe implementing our drilling strategy and using new drilling and completion techniques will enable us to find significant gas and oil reserves in the Cornerstone Project area.
 
 We conduct our main exploration and production operations through our wholly-owned subsidiary, POI.  We conduct additional operations through two other wholly-owned subsidiaries: (i) TR Rodessa and (ii) 59 Disposal.
 
 TR Rodessa owns an 80% undivided interest in and operates a 40-mile natural gas pipeline and gathering system which we currently use to transport our hydrocarbons to market.  Excess capacity on this system is used to transport third-party hydrocarbons.
 
 59 Disposal owns an 80% undivided interest in and operates a saltwater disposal facility which disposes saltwater and flow-back waste into subsurface storage.  The disposal activities have diminished over the past twelve months and in January 2011, we offered for sale certain assets of the subsidiary.  We held a letter of intent from a potential buyer for the purchase of certain of 59 Disposal’s assets which was valid for thirty days after its signing on March 1, 2011.  Although the letter of intent has expired, we are continuing negotiations with the potential purchaser with an anticipated closing of the sale in 2011.
 
 
 17
 
 Plan of Operations
  We intend to continue to use our competitive strengths to advance our corporate strategy.  The following are key elements of that strategy:
 
 ·
Develop the Cornerstone Project in East Texas through a lease renewal and lease acquisition program along with a drilling program.We will focus our near-term efforts on our leasing program and development drilling on existing acreage. We expect this drilling program to increase our proved reserve and cash flow profile.  In late 2010, we completed drilling the Norbord #1 well to 7,005 feet in the Travis Peak formation.  The deliverability rate is estimated at 3,381 MCF (a thousand cubic feet) per day and 55.2 BBLSPD (barrels per day).  Based on the success of this well, we will begin a developmental drilling program in midyear 2011. We have a gross working interest of 25% in the well as we have been carried for the cost of the well.



The Swamp Fox #1 test well was drilled to a total depth of 7,000 feet in December 2010.  The well is presently waiting on fracture stimulation after testing oil in the Pettit formation.  We need to obtain financing before the fracture stimulation can be started.·
Apply management expertise in the Cornerstone Project area and recent developments in drilling and completion technology to identify new drilling opportunities and enhance production. We plan to maximize the present value of our vertical wells by utilizing a shotgun-dual or sawtooth production technique.  We will also implement the latest drilling, fracturing and completion techniques including shotgun duals to develop our properties as well as horizontal drilling. These horizontal wells will primarily target the Bossier formation and we anticipate these wells will yield significantly higher hydrocarbon flow rates than our vertical wells.  We plan to begin our horizontal drilling programs in the second half of 2011.·
Continue to lease underdeveloped acreage in the Cornerstone Project area. We are continuing our leasing program to support our present and future drilling plans with existing funding. The program includes renewing existing leasehold and acquiring new leaseholds.  We are using our extensive proprietary database to help optimize additional drilling locations and to acquire additional acreage.  We intend to target acreage with exploitation and technology upside within the Cornerstone Project area. Most properties in the Cornerstone Project area are held by smaller independent companies that lack the resources to exploit them to the fullest extent. We intend to pursue these opportunities to selectively expand our portfolio of properties. These acreage additions will complement our existing substantial acreage position in the area and provide us with significant additional drilling inventory.·
Maintain a conservative and flexible financial strategy. We intend to continue focusing on maintaining a low level of corporate overhead expense in addition to continued utilization of outsourcing, when appropriate, to maximize cash flow. We believe this internally-generated cash flow, coupled with reserve-based debt financing when appropriate, will provide the optimal capital structure to fund our future drilling activity.
 
 In order to implement our strategy, we will first need to raise additional capital to develop our properties.  We are seeking to raise additional capital within the industry and from financial institutions.  We currently do not have any contracts or commitments for funding and there are no guarantees that we will be able to raise funds on terms acceptable to us, if at all.  We may also consider farm-out agreements, whereby we would lease parts of our properties to other operators for drilling purposes and we would receive payment based on the production.  We anticipate the cost of a horizontal oil well will be approximately $5 million and a vertical shallow gas well to be approximately $1 million.
 
 Our oil and gas assets are located in Cass and Marion counties in northeast Texas.  As of March 31, 2011, we operated 10 wells.
 
 As of April 1, 2011, our leasehold position at 100% interest is 25,362 gross acres and 16,359 net acres of which  Pegasi’s net acres is approximately 9,280. Our leasing program consists of renewing expiring leases and leasing previously unleased acreage.  We began discussions with two independent oil and gas companies during the first quarter of 2010 regarding leasing specific areas on the Cornerstone Project.  Agreements were finalized in the middle of February and late March 2010 and could result in up to $4,000,000 and $4,700,000, respectively, in lease acquisitions. We have presently spent approximately $5.1 million of the funds.  This includes both extensions and renewals of existing leasehold that we currently hold and acquisitions of new leaseholds in order to expand our acreage position.  The participating companies are paying 100% of the cost for a 50% interest in the acreage, resulting in no cost to us.  We believe that this will result in follow-up drilling opportunities.  We also finalized drilling agreements with various independent oil and gas companies in 2010 that have provided approximately $2.2 million in funds towards the drilling of the Norbord and Swamp Fox wells.
   18
  If we are able to obtain funding, our main emphasis will be to explore for oil with horizontal drilling.  The present discussions are based on pursuing an aggressive drilling program where we would be carried for an interest in any wells at no cost to us.  In addition, any funds raised could be used to apply fracture treatment to the Harris #2 and Childers #2 as well as deepening the Childers #1 and Harris #1.  The deepening will be to a minimum depth to complete the wells in the Cotton Valley formation and possibly deeper in order to evaluate the Cotton Valley Lime formation.
 
 Results of Operations
 
 Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010.
 
 Summarized Results of Operations
 
 2011 (As Restated)


2010


Increase (Decrease)Total revenues

$
357,322


$
251,742



105,580Total operating expenses


884,645



698,986



185,659Loss from operations


(527,323
)


(447,244
)


80,079Total other income (expenses)


(1,045,160
)


(144,754
)


900,406Loss from continuing operations before income tax benefit


(1,572,483
)


(591,998
)


980,485Income tax benefit


(9,959
)


-



9,959Loss from continuing operations


(1,562,524
)


(591,998
)


970,526Income (loss) from discontinued operations, net of tax expense


18,494



(90,879
)


109,373Net  loss

$
(1,544,030
)

$
(682,877
)


861,153
 
 Revenues:  Total revenues for the three months ended March 31, 2011 totaled $357,322, compared to $251,742 for the three months ended March 31, 2010.  Production revenues of oil and gas increased $23,450 to $201,166 for the three months ended March 31, 2011 compared to $177,716 for the three months ended March 31, 2010.  Although oil prices increased for the three months ended March 31, 2011 compared to the three months ended March 31, 2010, our oil production decreased, resulting in a $10,119 decrease in oil revenue.  This was offset by an increase in gas production from the Norbord well which began production in December 2010.  Gas prices decreased from the three months ended March 31, 2010 to the three months ended March 31, 2011, however, the increase in production from the Norbord well resulted in an overall $33,268 increase in gas revenues.  Transportation and gathering revenue increased $80,069 to $147,457 for the three months ended March 31, 2011 compared to $67,388 for the three months ended March 31, 2010.  The increase was mainly due to the Norbord gas being carried on the pipeline beginning in December 2010.
 
 Expenses:  Total operating expenses for the three months ended March 31, 2011 were $884,645, compared to $698,986 for the three months ended March 31, 2010 resulting in a total increase of $185,659.  This increase is comprised of an increase in general and administrative expenses, cost of gas purchased for resale, and lease operating expenses.
 
 Lease Operating Expenses:Total lease operating expenses for the three months ended March 31, 2011 were $101,500 compared to $76,261 for the three months ended March 31, 2010 which resulted in an increase of $25,239.  The primarily reason for the increase was the Norbord well starting production in December 2010 so that its initial lease operating charges were during the first quarter of 2011.
 
 Cost of Gas Purchased for Resale:  The $47,756 increase in cost of gas purchased for resale to $94,814 for the three months ended March 31, 2011 from $47,058 for the three months ended March 31, 2010 was primarily due to a higher volume produced in 2011 due to the Norbord well starting production in December 2010.
 
 General and Administrative Expense:The $72,272 increase in general and administrative expense to $587,586 for the three months ended March 31, 2011 from $515,314 for the three months ended March 31, 2010 was primarily due to an increase in accounting fees and consulting fees.  The increase in accounting fees was due to issues in obtaining required reports in a timely manner for the 10-K.  The increase in consulting fees is related to fees paid with the issuance of shares of stock.
 
 Other Income (Expenses):Total other expenses for the three months ended March 31, 2011 were $1,045,160 compared to $144,754 of other expenses for the three months ended March 31, 2010 resulting in an increase of $900,406.  The primary reason for this increase was due to the $881,203 loss resulting from the change in fair value of our warrant derivative liability.  The remaining change was due to the addition of the accrued and unpaid interest on the Teton note being added to the principal balance of the Teton Renewal Note on June 1, 2010 which resulted in higher interest expense.
   19
  Income (Loss) from Discontinued Operations:  The gain from discontinued operations for the three months ended March 31, 2011 was $18,494, compared to a loss of $90,879 for the three months ended March 31, 2010.  This $109,373 increase was due to an increase in disposal activity and a decrease in operating costs.  In the first quarter of 2011, the potential purchaser of certain assets of 59 Disposal agreed to provide an average of ten to twelve trucks per week to the disposal plant until they are able to complete the negotiations.  This caused an increase in disposal revenue.  Also, in the first quarter of 2010, a workover was done on the Whitfield well which resulted in higher operating expenses.
 
 Net Loss:As a result of the above described revenues and expenses, we incurred a net loss of $1,544,030 for the three months ended March 31, 2011 as compared to a net loss of $682,877 for the three months ended March 31, 2010.
 
 Liquidity and Capital Resources
 
 We held $651,711 in cash at March 31, 2011, made up of a majority of our cash accounts.  However, at March 31, 2011, several cash accounts had an overdraft which totaled $537,946, resulting in net cash of $113,765.  We also had a cash overdraft of $340,118 at December 31, 2010.  The increase in the cash overdraft is related to purchases of oil and gas properties and using cash to cover operating expenses.  In addition, our trade accounts payable have increased by $372,022 due to the drilling activity on the Norbord #1 and Swamp Fox #1 wells during the last quarter of 2010.
 
 Cash Flows
 
 The following table summarizes our cash flows for the three months ended March 31, 2011 and 2010:
 
 Three Months Ended March 31,2011


2010Total cash provided by (used in):Operating activities

$
285,713


$
(318,296
)Investing activities


(81,149
)


(104,180
)Financing activities


197,345



621,284Increase  in cash and cash equivalents

$
401,909


$
198,808
 
 Cash provided by all operating activities for the three months ended March 31, 2011 totaled $285,713, compared to $318,296 used in operating activities for the three months ended March 31, 2010.  The increase of $604,009 in cash provided is primarily due to additional cash provided by increases in the following accounts; joint interest billing receivables, related parties of $180,942, accounts payable of $273,229, accounts payable, related parties of $95,131, and revenue payable of $139,988. This increase in cash provided was offset by a decrease of $158,468 in accounts receivable.
 
 Cash used in investing activities for the three months ended March 31, 2011 was $81,149, compared to $104,180 for the three months ended March 31, 2010 for a net change of $23,031.  There were no property and plant purchases in the first three months of 2011 however we spent $84,920 in property and equipment purchases in the first three months of 2010 for the workover done on the Whitfield well.  This decrease was partially offset by an increase in lease and well equipment, and intangible drilling and completion costs for work done on the Norbord and Swamp Fox wells.   These costs increased from $19,070 for the first three months of 2010 to $86,047 for the first three months of 2011.
 
 Cash provided by financing activities for the three months ended March 31, 2011 totaled $197,345, compared to $621,284 for the three months ended March 31, 2010, resulting in a decrease in cash of $423,939.  No advances were received on the related party note payable during the three months ended March 31, 2011; however, we received proceeds of $623,000 on it during the three months ended March 31, 2010.  This decrease in cash received was offset by an increase of $197,828 in our cash overdrafts for the three months ended March 31, 2011.  There were no cash overdrafts at March 31, 2010.
 
 Sources of Liquidity
 
 Our two main sources of liquidity continue to be from funds generated by production promotion fees and financing from a related party in the form of notes payable. During 2010, we received promotion fees which paid for a portion or all of our cost in a proposed drilling well as well as prospect fees associated with the transactions. Any shortfall in revenue to cover costs has been covered by utilizing financing from a related party in the form of notes payable and delaying payment of accounts payable.  We believe that the proceeds from production and continued promotion of prospects, joint ventures with industry partners, and our anticipated selling of our disposal plant will be sufficient to finance our operations for 2011. In addition, future acquisitions and future exploration, development, production and marketing activities, as well as administrative requirements (such as salaries, insurance expenses, general overhead expenses, legal compliance costs and accounting expenses) will require a substantial amount of additional capital and cash flow.
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  We are pursuing sources of additional capital through various financing transactions or arrangements, including joint venturing of projects, debt financing, equity financing or other means.  We have aggressively contacted many potential investors both within the industry as well as institutional investors to secure additional financing.  Additional financing would be used for drilling opportunities and additional lease funding in the near future, along with working capital purposes.  We do not have any commitments or agreements for financing, and we cannot assure you that additional funding will be available on terms acceptable to us, if at all.
 
 Off Balance Sheet Arrangements
 
 We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our consolidated financial condition, revenues, results of operations, liquidity or capital expenditures.
 
 Critical Accounting Policies
 
 Our critical accounting policies, including the assumptions and judgments underlying them, are disclosed in the notes to consolidated financial statements which accompany the consolidated financial statements included in our annual report on Form 10-K filed with the SEC on March 31, 2011.  These policies have been consistently applied in all material respects and address such matters as revenue recognition and depreciation methods.  The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the recorded amounts of revenues and expenses during the reporting period.  Actual results could differ from these estimates.
 
 Accounts Receivable
 
 We perform ongoing credit evaluations of our customers’ financial condition and extend credit to virtually all of our customers.  Collateral is generally not required, nor is interest charged on past due balances.  Credit losses to date have not been significant and have been within management’s expectations.  In the event of complete non-performance by our customers, our maximum exposure is the outstanding accounts receivable balance at the date of non-performance.
 
 Property and Equipment
 
 Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets, which range from five to thirty-nine years.  Expenditures for major renewals and betterments that extend the useful lives are capitalized.  Expenditures for normal maintenance and repairs are expensed as incurred.  Upon the sale or abandonment, the cost of the equipment and related accumulated depreciation are removed from the accounts and any gains or losses thereon are recognized in the operating results of the respective period.
 
 Oil and Gas Properties
 
 We use the full-cost method of accounting for our oil and gas producing activities, which are all located in Texas.  Accordingly, all costs associated with the acquisition, exploration, and development of oil and gas reserves, including directly-related overhead costs, are capitalized.
 
 All capitalized costs of oil and gas properties, including the estimated future costs to develop proved reserves, are amortized on the units-of-production method using estimates of proved reserves.  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 will be added to the capitalized costs to be amortized.
 
 In addition, the capitalized costs are subject to a “ceiling test,” which limits such costs to the aggregate of the “estimated present value,” discounted at a ten percent interest rate, of future net revenues from proved reserves, based on current economic and operating conditions, plus the lower of cost or fair market value of unproved properties and less the income tax effects related to the properties.
 
 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 the operating results of the respective period.
 
 
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  Derivative Instruments
 
 For derivative instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in fair value recognized in earnings each reporting period. For warrant derivative instruments, the Company uses the Black-Scholes model to value the derivative instruments at inception and subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as a liability or as equity, is re-assessed at the end of each reporting period, in accordance with FASB ASC Topic 815, Derivatives and Hedging. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not the net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.
 
 Revenue Recognition
 
 We utilize the accrual method of accounting for natural gas and crude oil revenues, whereby revenues are recognized based on our net revenue interests in the wells.  Crude oil inventories are immaterial and are not recorded.
 
 Gas imbalances are accounted for using the entitlement method.  Under this method, revenues are recognized only to the extent of our proportionate share of the gas sold.  However, we have no history of significant gas imbalances.
 
 Income Taxes
 
 Deferred income taxes are determined using the “liability method” in accordance with FASB ASC Topic 740, Income Taxes.Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
 
 Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which such temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the operating results of the period that includes the enactment date.  In addition, a valuation allowance is established to reduce any deferred tax asset for which it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.
 
 Item 3.   Quantitative and Qualitative Disclosures about Market Risk
 
 Not required under Regulation S-K for “smaller reporting companies.”
 
 Item 4.  Controls and Procedures.
 
 (a) Evaluation of disclosure controls and procedures.
 
 Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as of March 31, 2011. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
 
 Based on management’s evaluation, our chief executive officer and chief financial officer concluded that, as a result of the material weaknesses described below, our disclosure controls and procedures are not designed at a reasonable assurance level and are ineffective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.  The material weaknesses, which relate to internal control over financial reporting, that were identified are:
 
 a)
We did not maintain sufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of GAAP 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.  For example, on August 4, 2011, we became aware that we had failed to recognize a warrant derivative liability with respect to the impact of an anti-dilution provision on our warrants and the subsequent measurement of fair value of the warrant derivative, as required by Accounting Standards Codification 815-40.  As a result, we determined that our consolidated financial statements for the year ended December 31, 2010 filed in the annual report on Form 10-K and our consolidated financial statements as of and for the three month period ended March 31, 2011 filed in the quarterly report on Form 10-Q (collectively, the “Reports”) should not be relied upon and needed to be restated; and
   22
 
 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 consolidated financial statements will not be prevented or detected on a timely basis.
 
 We are committed to improving our financial organization. As part of this commitment, in August 2011, we adopted additional controls to strengthen our internal controls over financial reporting as a result of the failure in recognizing the warrant derivative liability issued that resulted in the amendment to our Reports. If the issuance of any sercurties is contemplated, we will consult with legal counsel and appropriate accounting resources to evaluate the financial statement impact that the issuance of such warrants or other derivative financial instruments may have prior to issuance. Additional measures may be implemented as we evaluate the effectiveness of these efforts.  We cannot assure you that these remediation efforts will be successful or that our internal control over financial reporting will be effective in accomplishing the control objectives.
 
 In addition, we will look to increase our personnel resources and technical accounting expertise within the accounting function to resolve non-routine or complex accounting matters. In addition, when funds are available,  we will take the following action to enhance our internal controls: Hiring additional knowledgeable personnel with technical accounting expertise to further support our current accounting personnel, which management estimates will cost approximately $100,000 per annum.   As our operations are relatively small and we continue to have net cash losses each quarter, we do not anticipate being able to hire additional internal personnel until such time as our operations are profitable on a cash basis or until our operations are large enough to justify the hiring of additional accounting personnel.  We currently engage an outside accounting firm to assist us in the preparation of our consolidated financial statements and anticipate doing so until we have a sufficient number of internal accounting personnel to achieve compliance.  As necessary, we will engage consultants in the future in order to ensure proper accounting for our consolidated financial statements.
 
 Management believes that hiring additional knowledgeable personnel with technical accounting expertise will remedy the following material weakness: insufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of GAAP commensurate with our complexity and our financial accounting and reporting requirements.
 
 Management believes that the hiring of additional personnel who have the technical expertise and knowledge with the non-routine or technical issues we have encountered in the past will result in both proper recording of these transactions and a much more knowledgeable finance department as a whole. Due to the fact that our internal accounting staff consists solely of a Chief Financial Officer, additional personnel will also ensure the proper segregation of duties and provide more checks and balances within the department. Additional personnel will also provide the cross training needed to support us if personnel turn over issues within the department occur. We believe this will greatly decrease any control and procedure issues we may encounter in the future.
 
 (b) Changes in internal control over financial reporting.
 
 There were no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
  
 23
  PART II - OTHER INFORMATION
 
 Item 1. Legal Proceedings.
 
 From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse affect on our business, consolidated financial condition or operating results.
 
 Item 1A. Risk Factors.
 
 Not required under Regulation S-K for “smaller reporting companies.”
 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 
 None.
 
 Item 3. Defaults Upon Senior Securities.
 
 None
 
 Item 4. (Removed and Reserved)
 
 
 Item 5. Other Information.
 
 None.
 
 Item 6. Exhibits.
 
 10.01
Form of Third Amendment to Promissory Note, effective as of April 1, 2011, by and among Pegasi Energy Resources Corporation, Pegasi Operating Inc., TR Rodessa, Inc., 59 Disposal, Inc. and Teton, Ltd. †
 
 10.02
Form of Fifth Amendment to Promissory Note, effective as of April 2, 2011, by and among Pegasi Energy Resources Corporation, Pegasi Operating Inc., TR Rodessa, Inc., 59 Disposal, Inc. and Teton, Ltd. †
 
 31.01
Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 31.02
Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 32.01
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  †
Previously filed
 
 
 24
 
 
 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.
 
 PEGASI ENERGY RESOURCES CORPORATIONDate:   August 22, 2011
By:/s/ MICHAEL NEUFELDMichael NeufeldChief Executive Officer (Principal Executive Officer)Date:   August  22, 2011
By:/s/ RICHARD LINDERMANISRichard LindermanisChief Financial Officer (Principal Financial Officer and Principal Accounting Officer)