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The following is an excerpt from a 10-K SEC Filing, filed by TN-K ENERGY GROUP INC. on 4/17/2012.
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TN-K ENERGY GROUP INC. - 10-K - 20120417 - BUSINESS
ITEM 1. DESCRIPTION OF BUSINESS.

Overview

We are an independent oil exploration and production company, engaged in acquiring oil leases and exploring and developing crude oil reserves and production in the Appalachian basin. While we have acquired working interests in existing wells in an effort to balance our revenue sources, we primarily focus our efforts on acreage acquisitions in which we will the operator of the wells which we believe gives us the greatest ability to maximize our revenues over the long term. We concentrate our operations in Kentucky and Tennessee primarily in the Murfreesboro, Knox and Wells Creek formations, although we also have assets located in the Granville, Stones River and Sunnybrook formations. All of these formations are primary known producing formations. Our growth strategy is to focus on our operational growth in our core area, to convert our unproved reserves to proved reserves and to continue our acreage acquisitions while maintaining balanced, prudent financial management.

Our Operations

Our operations are divided between leases in which we have a participation interest/overriding royalty interest and leases in which we are the operator. Interests owned by participation leases means we have a working or royalty interest in a property that is operated or maintained by another interest owner under an agreement. Overriding royalty interest means we assisted in the negotiations between the buyers and sellers of lease sales which we retained an royalty interest, receive a finder’s fee, and are provided options for additional participation of future wells. For participation leases, we receive payments for our oil sales from the operator and we are billed by the operator for a percentage of joint expenses relative to the costs of drilling and transporting the oil from the wells to the sales point.

For drilling operations on leases in which we are the operator, we hire third parties to provide contract drilling services to us on an as needed basis. We have been able to reduce or eliminate our financial exposure in the initial drilling in our projects by creating joint venture arrangements that provide for others to pay for all or a disproportionate share of the initial drilling costs in exchange for a working or royalty interest in the well. We had sold working interests in 10 of our wells ranging from 30% to 50% per well through 2010, and respectively, in 2011, we had sold working interests in 5 of our wells ranging from 20% to 35% per well. For each sale, we are responsible for completion and operating costs on those wells ranging from 25% to 58% per well. This has allowed us to move forward in drilling a greater number of wells than we would otherwise able to drill based upon our limited financial resources. We expect to continue to use these types of relationships to partially or completely fund initial drilling of future wells.

Reserves

We own approximately 1,439.42 gross acres of leasehold interests with 40 producing oil wells in which we own an interest. Wells drilled in this area range from 900 feet to 2,000 feet in depth and the well spacing is generally four acres per well. The following table provides information on our reserves at December 31, 2011 and 2010.

   
Estimated Remaining Reserves at December 31,
 
   
2011
   
2010
 
   
Gross
   
Net
   
Future Net Revenue
   
Gross
   
Net
   
Future Net Reserves
 
Reserve Classification
 
Oil
(Bbls)
   
Oil
(Bbls)
   
Total
($)
   
Discount @ 10% ($)
   
Oil
(Bbls)
   
Oil
(Bbls)
   
Total
($)
   
Discount @ 10% ($)
 
Proved Developed
                                               
Producing
   
43,892
     
9,544
     
348,910
     
335,433
     
80,970
     
24,271
     
1,261,217
     
933,295
 
Non-producing
   
29,516
     
4,939
     
286,216
     
216,497
     
32,509
     
17,963
     
1,174,758
     
770,643
 
Sub-total
   
73,408
     
14,483
     
635,126
     
551,930
     
113,479
     
42,234
     
2,435,976
     
1,703,938
 
                                                                 
Proved Undeveloped
   
42,171
     
2,109
     
169,984
     
29,941
     
55,959
     
29,378
     
1,845,540
     
1,192,126
 
                                                                 
Total Proved
   
115,579
     
16,592
     
805,110
     
681,871
     
169,438
     
71,612
     
4,281,516
     
2,896,064
 
                                                                 
Probable
   
43,985
     
2,200
     
177,183
     
133,771
     
57,062
     
30,344
     
1,851,527
     
1,167,054
 
                                                                 
Possible
   
37,512
     
5,479
     
218,952
     
146,082
     
45,216
     
24,720
     
1,300,819
     
815,528
 
                                                                 
Total All Reserves
   
197,076
     
24,271
     
1,201,245
     
961,724
     
271,716
     
126,676
     
7,433,862
     
4,878,646
 
 
 
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When used in this table, “Bbls” means barrels of oil. We also use a number of terms when describing our reserves. “Proved reserves” are the quantities of oil that, by analysis of geosciences and engineering data, can be estimated with reasonable certainty to be economically producible. We provide information on two types of proved reserves - developed and undeveloped. “Proved developed reserves” are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods and “proved undeveloped reserves” are reasonably certain reserves in drilling units immediately adjacent to the drilling unit containing a producing well as well as areas beyond one offsetting drilling unit from a producing well.

Under recent SEC rules we are now also permitted to provide information about probable and possible reserves. “Probable reserves” are additional reserves that are less certain to be recovered than proved reserves but which, in sum with proved reserves, are as likely as not to be recovered. “Possible reserves” are additional reserves that are less certain to be recovered than probable reserves. The various reserve categories have different risks associated with them. Proved reserves are more likely to be produced than probable reserves and probable reserves are more likely to be produced than possible reserves. Because of these risks, the different reserve categories should not be considered to be directly additive.

Our reserve estimates at December 31, 2011 were prepared by Lee Keeling and Associates, Inc., an independent engineering firm. These reserve report which is filed as an exhibit to this report was prepared in accordance with the generally accepted petroleum engineering and evaluation principles and most recent definitions and guidelines established by the SEC. All reserve definitions comply with the applicable definitions of the rules of the SEC. The reserves were estimated using engineering and geological methods widely accepted in our industry. The accuracy of the reserve estimates is dependent upon the quality of available data and upon independent geological and engineering interpretation of that data. For proved developed producing, the estimates considered to be definitive, using performance methods that utilize extrapolations of various historical data including oil and water production and pressure history. For other than proved producing, proved undeveloped reserves and probable and possible reserve estimates were made using volumetric methods.

Our policies regarding internal controls over reserve estimates require reserves to be in compliance with the SEC definitions and guidance and for reserves to be prepared by an independent engineering firm under the supervision of our Chief Executive Officer. We provide the engineering firm with estimate preparation material such as property interests, production, current operation costs, current production prices and other information. This information is reviewed by our Chief Executive Officer to ensure accuracy and completeness of the data prior to submission to our third party engineering firm. A letter which identifies the professional qualifications of the independent engineering firm who prepared the reserve report is included in the reserve report. There was no conversion of undeveloped reserves to prove reserves during 2011. During 2011 we spent approximately $227,180 on converting proved undeveloped reserves to prove developed reserves.

The engineering report also projected discounted future net revenues (DFNR) from our net reserves and the present value, discounted at 10% per annum, of that future net revenue as summarized in the following table. Future net revenue is the amount, exclusive of federal and state income taxes, that will accrue to the subject interests for continued operation of the properties to depletion. It should not be construed as a fair market or trading value. Provisions have been made for future expenses required for recompletion and drilling, but no provision has been made for the cost of plugging and abandoning the properties. The pricing used was based on a determination of a 12-month average price, calculated as the unweighted average price of the monthly prices received by us for oil for the 12-month period prior to the end of the reporting period.

The following table presents our producing oil wells at December 31, 2011.

Producing Wells
 
Gross (a)
   
40
 
Net (b)
   
12.312
 

(a) The number of gross wells is the total number of wells in which a working interest is owned.

(b) The number of net wells is the sum of fractional working interests we own in gross wells expressed as whole numbers and fractions thereof.

Certain of the leasehold interests we own are subject to royalty, overriding royalty and other outstanding interests customary to the industry. The properties may also be subject to additional burdens, liens or encumbrances customary to the industry, including items such as operating agreements, current taxes, development obligations under natural gas and oil leases, farm-out agreements and other restrictions. We do not believe that any of these burdens will materially interfere with the use of the properties. The following table presents leased acres as of December 31, 2011.

 
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Gross
   
Net
 
Developed acres
   
304.00
     
85.15
 
Undeveloped acres
   
1,135.42
     
287.92
 
Total acreage
   
1,439.42
     
373.13
 
 
At December 31, 2011 there were 1,135.42 of gross acres of undeveloped acres and 287.92 acres of net undeveloped acres that we control under fee leases. The following table presents the net undeveloped acres that we control under fee leases and the period the leases are scheduled to expire, absent pre-expiration drilling and production which extends the term of the lease(s). The expiration dates of the leases are subject to automatic renewals so long as we are producing oil and/or gas on the lease.

   
Net Undeveloped Acres
 
Lease
 
Year of Expiration
 
Total Acres
 
Dishman Lease, Overton County, TN
 
Automatic Renewal
   
5.69
 
Anderson, Charles Lease, Overton County, TN
 
Automatic Renewal
   
7.8
 
Clark Lease, Green County, KY
 
Automatic Renewal
   
156.89
 
Bradley Lease, Green County, KY
 
Automatic Renewal
   
8.936
 
Anderson, Todd Lease, Clinton County, KY
 
Automatic Renewal
   
35.37
 
McClellan Lease, Clinton County, KY
 
Automatic Renewal
   
6.13
 
Chamber  Lease, Clinton County, KY
 
Automatic Renewal
   
13.8
 
Nadeau  Lease, Green County, KY
 
Automatic Renewal
   
53.37
 
 
The following table presents our development and exploratory drilling activities during the past three years. Because we did not commence operations until the fourth quarter of 2009, we did not undertake any drilling activities in 2008. There is no correlation between the number of productive wells completed during any period and the aggregate reserves to those wells. Productive wells consist of producing wells capable of commercial production.

   
Drilling Activities
 
   
2011
   
2010
   
2009
 
   
Gross
   
Net
   
Gross
   
Net
   
Gross
   
Net
 
Development:
                                   
Producing
    22       10.21       18       6.038       1       .375  
Non-Producing
    13       7.64       12       4.038       2       .750  
Injection
    0       0       0       0       0       0  
Dry
    5       3.08       7       2.025       0       0  
Total development
    40       20.93       37       12.10       3       1.125  
                                                 
Exploratory:
                                               
Productive
    0       0       0       0       0       0  
Dry
    0       0       0       0       0       0  
Pending determination
    0       0       0       0       0       0  
                                                 
Total drilling activity
    40       20.93       37       12.10       3       1.125  
 
As of the date of this report, we are continuing drilling activities on our leasehold interests in an effort to further expand our producing wells.

 
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Customers, Sales and Delivery

We store extracted oil in on-site bulk storage tanks awaiting delivery to our customers. Our customers pay all costs associated with transporting the oil from these storage tanks. In each of 2011 and 2010 we had two customers who represented 100% of our oil sales. Because there are other purchasers that are capable of and willing to purchase our oil, and because we have the option to change purchasers if conditions so warrant, we believe that our oil production can be sold in the market in the event that it is not sold to our existing customers.

The following table presents information regarding production volumes and revenues, average sales prices and costs, after deducting royalties and interests of others, with respect to oil production attributable to our interest for the last three years. In the following table, average production cost are costs incurred to operate and maintain the wells and equipment and to pay the production costs, which does not include ad valoreum and severance taxes per unit of production, and is exclusive of work-over costs.
 
   
Year Ended December 31,
 
Oil production (Bbls)
 
2011
   
2010
   
2009
 
Production
    18,145.26       24,861.69       1,151  
Average sales price
    90.04       75.9625       68.00  
Average production cost
    5.00       4.00       6.00  
 
Competition

We compete with major integrated oil and natural gas companies and independent oil and gas companies. Most of our competitors have substantially larger financial resources, operations, staffs and facilities and our competitors may be able to pay more for prospective oil and gas properties or prospects and to evaluate, bid for and purchase a greater number of properties and prospects than our financial or human resources permit. Given our size, limited operating history and limited financial resources there are no assurances we will ever be able to effectively compete in our segment.

Government Regulation

We are subject to numerous federal, provincial, state, local and foreign country laws and regulations relating to discharge of materials into, and protection of, the environment. These laws and regulations may, among other things, impose liability on the lessee under an oil lease for the cost of pollution clean-up resulting from operations, subject the lessee to liability for pollution damages and require suspension or cessation of operations in affected areas. Although environmental requirements have a substantial impact upon the energy industry, as a whole, we do not believe that these requirements affect us differently, to any material degree, than other companies in our industry. All of the jurisdictions in which we operate have statutory provisions regulating the exploration for and production of crude oil. These provisions include permitting regulations regarding the drilling of wells, maintaining bonding requirements to drill or operate wells, locating wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled and the plugging and abandoning of wells. We have made and will continue to make expenditures in our efforts to comply with these requirements, which we believe are necessary business costs in the oil industry.

Changes to existing, or additions of, laws, regulations, enforcement policies or requirements in one or more of the countries or regions in which we operate could require us to make additional capital expenditures. While the events in the U.S. Gulf of Mexico in 2010 resulted in the enactment of, and may result in the enactment of additional, laws or requirements regulating the discharge of materials into the environment, we do not believe that any such regulations or laws enacted or adopted as of this date will have a material adverse impact on our cost of operations.

Employees

As of March 31, 2012, we had one full time employee, Mr. Page, our Chief Executive Officer and one part time employee.

Our History

We were incorporated in Delaware on May 17, 1994 as CD Kidz Inc. On March 20, 1995, our name was changed to Wanderlust Interactive, Inc. In March 1996, we completed an initial public offering of our securities and the net proceeds were used principally to establish our New York headquarters and to produce two CD-ROM games based upon the Pink Panther character, which games were completed in September 1996 and September 1997, respectively. We initially marketed such games through distributors in the United States and licensed such games for distribution by others both in the United States and in over fifteen foreign countries.
 
 
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In February 1997, we acquired all of the outstanding stock of Western Technologies, Inc. as well as certain assets and liabilities of Smith Engineering, a sole proprietorship, from Jay Smith III, our then President, Chief Executive Officer and Treasurer. Western Technologies designed and developed video and computer games and electronic toys and electronic consumer products, mostly pursuant to funded contracts with other name brand manufacturers. The agreement provided for the sale of 100% of the outstanding shares of stock of Western Technologies and certain assets and certain liabilities of Smith Engineering in exchange for 266,667 shares of our common stock. The cost of the acquired enterprise was $5,082,000. We assigned value of $15 per share to the shares issued and assumed liabilities in excess of assets which amounted to $1,082,000. As part of the acquisition, a license agreement was entered into between Western Technologies and Mr. Smith in which Mr. Smith granted to Western Technologies the exclusive right to use and market patents and license agreements owned by Mr. Smith.

After expending most of the funds raised in our initial public offering to produce the two Pink Panther CD-ROM games during 1996 and 1997, we realized that the development costs of such CD-ROM games greatly exceeded both the short-term and long-term anticipated revenue streams from such products and shifted our focus to pre-funded or contract design and development work, such as that historically conducted by Western Technologies. In September 1997, we substantially downsized our New York office and shifted our headquarters to Western Technologies’ offices located in Los Angeles. In April 1998, we closed our New York office permanently and consolidated our entire staff in our remaining Los Angeles office and production space.

On May 14, 1998, our name was further changed to Adrenalin Interactive, Inc. In December 1999, we completed a reverse merger with McGlen Micro, Inc., in which the stockholders of McGlen Micro, Inc. acquired control of us. As a result of the acquisition, each share of McGlen Micro, Inc. was converted into 0.0988961 shares of our common stock, with 2,548,553 shares being issued. On December 17, 1999, we changed our name to McGlen Internet Group, Inc. and on March 15, 2002, we changed our name to Northgate Innovations, Inc.

On March 20, 2002, we completed a reverse acquisition with Lan Plus Corporation in which the stockholders of Lan Plus acquired control of our company. As a result of the acquisition, each share of Lan Plus was converted into approximately 3.128 shares of our common stock, with approximately 14,113,000 shares being issued. In addition, immediately prior to the close of the merger, we instituted a 10:1 reverse stock split and the our accounts payable to, and advances from Lan Plus, in the amount of approximately $2.3 million were converted to common stock eliminating the debt; the stock was then retired to treasury and cancelled. Lan Plus was a manufacturer of branded turnkey computer products and services. Under our Northgate(R) brand name we developed, manufactured, marketed, and sold a wide range of desktop systems, notebook computers, workstations and network servers, as well as offering a variety of hardware components and peripherals to complement our desktop systems, notebook computers, and network servers.

In December 2003, an investor group acquired a majority of our outstanding common stock and in early 2004 this investor group brought in a new management team and implemented a new business strategy. As part of this new business strategy, in June 2004, we changed our name from Northgate Innovations, Inc. to Digital Lifestyles Group, Inc. Beginning in late 2004, we deemphasized the sale of our Northgate(R) brand products to focus our resources solely on the development, marketing and sale of a new product line, branded hip-e, which featured desktop computers, notebook computers and peripherals and was designed and targeted to the teen market.

In April 2005, we received notice from Microsoft Corporation that it had terminated our license to use its proprietary Windows(R) operating system due to our failure to make required royalty payments. Due to the loss of the license, we were unable to ship our products, the majority of which use Microsoft’s proprietary Windows(R) operating system and as a result we were unable to fulfill any orders for our hip-e brand desktop computers. As we lacked sufficient funds required to renew our license with Microsoft and were unable to distribute or sell our products, our management team decided to cease all operations other than to liquidate our assets for the benefit of a secured creditor.

On October 9, 2009 we changed our name to TN-K Energy Group Inc. to better reflect our current operations.
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