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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED September 30, 2011

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

FOR THE TRANSITION PERIOD FROM ___________ TO _____________.

Commission file number: 000-28015

TREATY ENERGY CORPORATION
(Exact name of registrant as specified in its charter)

Nevada
 
86-0884116
(State or other Jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

201 St. Charles Ave., Suite 2558
New Orleans, LA 70170
(Address of principal executive offices)

(504) 599-5684
(Registrant’s telephone number, including area code)
 
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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
 
Indicate by check mark whether the registrant is a large 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
o
Non-accelerated filer 
o (do not check if a smaller reporting company)
Smaller reporting company
þ

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act).  Yes  o No þ
 
The number of shares of the registrant’s common stock outstanding as of November 9, 2011, was  744,099,069.
 


 
 

 
 
TREATY ENERGY CORPORATION
FORM 10-Q

INDEX
 
PART I – FINANCIAL INFORMATION        
         
Item 1 – Financial Statements
    3  
         
Item 2 - Management’s Discussion And Analysis Of Financial Condition And Results Of Operations
    27  
         
Item 3 - Quantitive And Qualitative Disclosures About Market Risk     29  
         
Item 4 – Controls and Procedures     29  
         
PART II – OTHER INFORMATION        
         
Item 1 – Legal Proceedings     30  
         
Item 1A – Risk Factors     30  
         
Item 2 - Unregistered Sales of Equity Securities     30  
         
Item 3 – Defaults Upon Senior Securities     31  
         
Item 4 - Submission of Matters to a Vote of Security Holders     31  
         
Item 5 – Other Information     31  
         
Item 6 – Exhibits     31  
         
SIGNATURES     32  
 
 
2

 
 
PART I – FINANCIAL INFORMATION
 
 
ITEM 1 – FINANCIAL STATEMENTS
 
TREATY ENERGY CORPORATION
BALANCE SHEETS

   
September 30, 2011 (Unaudited)
   
December 31, 2010
 
             
ASSETS
 
             
Cash and equivalents
  $ 8,731     $ 148  
Accounts receivable
    114,171       -  
Total current assets
    122,902       148  
                 
Oil and gas properties (successful efforts)
               
Proved producing, net
    1,148,776       -  
Unproved
    360,631       252,424  
                 
Property, plant and equipment, net
    674,577       1,759  
Prepaid expenses and other assets
    65,363       -  
TOTAL ASSETS
  $ 2,372,249     $ 254,331  
                 
LIABILITIES
                 
Accounts payable and accrued liabilities
  $ 404,256     $ 152,851  
Accrued salaries
    -       316,924  
Asset retirement obligation
    37,122       -  
Notes and accrued interest to related parties
    -       481,646  
Notes and accrued interest payable
    981,924       534,278  
Total current liabilities
    1,423,302       1,485,699  
                 
TOTAL LIABILITIES
  $ 1,423,302     $ 1,485,699  
                 
                 
Convertible Redeemable Class A Preferred Stock (12,000 and 0 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively, $5 redemption value )
    60,000       -  

The accompanying notes are an integral part of these financial statements.
 
 
3

 
 
TREATY ENERGY CORPORATION
BALANCE SHEETS
(Continued)

   
September 30, 2011 (Unaudited)
   
December 31, 2010 (Audited)
 
             
STOCKHOLDERS' EQUITY (DEFICIT)
             
Preferred stock - par value $0.001, 50 million shares authorized, none issued or outstanding at September 30, 2011 and December 31, 2010
    -     -  
Common stock – par value $0.001, 750 million shares authorized,  744,099,069 and 496,605,424 shares issued  at September 30, 2011 and December 31, 2010, and 735,099,069 and 496,605,424 shares outstanding at September 30, 2011 and December 31, 2010, respectively
    744,098       496,605  
Treasury Stock
    (355,500 )     -  
Additional paid in capital
    7,510,287       527,483  
Common stock payable
    64,000       204,000  
Accumulated loss - pre exploration stage
    (644,829 )     (644,829 )
Accumulated loss - exploration stage
        (6,429,109 )     (1,814,627 )
                 
Total stockholders' equity (deficit)
    888,947       (1,231,368 )
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
  $ 2,372,249     $ 254,331  

The accompanying notes are an integral part of these financial statements.
 
 
4

 
 
TREATY ENERGY CORPORATION
STATEMENTS OF OPERATIONS

   
Nine Months Ended September 30,
   
Three Months Ended September 30,
 
   
2011 (Unaudited)
   
2010 (Unaudited)
   
2011 (Unaudited)
   
2010 (Unaudited)
 
                         
REVENUES
                       
Oil and gas revenues
  $ 156,907     $ 1,570     $ 87,377     $ 1,570  
Drilling revenues
    59,005       -       17,500       -  
Total revenues
    215,912       1,570       104,877       1,570  
                                 
EXPENSES
                               
 Royalties
    54,352       275       38,684       -  
 Lease operating expenses
    372,351       343,031       150,640       330,806  
 Direct drilling costs
    25,381       -       17,394       -  
Transportation costs
    253       -       253       -  
 Production taxes
    7,231       -       4,026       -  
 General and administrative
    3,715,902       381,133       880,287       149,857  
 Depreciation, depletion and amortization
    53,817       154       31,616       154  
 Accretion of asset retirement obligation
    1,574       -       864       -  
 Interest expense
    139,845       10,037       13,052       3,624  
 Total expenses
    4,370,706       734,630       1,136,816       484,441  
                                 
 Operating Loss
    (4,154,794 )     (733,060 )     (1,031,939 )     (482,871 )
 
 
5

 

TREATY ENERGY CORPORATION
STATEMENTS OF OPERATIONS
 
   
Nine Months Ended September 30,
   
Three Months Ended September 30,
 
   
2011 (Unaudited)
   
2010 (Unaudited)
   
2011 (Unaudited)
   
2010 (Unaudited)
 
                         
OTHER INCOME AND EXPENSE ITEMS
                   
Gains/(losses) on disposition of royalty interests     790,776       291,973       790,776       -  
Gains / (losses) on retirement of debt
    (1,250,464 )     -       (179,762 )     -  
                                 
NET LOSS
  $ (4,614,482 )   $ (441,087 )   $ (420,925 )   $ (482,871 )
                                 
Net loss per common shares - basic and diluted
  $ (0.01 )   $ (0.00 )   $ (0.00 )   $ (0.00 )
Weighted average common shares outstanding - basic and diluted
    628,317,210       496,605,424       725,031,575       496,605,424  

The accompanying notes are an integral part of these financial statements.
 
 
6

 

TREATY ENERGY CORPORATION
STATEMENTS OF CASH FLOWS
 
   
Nine Months Ended September 30,
 
   
2011
Unaudited
   
2010
Unaudited
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net loss
  $ (4,614,482 )   $ (441,087 )
Adjustments to reconcile net loss to net cash provided by / (used in) operating activities:                
Depreciation, depletion and amortization
    53,817       154  
Gain on sales of oil and gas interests
    -       (291,973 )
Loss on conversion of debt for equity     1,250,464       -  
ORRI issued with note as inducement, expensed due to short term note
    25,900       -  
Gain on sale of ORRI
    (790,776 )     -  
Amortization of discount on notes payable
    45,076       -  
Accretion of asset retirement obligation
    1,574       -  
Stock based compensation (shares issued and owed)
    2,736,711       245,742  
Interest imputed on related-party notes
    11,517       5,859  
                 
Changes in operating assets and liabilities:
               
Accounts receivable
    (114,171 )     (1,295 )
Prepaid expenses & other assets
    (65,363 )     (19,575 )
Accounts payable & accrued expenses
    (67,851 )     480,160  
Net cash provided Used in operating activities
    (1,527,584 )     (321,315 )
 
 
7

 

TREATY ENERGY CORPORATION
STATEMENTS OF CASH FLOWS

   
Nine Months Ended September 30,
 
   
2011
Unaudited
   
2010
Unaudited
 
CASH FLOWS FROM INVESTING ACTIVITIES
       
Acquisitions of oil and gas properties & fixed assets
    (478,088 )     (137,234 )
Development of oil and gas properties
    -       (40,101 )
Proceeds from sale of ORRI
    515,000       -  
Proceeds from sales of oil and gas interests
    -       445,000  
Net cash provided by / (used in) investing activities
    36,912 )     (100,762 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
         
Expenses paid by related parties-cash
    -       129,130  
Advances from related parties, net
    1,011,362       (69,796 )
Proceeds from notes payable
    353,000       (5,000 )
Principal payments on notes payable
    (466,062 )     -  
Common stock issued for cash
    373,750       -  
 Proceeds from Sale of Treasury Stock     225,000       -  
 Bank overdraft     2,205       -  
Net cash provided by / (used in) financing activities
    1,499,255       54,334  
 
 
8

 

TREATY ENERGY CORPORATION
STATEMENTS OF CASH FLOWS

   
Nine Months Ended September 30,
 
   
2011
Unaudited
   
2010
Unaudited
 
Net increase / (decrease) in cash and cash equivalents
    8,583       684  
Cash and cash equivalents, beginning of period
    148       -  
Cash and cash equivalents, end of period
  $ 8,731     $ 684  
                 
SUPPLEMENTAL CASH FLOW INFORMATION
         
Purchase of treasury stock for increase in related party advance
  $ 790,000     $ -  
Cost of treasury shares in excess of cash received for resale
    214,500       -  
Shares issued for retirement of debt     2,153,014          
ORRI  issued to relieve debt
    176,351       -  
Acquisition of oil and gas properties with debt
    1,296,017       -  
Shares issued to acquire fixed assets     265,100       -  
Preferred shares converted to common shares
    120,000       -  
Note relieved in exchange for transfer of assets     69,011       -  
Assumption of asset retirement obligation with acquisition of oil and gas properties
    35,548       -  
Shares issued to relieve stock payable
    204,000       -  
Shares issued to shareholder to reimburse issuances on behalf of the company
    26,809       -  
 Related party notes payable forgiven     397,671       -  
 
 
 
9

 
 
TREATY ENERGY CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS

 
NOTE 1 – ORGANIZATION AND NATURE OF BUSINESS
 
Information Regarding Forward-Looking Statements
 
This report contains forward-looking statements that involve risks and uncertainties. We generally use words such as "believe," "may," "could," "will," "intend," "expect," "anticipate," "plan," and similar expressions to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described below and elsewhere in this report. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made, and our future results, levels of activity, performance or achievements may not meet these expectations. We do not intend to update any of the forward-looking statements after the date of this document to conform these statements to actual results or to changes in our expectations, except as required by law.
 
History
 
Treaty Energy Corporation, formerly known as Alternate Energy Corp., (“Treaty”, “the Company”, “we”, or “us”) was incorporated as COI Solutions, Inc. in the State of Nevada in August, 1997.

We incorporated as COI Solutions, Inc. on August 1, 1997 as a Nevada corporation. On May 22, 2003, we acquired all the assets of AEC I Inc., formerly known as Alternate Energy Corporation, and changed our name to Alternate Energy Corp. We commenced active business operations on June 1, 2003 and were a development stage company under Codification Topic No. 915 developing alternate renewable energy sources.

The Company merged with Treaty Petroleum, Inc., a Texas Corporation under a transaction commonly referred to as a reverse merger.  With the change in ownership in December 2008, we embarked on a new business plan, focusing on oil and gas production.
 
NOTE 2 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Presentation
 
The financial statements of the Company have been prepared in accordance with Generally Accepted Accounting Principals in the United States.

In June 2009, the Financial Accounting Standards Board (“FASB”) issued the FASB Accounting Standards Codification (the “ASC”). The ASC has become the single source of non-governmental accounting principles generally accepted in the United States (“GAAP”) recognized by the FASB in the preparation of financial statements. The ASC does not supersede the rules or regulations of the Securities and Exchange Commission (“SEC”), therefore, the rules and interpretive releases of the SEC continue to be additional sources of GAAP for the Company. The Company adopted the ASC as of September 30, 2009. The ASC does not change GAAP and did not have an effect on the Company’s financial position, results of operations or cash flows.
 
 
10

 
 
Use of Estimates
 
The preparation of consolidated financial statements in conformity with generally accepted accounting principles 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 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates underlying these consolidated financial statements include the estimated quantities of proved oil reserves used to compute depletion of oil and natural gas properties and the estimated fair value of asset retirement obligations.

All of the Company’s accounting policies are not included in this Form 10-Q.  A more comprehensive set of accounting policies adopted by the Company are included on our Form 10-K as of December 31, 2010 and are herein incorporated by reference.
 
Fair Value Measurement
 
The Company has adopted guidance contained in Codification Topic No. 820 which defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements. Topic 820 applies under other accounting pronouncements that require or permit fair value measurements and accordingly, does not require any new fair value measurements. Topic 820 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company believes that the adoption of Topic 820 will not have a material effect on its statements of operations and financial condition.  Topic 820 requires disclosure of assets and liabilities measured at fair value within a three-tiered hierarchy.

The Company does not have any financial instruments which are revalued on a recurring basis.
 
Revenue Recognition
 
The Company recognizes oil, gas and natural gas condensate revenue in the period of delivery. Settlement on sales occurs anywhere from two weeks to two months after the delivery date. The Company recognizes revenue when an arrangement exists, the product has been delivered, the sales price is fixed or determinable, and collectability is reasonably assured.
 
The Company recognizes drilling revenue in the period services are rendered.  The Company recognizes revenue when an drilling engagement exists, the service has been rendered, the contract fee is fixed or determinable, and collectability is reasonably assured.
 
Stock-Based Compensation
 
In December of 2004, the Financial Accounting Standards Board issued guidance now codified as Topic 718 (“Topic 18”) which applies to transactions in which an entity exchanges its equity instruments for goods or services and also applies to liabilities an entity may incur for goods or services that are based on the fair value of those equity instruments. For any unvested portion of previously issued and outstanding awards, compensation expense is required to be recorded based on the previously disclosed Topic 18 methodology and amounts.  Prior periods presented are not required to be restated. The Company adopted Topic 18 at its inception and applied the standard using the modified prospective method.
 
 
11

 
 
Class A Convertible Preferred shares
 
During the quarter ended June 30, 2011 the Company issued 36,000 shares of Class A Convertible Preferred shares. These shares have a stated value of $5 per share. The preferred shares are convertible into common stock at varying rates for each third (12,000 shares) of the preferred stock issued. The first tranche is convertible according to the stated value of the preferred shares divided by $0.03, the second tranche at $0.05, and the final tranche at $0.10. These preferred shares are also to be repaid to the holder in the event that the Company’s share price does not exceed the conversion value during the 24 months from the issuance date. The preferred shares are redeemable at their stated value of $5 per share on April 8, 2013 if this event occurs.

Based on these shares being conditionally redeemable under circumstances that are not within the control of the Company, these shares were accounted for outside of permanent equity and liabilities consistent with the applicable literature on conditionally redeemable preferred stock. The shares will be re-classed to permanent equity upon conversion to commons stock or to liabilities if redemption becomes certain to occur. As of September 30, 2011, 12,000 shares valued at $60,000 were outstanding.
 
Accounting for Asset Retirement Obligations
 
In June, 2006, the Company adopted the accounting guidance with respect to accounting for conditional asset retirement obligations.  Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. The Company estimates a fair value of the obligation on each well in which it owns an interest by identifying costs associated with the future dismantlement and removal of production equipment and facilities and the restoration and reclamation of a production operation’s surface to a condition similar to that existing before oil and natural gas extraction began.

In general, the amount of an Asset Retirement Obligation (“ARO”) and the costs capitalized will be equal to the estimated future cost to satisfy the abandonment obligation using current prices that are escalated by an assumed inflation factor up to the estimated settlement date which is then discounted back to the date that the abandonment obligation was incurred using an assumed cost of funds for the Company. After recording these amounts, the ARO is accreted to its future estimated value using the same assumed cost of funds and the liability is increased each period as the retirement obligation approaches.  See Note 11 for a discussion of our estimated Asset Retirement Obligation.
 
NOTE 3 – RECENT ACCOUNTING PRONOUNCEMENTS
 
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income”, which is effective for annual reporting periods beginning after December 15, 2011. ASU 2011-05 will become effective for the Company on January 1, 2012. This guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. In addition, items of other comprehensive income that are reclassified to profit or loss are required to be presented separately on the face of the financial statements. This guidance is intended to increase the prominence of other comprehensive income in financial statements by requiring that such amounts be presented either in a single continuous statement of income and comprehensive income or separately in consecutive statements of income and comprehensive income. The adoption of ASU 2011-05 is not expected to have a material impact on our financial position or results of operations.

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”, which is effective for annual reporting periods beginning after December 15, 2011. This guidance amends certain accounting and disclosure requirements related to fair value measurements. Additional disclosure requirements in the update include: (1) for Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (2) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use, the reason for the difference; (3) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (4) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. ASU 2011-04 will become effective for the Company on January 1, 2012. We are currently evaluating ASU 2011-04 and have not yet determined the impact that adoption will have on our financial statements.
 
 
12

 

In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring”. This amendment explains which modifications constitute troubled debt restructurings (“TDR”). Under the new guidance, the definition of a troubled debt restructuring remains essentially unchanged, and for a loan modification to be considered a TDR, certain basic criteria must still be met. For public companies, the new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructuring occurring on or after the beginning of the fiscal year of adoption. The Company does not expect that the guidance effective in future periods will have a material impact on its financial statements. In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805): Disclosure of supplementary pro forma information for business combinations.” This update changes the disclosure of pro forma information for business combinations. These changes clarify 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 that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. Also, the existing supplemental pro forma disclosures were expanded to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. These changes become effective for the Company beginning January 1, 2011. The Company’s adoption of this update did not have an impact on the Company’s financial condition or results of operations.

In December 2010, the FASB issued ASU 2010-28, “Intangible –Goodwill and Other (Topic 350): When to perform Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts.” This update requires an entity to perform all steps in the test for a reporting unit whose carrying value is zero or negative if it is more likely than not (more than 50%) that a goodwill impairment exists based on qualitative factors, resulting in the elimination of an entity’s ability to assert that such a reporting unit’s goodwill is not impaired and additional testing is not necessary despite the existence of qualitative factors that indicate otherwise. These changes became effective for the Company beginning January 1, 2011. The adoption of this ASU did not have a material impact on our financial statements.

 
 
13

 

NOTE 4 – GOING CONCERN

The accompanying financial statements have been prepared assuming that Treaty will continue as a going concern. As shown in these financial statements, we have had continuing negative cash flows from operations and a working capital deficit as of September 30, 2011.  These conditions raise substantial doubt as to our ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.  Management intends to finance these deficits by making additional shareholder notes and seeking additional outside financing through either debt or sales of its common stock.
 
NOTE 5 – OIL AND GAS PROPERTIES
 
Recent acquisitions

Acquisition of three leases in Texas from C&C Petroleum Management, LLC

On April 8, 2011, we closed our acquisition of three leases in in Texas from C&C Petroleum Management, LLC.  We initially paid $50,000 in cash, gave a note payable in the amount of $300,000 payable in 12 monthly installments. We also paid 6 million shares of common stock which we valued at the closing price on March 30, 2011 (the date of the original agreement) and valued the shares at $83,400.  In addition, we issued 36,000 shares of Class A Convertible Preferred Stock whose terms and accounting treatment are enumerated below.

The 36,000 shares of Class A Convertible Redeemable Preferred Stock (the “Preferred Stock”), stated value $5 per share, are convertible in three separate tranches: 12,000 shares are convertible at $0.03 per share, 12,000 at $0.05 per share and 12,000 at $0.10 per share.  Therefore, tranche 1 would convert into 2 million shares (12,000 times $5 divided by $0.03), tranche 2 into 1.2 million shares and tranche 3 into 600,000 shares.  The conversion price of all tranches was greater than market price of our common stock on the date of grant, therefore no beneficial conversion feature was recorded for the redeemable preferred shares.  In the event that the Company’s stock price does not reach the level that would trigger conversion by April 8, 2013, then the Company would be liable for payment of $60,000 per tranche, or $180,000 in total. These shares were recorded upon issuance at the face value of the shares equal to the $180,000 total. The unconverted portion remaining as of September 30, 2011 equal to 12,000 shares with a value of $60,000, has been classified outside of permanent equity and liabilities based on the conditional redemption features of the shares

We valued the preferred stock at its stated value of $5 per share.  If the preferred share tranche does not convert, then the Company has an obligation to repay the stated value of  the preferred shares to the shareholder.

Based on the above consideration paid, we valued the properties acquired at:

Initial cash paid
    50,000  
Note payable in 12 installments
    300,000  
6 million shares of common stock
    83,400  
36,000 shares of Class A Convertible Preferred shares
    180,000  
Total value of consideration paid
  $ 613,400  
 
 
14

 

We allocated the purchase price to well equipment and intangible lease cost as follows:

Purchase price allocated to:
     
Tangible well equipment
    191,775  
Intangible lease costs
    421,625  
Total purchase price allocated
  $ 613,400  

As of September 30, 2011, two of the three tranches have been converted to equity by issuing 3.2 million shares.  The third tranche of 12,000 shares remains unconverted and is accounted for in the balance sheet under Commitments and Contingencies.  See Accounting Policies for a rationale of the classification.

Purchase of the Great Eight Leases in Texas

On May 31, 2011, we acquired eight leases in Texas for $700,000, with $50,000 paid at closing and issuing a promissory note for the difference.  Subsequent to closing, the seller incurred an additional expenses totaling $42,538.  The promissory note was changed to $692,538 to reflect the additional expenses.  As of September 30, 2011, the Company is still evaluating the intangible vs. tangible asset allocation, however this has no impact on the aggregated assets or depletion expense as all costs will be allocated within one field and depletion is calculated on a field by field basis. As of September 30, 2011, all eight of the wells are classified as proved properties and are currently producing.

Purchase of the Shotwell Leases in Texas

On May 25, 2011, we acquired two leases in Texas for $170,000 paying $50,000 at closing and $90,000 subsequent to closing.  In July, 2011, we paid the remaining $30,000.

We allocated the purchase price to tangible and intangible costs as follows:
 
Purchase price allocated to:
     
Tangible well equipment
    29,800  
Intangible lease costs
    140,200  
Total purchase price allocated
  $ 170,000  
 
 
15

 

Our geographical proved and unproved properties are as follows:

   
09/30/11
   
12/31/10
 
Proved developed producing:
           
Texas
  $ 1,151,461     $ -  
Less: accumulated depletion
    (2,685 )     -  
Total
    1,148,776       -  
                 
Unproved:
               
Belize
    138,355       202,950  
Texas
    172,802       -  
Tennessee
    49,474       49,474  
Total
  $ 360,361     $ 252,424  

Production of Oil from all fields

We recorded depletion expense of $914 and $2,560 for the three and nine months ended September 30, 2011 based on total production of approximately 755.4 and 1,445.8 barrels, respectively.

For the three and  nine months ended September 30, 2011, we shipped 458.4 and 948.6 barrels, and reflect a $114,171 net  receivable (after  royalty and production tax reductions) for shipments made prior to September 30, 2011.   The receivable also includes 931 barrels that were awaiting shipment to a committed buyer.

During the nine months ended September 30, 2011, we sold a total of 17 % of the ORRI (Overriding Royalty Interests) from our Texas property.  This generated proceeds of $515,000 and relieved debt by $452,127.  The basis related to this disposal removed from oil and gas assets was $176,351, resulting in a gain on these transactions of $790,776.

NOTE 6 – PROPERTY, PLANT AND EQUIPMENT

Other property, plant and equipment consist principally of drilling rigs, and office furniture and equipment.  Historical cost and accumulated depreciation are as follows:

   
09/30/11
   
12/31/10
 
             
 Drilling rigs and related equipment
  $ 659,439     $ 759  
 Office equipment
    3,958       -  
 Furniture and fixtures
    1,000       1,000  
 Vehicles
    25,520       -  
 Equipment
    32,552       -  
 Total property, plant and equipment - at cost
    722,469       1,759  
 Less: accumulated depreciation
    (47,892 )     -  
 Net property, plant and equipment - other
  $ 674,577     $ 1,759  

Assets other than drilling equipment and vehicles generally have estimated useful lives of three years.  Estimated useful lives of drilling equipment and vehicles is five years .
 
 
16

 
 
NOTE 7 – NOTES PAYABLE
 
As of September 30, 2011 and December 31, 2010, we had notes and accrued interest payable of $981,924 and $534,278, respectively. Notes payable to related parties as of September 30, 2011 and December 31, 2010 were equal to $0 and $481,646, respectively.

This consisted of the following:

Liability relating to the Crockett County Leases ( net balance of $150,000 and $106,303 as of September 30, 2011 and December 31, 2010, respectively)
Upon assuming the rights to receive production revenues assigned to Treaty Energy Corporation from Treaty Petroleum, Inc., we agreed to service the note payable to the assignee of the working interest (Treaty Petroleum, Inc.) so long as the Company held the lease.

As is discussed more thoroughly in Note 4 to our annual report on Form 10-K as of December 31, 2010, we lost the Crockett County, Texas leases due to our failure to hold the leases by production.  At the point the leases were lost, we had net note balance owed of $85,049.  As of September 30, 2011, the net note balance is $150,000.  Although the Company has not issued a promissory note in this amount, we continue to carry this liability until we collect evidence that the original note made by Treaty Petroleum, Inc. has been retired.  During the nine months ended September 30, 2011, we amortized $43,697 of the discount on this note to interest expense.

When the Crockett County leases were lost, the assignor of the lease to Treaty Petroleum, Inc. sued the original shareholders of Treaty Petroleum, Inc. in Shelby County, Texas for the amount that was contractually obligated should the lease be lost.  That contractual amount was $150,000 which we maintain as a liability.

This liability has no stated interest rate and is callable on demand.  No interest was imputed on this liability due to the discount amortization representing the related interest for this note.  This note is also subject to the lawsuit described below.

Notes and Interest Payable to Previous Officers and Directors (Principal of $156,545 and Accrued Interest of $14,147 and $10,636 as of September 30, 2011 and December 31, 2010, respectively)
 
These liabilities arose principally between January, 2007 and December, 2008 as cash contributions and accrued compensation to officers and directors of Treaty Petroleum, Inc. with whom Treaty Energy Corporation merged in December of 2008.  Some additional compensation was accrued during 2009 until the Crockett County, Texas leases were lost.

This note, as well as, the Crockett County lease obligations are subject to following legal actions:
 
On January 29, 2010, a lawsuit (Highground et al. versus Ronald L. Blackburn et al.) was filed in the 22nd Judicial District Court, Parish of St. Tammany, Louisiana naming Treaty Energy Corporation, among others, as a defendant.  The lawsuit alleges certain wrongdoings by the defendants (other than Treaty) which have no bearing on our operations since inception.  The lawsuit also alleges certain monies owed to some of the plaintiffs by the Company.

On March 11, 2010, we filed a Notice of Removal of the state action to the United States District Court, Eastern District of Louisiana, based upon the diversity of all the parties.  The case has been moved to the United States District Court.

On April 11, 2010, the defendants filed a countersuit against the plaintiffs seeking damages against Highground, et al based on misrepresentation of the Crockett County, Texas leases.
 
 
17

 
 
In April , 2010, some of the plaintiffs in this lawsuit filed for protection under federal bankruptcy laws. This caused the action to be moved to the federal bankruptcy courts where it remains as of the filing of this report.
 
The notes bear interest at 3%.  Management believes that the interest rate stated in these notes does not adequately represent the Company’s incremental cost of capital.  Therefore, we have imputed interest at an additional 5% by charging interest expense and increasing Additional Paid in Capital.  For the nine months ended September 30, 2011, we have charged interest expense and increased interest payable in the amount of $3,510 for the amount of the 3% nominal interest on the notes.  We have also charged interest expense (and increased Additional Paid in Capital) with $5,859 for the additional imputed interest at 5%,

These notes are callable at any time.  However, because of the above lawsuit, the Company would require a court order before paying these liabilities.
 
Promissory Note Issued for the Purchase of a Drilling Rig ($126,798 and $0 as of September 30, 2011 and December 31, 2010, respectively)
 
On June 6, 2011, we issued a promissory note in the amount of $211,500 for the purchase of a Schramm Drilling Rig. The balance is due with monthly payments for 16 months following the date the note was made. The note was discounted to reflect the inherent interest within the agreement based on an interest rate of 5% which resulted in a discount value of $5,888. Amortization on the discount during the three and nine months ended September 30, 2011 was  $1,104 and $1,379 leaving a discount of $4,509 as of September 30, 2011. The net balance of this note as of September 30, 2011, was $122,289.
 
Promissory Note Issued for the Acquisition of the Great 8 lease (principal of $525,224 and accrued interest of $1,220 as of September 30, 2011 with no balance outstanding at December 31, 2010)
 
On May 31, 2011, we issued a promissory note in the amount of $692,539 for the Great 8 leases in Texas, the payment terms of which are: monthly payments including interest and principal with the final payment due on June 1, 2012. This note accrues interest at 5%.  At September 30, 2011, the Company was current on its payment obligations with this obligation.

Promissory Note Issued for Cash Deposit (principal of $12,500 as of September 30, 2011, and no balance outstanding at December 31, 2010)
 
On July 1, 2011, we issued a promissory note in the amount of $12,500 in return for a cash advance, the payment terms of which are that the lender will receive all hydrocarbon revenues earned between the loan date and May 15, 2012, until the note is paid in full.  There is no stated interest on the loan, however, the lender will also receive a ½% royalty interest on all wells to continue indefinitely. Royalty amounts are expensed and accrued with production.
 
All related party balances related to salary and consulting agreements have been recorded within accrued liabilities. The Company re-paid or converted all related party debt related to financing during the nine months ended September 30, 2011, see note 8 below related to conversions. During the nine months ended September 30, 2011 interest was imputed for the balances outstanding during the period equal to $11,517 based on the Company’s typical borrowing rate.
 
 
18

 
 
NOTE 8 – SHAREHOLDERS’ EQUITY
 
We are authorized to issue 750 million shares of our common stock.  At December 31, 2010, we had 496,605,424 shares issued and outstanding.  During the nine months ended September 30, 2011, we issued the following shares:

·  
On February 14, 2011, we issued 10,296,609 shares for cash and received $60,750.
 
·  
On March 1, 2011, we issued 1 million shares to a consultant.  We valued the shares at the closing price on the date of grant and recorded a charge to general and administrative expense of $8,200.
 
·  
Also on March 1, 2011, we issued 2,250,000 shares to our previous operator in Tennessee to settle contractual amounts owed by us to him.  We valued the shares at the closing price on the grant date and reduced his liability from $20,000 to $1,550.
 
·  
On March 3, 2011, we issued 23,500,000 shares to our seismic consultant in Belize, Patrick Wayne Maloy.  15 million of these shares were for services rendered in 2010.  We reduced our stock payable to the consultant from $204,000 to zero.  8.5 million of these shares were in payment of an aircraft for use on our Belize project.  These shares were valued at the closing price on the date of grant and we recorded our cost basis in the aircraft at $72,250. During the quarter ended September 30, 2011, this aircraft was transferred to a related party to relieve debt to that party of $69,011.  The carrying value of the asset was equal to the debt relieved as of the transfer date.
 
·  
Also on March 3, 2011, we issued 13,597,874 shares to a consultant for work performed during 2009 and 2010.  We valued the shares at the closing price on the grant date, reduced the liability from $94,345 to $23,500 and recorded a loss on retirement of debt in the amount of $69,737.
 
·  
On March 16, 2011, we issued 4 million shares to a previous director.  We valued the shares at the closing price on the grant date and charged general and administrative expenses with $34,000.
 
·  
On March 29, 2010, we issued 14 million shares to our previous CEO and Chairman, Randall Newton, for work performed during 2009 and 2010, and repayment of cash contributions made by him.  We valued the shares at the closing price on the grant date, reduced our liability to him from $269,024 to zero, and recorded a gain on retirement of debt of $87,024. This party was not considered to be related to the Company based on his resignation being during 2009 and he not holding a material share interest.
 
·  
On March 31, 2011, we issued 7,900,000 shares to our current CEO and Chairman, Andrew Reid in payment for services.  We valued the shares at the closing price on the grant date, and reduced our liability to him from $109,000 to $6,300.
 
·  
On April 6, 2011 we issued 1.5 million shares to a consultant for commissions on our Belize acquisition, valuing them at the closing price on the grant date and charging lease operating expense with $22,200.
 
·  
On April 8, 2011, we issued 6 million shares to the seller of one of our Texas acquisitions (see Note 5).  We valued the shares at the closing price on the grant date and included the value of $83,400 the stock in our carrying value of the Texas leases.
 
 
19

 
 
·  
On May 10, 2011, we issued 3.2 million shares for conversion of tranches 1 and 2 associated with our Texas leases (see Note 5).  We retired $120,000 mezzanine liability included in Commitments and Contingencies.  The conversion was according to the terms of the agreement.  Therefore, no gain or loss was recognized.
 
·  
On April 27, 2011, we issued 5,675,989 shares to an affiliate for services.  We valued the shares at the closing price on the grant date and charged general and administrative expenses with $306,503.
 
·  
On May 12, 2011, we issued 1 million shares to our President and Chief Operating Officer as a signing bonus.  We valued the shares on the grant date and charged general and administrative expense with $40,000.
 
·  
On June 22, 2011 we issued 2,333,333 shares to acquire certain equipment.  We valued the shares at the closing price on the date of grant, or $91,000, and recorded the equipment as an asset equal to the cash price of $77,000.   The difference of $14,000 is included in general and administrative expenses.
 
·  
Also on June 22, 2011 we issued 7,050,000 shares to various consultants for services.  We valued the shares at the closing price on the grant date and charged general and administrative expense with $255,340.
 
·  
On June 22, 2011, we issued 2,367,886 to certain creditors of a company controlled by our Chairman and Chief Executive Officer, Andrew Reid.  We valued the shares at the closing price on the grant date, crediting equity with $95,483, reducing our liability to the affiliate company by $67,083 and recording a loss on extinguishment of debt in the amount of $28,400.
 
·  
Also on June 22, 2011 we issued 11 million shares to the same company controlled by our Chairman and Chief Executive Officer, Andrew Reid in conversion of the outstanding balance of $664,190.  We valued the shares at the closing price on the grant date, crediting equity with $418,000, reducing our liability by $664,190 with an offsetting gain on extinguishment of debt.  Because the gain here and loss above were from a related party, we included the net gain in Additional Paid in Capital rather than recognizing a gain.
 
·  
Also on June 22, 2011, we issued 2.5 million shares to two creditors who loaned us money to acquire the leases in Tennessee to convert their debt balances to equity.  We valued the shares at the closing price on the grant date, crediting equity with $97,500, reducing our liability by $55,000 with an offsetting loss on extinguishment of debt of $42,500.
 
·  
Also on June 30, 2011, we issued 8.25 million shares to convert certain notes payable for debts we owed in connection with our Tennessee and Belize acquisitions.  We valued the shares at the closing price on the grant date, crediting equity with $330,000, reducing interest and principal due to these creditors by $125,761 with an offsetting loss on extinguishment of debt of $204,239.
 
·  
Also on June 22, 2011, we issued 450,000 shares in connection with our acquisition of certain heavy equipment.  We valued the shares at the closing price on the date of grant, or $18,450, and recorded the equipment as an asset equal to the cash price of $18,000.   The difference of $450 is included in Asset Impairments.
 
·  
Also on June 22, 2011, we issued 5,670,000 shares to several accredited investors for $137,000 in cash.
 
 
20

 
 
·  
Also on June 22, 2011, we issued an affiliate 77,258,753 shares as reimbursement for personal shares the affiliate used in various deals in Belize, Tennessee, Louisiana and Texas.  We valued the shares at the closing price on the grant date and credited Additional Paid in Capital with $3,285,170, charging Additional Paid in Capital with $483,577, liabilities with $119,500, loss on conversion of debt of $980,000 and operating expense with $1,702,093.
 
·  
On July 1, 2011, we contracted to provide a broker with 20,000,000 shares at a discounted price over a period of nine months.  On the same date, we issued 11,000,000 million of those shares from Treasury stock that we acquired from a related party.  Total amount due on this contract is $400,000, of which we have been paid $225,000 as of September 30, 2011.  
 
·  
Also on July 01, 2011 we issued 504,500 shares to a consultant for services.  We valued the shares at the closing price on the grant date and charged general and administrative expense with $19,928.
 
·  
 On July 13, 2011, we issued 1,530,000 shares to various consultants for services.  We valued the shares at the closing price on the grant date and charged general and administrative expense with $71,190.
 
·  
Also on July 13, 2011, we issued 2,000,000 shares to a consultant for services.  We valued the shares at the closing price on the grant date and charged general and administrative expense with $79,400.
 
·  
On June 25, 2011, the Company issued 2,625,000 shares to convert related party liabilities owed of $105,000. The value of the shares owed was equal to $110,000 which was recorded to stock payable at June 30,2011. The difference between the share value and the value of the liabilities relieved was recorded as a loss for $5,000 due to these parties being employed by the company and the excess being considered as additional compensation to the recipients
 
·  
Also on July 13, 2011, we issued 2,090,119 shares to various investors who paid a total of $48,000.
 
·  
On July 18, 2011, we issued 2,000,000 shares to extinguish a debt from advances by an investor.  We valued the shares as of the date the stock was granted at $95,000.  This same investor acquired a 2.0% ORRI valued at $37,127 in the Texas fields. These two transactions eliminated the balance of $130,000 due from a short term obligation.  A loss of $2,127 was recognized for the difference.
 
·  
On July 19,2011, the Company issued 8,625,000 shares to convert the acquisition liability owed to C&C Petroleum of $285,000. The value of the shares owed was equal to $345,000 which was recorded to stock payable at June 30, 2011. The difference between the share value and the value of the liabilities relieved was recorded as a loss for $60,000 during the second quarter.
 
·  
Also on July 19, 2011, the Company issued 500,000 shares to a consultant for services. We valued the shares at the closing price on the grant date and charged general and administrative expense with $20,000.
 
·  
 Also on July 19, 2011, we issued 76,548 shares to an investor who paid $2,000.
 
·  
On July 26, 2011, we issued 1,135,526 shares to a consultant for services. We valued the shares at the closing price on the grant date and charged general and administrative expense with $44,853.
 
 
21

 
 
·  
Also on July 26, 2011, we issued 2,000,000 shares to our current CEO and Chairman, Andrew Reid in payment of a signing bonus for his contract dated May 1, 2011.  We valued the shares at the closing price on the grant date, and charged general and administrative expense for $137,000.
 
·  
On July 29, 2011, we issued 6,083,181 shares to various consultants for services.  We valued the shares at the closing price on the grant date and charged general and administrative expense for $276,922.
 
·  
On August 8, 2011, we issued 2,000,000 shares to a consultant for services. We valued the shares at the closing price on the grant date and charged general and administrative expense with $108,000.
 
·  
On August 12, 2011, we issued 1,400,000 shares to an individual for both cash payments and reduction of an advance.  She paid $8,000 in cash (400,000 shares), and loaned the company $50,000.  In return for the remaining 1,000,000 shares she reduced the debt by $37,500. A loss of $28,800 was recorded for the difference in fair value of shares issued and the debt relieved.
 
·  
Also on August 12, 2011, we issued 23,912 shares to a vendor who had provided services to a related party.  The related party’s obligation was $2,917 and reduced our liability to the related party in the same amount. A gain of $1,269 was recorded for the difference in fair value of shares issued and the debt relieved
 
·  
Also on August 12, 2011, we issued 3,068,165 shares to investors who had paid a cash total of $98,000.
 
·  
On August 16, 2011, we issued 1,750,000 shares to a consultant for services.  We valued the shares at the closing price on the grant date and charged general and administrative expense with $87,500.
 
Stock Payable
 
·  
On May 20, 2011 the Company entered into a note agreement for $100,000 that required payment of 1,000,000 shares as an inducement to the lender. Due to the short term nature of the note the full value of the shares of $39,000 was expensed and recorded to stock payable with the agreement. These shares remained unissued as of September 30, 2011, and are recorded within stock payable as of September 30, 2011.
 
·  
On May 20, 2011, the Company agreed to issue 1,500,000 shares for $20,000 of cash proceeds received. These shares remained unissued as of September 30, 2011, and are recorded within stock payable as of September 30, 2011.
 
 
22

 
 
Treasury Stock

On July 1, 2011, we purchased  20 MM shares of our stock from to a related company also controlled by our Chairman and Chief Executive Officer, Andrew Reid.  The shares were valued at $790,000, the amount the company agreed to re-pay with an outstanding liability.
 
Also, on July 1, 2011, we issued 11,000,000 of those shares and reduced the Treasury Stock balance by $434,500.   Losses on the sale of Treasury Stock are not reflected on the Income Statement, therefore the difference between cost and the proceeds  received was charged to Additional Paid in Capital.
 
Imputed Interest
 
Pursuant to our notes payable to our former corporate secretary and the former operator of the Crockett County leases, the aggregate unpaid principal amount of which is $156,545, and which forms a portion of the lawsuit discussed in Note 5 to our annual report filed on Form 10-K as of December 31, 2010, we accrue simple interest at 3% per year.  This resulted in an interest charge collectively of $3,510 for nine months ended September 30, 2011.

Management believes that the stated interest on these notes is not equivalent to the Company’s realistic cost of capital.  We therefore imputed an additional 5% interest and charged interest expense with an additional $8,007 for the nine months ended September 30, 2011.

NOTE 9 – PENDING LITIGATION

On January 29, 2010, a lawsuit (Highground et al. versus Ronald L. Blackburn et al.)was filed in the 22nd Judicial District Court, Parish of St. Tammany, Louisiana naming Treaty Energy Corporation, among others, as a defendant.

The lawsuit alleges certain wrongdoings by the defendants (other than Treaty) which have no bearing on our operations since inception.  The lawsuit also alleges certain monies owed to the some of the plaintiffs by the Company.

On March 11, 2010, we filed a Notice of Removal of the state action to the United States District Court, Eastern District of Louisiana, based upon the diversity of all the parties.  The Complainants may challenge the removal, but as of the date of this report have not responded.

On April 11, 2010, the defendants filed a countersuit against the plaintiffs seeking damages against Highground, et al based on misrepresentation of the Crockett County, Texas leases.

Several of the defendants in the lawsuit filed for bankruptcy protection.  On April 30, 2010, the case was moved to the US Bankruptcy Court for the Eastern District of Louisiana, Section B.

Currently all arguments have been presented and the matter is awaiting the judge’s determination.
 
 
23

 

NOTE 10 – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities at September 30, 2011 and December 31, 2010 consist of the following:

   
09/30/11
   
12/31/10
 
Trade accounts payable
  $ 156,431     $ 152,851  
Royalties payable
    39,990       -  
Production taxes payable
    5,250       -  
Liabilities associated with our reverse merger in December, 2008
    200,380       -  
Bank overdraft     2,205       -  
Total
  $ 404,256     $ 152,851  
 
During the three and nine months ended September 30, 2011, the company owed three related parties a combined liability of $397,671 for cash advances and for accrued consulting fees.  At September 30, 2011, the three parties each agreed to waive their liability and contribute the total amount due to Additional Paid in Capital.  At September 30, 2011, the company had -0- remaining liability to these related parties.
 
NOTE 11 – ASSET RETIREMENT OBLIGATION

In June, 2006, the Company adopted the accounting guidance with respect to accounting for conditional asset retirement obligations.  Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. The Company estimates a fair value of the obligation on each well in which it owns an interest by identifying costs associated with the future dismantlement and removal of production equipment and facilities and the restoration and reclamation of a production operation’s surface to a condition similar to that existing before oil and natural gas extraction began.

In general, the amount of an Asset Retirement Obligation (“ARO”) and the costs capitalized will be equal to the estimated future cost to satisfy the abandonment obligation using current prices that are escalated by an assumed inflation factor up to the estimated settlement date which is then discounted back to the date that the abandonment obligation was incurred using an assumed cost of funds for the Company. After recording these amounts, the ARO is accreted to its future estimated value using the same assumed cost of funds and the liability is increased each period as the retirement obligation approaches.

Our asset retirement obligations at September 30, 2011 and December 31, 2010 were:

   
09/30/11
   
12/31/10
 
Obligations acquired upon purchase of producing properties
  $ 35,548     $ -  
Accretion to balance sheet date
    1,574       -  
Asset retirement obligation at balance sheet date
  $ 37,122     $ -  
 
 
24

 

NOTE 12 – COMPANY SEGMENTS

The Company’s operating segments are:

·  
Oil and gas production and
·  
Drilling

Since the Company has only recently acquired the drilling assets and producing properties in Texas and is still developing its concession in Belize, the majority of corporate expenses are still associated with formative activities.

Revenues as shown below represent sales to external customers for each segment. Intercompany revenues have been eliminated.

The primary financial measure used by the Company to evaluate performance of individual operating segments is earnings before interest and taxes (commonly referred to as “EBIT”) which represents net income before interest expense, net and income taxes in the unaudited condensed consolidated statements of income. Reconciling items for EBIT represent corporate expense items that are not allocated to the operating segments for management reporting.

   
Nine Months Ended September 30, 2011
 
   
Oil and Gas Production
   
Drilling
   
Total
 
                   
Net revenues
  $ 156,907     $ 59,005     $ 215,912  
Direct costs
    466,327       30,118       496,444  
Loss before interest and taxes
    (309,420 )     28,887       (280,532 )
                         
Corporate items not allocated to segments
                    4,307,372  
Interest expense
                    139,845  
Net loss before income tax effect
                  $ (4,727,749 )
 
   
Three Months Ended September 30, 2011
 
   
Oil and Gas Production
   
Drilling
   
Total
 
                   
Net revenues
  $ 87,377     $ 17,500     $ 104,877  
Direct costs
    220,778       17,937       238,715  
Loss before interest and taxes
    (133,401 )     (437 )     (133,838 )
                         
Corporate items not allocated to segments
                    387,302  
Interest expense
                    13,052  
Net loss before income tax effect
                  $ (534,192 )
 
 
25

 

NOTE 13 – RELATED PARTY TRANSACTIONS
 
During the nine months ended September 30, 2011, we had the following transactions with related parties:
 
·  
We paid $24,427 in cash to a major shareholder in repayment of cash contributions previously made.
 
·  
We accrued $90,000 in compensation costs to our Chairman and CEO and paid him 9.4 million shares, reducing the balance owed to Mr. Reid to $6,300 from $169,000.
 
·  
We issued 14 million shares to our previous CEO and Chairman, Randall Newton, for work performed during 2009 and 2010, and repayment of cash contributions made by him.  We valued the shares at the closing price on the grant date, reduced our liability to him from $269,024 to zero, and recorded a gain on retirement of debt of $87,024. This party was not considered to be related to the Company at the time of the conversion based on his resignation being during 2009 and he not holding a material share interest.
 
·  
We borrowed $1,746,411 from an entity owned by our Chairman and CEO, Andrew Reid, and repaid $227,081 in cash.  Additionally, we issued the affiliate entity, or creditors of the affiliate entity, shares which we recorded as a reduction of our liability to the affiliate.  The aggregate amount of shares issued for this purpose was 11 million which reduced the liability by $664,190. The related party has further settled $326,371 of amounts previously owed by contributing the amounts owed to Additional Paid in Capital   As of September 30, 2011, the company had -0- liability to this related party.
 
·  
During the three months ended June 30, 2011, the balance of a note issued in December, 2010 for the purchase of an aircraft used in our Belize operation was paid by an entity controlled by our Chief Executive Officer and Board Chairman, Andrew Reid.  During the three months ended September 30, 2011, this aircraft was transferred to that entity for the net book value recorded on the books.
 
·  
During the nine months ended September 30, 2011, the company accrued consulting fees to its Chairman and CEO, Andrew Reid and one other consultant affiliated with the company Mr. Reid controls totaling $71,300.  Both related parties have agreed to a debt settlement whereby all amounts owed will be contributed to Additional Paid in Capital, leaving a -0- balance owed to them.
 
NOTE 14 – SUBSEQUENT EVENTS
 
Subsequent to September 30, 2011, we paid an additional $78,573 on our promissory note on the Great Eight Texas leases (See Note 5).

During the quarter we signed an agreement to purchase the Woolridge lease(s) and made a $10,000 deposit.  The agreement calls for a closing date of 11/30/11.

We have evaluated subsequent events through the date of issuance of the financial statements.
 
 
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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
You should read the following discussion in conjunction with management’s discussion and analysis contained in our 2010 Annual Report on Form 10-K, as well as the financial statements and notes hereto included in this quarterly report on Form 10-Q. The following discussion contains forward-looking statements that involve risks, uncertainties, and assumptions, such as statements of our plans, objectives, expectations, and intentions. Our actual results may differ materially from those discussed in these forward-looking statements because of the risks and uncertainties inherent in future events.
 
Results of Operations
 
Nine Months Ended September 30, 2011, compared with Nine Months Ended September 30, 2010
 
We had $215,912 in revenues for the nine months ended September 30, 2011from our recent Texas acquisitions versus $1,570 for the same period in 2010.

Royalties have been $54,352 in 2011 versus $275 in 2010.

Our lease operating expenses were $372,351 in 2011 versus $343,031 in 2010 due to increased management oversight of expenses resulting from our Texas and Belize acquisitions.

General and administrative expenses have increased from $381,133 for the nine months ended September 30, 2010 to $3,715,902 in 2011, mostly resulting from significant increases in stock-based compensation.

Our depreciation, depletion and amortization expenses for the nine months ended September 30, 2011 were $53,817 as compared to $154 for the same period in 2010, owing to the start of depreciation on our equipment  that we use in Belize and from our unit of production depletion in Texas.

Interest expense is higher during the nine months ended September 30, 2011 versus the same period in 2010, due to higher debt levels during the first six months of the year.
 
Liquidity and Capital Resources
 
Our financial statements have been prepared on a going concern basis that contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business.
 
Currently, we are able to maintain our existing operations through funding agreements with related party companies. The existing cash balances and internally generated cash flows are from sales of oil production. We have determined that our existing capital structure is adequate to fund our planned growth. 
 
We intend to finance our drilling, work over and acquisition program by related party loans and private debt offerings. There can be no assurance that we will be successful in procuring the financing we are seeking. Future cash flows are subject to a number of variables, including the level of production, oil and gas prices and successful drilling efforts. There can be no assurance that operations and other capital recourses will provide cash in sufficient amounts to maintain planned or future levels of capital expenditures.
 
 
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Plan of Operation
 
Over the next twelve months we intend to develop the following initiatives:
 
Revenue Generation
 
Sales of oil for the quarter were less than expected as a result of lower oil prices.  Treaty was advised by one of its Directors, Bruce Gwyn, that the price decline would be temporary and should move back towards $100 in the coming months.  We did sell small amounts as the tanks were filled.  This strategy is allowing us to get $12 to $15 more per barrel of the oil that we’ve been selling for the last few weeks.
 
In Belize, we have secured funding for the first two wells.  Drilling of those wells began on October 25th, 2011.  Additional equipment is currently on its way to Belize and is estimated to arrive in port on November 14th, 2011.  This equipment will enable us to complete drilling activities.

In Texas, on August 1st, 2011 we had 20 wells in production on 12 of our 13 leases.  Production was at 20 barrels of oil per day.  As part of our ongoing maintenance and rework program, we were able to bring on 14 additional wells which will increase production on our existing wells.  Treaty is currently producing 50 barrels of oil per day.  Ten of the 13 leases have also been upgraded so that can operate more efficiently.  These upgrades allow for more consistent and steady production levels going forward.  We also have work to do on two injection wells as well as five more wells to rework.  We plan on converting one of the wells on the Burns Lease to an injection well eliminating the need to haul water.  Converting the Fiscus Lease to electricity from natural gas and injection wells to electric from gravity.

We should be able to finish all rework and maintenance activities by mid December 2011.  We also expect a minimum of 70 barrels of oil per day by that time.

Drilling
 
Treaty currently has hundreds of proven, undeveloped acreage in which we can drill on.  Depth of the new wells will range from a shallow 550 feet to 2600 feet.  Some wells will reach deeper than 4500 feet.
 
On August 4th, 2011 Treaty agreed to acquire the Mark H. & Eula E. Wooldridge Leases, totaling 260 acres.  This transaction will close on November 30th, 2011.  This Lease has one well currently producing 5 barrels of oil per day.  Treaty has secured funding in the amount of $700,000 in order to infield drill twelve new wells to 550 feet.  We expect to begin drilling by December 4th, 2011 and should take about six to eight weeks to complete.  These wells are expected to produce 14 to 22 barrels of oil per day each.  This will allow us to reach our goal of 200 barrels of oil per day the end of 2011.
 
Treaty has nine additional wells to drill on the Shotwell and Kennard Leases.  We are seeking funding for these wells, which we expect to produce at the depth 2,500 feet.  We estimate them producing anywhere from 30 to 150 barrels of oil per day initially.
 
Financing
 
We hope to finance our work over, drilling and acquisition programs by a combination of bank financing, owner financing and cash flows from operations.

There is no guarantee that we can raise the required capital to make acquisitions, drill new wells, or repair equipment on any acquired properties, or that undertaking such repairs, acquisitions and drilling program will make us profitable or self-sustaining.
 
 
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ITEM 3 - QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
A smaller reporting company is not required to provide the information required by this item.
 
ITEM 4 – CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based upon that evaluation, our Chief Executive Officer and principal financial officer concluded that, as of the end of the period covered in this report, our disclosure controls and procedures were not effective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officer, as appropriate to allow timely decisions regarding required disclosure.

Our management, including our principal executive officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. To address the material weaknesses, we performed additional analysis and other post-closing procedures in an effort to ensure our consolidated financial statements included in this annual report have been prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented.

Our annual report on Form 10-K as of December 31, 2010 reported the following material weaknesses:

     1.
As of December 31, 2010, we did not maintain effective controls over the control environment.  Specifically we have not developed and effectively communicated to our employees its accounting policies and procedures.  This has resulted in inconsistent practices.  Further, the Board of Directors does not currently have any independent members and no director qualifies as an audit committee financial expert as defined in Item 407(d)(5)(ii) of Regulation S-B.  Since these entity level programs have a pervasive effect across the organization, management has determined that these circumstances constitute e a material weakness.

2.
As of December 31, 2010, we did not maintain effective controls over financial statement disclosure. Specifically, controls were not designed and in place to ensure that all disclosures required were originally addressed in our financial statements.   Accordingly, management has determined that this control deficiency constitutes a material weakness.
 
Management has been addressing these weaknesses during the nine months ended September 30, 2011, however, believe that the material weakness assessment is unchanged.
 
Change In Internal Control Over Financial Reporting
 
There were no changes in our internal control over financial reporting that occurred during the three months ended September 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
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PART II – OTHER INFORMATION
 
ITEM 1 – LEGAL PROCEEDINGS
 
On January 29, 2010, a lawsuit (Highground et al. versus Ronald L. Blackburn et al.)was filed in the 22nd Judicial District Court, Parish of St. Tammany, Louisiana naming Treaty Energy Corporation, among others, as a defendant.

The lawsuit alleges certain wrongdoings by the defendants (other than Treaty) which have no bearing on our operations since inception.  The lawsuit also alleges certain monies owed to the some of the plaintiffs by the Company.

On March 11, 2010, we filed a Notice of Removal of the state action to the United States District Court, Eastern District of Louisiana, based upon the diversity of all the parties.  The Complainants may challenge the removal, but as of the date of this report have not responded.

On April 11, 2010, the defendants filed a countersuit against the plaintiffs seeking damages against Highground, et al based on misrepresentation of the Crockett County, Texas leases.

Several of the defendants in the lawsuit filed for bankruptcy protection.  On April 30, 2010, the case was moved to the US Bankruptcy Court for the Eastern District of Louisiana, Section B.

We may be involved from time to time in ordinary litigation, negotiation and settlement matters that will not have a material effect on our operations or finances. We are not aware of any pending or threatened litigation against us or our officers and directors in their capacity as such that could have a material impact on our operations or finances, except as disclosed in this report.
 
ITEM 1A – RISK FACTORS
 
Our business has many risks. Factors that could materially adversely affect our business, financial condition, operating results or liquidity and the trading price of our common stock are described under “Risk Factors in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010, filed April 15, 2011.

This information should be considered carefully, together with other information in this report and other reports and materials we file with the Securities and Exchange Commission.
 
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES
 
See Note 9 for a listing of shares issued during the six months ended September 30, 2011.
 
Options and Warrants
 
During the three months ended September 30, 2011, no options or warrants have been granted, expired or exercised.
 
 
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ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
 
None.
 
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None.
 
ITEM 5 – OTHER INFORMATION
 
None.
 
ITEM 6 – EXHIBITS

Exhibit No.
 
Description of Exhibit
     
3.1
 
Articles of Incorporation, as filed August 1, 1997 (included as Exhibit 3.1 to the Form 10-SB12G filed November 10, 1999, and incorporated herein by reference).
3.2
 
Bylaws (included as Exhibit 3.2 to the Form 10-SB12G filed November 10, 1999, and incorporated herein by reference).
3.3
 
Articles of Amendment to the Articles of Incorporation, as filed August 23, 1997 (included as Exhibit 3.3 to the Form 10-SB12G filed November 10, 1999, and incorporated herein by reference).
3.4
 
Articles of Amendment to the Articles of Incorporation, as filed November 20, 1998 (included as Exhibit 3.4 to the Form 10-SB12G filed November 10, 1999, and incorporated herein by reference).
3.5
 
Articles of Amendment to the Articles of Incorporation, as filed May 16, 2003 (included as Exhibit 3.5 to the Form 10-SB12G filed November 10, 1999, and incorporated herein by reference).
4.1
 
2003 Stock Benefit Plan, dated July, 1, 2003 (included as Exhibit 4.1 to the Form S-8 filed July 23, 2003, and incorporated herein by  reference).
4.2
 
Form of Class A Warrant (included as Exhibit 4 to the Form 8-K filed March 15, 2005, and incorporated herein by reference).
4.3
 
Form of Class B Warrant (included as Exhibit 4 to the Form 8-K filed March 15, 2005, and incorporated herein by reference).
4.4
 
Form of Class C Warrant (included as Exhibit 4 to the Form 8-K filed March 15, 2005, and incorporated herein by reference).
4.5
 
Subscription Agreement between the Company and various subscribers  (included as Exhibit 10.1 to the Form SB-2/A filed September 14, 2005, and incorporated herein by reference).
4.6
 
Subscription Agreement between the Company and various subscribers (included as Exhibit 4 to the Form 8-K filed March 15, 2005, and incorporated herein by reference).
14.1
 
Corporate Code of Ethics (included as Exhibit 14 to From 10-KSB filed March 16, 2004, and incorporated herein by reference).
2.1
 
Subsidiaries of the registrant (filed herewith).
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
 
Certification of Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
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SIGNATURES
 
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: November 21, 2011
 
Treaty Energy Corporation
 
       
  By:
 /s/ Andrew V. Reid
 
   
Andrew V. Reid
 
   
Chief Executive Officer
 
 
 
 
 
 
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