Attached files

file filename
EX-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 - WORTHINGTON ENERGY, INC.pxte10q20110331ex31-01.htm
EX-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 - WORTHINGTON ENERGY, INC.pxte10q20110331ex32-01.htm
EX-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 - WORTHINGTON ENERGY, INC.pxte10q20110331ex31-02.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2011

Commission File Number 000-52590

Paxton Energy, Inc.
(Exact name of registrant as specified in its charter)
 
Nevada
20-1399613
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
295 Highway 50, Suite 2, Lake Village Professional Building, Stateline, NV 89449
Mailing Address:  P.O. Box 1148, Zephyr Cove, NV 89448-1148
(Address of principal executive offices) (zip code)
 
(775) 588-5390
(Registrant’s telephone number, including area code)
 
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes
x
No
o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes
¨
No
¨

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

Large accelerated filer o
Accelerated filer ¨
Non-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
o
No
x

As of May 13, 2011, issuer had 41,200,621 outstanding shares of common stock, par value $0.001.

 
 

 

TABLE OF CONTENTS

 
Page
   
PART I – FINANCIAL INFORMATION
 
 
Item 1. Financial Statements
  1
 
Condensed Balance Sheets (Unaudited)
  1
 
Condensed Statements of Operations (Unaudited)
  2
 
Condensed Statement of Stockholders’ Equity (Deficit)  (Unaudited)
  3
 
Condensed Statements of Cash Flows (Unaudited)
  4
 
Notes to Condensed Financial Statements (Unaudited)
  5
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
  14
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk
  20
 
Item 4. Controls and Procedures
  21
     
PART II – OTHER INFORMATION
 
 
Item 1. Legal Proceedings
  23
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  23
 
Item 3. Defaults Upon Senior Securities
  23
 
Item 6. Exhibits
  23
 
Signature
  24


 
i

 


PART I – FINANCIAL INFORMATION


ITEM 1.  FINANCIAL STATEMENTS
 
Paxton Energy, Inc., has included its unaudited condensed balance sheets as of March 31, 2011, and December 31, 2010 (the end of its most recently completed fiscal year); and unaudited condensed statements of operations and cash flows for the three months ended March 31, 2011 and 2010, and for the period from June 30, 2004 (date of inception) through March 31, 2011; together with unaudited condensed notes thereto.  In the opinion of management of Paxton Energy, Inc., the financial statements reflect all adjustments, all of which are normal recurring adjustments, necessary to fairly present the financial condition, results of operations, and cash flows of Paxton Energy, Inc., for the interim periods presented.  The financial statements included in this report on Form 10-Q should be read in conjunction with the audited financial statements of Paxton Energy, Inc., and the notes thereto for the year ended December 31, 2010, included in our annual report on Form 10-K.

PAXTON ENERGY, INC.
 
(AN EXPLORATION-STAGE COMPANY)
 
CONDENSED BALANCE SHEETS
 
(Unaudited)
 
             
   
March 31,
   
December 31,
 
   
2011
   
2010
 
             
ASSETS
             
Current Assets
           
  Cash and cash equivalents
  $ 1,536     $ 53,421  
  Receivable from attorneys' trust accounts
    668       668  
  Prepaid expenses and other current assets
    -       9,339  
Total Current Assets
    2,204       63,428  
                 
Property and Equipment, net of accumulated depreciation
    238       341  
                 
Oil and gas properties, using full cost accounting
    587,886       587,886  
                 
Total Assets
  $ 590,328     $ 651,655  
                 
LIABILITIES AND STOCKHOLDERS' DEFICIT
                 
Current Liabilities
               
  Accounts payable
  $ 302,306     $ 193,651  
  Accrued liabilities
    513,647       376,903  
  Payable to Bayshore Exploration L.L.C.
    111,455       113,544  
  Payable to officer
    15,000       30,000  
  Advance on financing
    15,000       -  
  Notes payable
    225,000       225,000  
  Notes payable to related parties
    105,000       105,000  
  Unsecured convertible promissory notes payable, net of discount
    111,926       184,335  
  Accrued registration rights penalties and interest
    12,375       12,097  
Total Current Liabilities
    1,411,709       1,240,530  
                 
Long-Term Liabilities
               
  Long-term asset retirement obligation
    36,801       36,714  
  Derivative liabilities
    237,432       243,376  
Total Long-Term Liabilities
    274,233       280,090  
                 
Stockholders' Deficit
               
  Preferred stock, $0.001 par value; 10,000,000 shares authorized, none issued and outstanding
    -       -  
  Common stock, $0.001 par value; 500,000,000 shares authorized, 26,000,621 and 20,343,263 shares issued and outstanding, respectively
    26,001       20,343  
  Additional paid-in capital
    11,830,112       11,348,416  
  Deficit accumulated during the exploration stage
    (12,951,727 )     (12,237,724 )
Total Stockholders' Deficit
    (1,095,614 )     (868,965 )
                 
Total Liabilities and Stockholders' Deficit
  $ 590,328     $ 651,655  
 
    
See Notes to Condensed Financial Statements
 
 
1

 

PAXTON ENERGY, INC.
 
(AN EXPLORATION-STAGE COMPANY)
 
CONDENSED STATEMENTS OF OPERATIONS
 
(Unaudited)
 
               
For the Period from
 
               
June 30, 2004
 
   
For the Three Months Ended
   
(Date of Inception)
 
   
March 31,
   
through
 
   
2011
   
2010
   
March 31, 2011
 
                   
 Oil and gas revenues, net
  $ 5,479     $ 3,136     $ 368,039  
                         
Costs and Operating Expenses
                       
  Lease operating expenses
    3,390       1,731       146,858  
  Impairment loss on oil and gas properties
    -       -       3,847,192  
  Accretion of asset retirement obligations
    86       263       8,494  
  General and administrative expense
    422,899       51,669       3,112,229  
  Share-based compensation
    84,098       212,163       3,992,380  
    Total costs and operating expenses
    510,473       265,826       11,107,153  
                         
Loss from operations
    (504,994 )     (262,690 )     (10,739,114 )
                         
Other income (expense)
                       
  Interest income
    -       -       63,982  
  Change in fair value of derivative liabilities
    (37,181 )     (27,434 )     (278,754 )
  Gain on transfer of common stock from Bayshore Exploration, L.L.C.
    -       -       24,000  
  Interest expense
    (17,737 )     (27,343 )     (472,350 )
  Amortization of discount on convertible notes and other debt
    (154,091 )     -       (1,549,491 )
      Total other income (expense)
    (209,009 )     (54,777 )     (2,212,613 )
                         
Net Loss
  $ (714,003 )   $ (317,467 )   $ (12,951,727 )
                         
Basic and Diluted Loss Per Common Share
  $ (0.03 )   $ (0.10 )        
                         
Basic and Diluted Weighted-Average Common Shares Outstanding
    24,049,261       3,266,672          
See Notes to Condensed Financial Statements

 
2

 

PAXTON ENERGY, INC.
 
(AN EXPLORATION-STAGE COMPANY)
 
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
 
For the Three Months Ended March 31, 2011
 
(Unaudited)
 
                     
Deficit
       
                     
Accumulated
   
Total
 
               
Additional
   
During the
   
Stockholders'
 
   
Common Stock
   
Paid-In
   
Exploration
   
Equity
 
   
Shares
   
Amount
   
Capital
   
Stage
   
(Deficit)
 
                               
Balance - December 31, 2010
    20,343,263     $ 20,343     $ 11,348,416     $ (12,237,724 )   $ (868,965 )
                                         
Issuance of common stock and warrants for cash,
                                 
     January 2011, $0.15 per unit
    600,000       600       89,400       -       90,000  
                                         
   Issuance of common stock and warrants upon
                                       
     conversion of notes payable and accrued interest,
                                       
     January 2011 to March 2011, $0.03 to $0.05 per share
    5,057,358       5,058       308,198       -       313,256  
                                         
   Share-based compensation from grant of common
                                       
     stock options to officer and consultants
    -       -       84,098       -       84,098  
                                         
   Net loss
    -       -       -       (714,003 )     (714,003 )
                                         
Balance - March 31, 2011
    26,000,621     $ 26,001     $ 11,830,112     $ (12,951,727 )   $ (1,095,614 )

 
See Notes to Condensed Financial Statements

 
3

 

PAXTON ENERGY, INC.
 
(AN EXPLORATION-STAGE COMPANY)
 
CONDENSED STATEMENTS OF CASH FLOWS
 
(Unaudited)
 
               
For the Period from
 
               
June 30, 2004
 
   
For the Three Months Ended
   
(Date of Inception)
 
   
March 31,
   
through
 
   
2011
   
2010
   
3/31/2011
 
                   
Cash Flows From Operating Activities
                 
  Net loss
  $ (714,003 )   $ (317,467 )   $ (12,951,727 )
  Adjustments to reconcile net loss to net cash used in operating activities:
                       
    Impairment loss on oil and gas properties
    -       -       3,847,192  
    Share-based compensation for services
    84,098       212,163       3,992,380  
    Amortization of discount on convertible notes and other debt
    154,091       -       1,549,491  
    Gain on transfer of common stock from Bayshore Exploration, L.L.C.
    -       -       (24,000 )
    Accretion of asset retirement obligations
    86       263       8,494  
    Depreciation expense
    103       166       4,925  
    Change in fair value of derivative liabilities
    37,181       27,434       278,754  
    Changes in assets and liabilities:
                       
      Accounts receivable
    -       -       16,818  
      Prepaid expenses and other current assets
    9,339       (671 )     -  
      Accounts payable and accrued liabilities
    251,942       (34,897 )     1,170,746  
      Payable to officer
    (15,000 )     -       15,000  
      Accrued registration rights penalties and interest
    278       17,005       302,689  
  Net Cash Used In Operating Activities
    (191,885 )     (96,004 )     (1,789,238 )
                         
Cash Flows From Investing Activities
                       
  Acquisition of oil and gas properties
    -       -       (1,916,515 )
  Purchase of property and equipment
    -       -       (5,163 )
  Net Cash Used In Investing Activities
    -       -       (1,921,678 )
                         
Cash Flows From Financing Activities
                       
  Proceeds from the issuance of common stock and warrants, net of registration and offering costs
    90,000       -       3,134,970  
  Proceeds from issuance of convertible notes and other debt, and related beneficial conversion features and common stock, less amounts held in attorneys' trust accounts
    35,000       93,094       1,272,332  
  Advance on financing
    15,000       -       15,000  
  Proceeds from related parties for issuance of secured convertible notes and other debt, and related beneficial conversion features and common stock
    -       -       180,000  
  Payment of payable to Bayshore Exploration L.L.C.
    -       -       (489,600 )
  Payment of principal on notes payable to stockholder
    -       -       (325,000 )
  Payment of principal on note payable
    -       -       (75,250 )
  Net Cash Provided By Financing Activities
    140,000       93,094       3,712,452  
Net Increase (Decrease) In Cash And Cash Equivalents
    (51,885 )     (2,910 )     1,536  
Cash and Cash Equivalents At Beginning Of Period
    53,421       4,026       -  
Cash and Cash Equivalents At End Of Period
  $ 1,536     $ 1,116     $ 1,536  
                         
Supplemental Cash Flow Information - Note J.                         
  

See Notes to Condensed Financial Statements

 
4

 

PAXTON ENERGY, INC.
(An Exploration Stage Company)
Notes to Condensed Financial Statements
(Unaudited)

(A)           Organization, Change in Control and Significant Accounting Policies

Organization Paxton Energy, Inc. (the “Company”) was organized under the laws of the State of Nevada on June 30, 2004.  During August 2004, shareholder control of the Company was transferred, a new board of directors was elected and new officers were appointed.  These officers and directors managed the Company until March 17, 2010, at which time, the existing members of the Company’s board of directors resigned, new members were appointed to the board of directors, and managerial control of the Company was transferred to new management.  The new board of directors immediately commenced, among other things, the placement of unsecured convertible promissory notes to raise funds for working capital and held a meeting of stockholders on June 29, 2010, at which the stockholders approved 1) a 1-for-3 reverse common stock split, 2) a second reverse stock split of approximately 1 share for 2.4 shares of common stock, 3) the amendment of the Company’s certificate of incorporation to increase the Company’s authorized capital from 100 million to 500 million shares of common stock and from 5 million to 10 million shares of preferred stock, and 4) the adoption of the 2010 Stock Option Plan.

Nature of Operations During June 2005, the Company commenced acquiring working interests in oil and gas properties principally located in the Cooke Ranch prospect in LaSalle County, Texas.  The Company is engaged primarily as a joint interest owner with Bayshore Exploration L.L.C. (Bayshore) in the acquisition, exploration, and development of oil and gas properties and the production and sale of oil and gas.  Through March 31, 2011, the Company has participated in drilling ten wells.  Additionally, the Company owns a working interest in the 8,843-acre balance of the Cooke Ranch prospect and has the right to participate in a program to acquire up to a 75% working interest in leases adjacent to the Cooke Ranch prospect, where, to date, the Company has acquired an interest in leases on approximately 2,268 gross acres.  New management of the Company is currently evaluating existing oil and gas properties and also evaluating other expansion opportunities. The Company is considered to be in the exploration stage due to the lack of significant revenues.

Condensed Interim Financial Statements – The accompanying unaudited condensed financial statements of Paxton Energy, Inc., have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q.  Accordingly, these financial statements do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements.  These financial statements should be read in conjunction with the Company’s annual financial statements and the notes thereto for the year ended December 31, 2010, and for the period from June 30, 2004 (date of inception) through December 31, 2010, included in the Company’s annual report on Form 10-K.  In the opinion of the Company’s management, the accompanying unaudited condensed financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to fairly present the Company’s financial position as of March 31, 2011 and its results of operations and cash flows for the three months ended March 31, 2011 and 2010, and for the period from June 30, 2004 (date of inception), through March 31, 2011.  The results of operations for the three months ended March 31, 2011, may not be indicative of the results that may be expected for the year ending December 31, 2011.

Business ConditionThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern.  The Company has not had significant revenue and is still considered to be in the exploration stage.  The Company incurred losses of $714,003 for the three months ended March 31, 2011 and $4,154,493 for the year ended December 31, 2010.  The Company also used cash of $191,885 and $498,605 in its operating activities during the three months ended March 31, 2011 and the year ended December 31, 2010, respectively.  Through March 31, 2011, the Company has accumulated a deficit during the exploration stage of $12,951,727.  At March 31, 2011, the Company has a working capital deficit of $1,409,505 including current liabilities of $1,411,709.  These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

 
5

 

As discussed above, the existing members of the Company’s board of directors resigned on March 17, 2010 and new members were appointed.  During the period since the change of control in March 2010, the accomplishments of the new board of directors include, among other things, the following:
 
 
·
The placement of unsecured convertible promissory notes in the amount of $418,000 to provide working capital for the Company.

 
·
The settlement of its liability for accrued registration rights penalties and interest in the amount of $698,092 by the issuance of common stock.

 
·
The conversion of all outstanding options and warrants to purchase 683,176 shares of common stock into 683,176 shares of common stock.

 
·
The consummation of two reverse stock splits that resulted in a total of approximately 10 million post-consolidation shares of common stock outstanding at the date of the reverse stock splits.

 
·
The sale of $255,000 of equity securities as of March 31, 2011.

 
·
The sale of convertible debentures and warrants for gross proceeds of $2,133,250 subsequent to March 31, 2011.

 
·
The acquisition of a 70% leasehold working interest, with a net revenue interest of 51.975%, of certain oil and gas leases owned by Montecito, for $1,500,000 in cash, a subordinated promissory note in the amount of $500,000, and 15 million shares of common stock.  This acquisition closed subsequent to March 31, 2011.

 
·
An agreement of merger with Virgin Oil Company, Inc. and Virgin Offshore U.S.A., Inc., a wholly owned subsidiary of Virgin, entered into on April 29, 2011.  Pursuant to the terms of the agreement, at closing, the shareholders of Virgin will receive an aggregate of 70 million shares of the Company’s common stock in exchange for all of the issued and outstanding shares of Virgin Oil.  The merger is subject to the satisfaction of certain conditions.

The Company entered into an agreement with a consulting company on September 7, 2010, under which the consultant agreed to provide the Company with one or more financial and strategic business plans.  Thereafter, on September 27, 2010, the Company entered into an agreement with an investment banking firm to provide investment banking and financial advisory services.  Services under these two agreements are being provided to the Company in connection with the evaluation and due diligence of potential oil and gas property acquisitions.

The Company is currently seeking equity, debt, and transaction financing to fund these potential acquisitions and other expenditures, although the Company does not have any definitive contracts or commitments for either at this time.  The Company will have to raise additional funds to continue operations and, while the Company has been successful in doing so in the past, there can be no assurance that it will be able to do so in the future.  The Company’s continuation as a going concern is dependent upon its ability to obtain necessary additional funds to continue operations and the attainment of profitable operations.

Basic and Diluted Loss per Common Share – Basic loss per common share amounts are computed by dividing net loss by the weighted-average number of shares of common stock outstanding during each period.  Diluted loss per share amounts are computed assuming the issuance of common stock for potentially dilutive common stock equivalents. All outstanding stock options, warrants, and convertible promissory notes are currently antidilutive and have been excluded from the diluted loss per share calculations.  None of the options and warrants to acquire 16,722,954 shares of common stock, or the promissory notes convertible into approximately 4,290,096 shares of common stock and warrants to purchase 961,949 shares of common stock were included in the computation of diluted loss per share at March 31, 2011 and none of the warrants and options to acquire 683,176 shares of common stock were included in the computation of diluted loss per share at March 31, 2010.

 
6

 

Fair Values of Financial Instruments – The carrying amounts reported in the balance sheets for receivable from attorneys’ trust accounts, accounts payable, payable to Bayshore Exploration L.L.C., payable to officer, and advance on financing approximate fair value because of the immediate or short-term maturity of these financial instruments.  The carrying amounts reported for notes payable, notes payable to related parties, and unsecured convertible promissory notes payable approximate fair value because the underlying instruments are at interest rates which approximate current market rates.  The fair value of derivative liabilities are estimated based on the method disclosed in Note G to these condensed financial statements.

Recently Issued Accounting Statements – In October 2009, the Financial Accounting Standards Board (the FASB) issued a new accounting standard which amends guidance on accounting for revenue arrangements involving the delivery of more than one element of goods and/or services. This standard addresses the unit of accounting for arrangements involving multiple deliverables and removes the previous separation criteria that objective and reliable evidence of fair value of any undelivered item must exist for the delivered item to be considered a separate unit of accounting. This standard also addresses how the arrangement consideration should be allocated to each deliverable. Finally, this standard expands disclosures related to multiple element revenue arrangements. This standard was effective for the Company beginning January 1, 2011. The adoption of this standard did not have a material impact on the Company’s condensed financial statements.

In December 2010, the FASB issued accounting guidance which specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only.  This guidance also expands supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in reported pro forma revenue and earnings. This guidance was effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Other than requiring additional disclosures for business combinations that the Company enters into in the future, the adoption of this guidance is not expected to have a material impact on the Company’s financial statements.

(B)           Accrued Liabilities

Accrued liabilities consisted of the following at March 31, 2011 and December 31, 2010:

   
March 31,
   
December 31,
 
   
2011
   
2010
 
             
Accrued salaries
  $ 391,580     $ 281,593  
Accrued payroll taxes
    41,690       27,262  
Accrued director fees
    24,000       18,000  
Accrued interest
    53,877       47,548  
Other accrued expenses
    2,500       2,500  
                 
Total accrued liabilities
  $ 513,647     $ 376,903  


(C)           Unsecured convertible promissory notes payable

$300,000 Convertible Promissory Note Offering

Commencing in March 2010, new management of the Company initiated the placement of unsecured convertible promissory notes to raise up to $300,000 for the payment of transaction expenses, payment of certain accounts payable, and to provide working capital.  These notes bear interest at 9% per annum.  The repayment of the notes, including accrued interest, was due on December 31, 2010 if not converted into common stock earlier.  Originally, the principal amount of the notes, plus accrued interest, were to be automatically converted, in whole, into shares and warrants of the Company upon the completion of a $3,000,000 sale of common stock and warrants as part of the change of control and the exchange of oil and gas interests by the Company’s new chief executive officer with the Company.  However, in October 2010, management of the Company decided to allow the conversion of notes payable under this offering prior to the completion of the $3,000,000 placement and prior to the automatic conversion process described in the notes.  

 
7

 

The number of shares of common stock and warrants to be issued upon such conversion is equal to a discount of 66% of the price of the common stock and warrants in the $3,000,000 sales of common stock and warrants.  As such, the conversion price is $0.051 per share of common stock and warrant to purchase one half share of common stock.  The holders of these convertible promissory notes will be entitled to the same registration rights, if any, given to the purchasers of the $3,000,000 offering.  Proceeds from the convertible note offering totaled $298,000.  In November 2010, the Company received notice of conversion of notes totaling $158,000, plus accrued interest of $8,630, which were converted into 3,267,247 shares of common stock and warrants to purchase 1,633,625 shares of common stock.  During the three months ended March 31, 2011, the Company received notice of conversion of notes totaling $47,500, plus accrued interest of $2,412, which were converted into 978,657 shares of common stock and warrants to purchase 489,329 shares of common stock.  The warrants are exercisable at $0.45 per share until August 31, 2013.  The unconverted balance of these promissory notes is $92,500 and $140,000 at March 31, 2011 and December 31, 2010, respectively.  The unconverted notes came due on December 31, 2010 and have not been paid.  Both the non-payment of interest and the Company’s failure to repay the notes when they matured constitute events of default under the notes.  Upon the occurrence of an event of default, the noteholders have the right to exercise their rights associated with the notes.  

Convertible Promissory Notes to an Unaffiliated Entity

On April 28, 2010, the Company issued an unsecured convertible promissory note to an unaffiliated entity.  Proceeds from the convertible promissory note were $50,000.  On December 20, 2010, the Company issued a second unsecured convertible promissory note to this entity.  Proceeds from this second convertible promissory note were $35,000.  On February 7, 2011, the Company issued a third unsecured convertible promissory note to this entity.  Proceeds from this third convertible promissory note were also $35,000.  The convertible promissory notes bear interest at 8% per annum.  The original promissory note was due January 28, 2011.  The second and third promissory notes are due September 22, 2011 and November 9, 2011, respectively.  In general, the notes are convertible until maturity at a variable conversion price equal to 50% of the average of the lowest three closing bid prices from the ten trading days prior to the date of the conversion notice.  In December 2010, the Company received notices of conversion of notes totaling $21,000, which were converted into 377,290 shares of common stock, or a weighted-average conversion price of $0.05566 per share.  During the three months ended March 31, 2011, the Company received notices of conversion of notes totaling $29,000 and accrued interest of $2,000, which were converted into 994,315 shares of common stock, or a weighted-average conversion price of $0.03118 per share.

This variable conversion feature constitutes an embedded derivative under generally accepted accounting principles and is required to be valued at its fair value.  The fair value of the beneficial conversion feature was estimated at $42,308 for the original note and at $35,000 for the second and third notes, which were recorded as discounts to the carrying amount of the convertible promissory notes.  The discounts are being amortized over the period from the issuance dates to the maturity dates.  The Company recognized interest expense from the amortization of the discounts in the amount of $20,530 for the three months ended March 31, 2011.  The carrying amount of the convertible promissory notes is $19,426 at March 31, 2011, representing their unconverted face amount of $70,000 less the unamortized discount of $50,574.  The carrying amount of the convertible promissory notes was $27,896 at December 31, 2010, representing their unconverted face amount of $64,000 less the unamortized discount of $36,104.   

Convertible Promissory Notes Issued in Exchange for Accounts Payable

On October 12, 2010, an unrelated third party acquired the rights to certain of the Company’s past-due accounts payable totaling $193,676.  That entity and the Company then agreed to convert the past-due accounts payable into Convertible Redeemable Notes Payable with an aggregate principal amount of $193,676.  These notes were due October 12, 2012 and bore interest at 6%.  Interest was payable on or before the due date of the notes and was payable in shares of the Company’s common stock.  The holder of the notes was entitled, at its option, to convert all or any portion of the principal of the notes, along with related accrued interest, into shares of the Company’s common stock at a conversion price equal to $0.05 per share.  On October 18, 2010, the note holder converted $43,676 of principal into 873,522 shares of common stock. During the three months ended March 31, 2011, the remaining $150,000 of principal and $4,219 of accrued interest were converted into 3,084,386 shares of common stock.

 
8

 

The fair value of the beneficial conversion feature was originally estimated at $193,676 for these convertible promissory notes, which was recorded as discounts to the carrying amount of the convertible promissory notes.  The discounts were amortized over the period from the issuance dates of the notes to the earlier of the maturity dates or the conversion dates.  The Company recognized interest expense from the amortization of the discounts in the amount of $133,561 for the three months ended March 31, 2011.  The carrying amount of the convertible promissory notes was $16,439 at December 31, 2010, representing their unconverted face amount of $150,000 less the unamortized discount of $133,561.

A summary of unsecured convertible promissory notes at March 31, 2011 and December 31, 2010 is as follows:

   
March 31, 2011
   
December 31, 2010
 
   
Unpaid
Principal
   
Unamortized
Discount
   
Carrying
Value
   
Unpaid
Principal
   
Unamortized
Discount
   
Carrying
Value
 
                                     
$300,000 Convertible Note Offering
  $ 92,500     $ -     $ 92,500     $ 140,000     $ -     $ 140,000  
Convertible Notes to an Unaffiliated Entity
    70,000       50,574       19,426       64,000       36,104       27,896  
Convertible Notes Issued for Accounts Payable
    -       -       -       150,000       133,561       16,439  
                                                 
    $ 162,500     $ 50,574     $ 111,926     $ 354,000     $ 169,665     $ 184,335  
  
(D)           Notes Payable

On September 3, 2008, the Company issued $225,000 of secured promissory notes to four individuals who are unaffiliated with the Company and $75,000 of secured promissory notes to two individuals who were related parties at the time.  All of these promissory notes bear interest at 12% per annum, with interest payable monthly.  The promissory notes were originally due September 1, 2009 and are secured by all of the assets of the Company.  With the change in management control in March 2010, accrued interest on these notes was paid through January 31, 2010 and the due dates of the promissory notes were extended to August 31, 2010.  The notes came due on August 31, 2010 and have not been paid.  Both the non-payment of interest and the Company’s failure to repay the notes when they matured constitute events of default under the notes.  Upon the occurrence of an event of default, the noteholders have the right to exercise their rights under the security agreement associated with the notes.  These rights include, among other things, the right to foreclose on the collateral if necessary.  In light of recent financing as discussed more fully in Note K to these condensed financial statements, the Company is currently working to resolve the default on these notes.  The Company can provide no assurance that it will obtain a resolution, or that the secured creditors will not eventually foreclose if not paid in the near term.

Between July 9, 2009 and December 31, 2009, the Company’s two former officers and directors loaned the Company a total of $30,000 to provide working capital for the immediate needs of the Company.  These notes bear interest at 12%, are not collateralized, and were originally due December 30, 2009.  With the change in management control in March 2010, accrued interest on these notes was paid through January 31, 2010 and the due dates of the promissory notes were extended to August 31, 2010.  The notes came due on August 31, 2010 and have not been paid.  Both the non-payment of interest and the Company’s failure to repay the notes when they matured constitute events of default under the notes.  In light of recent financing as discussed more fully in Note K to these condensed financial statements, the Company is currently working to resolve the default on these notes.  The Company can provide no assurance that it will obtain a resolution.

(E)           Common Stock

Issuance of Common Stock and Warrants for Cash

During the three months ended March 31, 2011, the Company sold 600,000 shares of common stock and warrants to purchase 300,000 shares of common stock.  The warrants are exercisable at $0.45 per share and expire on August 31, 2013.  Proceeds to the Company from the sale were $90,000, which were allocated $60,780 to the common stock and $29,220 to the warrants based on their relative fair values.

 
9

 

Issuance of Common Stock in Satisfaction of Payable to Former Officers and Consultant

In connection with the change of managerial control of the Company in March 2010, the new board of directors agreed to issue 1,250,000 post-split shares of the Company’s common stock to former management and 250,000 post-split shares to a consultant as compensation for services.  The former management and consultant completed all that was required of them under this arrangement during March, 2010.  Accordingly, the Company recognized this obligation to these individuals and the associated compensation during March, 2010 by recording $212,163 of share-based compensation representing the estimated value of 1,500,000 shares of post-split shares of the Company’s common stock.  The estimated value of the shares was based on the closing price of the common stock on March 17, 2010, adjusted for the expected dilutive effects of various stock issuances that were required to occur prior to the issuance of the post-split shares.  In September, 2010, the Company issued 1,500,000 shares to the former management and consultant, and the obligation was satisfied.

(F)           Stock Options and Warrants

Stock Options and Compensation-Based Warrants

On June 29, 2010, the stockholders of the Company approved the adoption of the 2010 Stock Option Plan.  The Plan provides for the granting of incentive and nonqualified stock options to employees and consultants of the Company.  Generally, options granted under the plan may not have a term in excess of ten years.  Upon adoption, the Plan reserved 20 million shares of the Company’s common stock for issuance there under.

Generally accepted accounting principles for stock options and compensation-based warrants require the recognition of the cost of services received in exchange for an award of equity instruments in the financial statements, is measured based on the grant date fair value of the award, and requires the compensation expense to be recognized over the period during which an employee or other service provider is required to provide service in exchange for the award (the vesting period).  No income tax benefit has been recognized for share-based compensation arrangements and no compensation cost has been capitalized in the accompanying condensed balance sheet.

A summary of stock option and compensation-based warrant activity for the three-month period ended March 31, 2011 is presented below:

             
Weighted
     
   
Shares
   
Weighted
 
Average
     
   
Under
   
Average
 
Remaining
 
Aggregate
 
   
Option or
   
Exercise
 
Contractual
 
Intrinsic
 
   
Warrant
   
Price
 
Life
 
Value
 
                     
Outstanding at December 31, 2010
    13,750,000     $ 0.30  
 8.9 years
     
Granted or issued
    -       -          
                         
Outstanding at March 31, 2011
    13,750,000       0.30  
 8.7 years
  $ -  
                           
Exercisable at March 31, 2011
    9,916,664     $ 0.26  
 8.5 years
  $ -  

There were no stock options granted or compensation-based warrants issued during the three months ended March 31, 2011 or 2010.  For the three-month period ended March 31, 2011, the Company reported compensation expense related to stock options and compensation-based warrants of $84,098 (none for the three-month period ended March 31, 2010).  As of March 31, 2011, there was approximately $294,000 of unrecognized compensation cost related to stock options that will be recognized over a weighted average period of approximately 1.9 years.  The intrinsic values at March 31, 2011 are based on a closing price of $0.13.


 
10

 

Other Stock Warrants

A summary of other stock warrant activity for the three-month period ended March 31, 2011 is presented below:

             
Weighted
     
   
Shares
   
Weighted
 
Average
     
   
Under
   
Average
 
Remaining
 
Aggregate
 
   
Option or
   
Exercise
 
Contractual
 
Intrinsic
 
   
Warrant
   
Price
 
Life
 
Value
 
                     
Outstanding at December 31, 2010
    2,183,625     $ 0.45  
 2.7 years
       
Issued
    789,329       0.45            
                           
Outstanding at March 31, 2011
    2,972,954       0.45  
 2.4 years
  $ -  
     
(G)           Derivative Liabilities

Beneficial Conversion Feature

As described above in Note C to these condensed financial statements, the Company issued unsecured convertible promissory notes to an unaffiliated entity which contains a beneficial conversion feature which is treated as an embedded derivative under generally accepted accounting principles and is required to be accounted for at fair value.  The Company has estimated the fair value of the beneficial conversion feature based on the intrinsic value of the conversion feature, which equals the difference between the variable conversion price of the note and the closing price of the Company’s common stock on the date of the valuation.  The fair value of the beneficial conversion feature was estimated to be $237,432 and $243,376 as of March 31, 2011 and December 31, 2010, respectively.  The Company recognized a loss from the change in fair value of this beneficial conversion feature of $37,181 for the three months ended March 31, 2011.

Warrants

Effective January 1, 2009 the Company adopted the provisions of new accounting standards related to embedded derivatives and reclassified the fair value of certain common stock purchase warrants from equity to liability status as if these warrants were treated as a derivative liability since their date of issue in April 2006.  The warrants did not qualify for hedge accounting, and as such, all changes in the fair value of these warrants were recognized currently in results of operations until June 29, 2010 when the warrants were canceled.  The Company recognized a loss from the change in fair value of these warrants of $27,434 for the three months ended March 31, 2010.  These common stock purchase warrants did not trade in an active securities market, and as such, the Company estimated the fair value of these warrants using the Black-Scholes option pricing model.

(H)           Fair Value Measurements

For asset and liabilities measured at fair value, the Company uses the following hierarchy of inputs:

 
 
Level one — Quoted market prices in active markets for identical assets or liabilities;
       
 
 
Level two — Inputs other than level one inputs that are either directly or indirectly observable; and
       
 
 
Level three — Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.

 
11

 
 
Liabilities measured at fair value on a recurring basis at March 31, 2011 are summarized as follows:

   
Level 1
   
Level 2
   
Level 3
   
Total
 
                         
Fair value of beneficial conversion feature
  $ -     $ 237,432     $ -     $ 237,432  
Liabilities measured at fair value on a recurring basis at December 31, 2010 are summarized as follows:
   
Level 1
   
Level 2
   
Level 3
   
Total
 
                                 
Fair value of beneficial conversion feature
  $ -     $ 243,376     $ -     $ 243,376  
As further described in Note G, the fair value of the beneficial conversion feature is measured using the intrinsic value method, equal to the excess of the market price of the stock over the conversion price, multiplied by the number of shares to be received upon conversion.

(I)           Related-Party and Other Transactions

Payable to Officer

In connection with their employment agreements, the Company agreed to provide for one-time payments aggregating $70,000 to reimburse two of the executive officers for sums and expenditures made and services provided prior to and in connection with the change of control of the Company in March 2010.   The Company has reimbursed part of this amount, leaving a balance payable to one of these officers of $15,000 and $30,000 as of March 31, 2011 and December 31, 2010, respectively.

Advance on Financing

To provide working capital to the Company, a prospective investor advanced the Company $15,000 on March 28, 2011.  This amount is to be repaid at the first closing of the bridge financing.  In the event such amount is not paid in such financing, the advance shall accrue interest at the rate of 10% per annum and be promptly repaid.

(J)           Supplemental Cash Flow Information

During the three months ended March 31, 2011, the Company had the following noncash investing and financing activities:

 
The Company issued 978,657 shares of common stock as a result of the conversion of $47,500 of principal of 9% convertible promissory notes and $2,412 of related accrued interest.
     
 
The Company issued 994,315 shares of common stock as a result of the conversion of $29,000 of principal of 8% convertible promissory notes with an unaffiliated entity and $2,000 of related accrued interest.
     
 
The Company issued 3,084,386 shares of common stock as a result of the conversion of $150,000 of principal of 6% convertible promissory notes with an unaffiliated entity and $4,219 of related accrued interest.

There were no noncash investing and financing activities during the three months ended March 31, 2010.

The Company paid $0 and $28,093 for interest during the three months ended March 31, 2011 and 2010, respectively.


 
12

 

(K)           Subsequent Events

Sale of Secured Convertible Debentures

On May 5, 2011, the Company sold secured convertible debentures and warrants to certain investors for gross proceeds of $2,133,250 at a price of $30,000 per unit.  Each unit consists of a secured convertible debenture in the principal amount of $30,000 and a warrant to purchase 200,000 shares of common stock.  The debentures mature on May 5, 2012 and bear interest at 9% per annum and are convertible at a conversion price of $0.15 per share.  The debentures will automatically be redeemed with a 30% premium upon a Change of Control or Listing Event, as defined in the debenture agreement.  The debentures contain full ratchet anti-dilution protection.  Additionally, the conversion price shall be adjusted if the conversion price of securities in a subsequent offering by the Company is adjusted pursuant to a make good provision.  The warrants are exercisable for a period of five years at an exercise price of $0.30 per share.

The Company paid its placement agent a cash payment of $305,990, which represented a 10% commission, a 2% non-accountable expense allowance, and a $50,000 retainer.  Additionally, the Company issued the placement agent warrants to acquire 1,422,167 shares of common stock.  These warrants have a term of five years and are exercisable at $0.30 per share.

The Company also entered into a Mineral Mortgage with the purchasers of the secured convertible debentures, granting them a first priority lien on all assets acquired from Montecito Offshore, L.L.C. pursuant to the Asset Sale Agreement.

Montecito Agreement

On May 6, 2011, the Company closed an Asset Sale Agreement (the Montecito Agreement) with Montecito Offshore, L.L.C. (Montecito).   Pursuant to the terms of the Montecito Agreement, Montecito agreed to sell the Company a 70% leasehold working interest, with a net revenue interest of 51.975%, of certain oil and gas leases owned by Montecito, for $2,000,000 and 15 million shares of the Company’s common stock.  Pursuant to an amendment of the Montecito Agreement, the payment terms were amended to $1,500,000 in cash, a subordinated promissory note in the amount of $500,000, and 15 million shares of common stock.   The subordinated promissory note is due ninety days following the closing.

Virgin Oil Agreement

On April 29, 2011, the Company entered into an Agreement of Merger (the Agreement) with PaxAcq Inc. (PaxAcq), a newly created wholly owned subsidiary of the Company, with Virgin Oil Company, Inc. (Virgin), and with Virgin Offshore U.S.A., Inc., a wholly owned subsidiary of Virgin.  Pursuant to the terms of the Agreement, at closing, the shareholders of Virgin will receive an aggregate of 70 million shares of the Company’s common stock in exchange for all of the issued and outstanding shares of Virgin and PaxAcq will merge with and into Virgin, so that Virgin will become a wholly-owned subsidiary of the Company.

The closing of the Agreement is subject to the satisfaction of customary closing conditions, as well as the following closing conditions, among others:

 
Completion of audited and reviewed financial statements of Virgin;
 
 
Receipt of an updated independent engineering report acceptable to the Company relating to the assets of Virgin;
 
 
Raising of funds by the Company;
 
 
Settlement of claims by creditors of Virgin; and
 
 
Approval of the bankruptcy judge overseeing Virgin, as Virgin is currently a debtor-in-possession under a Chapter 11 proceeding.
  
In the event the Agreement has not been closed by December 31, 2011 or any condition to closing has not been completed by November 30, 2011, either party may terminate the Agreement by providing written notice to the other party.

 
13

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and notes to our financial statements included elsewhere in this report.  This discussion contains forward-looking statements that involve risks and uncertainties.  Actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors discussed elsewhere in this report.
 
Certain information included herein contains statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, such as statements relating to our anticipated revenues, costs and operating expenses and results, estimates used in the preparation of our financial statements, future performance and operations, plans for future oil and gas exploration, sources of liquidity, and financing sources.  Such forward-looking information involves important risks and uncertainties that could significantly affect anticipated results in the future, and accordingly, such results may differ from those expressed in any forward-looking statements made herein.  These risks and uncertainties include those relating to the availability of funding from external sources on terms acceptable to us for planned exploration, development, or acquisitions; the ability of our management to develop and execute an effective exploration, development, and acquisition plan; the ability of third-party project operators and contractors to identify suitable prospects and conduct required operations effectively and economically and in accordance with contractual requirements; future results of drilling individual wells and other exploration and development activities; future variations in well performance as compared to initial test data; the prices at which we may be able to sell oil or gas; domestic or global economic conditions; the inherent uncertainty and costs of prolonged arbitration or litigation; and changes in federal or state tax laws or the administration of such laws.
 
Company Overview
 
Paxton Energy, Inc. (the “Company”, “we,” “us”) is a small oil and gas exploration and production company with a minority working interest in limited production and drilling prospects in the Cooke Ranch area of La Salle County, Texas, and Jefferson County, Texas (“Cooke Ranch”), which are operated by Bayshore Exploration L.L.C. (“Bayshore”). We also have a leasehold working interest in certain oil and gas leases located in the shallow waters of the Gulf of Mexico offshore from Louisiana.  No drilling or production has commenced in this location as of yet, and the Company has the option of being the operator of the leasehold or engaging another party as operator.
 
We have working interests ranging from 4% to 31.75% (net revenue interests ranging from 3% to 23.8125%) in the various wells in which we have participated.  A “working interest” is a percentage of ownership in an oil and gas lease granting its owner the right to explore, drill, and produce oil and gas from a tract of property.  Working interest owners are obligated to pay a corresponding percentage of the cost of leasing, drilling, producing, and operating a well or unit.  After royalties are paid, the working interest also entitles its owner to share in production revenues with other working interest owners based on the percentage of working interest owned.  A “net revenue interest” is a share of production after all burdens, such as royalties, have been deducted from the working interest.  It is the percentage of production that each party actually receives.

Organization

Paxton Energy, Inc. was organized under the laws of the State of Nevada on June 30, 2004.  During August 2004, shareholder control of our company was transferred, a new board of directors was elected, and new officers were appointed.  These officers and directors managed us until March 17, 2010 when we entered into a “Change of Control and Recapitalization Agreement” with Charles Volk of San Francisco, California.  On that same day, all our directors and officers resigned and were replaced by Charles F. Volk, Jr., James E. Burden, and Clifford Henry as directors and Charles F, Volk, Jr. as CEO, Treasurer (Chief Financial Officer) and Chairman of the Board of Directors and James E. Burden as President and Secretary.  The new board of directors immediately commenced, among other things, the placement of unsecured convertible promissory notes to raise funds for working capital and held a meeting of stockholders on June 29, 2010, at which the stockholders approved (1) a 1-for-3 reverse common stock split, (2) a second reverse stock split of approximately 1 share for 2.4 shares of common stock, (3) the amendment of our certificate of incorporation to increase our authorized capital from 100 million to 500 million shares of common stock and from 5 million to 10 million shares of preferred stock, and (4) the adoption of the 2010 Stock Option Plan.

 
14

 

Recent Developments

Montecito Agreement

On March 28, 2011, we entered into an Asset Sale Agreement (the “Montecito Agreement”) with Montecito Offshore, L.L.C. (“Montecito”).  Pursuant to the terms of the Montecito Agreement, Montecito agreed to sell us a 70% leasehold working interest, with a net revenue interest of 51.975% of certain oil and gas leases owned by Montecito, for $2,000,000 and 15,000,000 shares of our common stock, of which $250,000 was required to be paid by April 4, 2011 and the remaining $1,750,000 and 15 million shares were due at closing.

On April 7, 2011, we entered into a First Addendum to the Montecito Agreement (the “Amendment”).  Pursuant to the Amendment, the payment terms of the Montecito Agreement were amended to $1,500,000 in cash, a subordinated promissory note in the amount of $500,000, and 15 million shares of our common stock, of which $20,000 was required to be paid by April 11, 2011 and the remaining $1,480,000 and 15 million shares were due at closing.  The subordinated promissory note is due ninety (90) days following the closing.

On May 6, 2011, we completed the acquisition of the assets contained in the Montecito Agreement, namely the leasehold working interest in certain oil and gas leases owned by Montecito. The oil and gas leases are located in the Vermillion 179 tract (“VM 179”), which is in the shallow waters of the Gulf of Mexico offshore from Louisiana, adjacent to Exxon's VM 164 #A9 well. The Company has obtained an independent reserve report relating to proven and probable reserves in the VM 179 area, which is approximately 547 acres in size.  No drilling or production has commenced as of yet, and the Company has the option of being the operator at VM 179 or engaging another party as operator.

Virgin Agreement

On April 29, 2011, we entered into an Agreement of Merger (the “Virgin Agreement”) with PaxAcq Inc., a wholly owned subsidiary of ours (“PaxAcq”), Virgin Oil Company, Inc. (“Virgin”), and Virgin Offshore U.S.A., Inc., a wholly owned subsidiary of Virgin.

  Pursuant to the terms of the Agreement, at closing, the shareholders of Virgin will receive an aggregate of 70 million shares of our common stock in exchange for all of the issued and outstanding shares of Virgin and PaxAcq will merge with and into Virgin, so that Virgin will become our wholly-owned subsidiary.

The closing of the Virgin Agreement is subject to the satisfaction of customary closing conditions, as well as the following closing conditions, among others:

 
Completion of audited and reviewed financial statements of Virgin;
     
 
Receipt of an updated independent engineering report acceptable to the us relating to the assets of Virgin;
     
 
Raising of funds by us;
     
 
Settlement of claims by creditors of Virgin; and
     
 
Approval of the bankruptcy judge overseeing Virgin, as Virgin is currently a debtor-in-possession under a Chapter 11 proceeding.

In the event the Virgin Agreement has not been closed by December 31, 2011 or any condition to closing has not been completed by November 30, 2011, either party may terminate the Virgin Agreement by providing written notice to the other party.

 
15

 

Results of Operations

Comparison of Three Months Ended March 31, 2011 and 2010

Oil and Gas Revenues
 
Our oil and gas revenues were $5,479 for the three months ended March 31, 2011, compared to $3,136 for the three months ended March 31, 2010, representing an increase of $2,343 for the three-month period.  The increase in oil and gas revenue is principally related to small increases in revenue from our interests in two wells located on the Cooke Ranch, the Cooke #2 and Cooke #6 wells.  The level of oil and gas production through March 31, 2011 continues not to be significant, and accordingly we continue to be characterized as an exploration-stage company.

Cost and Operating Expenses
 
Our costs and operating expenses were $510,473 for the three months ended March 31, 2011, compared to $265,826 for the three months ended March 31, 2010, representing an increase of $244,647 for the three-month period.

Lease Operating Expenses
 
Lease operating expenses were $3,390 for the three months ended March 31, 2011, compared to $1,731 for the three months ended March 31, 2010, representing an increase of $1,659, for the three-month period.  The level of oil and gas production through March 31, 2011 was not significant and our amount of lease operating expenses is relatively consistent in relation to our oil and gas production.

Accretion of Asset Retirement Obligations
 
Accretion of asset retirement obligations was $86 for the three months ended March 31, 2011, compared to $263 for the three months ended March 31, 2010, representing a decrease of $177 for the three-month period.  The decrease in accretion of asset retirement obligations expenses principally reflects the fact that the original accretion period for certain wells has now past.

General and Administrative Expense
 
General and administrative expense was $422,899 for the three months ended March 31, 2011, as compared to $51,669 for the three months ended March 31, 2010, representing an increase of $371,230 for the three-month period.  The increase in general and administrative expense during the three months ended March 31, 2011 is related primarily to (1) $164,427 for compensation and related payroll taxes accrued for the three officers of the Company under employment agreements in effect during the three months ended March 31, 2011, but not in effect during the three months ended March 31, 2010; and (2) increases for consulting, legal, accounting, and audit  services of $219,273 for the three months ended March 31, 2011 compared to the prior period.

Stock-Based Compensation
 
During the period since the reorganization, we have granted options to acquire common stock to our new executive officers.  Options to acquire 6,000,000 shares were granted to our Chief Financial Officer and to two consultants, and these options are vesting over a period of thirty months.  Share-based compensation is measured on the grant date and recognized over the vesting period.  For the three months ended March 31, 2011, we reported share-based compensation related to these stock options of $84,098.

 
16

 
 
During the three months ended March 31, 2010, the new board of directors agreed to issue 1,250,000 post-split shares of our common stock to former management and 250,000 post-split shares to an advisor as compensation for services in connection with the change of managerial control.  The former management and advisor completed all that was required of them under this arrangement during the quarter ended March 31, 2010.  Accordingly, we recognized this obligation to these individuals and the associated compensation during the quarter ended March 31, 2010 by recording $212,163 of stock-based compensation representing the estimated value of 1,500,000 shares of post-split shares of our common stock.
 
Although the net changes with respect to our revenues and our costs and operating expenses for the three months ended March 31, 2011 and 2010, are summarized above, the trends contained therein are limited and should not be viewed as a definitive indication of our future results.

Other Income (Expense)

Change in fair value of derivative liabilities
 
As more fully discussed in Notes C and G to the accompanying condensed financial statements, we issued unsecured convertible promissory notes to an unaffiliated entity in April 2010, December 2010, and in February 2011.  These notes contain a variable conversion price (beneficial conversion feature) which is treated as an embedded derivative under generally accepted accounting principles and is required to be accounted for at fair value.  We have estimated the fair value of the beneficial conversion feature based on the intrinsic value of the conversion feature, which equals the difference between the variable conversion price of the notes and the closing price of our common stock on the date of the valuation.  The fair value of the beneficial conversion feature was estimated to be $237,432 and $243,376 as of March 31, 2011 and December 31, 2010, respectively.  We recognized a loss from the change in fair value of this beneficial conversion feature of $37,181 for the three months ended March 31, 2011.
 
Effective January 1, 2009 with the adoption of the provisions of new accounting standards for embedded derivatives, warrants to acquire our common stock that were previously treated as equity must be treated as a derivative liability and measured at fair value.  These warrants were canceled in June 2010 with the issuance of common stock.  We recognized a loss from the change in fair value of these warrants of $27,434 for the three months ended March 31, 2010.

Interest Expense
 
We incurred interest expense of $17,737 for the three months ended March 31, 2011 compared to $27,343 for the three months ended March 31, 2010, a decrease of $9,606.  The decrease in interest expense principally relates to the fact that with the issuance of common stock in settlement of substantially all of the registration rights penalties, we are no longer accruing interest on the penalties that were settled.  However, this decrease is partially offset by interest that we are incurring in 2011 on convertible promissory notes that have been issued in the previous twelve months.

Amortization of discount on convertible notes and other debt
 
We have amortized $154,091 of discount on convertible notes for the three months ended March 31, 2011 compared to none for the three months ended March 31, 2010.  As more fully discussed in Note C to the accompanying condensed financial statements, we issued convertible promissory notes to several individuals or entities during the previous twelve months.  In each case, the notes have a favorable conversion price in comparison to the market price of our common stock on the date of the issuance of the notes.  The fair value of this beneficial conversion feature is measured on the issue date of the notes.  Generally, a discount is recorded for this beneficial conversion feature and amortized over the life of the note as a non-cash charge to the statement of operations.  For the three months ended March 31, 2011, we amortized $154,091 related to the convertible notes to unaffiliated entities.  As of March 31, 2011, there is $50,574 of recorded, but unamortized discount on the convertible notes to unaffiliated entities that will be amortized in the year ending December 31, 2011.

 
17

 
 
Liquidity and Capital Resources
 
During the previous twelve months, our principal sources of liquidity consisted of proceeds from recently issued unsecured convertible promissory notes and proceeds from the issuance of common stock and warrants.  We received proceeds from a placement of convertible promissory notes in the aggregate amount of $298,000, plus proceeds of an additional $120,000 from three separate unsecured convertible promissory notes.  Additionally, we received proceeds of $255,000 from the issuance of common stock and warrants.  At March 31, 2011, we have $1,536 in cash and $668 of receivables from an attorney’s trust account.  At March 31, 2011, we had a working capital deficit of $1,409,505 as compared to a deficit of $1,177,102 as of December 31, 2010.  In addition, we have a deficit in our total stockholders’ equity of $1,095,614 at March 31, 2011, compared to total stockholders’ deficit of $868,965 at December 31, 2010, an increase in the stockholders’ deficit of $226,649.
 
Our operations used net cash of $191,885 during the three months ended March 31, 2011, compared to using $96,004 of net cash during the three months ended March 31, 2010.   Net cash used in operating activities during the three months ended March 31, 2011 consisted of our net loss of $714,003, which was offset by non-cash expenses of stock-based compensation of $84,098, changes in fair value of derivative liabilities of $37,181, amortization of discount on convertible notes of $154,091, depreciation expense of $103, and accretion of asset retirement obligations of $86, and further offset by non-cash changes in working capital of $246,559.
 
We had no investing activities during the three months ended March 31, 2011 or 2010.
 
Financing activities provided $140,000 of net cash during the three months ended March 31, 2011, as compared to $93,094 during the three months ended March 31, 2010.  Cash flows from financing activities during the three months ended March 31, 2011 relate to the receipt of proceeds from the placement of an unsecured convertible promissory note in the amount of $35,000, proceeds of $90,000 from the issuance of common stock and warrants, and an advance of $15,000 to be repaid from the proceeds on an anticipated bridge financing.
 
We entered into a consulting agreement with Undiscovered Equities on September 7, 2010.  Under the terms of the agreement, the consultant agreed to provide us with one or more financial and strategic business plans.  Thereafter, on September 27, 2010, we entered into an agreement with National Securities Corp. to provide investment banking and financial advisory services.  Services under these two agreements are being provided to us in connection with the evaluation and due diligence of potential oil and gas property acquisitions.
 
We are currently seeking debt and equity financing to fund potential acquisitions and other expenditures, although we do not have any contracts or commitments for either at this time. We will have to raise additional funds to continue operations and, while we have been successful in doing so in the past, there can be no assurance that we will be able to do so in the future. Our continuation as a going concern is dependent upon our ability to obtain necessary additional funds to continue operations and the attainment of profitable operations.

May 5th Financing
 
On May 5, 2011 we sold to certain investors (“Purchasers”) units (“Units”) for aggregate cash gross proceeds of $2,133,250 at a price of $30,000 per Unit (the “Financing”). Each Unit consisted of (i) a $30,000 principal amount secured convertible debenture (the “Note”) and (ii) a warrant (“Warrant”) to purchase 200,000 shares of the Company’s common stock (“Common Stock”).
 
The Notes mature on May 5, 2012 and bear interest at 9% per annum and are convertible at the holder’s option at any time into Common Stock at a conversion price of $0.15 per share.  The Notes will automatically be redeemed with a 30% premium upon a Change of Control or Listing Event (each as defined in the Note). Interest on the Notes is payable quarterly in arrears in cash.  The Notes contain full ratchet anti-dilution protection.  In addition the conversion price shall be adjusted if the conversion price of securities in a subsequent offering by us is adjusted pursuant to a make good provision.  The shares of Common Stock issuable upon conversion of the Note are entitled to piggyback registration rights.

 
18

 

The Warrants are exercisable for a period of five years at an exercise price of $0.30 per share.  The Warrants will be exercisable on a cashless basis at any time six months after issuance if there is not an effective registration statement registering for resale the shares issuable upon exercise of the Warrants. The shares of Common Stock issuable upon exercise of the Warrants are entitled to piggyback registration rights.
 
Pursuant to the Notes and Warrants, no holder may convert or exercise such holder’s Note or Warrant if such conversion or exercise would result in the holder beneficially owning in excess of 4.99% of our then issued and outstanding common stock. A holder may, however, increase or decrease this limitation (but in no event exceed 9.99% of the number of shares of Common Stock issued and outstanding) by providing the Company with 61 days’ notice that such holder wishes to increase or decrease this limitation.

Pursuant to a Mineral Mortgage (the “Security Agreement”), between ourselves and the Purchasers, we granted the Purchasers a first priority lien on all assets acquired from Montecito pursuant to the Montecito Agreement.

Critical Accounting Policies
 
We have identified the policies outlined below as critical to our business operations and an understanding of our results of operations.  The list is not intended to be a comprehensive list of all of our accounting policies.  In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States, with no need for management's judgment in their application.  The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis or Plan of Operations where such policies affect our reported and expected financial results.  For a detailed discussion on the application of these and other accounting policies, see the Notes to the December 31, 2010 Financial Statements filed in our Annual Report on Form 10-K with the U.S. Securities and Exchange Commission on April 1, 2011.  Note that our preparation of the financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period.  There can be no assurance that actual results will not differ from those estimates.
 
Stock-based Compensation
 
We calculate the fair value of all share-based payments to employees and non-employee directors, including grants of stock options and stock awards and amortize these fair values to share-based compensation in the statement of operations over the respective vesting periods of the underlying awards.  Share-based compensation related to stock options is computed  using the Black-Scholes option pricing model.  We estimate the fair value of stock option awards using assumptions about volatility, expected life of the awards, risk-free interest rate, and dividend yield rate. The expected volatility in this model is based on the historical volatility of our common stock. The risk-free interest rate is based on the U.S. Treasury constant maturities rate for the expected life of the related options. The expected life of the options granted is equal to the average of the vesting period and the term of the option, as allowed for under the simplified method prescribed by Staff Accounting Bulletin 107.  The expected dividend rate takes into account the absence of any historical payments and management’s intention to retain all earnings for future operations and expansion.  We estimate the fair value of restricted stock awards based upon the closing market price of our common stock at the date of grant. We charge the fair value of non-restricted awards to share-based compensation upon grant.
 
We account for equity instruments issued in exchange for the receipt of goods or services from other than employees and non-employee directors in accordance with ASC 505-50, Equity-Based Payments to Non-Employees.  Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably measurable.  The value of equity instruments issued for consideration other than employee services is determined on the earlier of a performance commitment or completion of performance by the provider of goods or services.  The fair value of the equity instrument is charged directly to share-based compensation expense and credited to paid-in capital.


 
19

 

Convertible Debt and Derivative Accounting
 
For convertible debt that is issued with a beneficial conversion feature, we perform an allocation of the proceeds of the convertible note between the principal amount of the note and the fair value of the beneficial conversion feature.  The fair value of the beneficial conversion feature is recorded as a discount to the principal amount of the note, but not in excess of the principal amount of the note.  The discount is amortized over the period from the issuance date to the maturity date or the date of conversion, whichever occurs earlier, as a non-cash charge to the statement of operations.  Upon the issuance of the note, an assessment is made of the beneficial conversion feature to determine whether the beneficial conversion feature should be accounted for as equity or liability.  In the case of a variable conversion price, the feature is accounted for as a derivative liability and carried at fair value on the balance sheet.  The fair value of the derivative liability is remeasured each reporting period and the change in fair value to recorded in the statement of operations.
    
Revenue Recognition
 
All revenues are derived from the sale of produced crude oil and natural gas.  Revenue and related production taxes and lease operating expenses are recorded in the month the product is delivered to the purchaser.  Payment for the revenue, net of related taxes and lease operating expenses, is received from the operator of the well approximately 45 days after the month of delivery.  Accounts receivable are stated at the amount management expects to collect.  Management provides for probable uncollectible amounts through a charge to earnings and a credit to an allowance based on its assessment of the collectibility of the receivable.  At March 31, 2011 and 2010, no allowance for doubtful accounts was deemed necessary.
 
Income Taxes
 
Provisions for income taxes are based on taxes payable or refundable and deferred taxes.  Deferred taxes are provided on differences between the tax bases of assets and liabilities and their reported amounts in the financial statements and tax operating loss carryforwards.  Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled.  As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

Impairment of Long-Lived Assets
 
Long-lived assets, including oil and gas properties, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.  Recoverability is measured by a comparison of the carrying amount of an asset or asset group to estimated future undiscounted net cash flows of the related asset or group of assets over their remaining lives.  If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment charge is recognized for the amount by which the carrying amount exceeds the estimated fair value of the asset.  Impairment of long-lived assets is assessed at the lowest levels for which there are identifiable cash flows that are independent of other groups of assets.  The impairment of long-lived assets requires judgments and estimates.  If circumstances change, such estimates could also change.
 
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.


 
20

 

ITEM 4.  CONTROLS AND PROCEDURES

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 our 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 Securities and Exchange Commission rules and forms, and that such information is not accumulated nor 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 have sufficient personnel in our accounting and financial reporting functions.  As a result, we were not able to achieve adequate segregation of duties and were not able to provide for adequate review of the financial statements. 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;
     
  b)
We did not maintain sufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of U.S. generally accepted accounting principles (“U.S. GAAP”) commensurate with our complexity and our financial accounting and reporting requirements. This control deficiency is pervasive in nature. Further, there is a reasonable possibility that material misstatements of the financial statements including disclosures will not be prevented or detected on a timely basis as a result; and
     
  c)
We lack a system to administratively review, audit or verify the reporting by Bayshore of revenues and expenditures in connection with the oil and gas properties on which we conduct activities.  Similarly, we have not obtained units of production or similar third-party purchaser confirmation of the details of our oil and gas production.  There is a reasonable possibility that material misstatements of the financial statements will not be prevented or detected on a timely basis without the ability to independently review and verify the results of our revenue and expenses related to our operations.
 
The material weaknesses identified did not result in the restatement of any previously reported financial statements or any other related financial disclosure, and management does not believe that the material weaknesses had any effect on the accuracy of our financial statements for the current reporting period.
 
We are committed to improving our financial organization. As part of this commitment, we will create a segregation of duties consistent with control objectives and will look to increase our personnel resources and technical accounting expertise within the accounting function by the end of fiscal 2011 to resolve non-routine or complex accounting matters. In addition, when funds are available to us, which we expect to occur by the end of fiscal 2011, 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 $75,000 per annum. We have in the past, and will continue to engage outside consultants in the future as necessary in order to ensure proper treatment of non-routine or complex accounting matters.  In addition, management is working to establish a system to administratively review, audit or verify the reporting by Bayshore of revenues and expenditures in connection with the oil and gas properties on which we conduct activities.

 
21

 
 
Management believes that hiring additional knowledgeable personnel with technical accounting expertise will remedy the following material weaknesses: (A) lack of sufficient personnel in our accounting and financial reporting functions to achieve adequate segregation of duties; and (B) insufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of US 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 accounting staff consists of a Chief Financial Officer working with other members of management, 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 turnover issues within the department occur. We believe this will greatly decrease any control and procedure issues we may encounter in the future.
 
We will continue to monitor and evaluate the effectiveness of our disclosure controls and procedures and our internal controls over financial reporting on an ongoing basis and are committed to taking further action and implementing additional enhancements or improvements, as necessary and as funds allow.
 
Changes in internal control over financial reporting.
 
We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating activities, and migrating processes.
 
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 
22

 

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. 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 effect on our business, financial condition or operating results.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
During the quarter ended March 31, 2011, we sold 600,000 shares of common stock and issued warrants to purchase 300,000 shares of common stock for gross proceeds of $90,000.  The warrants are exercisable at $0.45 per share and expire on August 31, 2013.

During the quarter ended March 31, 2011, we issued 978,657 shares of common stock as a result of the conversion of $47,500 of principal of 9% convertible promissory notes and related accrued interest of $2,412.

During the quarter ended March 31, 2011, we issued 994,315 shares of common stock as a result of the conversion of $29,000 of principal of 8% convertible promissory notes and related accrued interest of $2,000.

During the quarter ended March 31, 2011, we issued 3,084,386 shares of common stock as a result of the conversion of $150,000 of principal of 8% convertible promissory notes and related accrued interest of $4,219.

All of the above stock issuances or promises to issue stock to certain individuals or groups are exempt from registration by reason of the exemptions from registration provided by Regulation D, Rule 506 relating to sales to accredited investors or by reason of the exemption from registration provided by Section 3(a)(9) of the Securities Act of 1933 relating to securities exchanged by the issuer with its existing security holders exclusively where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

On September 3, 2008, we issued $300,000 of secured promissory notes to six individuals, two of whom are related parties.  All of these promissory notes bear interest at 12% per annum, with interest payable monthly.  The promissory notes were originally due on September 1, 2009 and are secured by all of our assets.  With the change in management control in March 2010, accrued interest on these notes was paid through January 31, 2010 and the due dates of the promissory notes were extended to August 31, 2010.  The notes came due on August 31, 2010 and have not been paid.  Both the non-payment of interest and our failure to repay the notes when they matured constitute events of default under the notes.  As a result of the event of default, the noteholders have the right to exercise their rights under the security agreement associated with the notes.  These rights include, among other things, the right to foreclose on the collateral.  We are currently negotiating with our secured lenders for an extension or other resolution.  We can provide no assurance that we will obtain an extension or other resolution, or that the secured creditors will not eventually foreclose if not paid in the near term.
 
ITEM 6.  EXHIBITS
 
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.


 
23

 

SIGNATURE

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.

 
PAXTON ENERGY, INC.
   
(Registrant)
     
Date:  May 16, 2011
By:
/s/ Charles F. Volk, Jr. 
   
Charles F. Volk, Jr.
Chief Executive Officer (Principal Executive Officer)
 
 
 
 
24